Urban water pricing

Today I have been at the Wodonga campus of La Trobe University attending an interesting workshop on urban water pricing.

John Quiggin introduced the major ideas of the workshop with an interesting paper presented by teleconferencing from the University of Queensland. The actual teleconferencing worked quite well from our perspective though John could not see us. He looks very different without his trademark beard!

John noted the role of increasing population and what seems to be a longer-term trend of reduced flows into the water catchments of Australia’s major cities in creating an urban water problem. His general perspective is that in the short-run restrictions on water use have strong effects but price changes affect mainly incomes not demand. Longer-term restrictions wear out in usefulness but price changes have a more substantial effect. Hence use restrictions for short-term water supply issues but longer-term rely on price. Using restrictions to address long-term water shortages also reduces the availability of a key policy instrument for addressing short-term crises.

He argued that everyone agrees that prices must rise. The limit to price rises is the backstop cost of recycling water or the use of desalination technology which John valued at about $1-50 per kilolitre. This backstop cost can be much lower if rural water users can sell their water to urban users as they potentially can in, for example, Melbourne.

John’s suggested pricing scheme was a two part pricing scheme that would allow families a 50 kiloliter allowance per family member free coupled with marginal cost pricing at around $1-50 per kilolitre beyond that. This is a demogrant proposal – a lump sum grant made to families on the basis of some demographic characteristic – in this case just the number of family members. The idea is that most people will consumer in excess of 50 kilolitres per year so most families will pay the long-run marginal cost of water use boosted to account for the cost of the free allowance – so the scheme will be self-funding.

The idea is to move to offset the regressive effects of a move toward efficient pricing. The idea is to make the free allowance large enough to give families relief but low enough so households face marginal cost.

Alastair Watson followed with a discussion of the role of pricing concessions in water pricing – around 35% of households receive concessions which seems extraordinarily high. He also argued that the effects of concessions and free allowances will be swamped in Victoria by forthcoming price increases that stem from the flawed move to rely on a costly desalination plant and by the ideological opposition to new dam projects and to trading rural water supplies. The overriding principle should be that water should be supplied from the cheapest source.

This was followed by interesting papers by Geoff Edwards on efficiency issues , by Bethany Cooper who is studying the way water restrictions operate in NSW and Victoria and by conference organisers Sue O’Keefe and Lin Crase on how the demogrant proposal of John’s works out in a sample of Victorian households – it does indeed provide improved equity outcomes.

In a closing discussion attention turned to the case for a uniform price versus a IBT tariff (increasing block tariff) with almost all the economists favouring the uniform charge and some from the water utilities promoting the IBT as a means of encouraging conservation. The economics of this are simple – a uniform price makes sense because one wishes to equate the marginal cost of water use across users to achieve economic efficiency.

The demogrant proposal was criticised more strongly on the grounds that it seemed to be largely a cosmetic proposal designed to facilitate the achievement of uniform pricing rather than the IBT. In terms of addressing social welfare and poverty issues the value of the grant for a family of 4 with a price of water set at $1-50 per kilolitre is $300 or about $1 per day. This would have at best a very marginal effect on distribution. Generally there was opposition towards seeking distributive justice by tinkering with the pricing of goods that did not play a significant part in household budgets. The general tax-transfer mechanism would seem a better way of doing this.

There was also questioning of the implementation costs of the demogrant proposal in terms of the costs of identifying family size. If the redistributive benefits are very small then these might be swamped by transaction costs. It might be better to just go for aq stark uniform charge that was contingent on the current supply situation.

A well-organised workshop.