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YOU DECIDE: Can economics help us conserve water?

November 09, 2007

MEDIA CONTACT: Dr. Mike Walden, 919.515.4671 or michael_walden@ncsu.edu

Dr. Mike Walden
Media representatives: For a black-and-white or color copy of this photo, call 919.513.3127 or e-mail dave_caldwell@ncsu.edu.

Although recent rains have helped, North Carolina is still suffering from the worst drought in 100 years. Many municipalities are counting the days until reservoirs are empty, and rural water users worry their wells will run dry.

Governments have responded to the crisis in two ways. They have called on households and businesses to voluntarily conserve water. And, they have imposed restrictions on the use of water, particularly for outside irrigation.

However, water restrictions require rules about who can use water, when they can use it, and what they can use water for. Inevitably, questions are raised about the fairness and implications of such rules. As the restrictions are tightened, the questions become more intense.

Furthermore, to be effective, regulations about water use must be enforced, so governments must spend resources on policing the rules or rely on residents to report violators.

Economists argue there is another approach to managing water availability during droughts, and it's based on the fundamental economic principle of incentives. Simply put, the easiest way to motivate people to do something is to give them a financial motivation to do it on their own. This means appealing to their wallet or pocketbook.

Therefore, economists say, if we want people to use water more frugally, the quickest and most direct way to do so is to increase the price of water. The core economic principle of "demand" says the higher the price of a product, the less people will use. It doesn't matter if the product is a truck, hamburger or drinkable water. Indeed, studies show that every 10 percent increase in the price of water decreases water use by about 3 percent.

Recently, two of my colleagues, Roger von Haefen and Robert Fearn, have proposed incentives-based water usage plans. One plan is tier-based water pricing. Here, the price of water rises as water usage rises. For example, consumers would pay the lowest rate for the first "x" gallons used per month, then would pay a higher rate for the next "y" gallons used, and a still higher rate would be paid for the next "z" gallons used. Water authorities could implement as many tiers as desired.

The purpose of tier-based water pricing is to charge the lowest price for the most essential uses of water, such as for cleaning and bathing, and then charge higher rates for less important uses, such as grass watering and filling swimming pools. As a result, consumers will be motivated to cut back on less essential - and now more expensive - water uses.

The second approach - the Fearn plan - would explicitly add a "drought fee" to the price of water whenever water supplies fall below acceptable levels. The purpose of the fee would be twofold. First, it would prompt people and businesses to use less water. But second, the additional revenues from the fee would be used to finance the installation of water-saving technology in homes and firms and to expand future water supplies.

Importantly, the level of the drought fee could be changed as water conditions change. If the drought worsened and more water conservation was needed, the fee could be increased. However, once the drought ended, the fee would be removed.

Some water systems already use the tiered pricing system, but to my knowledge, no system applies the drought fee concept. One reason may be that not everyone is convinced the economic approach to managing droughts makes sense. Higher prices are seen as painful, particularly for a necessity like water. Instead, managing water supplies through appeals to conservation and with government rationing plans is often viewed as more logical and fair.

The skepticism to the economic reliance on prices to change water consumption is understandable, but economists do have a response. The price of any resource reflects both the relative value of that resource and its scarcity. That is, price is a signal. When the price rises, it tells the user the resource has become more limited, and consequently, remaining amounts of the resource are more valuable. Users are therefore prompted to treat the available quantity more carefully. And, isn't this exactly what we want consumers to do when there's a shortage of water?

Economists think so. But, you decide!

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Dr. Mike Walden is a William Neal Reynolds Professor and North Carolina Cooperative Extension economist in the Department of Agricultural and Resource Economics of N.C. State University's College of Agriculture and Life Sciences. He teaches and writes on personal finance, economic outlook and public policy. The Department of Communication Services provides his You Decide column every two weeks. Earlier You Decide columns are at http://www.cals.ncsu.edu/agcomm/writing/walden/decide.htm

Related audio files are at http://www.ces.ncsu.edu/depts/agcomm/writing/walden/index.html

Posted by Dave at November 9, 2007 01:55 PM