Water  scarcity  pricing  in  urban   centres   Chris  White  

 

Australian  National  University,  Australia   January 2012  

Discussion  Paper  1204     This   article   argues   that   water   scarcity   pricing   is   an   efficient   and   equitable   way   of   managing   urban   water   demand   when   accompanied   by   subsidies   that   are   independent  of  water  use.  

of large scale investments in water supply, there is an increasing move away from supply side management of water resources to a demand side focus. This article argues that scarcity based water pricing, combined with

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subsidies that are independent of water use, is an efficient and equitable way of managing urban water demand. Most urban water utilities manage water consumption through non-price instruments such as water restrictions and policies that encourage water efficiency, however, both of

Keywords:  urban  water  pricing;  scarcity  pricing;  urban  water   demand.      

these

With growing pressure on water resources in

First, while water restrictions can be effective

many urban centres, concerns over water

in reducing demand, they have been shown to

security are becoming increasingly important.

cause significant welfare losses because they

In

water

ignore differences in the marginal value of

demand so that water resources are used

water when used for different purposes and

efficiently and sustainably is becoming a key

when used by different users1 (see Welfare

issue in urban water management. Further,

impacts of urban water pricing versus water

due to the economic and environmental costs

rationing).

many

areas,

regulating

urban

methods

can

lead

to

inefficient

outcomes.

Suggested  Citation:  White,  C.  2012,  ‘Water  scarcity  pricing  in  urban  centres’,  GWF  Discussion  Paper  1204,  Global  Water  Forum,  Canberra,   Australia.  Available  online  at:  http://www.globalwaterforum.org/2012/02/06/water-­‐scarcity-­‐pricing-­‐in-­‐urban-­‐centres/  

Water  scarcity  pricing  in  urban  centres     Second, with regards to water efficiency measures, the use of water-saving devices does

not

necessarily

reduce

water

consumption. This is because increasing a device’s water efficiency effectively reduces the unit cost of using it and so can lead to greater use and no overall reduction in water consumption2,3. As a result, subsidising water efficiency measures can be an expensive method that only has a small impact on water

Figure 1. Source: Grafton et al. (2011)

consumption. However, water is not just about efficiency, According to economic theory, the most

and ensuring that low-income households

efficient way to regulate demand is through

have equitable access to water is a key part of

prices; as the price increases, consumers use

urban

less, and demand falls. In a recent survey of

concerns that using water prices to regulate

1,600

countries,

demand may be inequitable because low-

price-based

income households spend a higher proportion

approaches are one of the most efficient

of their income on water so would be

demand2

disproportionately affected by higher water

Grafton

households et

al.

across found

ten

that

methods of managing urban water

(see Managing residential water demand in

water

management.

This

raises

prices.

the OECD) (see Figure 1). An example of the successful use of pricing to regulate water

In order to address these concerns, the impact

demand is Denmark, where continued rises in

of

water prices since 1993 mean they are now the

households can be reduced through measures

highest in the OECD. As a result of the

such as: reduced water access fees for low-

continued price increases, urban water use

income households, water vouchers, or lump

has decreased substantially from 155 to 125

sum transfers. Indeed, a study by Rogers et al.

litres per person per day, one of the lowest

suggests that, if demand based water pricing

levels in the OECD.

schemes are designed well, higher prices can

higher

water

prices

on

low-income

actually improve equity, as the revenues can be used to increase water access among lowincome households4.

 

Water  scarcity  pricing  in  urban  centres     Despite the potential benefits, prices are not

and volumetric charges designed to encourage

commonly used to manage urban water

access by keeping prices equal to average costs

demand. Instead, water prices are often set at

do not take into account the availability of

low levels in order to encourage equitable

water resources in times of scarcity leading to

access, usually through one of the following

imbalances in water supply and demand.

water pricing frameworks: A potential solution to this problem is to use 1.

Flat rates, where consumers pay a flat

scarcity pricing to regulate demand and

rate regardless of their water use.

ensure that water is used efficiently, combined with subsidies to low-income households that

2. Volumetric rates, where consumers pay a single rate per cubic metre of

are independent of water use to ensure that water is allocated equitably.

water used. 3. Increasing block tariffs, where the rate increases with the amount of water used.

Under such an approach, water prices could rise when water is scarce and fall when water is abundant. Raising prices in times of water scarcity reduces demand (since consumers

4. Decreasing block tariffs, where the

face higher prices), and increases supply (by

rate decreases with the amount of

making investments in water infrastructure

water used.

profitable and raising revenues to invest in infrastructure). Thus, scarcity pricing could be

The problem with such approaches that it is

used to encourage efficient and sustainable

very difficult to achieve goals of efficiency and

use of urban water, allowing water supply and

equity through a single instrument such as

demand to be managed to alleviate problems

pricing. As a result, using such pricing

of water scarcity.

frameworks to encourage equitable access to water often leads to inefficient or inequitable

A potential concern with such a strategy is

water use.

that scarcity pricing may lead to highly variable revenues for water utilities which may

For example, flat rates and decreasing block

not be sufficient to cover recurring costs such

tariffs encourage people to over consume

as meter reading. To alleviate this problem, a

water as the price per unit of water falls when

fixed access fee could be included with a

more water is consumed; increasing block

volumetric scarcity price to ensure stable

tariffs penalise low-income households with

revenues. However, in areas where water

large families and higher water consumption;

scarcity is a significant problem this may not

 

Water  scarcity  pricing  in  urban  centres     be necessary as the revenue generated from

of water consumed, unlike in schemes where

during times of scarcity should offset potential

low-income households pay a flat subsidised

losses when supply is at full capacity and

rate for water regardless of the amount used,

prices are low5.

or pay a lower rate when consumption rises (as in decreasing block tariffs). This is because

The second part of this approach is in

schemes in which subsidies are dependent on

ensuring equitable water access by reducing

the level of water consumed create incentives

the impact that high water prices during times

to

of scarcity have on low-income households.

exacerbate urban water scarcity issues.

overuse

water

resources

which

can

This could be achieved in a number of ways: In conclusion, evidence suggests that prices 1.

Using revenues collected during times

are an effective and efficient method of

of scarcity to provide water bill relief

regulating urban water demand. However,

to poor households through water

trying to achieve the competing goals of equity

vouchers or lump-sum payments.

and efficiency with a single instrument is

2. If a fixed access fee is included the fee could be negative for poor households during times of water scarcity.

likely to be ineffective as one goal is likely to compromise

the

other.

Instead,

better

outcomes are likely to be achieved if separate instruments are used so that water prices are

3. Introducing water use thresholds so

based on the scarcity of water resources to

that poor households pay a lower

encourage efficient use of water, and subsidies

charge whereas others pay the full

are set independently of consumption to

scarcity price5.

achieve equitable access.

Whatever measure is chosen, it is important that the subsidy is independent of the amount References 1. 2. 3. 4. 5.

Grafton, R.Q. and M.B. Ward (2008), “Prices versus Rationing: Marshallian Surplus and Mandatory Water Restrictions”, Economic Record, Vol. 84, Issue Supplement s1, pp. S57-S65. Grafton, R.Q. et al. (2011), “Determinants of Residential Water Consumption: Evidence and Analysis from a 10-country Household Survey”, Water Resources Research, Vol. 47, No. W08537, doi:10.1029/2010WR009685. Olmstead, S. M., and R. N. Stavins (2009), Comparing price and nonprice approaches to residential water conservation, Water Resources Research, Vol. 45, No. W04301, doi:10.1029/2008WR007227. Rogers, P., R. de Silva and R. Bhatia (2002), “Water is an Economic Good: How to Use Prices to Promote Equity, Efficiency, and Sustainability”, Water Policy, Vol. 4, pp. 1-17. Grafton, R.Q. and T. Kompas (2007), “Pricing Sydney Water”, The Australian Journal of Agricultural and Resource Economics, Vol. 51, No. 3, pp. 227-241.

 

Water  scarcity  pricing  in  urban  centres     About the author(s) Chris White is an Editor of the Global Water Forum. Chris read Philosophy, Politics and Economics at Oxford University; completed a Masters degree in Environmental and Resource Economics at the Australian National University; and now works as an Environmental Economist at the Crawford School of Economics and Government.

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