Thursday, December 30, 2010

Water Pricing and Coping with Drought in the Southwest

The Director of my UCLA Institute has just edited a special issue for the Proceedings of the National Academy of Sciences. Here is Glen MacDonald's PNAS Volume link.

Given the growth of population and jobs in the Southwest and the basic need for water, if the supply of water is threatened by drought --- how can this region continue to flourish?  An economist would say that allowing water prices to reflect scarcity would take care of this problem.   Consider Peter Gleick's quote;

"Part of the challenge we face in the Southwest is old-style thinking," said Peter Gleick, president of the Pacific Institute and an author of another analysis. "We brought to the Southwest very European ideas about water, developed in water-rich areas. ... That worked OK for a while, although not really. But now it's clear that green lawns and unlimited swimming pools and inefficient irrigated agriculture can't be sustained."
Gleick says the solution lies in a combination of encouraging the development of untraditional water sources, such as reclaimed wastewater, policies to encourage more efficient water use, efforts to coordinate water policy at local, state and federal levels, and planning to help water utilities adapt to climate change."

I agree with Peter but I would say that allowing water prices to rise would simply and equitably solve this problem.  You would see less green grass in Los Angeles, fewer private swimming pools, and farmers (who use the majority of the water) would use water more efficiently and would make better choices over what to grow.  Water engineers (such as my colleague UCLA's Yoram Cohen) would have strong incentives to innovate to figure out how to reclaim water and use it for the variety of tasks we need water for.

Many new economics students worry that such "price gouging" will hurt the poor.  It doesn't have to.
Consider the following scheme.

Suppose a public health expert says that every person needs X gallons of water a day as minimum for bathing and washing and other essential services.

Suppose the free market price for water is  p cents per gallon.  In this case, we would have a public policy that gives each poor person 365*p*X/100  dollars per year so that they can afford their water needs under the new water pricing rules.

If there are  Z  poor people and  N total tax payers who are not poor, then the per-capita tax of protecting the poor would equal   365*p*X*Z/(100*N)

Politicians would need to "draw the line" in defining who qualifies as poor for this cash transfer but note that we can have the best of both worlds;  the Southwest's suffering from drought ends as we now face a proper pricing signal for not "wasting water" and the poor's basic rights are protected.

This example highlights why economists are useful people.  The climate scientists have shown that under the status quo, the Southwest (including my Los Angeles) has a problem -- and the economists know how to redesign incentives to mitigate the problem. This is the social science of climate change adaptation and this is the guts of my Climatopolis.

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