Thursday, March 5, 2009

Water pricing: insights from Harvard

It has been argued on this blog ("Should water be priced according to its market value?", "On the municipal price of water") that water pricing is an important policy instrument to manage water scarcity and risks.

A recent blogpost (As reservoirs fall, prices should rise) from Prof. Robert Stavins, environmental economist at Harvard University again states this clearly in the US context:

Throughout the United States, water is under-priced.  Efficient use of water will take place only when the price reflects the actual additional cost of making that water available.  Lest one fear that higher water rates would mean that Americans would go thirsty, take note:  On average, each of us uses 183 gallons of water a day for drinking, cooking, washing, flushing, cleaning, and watering, but less than 5% of that is for drinking and cooking combined.  There is plenty of margin for change if people are given the right price signals.

Fifty years of economic analyses have demonstrated that water demand is responsive to price changes, both in the short term, as individuals and firms respond by making do with less, and in the long term, as they adopt more efficient devices in the home and workplace.  For example, when Boulder, Colorado moved from unmetered to metered systems, water use dropped by 40% on a sustained basis.

But prices are typically set well below the social costs of the water supplies, since historical average costs are employed, rather than true additional (marginal) costs of new supplies.  Although water scarcity typically develops gradually across seasons of low rainfall and low accumulations of snow pack, pronounced droughts are usually felt in the summer months of greatest demand.  The economically sensible approach is to charge more at these times, but such “seasonal pricing” is practiced by less than 2% of utilities across the country.

A reasonable objection to jacking up the price of water is that it would hurt the poor.  But we can take a page from the play book of electric utilities who subsidize the first kilowatt-hours of electricity use with very low “life-line rates.”  Indeed, the first increment of water use can be made available free of charge.  What matters is that the right incentives are provided for higher levels of usage.

No comments: