Thursday, April 20, 2006

Urban water

In a moment of idleness I analysed my water bill on this blog and decided that, with current pricing rules in place, I had low incentives to change my household's relatively high usage. John Quiggin in today's Australian Financial Review (subscription required) nicely analyses the case for using price rather than quantity restrictions to manage urban water use in Australia. This is topical as the Victorian Government announced today scaled up fines for using water 'wastefully' and a program of moral exhortation to cut Melbourne's water consumption by 30%.

In resource economics quantity restrictions are often advocated for dealing with short-term emergencies while pricing is often seen as a more efficient way of managing use longer-term. This is John's approach and I agree 100%. Particularly if price increases rise steeply enough with increasing household usage. The failure to impose a steep gradient on prices in Melbourne is the reason that, as discussed above, I am rather slack in limiting my family's water use.

John's argument too, is that using price to balance supply and demand in the longer-term leaves open the option to use quantity restrictions to deal with short-term issues shocks such as droughts. Otherwise draconian restrictions or price increases are needed during shocks which hurts all. Moreover, attaching a price to water encourages appropriate cost-efficient investments in water conservation in urban and rural sectors. Currently, driven by quantitative restrictions, excessively expensive conservation investments are occurring in urban areas when cheaper conservation measures could be initiated in the country.

John's aricle is posted at the new RSMG blogsite he has set up.


russ said...

Harry, a couple of quibbles.

First, focusing on rural instead of urban water saving measures only makes sense if you can transfer between the two sectors. You can in most regional areas, but Melbourne's water catchment is almost exclusively urban, and the cost of taking it from others (both economically and politically) is enormous.

Second, droughts aren't really "shocks". They are recurring and persistent events in the weather cycle that we have sufficient storage (in Melbourne anyway) to balance our long-term usage against -- without either draconian prices or restrictions -- provided, as you mentioned to in your previous post, that people get sufficiently large bills when they use significant amounts of water.

One other thing though. If we had significantly higher water prices, the money from which went into consolidated revenue or private companies (the cost of provision hasn't increased after all), then there would be a significant number of people who would prefer periodic (and equitable) restrictions. I'm not one of them, but then, I won't be paying much more for my water.

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hc said...

Russ, They seem good points. I want to get some facts - particularly about the first point and think it through. I'll then respond.

I think JQ is right in saying that market forces should be used to get rid of persistent excess demands and then to use restrictions to deal with unexpectedly large shocks . You might build some reserve to account for periodic droughts into desired steady state storage levels.

On the last point I am mainly interested in the signalling role of prices to ensure efficiency. Transfers don't overly concern me because they can be taxed etc and used to cut other taxes and charges.

hc said...

Russ, I'vre changed my mind on this issue of pricing and conservation. I am very persuaded by Hugh Sibly's piece in Agenda (subscription required) 13, 1, 2006, 17-30 where he argues that efficient pricing is best acghieved by a two part tariff (fixed charge plus variable charge) and that this is better than an IBT (increasing block tariff). The variable charge should reflect current and future availability of water AT EACH LOCATION so obviously if there is no interconnection between urban and rural systems there need be no relation between pricing in the respective systems. Incentives to conserve in each system should be motivated by the respective prices in each area and so are not interdependent as suggested above.

So I agree with your point and also reject my earlier support for IBT. I'll post on this when I get a chance.

I'll post a query on this issue to JQ's site.