Wednesday, October 01, 2008

What is the value of water? The debate

From the inbox:

Given the increasing scarcity of water in certain regions I remain confident that this will lead to future armed conflict and indeed it could be argued that is already has done.

The Economist debate is therefore timely. I have voted "pro" at this early stage.

This house believes that water, as a scarce resource, should be priced according to its market value.”

September 30th The Economist will start a two-week long Oxford-style online debate on the value of water. The proposition is “This house believes that water, as a scarce resource, should be priced according to its market value.”

Some of the issues the debate will cover include: Would water supplies be better managed if it were treated as a commodity, and priced accordingly? Or is water a basic human right that governments should secure for their citizens? As both an industrial input and a prerequisite of life, water has become extremely scarce for roughly a billion people who do not have a constant supply of clean and safe water, so the issue is of extreme importance.

Debate Schedule
• September 30th. Opening statements and comments and voting open to the public
• October 1st. Guest Participant post by Dr. Michael W. Hanemann, chancellor's professor, Department of Agricultural & Resource Economics, University of California
• October 2nd. Guest Participant post by Anup Jacob, partner, Virgin Green Fund
• October 3rd. Rebuttal statements and Guest Participant post by Colin Chartres, director general, International Water Management Institute
• October 6th. Guest Participant post by Dr. Peter Gleick, president and co-founder, Pacific Institute
• October 7th. Guest Participant post by Peter L. Cook, executive director, National Association of Water Companies
• October 8th. Closing statements
• October 9th. Guest Participant post by Dr. Ashok Gadgil, senior scientist and deputy director, Environmental Energy Technologies Division, Lawrence Berkeley National Laboratory
• October 10th. Winner announced

Pro and Con Opening Statements

Pro Opening Statement
Stephen J. Hoffmann, Managing Director, WaterTech Capital & co-founder, Palisades Water Index Associates

The severe spatial and temporal imbalances in the supply of and demand for water—and safe drinking water in particular—dictate that water be priced at the true market value in order to resolve our global water challenges.

The notion of sustainability is gaining momentum with respect to the use of water and is likely to permeate virtually every aspect of water-resource management in the 21st century. While the hydrologic cycle is a closed biogeochemical process, the fact that the aggregate amount of water on Earth, in its various forms, is virtually constant on a human time scale does not mean that we do not face enormous challenges with respect to its spatial and temporal distribution.

Water is a critical factor in poverty, has a fundamental impact on human health, and is increasingly crucial in economic development. The World Health Organisation reports that 1.1 billion people worldwide lack access to safe drinking water and 2.7 billion people lack basic sanitation needs. Yet despite its stature as a prerequisite for life and for living, the price of water remains artificially low based on an institutional ideology that developed when accessible freshwater was relatively abundant and when contamination was mitigated by the ubiquity of the resource.

Sustainability is the mantra behind many emerging regulations, water-policy initiatives and technological advances. And nowhere is the market price of water more critical than in the concept of sustainability. Efficiency is critical in achieving sustainability and a market-driven price is paramount to the efficient allocation of water resources. The sustainability criterion suggests that, at a minimum, an allocation must leave future generations no worse off than current generations. Economics has much to say about the efficiency of the allocation.

The pricing of water must go beyond the mechanical and political aspects to the basic factors that affect the relationships between producers and consumers, and that are implicit in the rate structure. The principle of sustainability is critically dependent upon efficiency in water use. And efficiency cannot be achieved without the proper signals included in market prices. Market value is equivalent to water rates based on economic principles of water-resource pricing. In that regard, resource economics requires the convergence of two key principles: equimarginal value in use and marginal cost pricing.

Economic principles of resource allocation dictate that when costs are incurred in the acquisition, treatment and transport of water supplies to customers, the principle of equimarginal value in use should be combined with the principle of marginal cost pricing; that is, market value must govern. Additional units of water can always be made available by expending more resources to acquire and transport it, that is, at a given marginal cost.

The question of where to stop in increasing the supplies made available is then added to the question of how to arrange for the allocation of the supplies in store at any point in time. On efficiency grounds, additional units should be made available as long as any customers are willing to pay the incremental or marginal cots incurred. To meet the criterion of equimarginal value in use, however, the price should be made equal for all customers in a class.

It is precisely because of practical considerations such as alternative supplies, location, use patterns, types of service etc, that the marginal costs of serving all customers will not be the same. Pricing should be arranged, then, so that all customers within a class served under identical cost conditions pay the same amount equal to the marginal cost or market value. Between classes, however, prices should differ, and the difference should be the difference in marginal costs involved in serving the two. In general, the economic principles of resource allocation indicate that customers served under identical cost conditions should be charged equal prices and that the water should be supplied and priced in such a way that the price for each class of service equals the marginal cost of serving that class.

Water rates should be designed to fully recover the costs of providing water by charging customers in accordance with how they contribute to the costs. Schedules of water rates that charge customers in accordance with the cost of service would be efficient from the economic point of view, in that the price of a unit of water would be equal to the cost of the resources used to obtain and deliver that water. Further, they would be equitable in that no customer would be required to subsidise any other customer. To sum it up, the dictates of efficiency are clear: water should be allocated so that the marginal net benefit is equalised for all users. If marginal net benefits are not equalised, it is possible to increase net benefits by transferring water from those uses with low net marginal benefits to those with higher net marginal benefits. Again, the pricing of water at the ‘market’ value is the only way to make these determinations.

The amount of easily accessible freshwater is coming under increasing pressure as a result of global population growth, particularly in developing countries where urbanisation and industrialisation are underway, and the degradation of existing supplies. The amount of readily accessible freshwater is a minuscule percentage of the Earth’s total water budget. If per capita consumption of water continues to increase at its current rate, we will be using over 90% of all available freshwater with 20 years.

Scarcity, spatial and temporal, must be reflected in a pricing mechanism. Water is like any other economic good for which there is supply and demand and a pricing mechanism that seeks equilibrium between the two.

This is not a process-oriented enchantment with the free market that it may appear to be. While this might sound like so much economic rhetoric, the reality is that market pricing is central to enabling the forces that allow the efficient allocation of the resource. It is simply a recognition that market prices convey a great deal of information; information with respect to incentives, efficiency and allocational considerations. The pricing of water based on its true market value is also critical in resolving the issues associated with its allocation among competing beneficial uses.

Desalination is an example of where the market value of water plays an important role as a catalyst for problem resolution. In regions of the world where water is permanently scarce, desalination has emerged to meet demand. And it has done so only because there are few options. Granted, desalination is more attractive where energy is cheap, but it points to the reality that if water is simply unavailable, the market value argument is easy to acknowledge. It stands to reason that water priced at the market value (which includes scarcity, regulatory costs, treatment costs and resource management considerations) would be beneficial for the entire spectrum of conditions.

The signals and incentives contained in pricing water at its market value also enable the processes of recycling, reuse and conservation that are central to achieving sustainable water use. That water is not priced (valued) at its market value is the main reason why we are experiencing many of our severe water-quality and -quantity issues. Resource economics dictates the allocational efficiency of market-driven pricing.

# # #

Con Opening Statement
Dr. Vandana Shiva, Director, Research Foundation for Science, Technology & Natural Resource Policy

Between last year and this the market value of Lehman Brothers dropped from $38.4 billion to $5 billion, Merrill Lynch from $71.9 billion to $33.1 billion, and Morgan Stanley from $70.2 to $43 billion. Since then Lehman Brothers has collapsed. There is clearly no reliable "market price" in a volatile world driven by greed and profits, with no social regulation. The idea that the management and distribution of and access to a scarce and vital resource like water can be left to the market—and that the market can assign a reliable price reflecting the real value of water—is both absurd and irresponsible.

All cultures have viewed water as the basis of life. Marketisation, however, allows water to be perceived as no different from any other commodity in the global market place–to be owned and bought and sold at arbitrary, unreliable prices.

The commodification of water shifts the focus from the water cycle on to water markets – diverse species, ecosystems and water systems adapted to millions of years of evolution are replaced by instantaneous relationships between “sellers” and “buyers” negotiating a commodity transaction which determines how water will be used, where it will flow, and where and to whom it will stop flowing. It is assumed that water will flow from “low value” to “high value” use. This increase in “value” (which refers to price) is supposed to magically overcome water scarcity and allocate water equitably.

We need to focus our thinking on water cycles rather than water markets, on human rights to water rather than profits to be made from commoditising a scarce resource. It is our relationship with the ecology of water that has the capacity to sustain water supplies for us and other species. Trade in water can help water markets grow in the short term, but unregulated markets will make our scarce and fast-disappearing water resources disappear ever faster. It is the discipline of ecology and hydrology that we need to guide our efforts at conservation, not the ecological indiscipline of markets.

The anarchy of the water market can be a good guide to profits – but it is a bad guide for the equitable, just and sustainable use of our precious water systems.

In the years ahead, the ecological and commercial paradigms will clash intensely as globalisation displaces cultures of water conservation and replaces them with a commercial monoculture of water as a commodity.

The commodification of water resources is being promoted by the World Bank and free-trade agreements like NAFTA and WTO. The World Bank is using Structural Adjustment programmes to privatise water resources. Free-trade agreements are defining water as an environmental service covered by rules of free trade in services. Privatisation and commodification are threatening to accelerate the processes that have led to the growing crisis of drought, desertification and water famines.

The market paradigm of water involves the assumptions that:

1. Increase in price is increase in value.

2. Increase in water trade is increase in water supply and hence free trade in water can overcome the water crisis.

The assumption that water markets will overcome the water crisis is, however, fallacious and malicious. Firstly, water markets cannot reduce water use and conserve water because commercial exploitation has created water scarcity by fuelling over-exploitation. In a world of inequality, higher prices do not tame consumption–they increase the luxury consumption by the rich and deprive the poor even of survival needs.

Secondly, water trade cannot increase water supplies. Water cannot be created by markets. It can be stored, diverted, polluted and also over-exploited, but its overall availability cannot be enhanced.

Water is defined by the water cycle and renewed if the water cycle is maintained. The ecological paradigm recognises that:

1. Water is the basis of all life on the planet including diverse species and all human communities.

2. Non-sustainable water use spurred by non-sustainable economies and technologies which violate the limits and the integrity of the water cycle are creating a water crisis.

3. The current water crisis can only be overcome by respecting the limits on water use that are enforced by the water cycle.

Markets driven by commercial values can neither recognise or respect the ecological limits set by the water cycle, nor give water its real value as the very basis of life. The real value of water is assigned by culture, which treats water as sacred; it is also assigned by rules of social equity and justice which recognise that everyone has a human right to water.

Water Markets Violate the Water Cycle

Water markets define “value” only as commercial and market value, and try and maximise this value as profits through commercial transactions and trade.

In nature’s economy, the primary value is sustainability and maintenance of nature’s essential ecological processes. Conservation is the imperative in nature’s economy for maximising ecological values.

In the sustenance economy, meeting people’s biological and livelihood needs for water are the primary objectives. Equity, justice and human rights are the primary values. Sharing of scarce water equitably is the imperative in the sustenance economy.

When water's social and ecological values are ignored and markets determine how water flows, it starts to move against the law of gravity. It moves upwards – to money – from the poor to the rich, from agriculture to industry, from the countryside to the city. In water markets, water moves from having a high ecological and social value, but a low market value, to having a low ecological and social value, but a high market value.

Water markets take water from where it is needed by nature’s economy, people’s economy and the countryside, to where there is purchasing power for water as a commodity—the urban areas, industry and industrial agriculture. Managing a scarce and precious resource like water requires conservation, equity and the recognition that as the basis of life, water is priceless.

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