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You could raise the price for water, then redistribute the revenues per capita (or use them to cut other taxes, or raise other transfers). In principle you could make everyone better off this way.

I pay 7.5 cents per kWh at the margin for electricity from Hydro Quebec. (It's only 5.45 cents per kWh for the first 30 kWh per day). I use it to heat my home. It's cheap because the *average* cost of electricity is low in Quebec (lots of hydro). But, given easy transmission to Ontario and the US, the *marginal* cost (which is a marginal *opportunity* cost -- i.e. the price we could sell it for to Ontario and the US) is I think higher. But despite Lucien Bouchard's plea for a "Lucid" economic policy (raise the price of electricity in Quebec to the marginal cost), it doesn't happen. Why?

Nick: As an ex-pat Quebecer, I'm supposing that's a rhetorical question or a joke ;)

IT can help, if the cost of going geek is worth it. It is possible to have different prices for water used for different reasons and in different amounts. Surcharges for water use over some basic per capita allotment, surcharges for people with big lawns, special meters on outdoor taps, etc. But maybe it's a case of having a hammer, so I see everything as a nail.

Nick, taxes+redistribution would seem like the obvious way to go. BC did it with carbon taxes, and both BC and Ontario are trying it with HST. Issues:
- the BC and Ontario experience demonstrate how effective this is as a vote getter
- if it's not income tested, the policy gets the "why are you writing cheques to multimillionaires" critique
- if it is income tested, then it boosts up the marginal tax rate when it's phased out creating another kind of inefficiency, plus there's resistance to what would be seen as welfare. And if it is income tested, there's no one with political power with an interest in making sure the cheques continue to be paid.

Patrick, yes, metering, definitely. Even time of use metering would help if it encouraged people to water lawns at night. (Though special meters on outdoor taps would be easy to circumvent with a hose through a window).

But metering is a drop in the bucket (so to speak) unless something changes with respect to commercial use - it's golf courses not lawns. And then there's the standard difficulties with taxing corporations in a world where capital is mobile.

Have water use brackets. Charge a small amount for the first n litres, a bit more for the next n litres, and so forth. Thus, the struggling artist or student who uses relatively little water pays little, while the millionaire who wants their lawn to look like a golf course pays a lot.

What's not to like about that?

Frances,

I'm not sure that capital mobility is really a problem when it comes to golf course - capital may be mobile, golf courses aren't.

Obviously, thought, increasing water prices would be difficult for more mobile industries where water is an important input. But here's the thing, if industries are only located in a jurisdiction because the price of water is artificially low (either because it is explicitly subsidized or because the price doesn't reflect the true marginal cost of its use), then having those industries leave your jurisdiction isn't a bad thing. While society suffers a loss from the loss of that industry, if the price of water was really less than the marginal cost of that water, there should be an offsetting benefit (indeed, more than an offsetting benefit).

I think the analogy is the race to the bottom-type argument that you see in respect of labour or environmental regulation. The usual story is that regulations are "bad" because they cause industries to up and leave, losing jobs (and therefore, there should be a race to the bottom in terms of regulatory standards). But implicit in that argument is the assumption (a somewhat surprising one given the people who are making the race to the bottom argument) is that there is no benefit from the reduction of pollution (or the increase in labour standards). If pollution is at an inefficiently high level (i.e., the price of pollution is too low) reducing pollution (either by pricing or by regulation) should be, overall, welfare enhancing.

To be sure, there are redistributive effects of regulation - workers in polluting industries will lose, at least in the short-run. But if the original level of pollution really was socially inefficient, their loss should be offset by social gains from the reduction in pollution. If not, then query whether the original level of pollution (or, in our case, the original pricing of water) really was inefficient. The real problem isn't an economic one, but a political ones. The benefits of polluting or consuming water are tangible and observable (certainly to the people who work in industries which polute or consume water), while the benefits of reducing pollution or reducing water consumption are often intangible, and not strongly felt by the people who benefit from them. The difficulty isn't really a capital flight problem, but a political one, i.e., pursuading the population as a whole that they are, in fact, better off with accurate pricing (be it of pollution or water).

Make water free market to raise the prices and thus drop the more wasteful uses.

It's an oasis, what did you expect? :)

There are other ways to bring about social change. Say I was a California activist and I was concerned about the errant misting of sidewalks by highend boutique stores. I'd launch a tongue in cheek ad campaign or issue a press release commending some targeted (maybe even fictional - call it "Snooties") high profile Palm Springs establishment for their "conservation efforts", which includes the recycling of "greywater" in their sidewalk misters. Then, over say urinals in public places, or on telephone poles, place notices: Flush twice. Snooties needs more water for sidewalk misting. It may get some local press attention, put Snooties on the defensive to at best argue that they are wasting perfectly clean potable water (not used dirty), and make mistees ask themselves the question "Do I know where that water has previously been?", and steer clear of their entrance/property.

Maybe a bit farfetched, but maybe not. In her book How to Save the World in Your Spare Time Elizabeth May describes successful action of a similar nature. When regulation, failed hearing interventions etc and gov't inaction failed to convince a polluter (or a water utility, or the gov't to enforce regs- I can't remember specifically) to clean up its water system, an activist (I'm going to say it was RFK jr, but not sure) had a meeting with a senior official (gov't I believe) with a made up newspaper ad, ready to run in the newspapers in the following days (was it NY Times?). According to May's book, it had a closeup picture of a well endowed male, with hot and cold water handles strategically placed to make it resemble your kitchen faucet, with the caption, something to the effect of "Do you know where your water comes from"? The policy was altered in that meeting, and the ad campaign dropped. (I'm sure I have many details wrong - but the general facts should be close).

In any event, the point being that there are many other levers beyond price signals/regs to affect change.

Nick,
I was wondering the same about the average Quebecer's resistance to raising electricity costs despite all the good fiscal and environmental reasons to do so. "Tout le monde en parlait" (tv show on specific episodes in Quebec history, using old news footage combined with contemporary interviews of key witnesses) throws some light on it. During the 70s push to develop nuclear energy in Quebec, opponents used notions of god-given, unlimited water riches and the likes. They won and I'm afraid it got ingrained in the collective psyche. Plus, everybody has a father or uncle who worked in Baie James. They feel they're the owners of the dams, it was built with their family's sweat, so they shouldn't have to pay for electricity.

Yohanna: you are probably right. But it's still a puzzle. Why not: "We built these dams, and we own them, and we want tax-dividends, not cheap electricity"? But yes, it won't work, will it. People understand cheap electricity. They don't understand deadweight cost triangles, and the government budget constraint so easily.

Hydro Quebec is the flagship of Quebec Inc. - with its roots going back to the nationalization with Rene Levesque as Minister of National Resources in the 1960's Lesage gov't - "maitre chez nous" and all that. It has emotional , which are often not rational, attachments.

Btw, just bought 4 tonnes of flagstone in Ontario - on sale because it comes from northern Quebec - and you can only get road access to N. Quebec for a few months of the year (not good if you want to be a reliable year round rock supplier). One of my neighbours commented "Yeah, like Ontario is running out of rocks". I suspect it is waste from one of Jean Charest's latest hydroelectric projects - so either I am subsidizing HQ electricity by not adhering to my 100 mile diet, or HQ is subsidizing me by giving away the spoils and allowing others to ship rocks half way across the country.

But, they look nice - separately, and collectively.

I don't know what can be done in reality, but in the ideal as it seems to me, the solution to the suggested water usage problem is to somehow arrange to have (approximate) equality of wealth and income among the people, so that price rationing works properly for water and for everything else.

nitroglycol has it about right. Water metering is the way to go:

http://en.wikipedia.org/wiki/Water_metering

Though I don't know about different price bands for higher uses, although I think you could have two bands, the first costing zero from 0 to n litres where n was some minimum acceptable usage, and then a second band for all usage above that.

Yes, one can drive south of San Francisco and admire the once salmon-bearing streams that no longer reach the Pacific Ocean for much of the year. Rumour has it that the salmon and steelhead have given up, grown lungs, moved to LA and joined Indie Rock bands.

I seem to recall some evidence that metered residential water users typically use 1/3 of the per capita water use of non-metered residents.

The water issue is intertwined with other issues: namely a hugely subsidized, ecologically destructive agricultural sector, and, perhaps coincidentally, an alarming obesity epidemic. Food is clearly under-priced.

Solution? As Nick suggests, charge more for water. Moreover, slash agricultural subsidies to zero. Politically tough. Though it must be somewhat embarrassing for North Americans to recognize that Santiago de Chile already meters 99% of residential water use (see the wiki page posted by Alex).

nitroglycol, Alex - some amount of metering is a no brainer - yes, of course there should be metering. But there's a limit to how much of a difference it can make.

Ottawa has metering - in 2008 my bill for a four person household was $531, or less than $150 per person per year. That's with a shower-obsessed teenager and people working from home.

Compare that annual four-person household total with the cost of some things that might make a difference to water consumption -
- a rainbarrel ($60 to $80)
- new plumbing (several hundred dollars with installation)
- a grey water system that would recycle shower water and use it to flush the toilets (thousands and thousands)

The cost of water would have to be much much higher than it is at present in order for it to make a difference to our decisions. And if it was that much higher, it would be really important to get the implementation right.

- the rate bands have to take into account household size which can be hard to measure
- should rate bands be different for the employed who can flush at work?
- if the rates are too high they'll discourage household production - cooking at home becomes unattractive relative to eating out.

Bob - agriculture is highly water intensive and much of it is pretty mobile e.g. factory farming.

"But, given easy transmission to Ontario and the US, the *marginal* cost (which is a marginal *opportunity* cost -- i.e. the price we could sell it for to Ontario and the US) is I think higher."

No, the fact that the opportunity cost is lower than the average cost is what causes all the waste.

Phoenix (in Southern Arizona) doesn't have a lot of water, but Northern and central Arizona has tons of water. If you build canal systems to move water from the north to the south, then water is much cheaper.

So cheap, in fact, that Arizona is home to cotton farms (better growing seasons due to the lack of rain:) as well as alfalfa farms that consume 70% of the water at a significant subsidy to the cost provided to non-agricultural industry, which is itself subsidized above the cost paid by households, who only consume about 20% of the water, even though they all have swimming pools and water their lawns.

As with most industries, the cost will be dominated by your fixed investments, and the marginal price will be lower than the average price, meaning that some form of markup or monopoly pricing must be used in order for the business to function, simply due to technology and economies of scale:

Given that the canals have been built and once the costs of servicing those canals are met, any additional unit of water sold is almost all pure profit. If several sellers are forced to compete, then they will offer that water at basically any non-zero price, which is why utilities almost always tend to be monopolies of some form.

The same could be said for energy. If we made huge fixed investments in say, nuclear power or solar/hydro power, we could drive the opportunity cost to near zero. This is the situation in central Texas, which has seen so much wind power development that the wholesale spot market can be driven to zero, or even negative values due to a $20/MW subsidy. Even adding back the subsidy, the marginal cost price is about 1/5 of the average cost (e.g. $20 versus $100).

And lets not forget the depression era programs in which milk was poured into the ground and animals were slaughtered and burned because the spot price was far lower than the average price. These programs have modern equivalents of subsidies that pay farmers not to grow food in order to keep the spot price from falling below the average price.

Rather than blaming this on government waste, this is an effect you see in every increasing return industry or constant return industry in which there are high fixed costs. If the government wouldn't pay farmers to not grow food, the industry would need to reach some other cartel-like agreement in order to prevent mass bankruptcy from the spot price falling below the average cost. In those cases in which the agreement failed -- e.g. when the market worked -- then quickly new entrants, such as wind power in Texas, which still only accounts for about 1/5 of total power, are enough to drive spot prices to uneconomical values for everyone involved.

This opportunity cost vs. average cost discrepancy is what *causes* the waste of resources, whether we are pouring milk into the ground, or pouring water on empty streets. The only solution that I am aware of is some informal or government-forced markup/fee or price floor that would guarantee that the spot price is equal to the average cost. This is almost always going to be the case with regulated utilities selling retail. So you do not want the cost of water to be the marginal opportunity cost -- that is far too low to prevent waste. You need to artificially increase the price via a mark-up, and if water is still being wasted, then raise the price floor even more.

Whoah there, RSJ!

There are two distinctions, quite separate:

1. Marginal Cost vs Average Cost

2. Opportunity Cost vs Out of Pocket/Accounting costs

Lets start with the first.

We want to produce the quantity of electricity to maximise V = Total Benefit minus Total Cost.

Take the derivative of V wrt quantity, set it equal to zero, and you get:

dV/dq = Marginal Benefit - Marginal Cost = 0

(assume second order conditions satisfied)

So MB=MC.

Each individual consumer, who takes Price as exogenous, will maximise his utility by consuming that quantity at which MB=P. (That's because, for the individual consumer, price is the marginal cost to his pocket.)

So, to make MB=MC, you need to set P=MC. That's the argument for pricing electricity at marginal cost.

JVFM, yes, Palm Springs is an oasis (I've only just learned that).

Palm Springs is an oasis because it is built on a fissure in the earth's crust right by the San Andreas fault - the palms are fed by ground water coming up through the fissures .

Ground water is a lot like oil in that many of the reserves were put down a very long time ago - you can think of it as 'fossil water' similar to fossil fuel. And though not exactly non-renewable, so slowly renewable that it needs to be used carefully.

In this context, privatizing groundwater and putting a high price on it might just encourage over-exploitation of the resource - sell the ground water today, enjoy life, and don't worry about tomorrow.

RSJ - I'm wondering about the water abundance in N. Arizona - how much of that is glacial melt of 'fossil water'?

Whoah there,RSJ FW!

There are two distinctions, quite separate:

Main Entry: oa·sis
Pronunciation: \ō-ˈā-səs\
Function: noun
Inflected Form(s): plural oa·ses \-ˌsēz\
Etymology: Late Latin, from Greek
Date: 1613

1 : a fertile or green area in an arid region (as a desert)
2 : something that provides refuge, relief, or pleasant contrast

I meant the second - was just joshing you. :)

JVFM - sorry, should have read more carefully before responding.

FW writes:


Do the readers of WCI collectively know enough to contribute to the solution of California's water shortage?

That depends on what one means by water shortage. Regarding, glacier melt. Most of the southwest draws water from the Colorado. That water is snow-pack melt, but its annual snow-pack not glacial.

Water-rights are a VERY big deal in the countryside, but not in many cities (more on that later). For instance, in Utah grey-water systems and rain-barrels are illegal. The state owns the rain-water, and you mustn't interfere with its drainage into the rivers and tributaries. There is also private ownership. For instance, your neighbors have a cause of action against you for collecting and diverting rainwater in a way that reduces the drainage of the water from your land to theirs.

I think that answers part of your question about inducing people to use rain-barrels. That water is not being wasted even without the rain-barrels. Its assuredly and thoroughly used.

California: massive amounts of water are transported from the North to the South. I think its a stretch to claim there is water-shortage in NoCal. In so much as there is, its SoCal which creates it, but there is a curious thing. Up North, the government is fastidious about water usage. Heavy fines for watering the sidewalks, time-of-day restrictions on irrigation, mandatory browning during the summer months (grass can go dormant if given just a little water), no self-washing of cars (car washes recycle the water), no outdoor fountains, etc. Inspectors troll businesses with water efficiency standards. Its aggressive. Now look at LA. In Pasadena, the municipal code lays out a schedule of fines for anyone whose lawn is not green or whose shrubs brown (sic). Outdoor water restrictions are mild: odd number houses on odd numbered days, even numbered houses are even numbered days. Extensive use of misters by businesses. Etc. I think the rules in LA proper may be slightly more restrictive, but the city of pasadena only declared a 'class I' water shortage, and all conservation measures are only voluntary and advisory, and yes the city still pays the inspect to come around and check to ensure your grass is green and still mans the hotline to report your neighbor for allowing his to brown.

The attitude is different.

But there is more. Water is what made the LA basin a success. LADWP under Mulholland built an elaborate system of water-collection. I believe the LADWP is the largest single land-holder in the state. They own vast swatches of land for the purpose of owning the rain-water, collecting it, and diverting it to the city. From 1905-1913 they built a 200mi aquaduct to owens valley and own 1214 sqkm of land there. In the 1930s they extended the aquaduct another 150 mi north and bought-up the water-rights around mono-lake.

http://wsoweb.ladwp.com/Aqueduct/realtime/realtimeindex.htm

- if the rates are too high they'll discourage household production - cooking at home becomes unattractive relative to eating out. -FW

What implicit assumption are you making? That restaurants will face lower costs of water or will be able to more efficiently and cost-effectively recycle grey water?

I would think that 'eating out' would be just as much affected by transportation costs, i.e., the cost of petrol or diesel. Come to think of it, northern European level excise taxes on petrol would probably hammer the US restaurant and fast-food industry. There could also be negative 'knock-on effects' for the pharmaceutical industry.

Westslope - the point is just that relative prices will change - yes, they could change in favour of household production if commercial rates increased more than domestic rates.

This notion that there would be a significant switch in home consumption of food to restaurant consumption based on water prices increasing seems pretty ridiculous. While it's possible to some tiny degree, the cost of water in home preparation is such a tiny proportion of the overall cost, and the up-front margins of restaurant food so high, you'd have to come up with some pretty extreme assumptions to believe it would move the curve much. It'd get swamped by all other price movements.

You could come up with a number of elaborate feedback effects, marginal tax rate implications, GST/sales tax interactions, etc. But all those are trivial compared to relative cost of water as part of preparing food vs restaurant meals, unless you're assuming some high water-intensity home farming arrangement.

I could imagine, at the extreme, a small move to certain prepared foods that use little water: bread instead of pasta, maybe, but not much else.

The Economist had a feature on water recently. They made a point that is pretty important: not all water use is equal. A process that merely uses water and requires little in the way of treatment is much more sustainable than processes that result in a great deal of evapotranspiration (ie, evapouration or transpiration by plants) since these processes remove water from the watershed.

Ok, Nick, I've whoaed :)

Say your fixed costs are A. A allows you to generate a flow of water up to X units. Think of A as your dams. To get X+1 units, you need to build more dams.

Let's suppose that the fixed costs necessary to deliver a given capacity, X, are increasing with X -- as you build more dams, their marginal productivity in terms of increasing capacity is decreasing.

However, the variable costs, within a given capacity, are decreasing with Q, the quantity of water actually delivered. Up until you max out your capacity, and then need to build another dam.

From the point of view of the water provider, their cost function in terms of quantity, C(Q), is a discontinuous function that spikes up and is almost flat, spikes up again when capacity is maxed out and is again almost flat, etc.

Because the max-capacity points are discreet, but Q is continuous, with probability one, the intersection of the supply and demand curve will occur in an environment of falling marginal costs as well as declining marginal benefit and your second order condition will not be met.

Local analysis will not give the optimum pricing, but the market responds to the local analysis.

To go from X to X+1 may cost 50 billion dollars (build another dam). But to go from X-1 to X may cost one thousandth of a penny. Once the second dam is built, again, the cost of going from X+1 to X+2 could be a thousandth of a penny.

This is, I believe, a common problem.

Do you take the "big picture" view and smooth out the step function to get an increasing cost function? You could draw a curve through the mid-points of the flat part of the stair-step. Then you can apply calculus to the smoothed out function.

But don't expect the market participants to react in the same way. Their cost functions are not smoothed out -- they are responding to their actual cost and benefit functions. The purpose of the price floors imposed by regulators is to impose the smoothed out (and somewhat arbitrary) costs when the actual market costs have the wrong local characteristics in order to allow for equilibrium.

In that case, your analysis applies from a social planner view, but there is no market-mechanism to ensure that the "right" number of dams are built or that the right cost per gallon is charged to prevent waste and/or make the project uneconomical.

You need regulators to impose the stylized cost curve when the real-life cost curve has the wrong second order characteristics. If, for some reason, the regulators screw up -- such as allowing wind power development in Texas without forcing other utilities to shut down, then too much capacity is built and the declining marginal price falls to (effectively zero), causing waste and uneconomic pricing for the energy providers.

FW,

No, the water does not come from glaciers -- I don't think there are any glaciers in northern Arizona.

Arizona collects a large part of the Colorado River -- it is the Grand Canyon state :). Glenn Canyon Dam, Hoover Dam, Davis Dam, Parker Dam, and Imperial Dam are all on this river. Also, Northern AZ has more mountains, in terms of square miles, than Switzerland. Don't ask me why I remember this -- 20 years ago I heard it in a Rotary club speech :) From that watershed also flows the little Colorado and Verde river, as well as the Salt River, and these are also dammed by Roosevelt Dam, Bartlett Dam, etc. More Dams than you can shake a stick at. Then there is the Gila River coming from New Mexico and that is dammed by Coolidge Dam, etc. All this water is then channeled through a system of canals to Phoenix.

I once read a book "Cadillac Desert", but have forgotten most of the data. It's a great read, though.

I am not claiming that the water is not wasted. There is enormous waste when desert houses have swimming pools and green lawns. I am arguing about market's inability to set pricing correctly, leaving the job to regulators. In which case bad regulation can cause waste.

And as an aside, I think a similar problem applies to trying to reach general equilibrium. The presence of discontinuous fixed costs means that the production function is not upper hemi-continuous, and your CE analysis does not apply. You can "smooth out" the function, of course, but then why would your auction process will converge to the smoothed out solution?

If there is some result here -- that the smoothed out CE solution approaches the actual CE result under some conditions by which the discontinuous functions are approximated by smooth ones, then I'd like to know it, and then we can analyze why this result does not apply in some observed cases.

One thing I meant to mention was that acting against climate change would also help California's water supply.

Also, it seems there's news on this front:

http://www.latimes.com/news/local/la-me-arnold-water-20100630,0,5464745.story

Economists, being fixated on prices and markets, tend to neglect the fact that simple legal coercion is a powerful and legitimate tool in the public policy toolkit. That being said, we ought to consider simply outlawing wasteful uses of water as well as the production of water-inefficient technologies. A more efficient water pricing mechanism on top of this would further reduce wastage; but as one commenter has already said, it would be impracticable to price water so highly as to induce individuals and corporations to make the large investments/lifestyle changes necessary to reduce wastage to optimal levels.

Also, how can we expect a market for water to function optimally when no market to date, even with the help of government regulation, has been able to internalize the costs of environmental destruction? Why do we assume that it is even possible to quantify these costs? Even if we could accurately price water, anthropologists and sociologists have documented for decades that post-paid costs (tax bills, water bills... cell phone bills) don't factor into people's decision-making in the way many economists assume. And when these bills get unbearably high -- as they must in order to eliminate waste -- the public simply demands that the government lower them with the stroke of a pen. With legal prohibitions, however, the costs are opaque (except to corporate interests) whereas the moral message is clear.

"Economists, being fixated on prices and markets, tend to neglect the fact that simple legal coercion is a powerful and legitimate tool in the public policy toolkit." -Winston

Absolutely not true. Economists tend to be highly critical of approaches that emphasize regulations, standard and legal coercion.

The last recession was in part caused by this fixation with regulations, witness emissions regulations that excepted SUVs and Light Trucks.

The problem with most voting adult Americans is that they have lost faith in magic of free markets and power of price signals assuming they had that faith in the first place.

"Economists tend to be highly critical of approaches that emphasize regulations, standard and legal coercion."

This doesn't contradict what I said. I acknowledge this tendency among economists, and I think it's unwarranted. There are legitimate moral and pragmatic reasons to absolutely prohibit undesirable behaviours rather than make them financially costly.

Winston, I was trying to be slightly funny.

You know, I like your idea. There should be a law prohibiting the state from subsidizing private debt. Good luck enforcing it.

On a related issue, Jon's post pointing out the differences in water policies between northern and southern California reminds us that our water allocation institutions evolve in a context of social conventions and priorities that inevitably shape water consumption patterns.

Take Victorian lawns for example. Many North Americans believe that they can signal their social worth with a big, well-irrigated, lush green Victorian lawn. Perhaps it is time to relegate the Victorian lawn as a status symbol to the dustbins of history?

Society could start promoting Victorian lawns as something only uneducated, anti-ecological low-income workers would want. After all, isn't that what is happening to public tobacco use?

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