The Economics of Wiser Water Use: Making the most from the quintessential resource

http://www.europeanfinancialreview.com/?p=5332

June 19th, 2012

Water is essential to nearly every economic activity and all ecological systems. It underpins a range of economic activities including farming, energy and industry. The water challenge encompasses a range of issues from both the demand and supply sides. Supply can refer to a quantity of water (volume) or a quantity of water at a sufficient quality level to enable a particular use. Insufficient supply, unreliable supply or mismanagement of existing supply are constraints on users. The rationale for water economics is not just wasteful water use, but more importantly how to address scarcity (quality and quantity) and the range of values of water. Applying smarter water economics can help manage the situation and enable actors to use water efficiently, protect it more vigorously and allocate it wisely.

A growing water gap

Water resources are both renewable and finite. Despite the presence of unexploited resources, such as deep groundwater resources, in many places there will be fairly limited options for increasing supply. As more accessible water resources are already being abstracted and with the increasing trend of energy prices, the costs of developing new water resource supply systems are expected to rise. The constraints are worsened by the degradation of ecosystems and declining water quality, which further reduce the availability of water for particular uses. As demand for water increases and availability remains ultimately limited, water scarcity emerges in more regions around the globe.

“Water economics seeks to apply economic principles and tools to address the growing gap between the supply and demand of water in order to pursue a more equitable and efficient use and allocation of water.”

A number of factors are set to escalate global water demand. Global population, which currently stands at seven billion people, is still growing at a high rate: an estimated one billion of additional population will be reached in merely 12 years. Population growth will exert some pressures toward higher economic growth that enables the provision of employment to the growing population. Even for those countries with matured population growth, the needs for better living standards and quality of life will require economic development. As water use is highly influenced by temperature, a warming planet will most likely intensify water demand, both for human and ecosystem services on which human activities rely.

Putting a value on water

Water economics seeks to apply economic principles and tools to address the growing gap between the supply and demand of water in order to pursue a more equitable and efficient use and allocation of water. It underpins investment in water management by demonstrating the tradeoffs and opportunity costs for different uses of water, and how the costs and benefits will be distributed across different groups in society. This in turn can lead to optimised strategies to enable the highest returns on water use. It also allows for strategic long term planning. In North America’s Rio Grande Basin, for example, a comprehensive study evaluated water use and allocation trajectories over time, and concluded that ensuring the sustainability of water stocks over the next 20 years would cost 6-11 percent of the total annual economic value provided by the basin. This knowledge allows decision makers to create policies that are informed by a stronger sense of the expected costs and benefits of conserving water.

“Economics facilitate a better understanding of water scarcity, its values, and the tradeoffs associated to different uses of water and management options. This understanding is important in finding efforts to reach a more equitable distribution of costs and benefits.”

Economic analysis also enables cost effective investments to keep water clean, and value the health benefits of cleaner water. For example, when Sweden decided to phase out the use and emissions of mercury, it first conducted extensive studies to estimate the costs of the health risks posed and the losses the nation would face by reducing the use of mercury in its different forms, such as dental amalgam. The costs of the health risks posed were greater than the expected losses, enabling a rational policy decision and phasing out of the use and emissions of the substance.

Overcoming obstacles to optimal management

Due to the existence of numerous socially constructed barriers, the true values of water are still not reflected in all water-related decision-making. Economics facilitate a better understanding of water scarcity, its values, and the tradeoffs associated to different uses of water and management options. This understanding is important in finding efforts to reach a more equitable distribution of costs and benefits. Overcoming those barriers will allow for the rationalization of use, align incentives and accommodate additional productive uses of water, thereby increasing overall welfare from the same volume of water.

“Water managers must become better at taking into account economic principles, including expressing water use in economic terms.ˮ

To achieve this, water managers must become better at taking into account economic principles, including expressing water use in economic terms, through the investigation of efficiency, effectiveness, equity, preference, risk and behavioral dimensions to managing the resource. This is an essential first step towards the creation of a common language between water science and policy, which is needed for constructive debate of water policy choices where the most economically efficient ways to manage water and reduce its waste can be clearly presented and understood by decision-makers.

While the challenges and pressures of water demand mount, recent advancements provide tools and technologies that can enable us to address them. Hydro-economic modeling is one tool that has improved our ability to conceptualise and test the hydrologic and economic impacts of potential development investments and to pinpoint times and places where water can be transferred to higher valued uses. Compensation mechanisms, payment for ecosystem services, water quality trading and the use and reform of taxes and subsidies are some other examples of economic instruments that can be used to achieve higher efficiency and equity in water management.

A wise investment

The growing demand for water and constraints in water availability pose substantial challenges to governments and companies for sustaining economic growth and insulating against risks. Mismanagement of water can constrain growth in countries, communities and companies alike. Smart managers must understand the tradeoffs between different uses of water, especially in places where supply is scarce and demand is high. They must also grapple with moving targets, as human and environment needs for water evolve over time and space, as does the availability of water. Decision makers from governments and businesses can benefit greatly by understanding how economic tools, incentives and approaches can facilitate the optimization of efficiency, equity and generated values from the use of water resources. Finding a good water economist may be the shrewdest move they can make to safeguard their future growth.

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