### Grant McDermott

Assistant Professor
Dept. of Economics
University of Oregon

# Water pricing in different sectors

My previous post linked to a new alarming/alarmist (potato, potahto) study of South Africa’s water pollution problems. I mentioned some economic elements that I feel need addressing if we’re ever going to provide the right set of incentives to ensure sustainable water use.

What I didn’t really discuss was the fact that water has a multitude of different uses, which can make valuation very hard. With regards to pricing structures, can you apply the same set of rules to all different users (residential vs agricultural vs industrial)? I can see more than a few practical problems, but there are certainly those who believe that we can and should do so. Prolific water blogger $$–$$ and recent addition to the job market! – David Zetland has long advocated a system of “all-in auctions”. In other words, very low prices for water aimed at meeting basic human needs, after which all comers are subject to compete against each other on price bids.

Having been raised in agricultural country, I can think of of a number of farmers that aren't going to be too happy with this type of proposal. However, that's a practical obstacle that can be overcome $$-$$ largely through greater dialogue and explanation of the actual procedures. Further to the point, a large number of farmers already control their own water sources in the form of small dams and so forth; you've obviously no need to submit to an auction if you already own the resource. In a similar vein, in instances where a bunch of farms are located along a river, the bidding could first be among that group of farmers. In cases where rivers flow to cities or industrial areas, up stream farmers could potentially make money by auctioning off "usage rights" to urban and industrial consumers.

On the subject of water usage by different consumers and sectors, I posted some relevant comments a while ago on a blog run by some Austrian friends (ideologically speaking that is, not geographically). With minor edits for style and following a discussion on the urgent need for a hike in (residential) water prices in SA:
One of the better articles on environmental issues published on this site. (Some of your climate and pollution arguments have been rather lacking in my opinion…) [Ed: For instance.]

Anyway, I certainly agree that water will be a defining issue for South Africa long before other crises and our current pricing structure is woefully inadequate. (As with many countries, the focus is on recuperating short-run average/operating costs instead of the economically sensible long-run marginal costs. While SRAC could be considered as constant, LRMC are typically increasing over time, so prices lie below their optimal value…)

However, the article does skirt around perhaps the most tricky issue with regards to water: There are MANY different uses for water and thus many different marginal values. Residential water consumption is fairly minute in comparison to agriculture and, to a lesser degree, industry. Thus $$–$$ and although it may not agree with your definition of inflation (i.e. an expansion of money supply) $$–$$ correct marginal pricing of water will certainly bring about an increase in general prices. Why? Water is a crucial factor of production for virtually everything we consume. Thus, an increase in price will carry through to all final products.

Not easy for society, but that is simply the bitter pill we need to swallow in order to establish sustainable use of what is perhaps our most valuable commodity.

After a fairly odd reply regarding my understanding inflation $$-$$ like all proud Austrians, they love to focus on inflation as a definitional good $$-$$ I ended an additional comment with:
[A]n increase in water prices will have much further implications than simply raised costs of showering or watering our gardens; it will affect prices for an entire host of economic goods.