The economics of water supply

Let’s now look at the most abundant chemical on the planet: water, and its inequity. Compared with someone in certain Third World countries, where every drop counts, if you live in a developed nation like the UK, you probably don’t even give it a moment’s thought when you turn the shower on, fill the bath or wash the car. As the world population rises further though, and climate change limits where we can live and how much water is available, the price and value of water will matter increasingly to all of us, regardless of where we live. And that means that we need to think about the economics of what will become a supply-limited resource. Which is what Quentin Grafton, speaking with Chris Smith, has been considering, by asking 5 key questions: why water is, or is not, priced and valued; what are the key economic concepts behind pricing water; how are water supply assets valued for full cost recovery, who bears these costs versus who enjoys the benefits, and when will the price of water change…

Quentin - We need to price water, because if it's not priced, there's the tendency to not conserve it, not look after it, use too much. And that's true, whether it's you're a farmer, whether you're a household or an individual. The value is really around the different uses of water. Whether it's, you know, for drinking - very high value - or whether it's for the garden which is less highly valued. So that we know if we have to prioritise water across different alternative and competing uses, we want to make sure it goes to the highest value possible. In places that don't have much water, which is good part of Australia, the priority always goes to drinking water. And then you set up all your planning, all your water infrastructure to make sure that's where it goes.

Chris - So what are the key concepts that economists should use then when trying to come up with a pricing strategy for water?

Quentin - The issue is really around marginal cost and marginal benefit. Marginal just means some incremental amount of water that's delivered to me as a farmer, to a household. And the cost is, well, how much did we spend and expend to actually get that delivery? So that's marginal cost. And the other concept is this idea of marginal benefit, which is really about what extra we get from consuming water - marginal benefit and marginal cost - whilst making sure that the essential uses for water are available to everybody.

Chris - So how should it be priced then? Because also it's going to really vary according to where you live on earth. Whether you have a too much water problem or a too little water problem, or no money in your, in your pocket, some money in your pocket.

Quentin - I have lived in a number of cities around the world. So one is Wellington New Zealand. Now there in those in the city of Wellington, you don't pay a volumetric price for water. So what that means is that a lot of people will waste water and also the suppliers of water in Wellington don't have the incentive to deal with water that gets lost in the pipes, that doesn't actually get to the households. Compared to where I live in can Australia, we pay very high volumetric prices in Canberra and that ensures that we have the right signals to look after the water in the sense that we are not going to waste the water.

Chris - How does that though incentivise the people who are delivering you the water to make sure their pipes aren't leaky? Because I saw a staggering statistic for UK water supplies recently, which suggested that the amount that actually comes out of a tap somewhere is only a fraction of the amount that went in. It's not like losses are a little bit on top. It's like there are losses with a little bit of delivery on top.

Quentin - A part of the problem is if you're not being paid as the supplier per amount of water of litre that you're selling, so to speak, the incentive to do something about, it's just not there. Compare that to Canberra. If you are getting paid per litre, the water supplier in that context has every incentive to deal with those leaks and leaky pipes because they're gonna get much higher revenue if they actually deal with 'em.

Chris - Ultimately, it comes down to the who though, doesn't it? Which is one of your other questions. Who is, is benefiting or, or needing the water? And there's the staggering statistic in your review that half the world population are in water crisis at least once a year for a month or so. So how do we sort this one out given where people are, the massive scale we're dealing with and the unpredictability with climate change and other things in the source of geographies that we're gonna have to consider?

Quentin - Well, it's a water supply issue in some sense. The water is, needs to be accessible and an affordable price, and that's an infrastructure story. But that story is also not just about pipes, it's also about protecting wetlands. It's about protecting upper catchments, you know, with forest. So you actually maintain quality water in terms of not having sediment in it, for example. And then you also have this whole issue around making sure that yes water's affordable, yes, that it's safe, but also, that the costs are covered. So we need to deal with that. And that is around pricing, but it's also around water values as well, key values. And the highest value is really drinking water and not just for people living in, in big cities, but also people on the fringes of the urban areas and also people in rural areas. That's the missing dimension to it.

Chris - So is your approach here that when a country is looking to try to improve its water situation, they should be thinking about these economic principles and then there's a sort of a framework for them to follow, which hitherto has been very ad hoc geographically.

Quentin - Exactly right. So I mean, if I were to say there, you know, the four pillars really in terms of how we should respond to the water prices in the context of water pricing and values, you know, we need, we need to get cost recovery because the person supply need to get their cost covered, otherwise they're not gonna supply. So that the price that people are paying, it's transparent and it also covers that, that extra cost to bring it into your household or to your farm. Basic water needs need to be met. And then the last but not least is consumers need to be incentivised and that's where water prices come in. So they incentivise to conserve water, not to waste water, not to over-extract water. Those are the things that pricing can do that can be done and has been done in both rich and poor countries. So we can do this. It's something that we can fix certainly with an urban context and anywhere in the world it becomes more challenging in rural areas 'cause it's much, much more difficult to just supply accessible safe water in the whole parts of the world. In remote communities, for example.