Water conservation: the role of price and regulation in residential water consumption

Economic Papers (Economic Society of Australia), Sept, 2004 by Greg Barrett

This paper examines evidence on the role of pricing and regulation in encouraging conservation in residential water consumption. The paper uses the criteria of effectiveness, efficiency, and equity to compare pricing and regulatory approaches to water conservation. The paper concludes that both approaches are important and that a pragmatic mix of policies is most likely to encourage residential water conservation.

Keywords: Water conservation

JEL Codes: D12, D61, H42, L95

1 Introduction

In the past, water supply utilities typically met growing demand for water consumption by expanded supply infrastructures. Normally this was subsidised from the public purse. Environmental costs were rarely considered. An ever-expanding water supply has, however, become too expensive. New water supply dams face a shortage of suitable sites and escalating financial and environmental costs.

In place of new dams, measures to reduce residential water consumption are now being adopted in Australia. For example, the Sydney Water Corporation has been required under its operating licence to reduce the quantity of water drawn from all storages on a per capita basis by at least 25 per cent between 1990-1991 and 2000-2001, and by at least 35 per cent between 1990-1991 and 2010-2011 (see IPART, 1996, p. 23). (1)

The Sydney Catchment Authority's Operating Licence also supports water conservation. It can only expand its water supply capacity after it has determined that Sydney Water has no further scope for demand management. (2)

There is a range of policies that governments can use to encourage water conservation. The traditional policy has been regulation, particularly bans on certain water uses at certain times, but a wide range of policies is available, as shown in Table 1.

This article compares the roles of markets and regulation in promoting residential water conservation. The importance of this issue has been noted elsewhere. "An important issue is the relative weight that should be placed on price and non-price measures to achieve demand management" (see IPART, 1996, p. 24).

2 Environmentalists Versus Economists

There has been a long debate in environmental economics over the role of prices (allocation by markets) versus the role of regulatory controls (allocation by governments) in reducing consumption and pollution. Water industry examples of the pricing approach are the call for a 30 per cent rise in residential water prices (with a shift to user charges in place of property-based charges) (see Hamilton et al., 1997, p. 24) and the call for residential water real price rises, of the order of 10 to 15 per cent, each year over five years (see Wright, 1996, p. 88). A 1994 World Bank survey shows that internationally tariffs for water and sanitation have risen to between $A1.30 and $A1.90/kilolitre (kL) from between $A0.40 and $A0.60/kL over the previous few years (see World Bank, 1995, p. 45).

The increasing use of markets and pricing to manage water consumption (see Duke & Montoya, 1994, and Raftelis, 1993) makes this debate relevant for Australian water consumers and utilities. As Savage (1994, p. 1) has written:

   Universal provision of essential services by government trading
   enterprises at readily affordable prices financed by central
   government revenues, has been replaced by arguments for
   'user-pays' pricing schemes designed to meet full cost recovery
   or higher profit targets and to pay dividends to government.
   Notions of 'benefit equity' (paying for what you get) related
   to 'user pays' pricing are promoted as more appropriate than
   vertical equity (paying according to your means).

Typically, environmentalists regard prices as ineffective and inappropriate to control the use of environmental resources. They point to widespread market failures and price-unresponsive (inelastic) demand for environmental resources. Environmentalists generally favour direct regulatory controls on environmental resource use. These direct controls (regulation) include prohibition, licensing, etc. However, it should be noted that in recent years some environmentalists have begun to support a greater role for pricing in environmental allocation issues.

Typically, economists regard prices as the most appropriate means of controlling environmental resources. They point to the greater efficiency of pricing (lower administrative costs and greater congruence between individuals' willingness to pay for environmental resources and the cost of providing those resources).

In summary, economists stress the efficiency of pricing and environmentalists empahsise the effectiveness of regulations. Equity issues receive little attention from either.

3 Criteria to Evaluate the Two Approaches to Water Conservation

To evaluate the pricing and regulatory approaches to managing residential water consumption we can use the criteria of effectiveness and appropriateness. In this context, effectiveness measures the extent of water conservation. Appropriateness measures the impact of water conservation on both efficiency (cost per unit of water saved) and equity.