Annual drought / water pricing post

North Carolina is experiencing severe drought. In response, voluntary command and control regulations have arisen to deal with the water shortage. Funny story ... voluntary command and control regulations don't work (Raleigh's water use sets record in August):

Despite mandatory restrictions, Raleigh's water use has soared this month, setting three all-time daily highs.

The use directly correlates with recording-breaking temperatures. Still, the numbers startled city officials, because use spiked when only half of their water customers should have been watering their lawns, which officials think accounts for as much as 20 percent of total water consumption.

Yesterday, Governor Easley asked North Carolina residents to reduce water use by 20% and Raleigh "... will limit lawn watering with sprinklers and irrigation systems to one day a week and vehicle and power washing to the weekends." Don't expect these policies to have much impact. Command and control regulatees usually can find a way around restrictions. If commercial fishermen are told to reduce the number of fishing trips then they get bigger boats so that they can catch more fish on each trip. In the same way, if households are asked to water their lawns on a limited number of days, then they'll increase the amount of water they put on their lawn that day.

Price controls are the real problem. If the price of water was allowed to rise sufficiently in response to drought conditions (i.e., a supply reduction) water consumption (i.e., quantity demanded) would fall during a drought. Here is how Olmstead, Hanemann and Stavins say it in their conclusions in the latest issue of the Journal of Environmental Economics and Management (doi:10.1016/j.jeem.2007.03.002):

... To the extent that [increasing block prices] increase the portion of consumers facing efficient prices for a scarce resource on the margin, they may well be welfare improving (and environmentally beneficial at the same time). Exploration of the efficiency advantages of IBPs is another area for further research.

Got that?

Comments

[robertdfeinman]

This is a variation of the old issues about using taxes to control behavior.

The first issue has to do with the use of the revenue raised. The prototypical example is the cigarette tax which was supposed to fund anti-smoking programs in some states, but quickly got shifted elsewhere. If smoking declines because of the rise in cost than the revenue stream also declines. This puts the government in the position of having goals in conflict with each other.

The second issue has to do with fairness. Usage taxes for necessities always impact the poor more. I'm willing to bet that it isn't the poor who are watering their lawns or filling their swimming pools. Those that are over using the water supply would be putting a burden on those who can least afford it and who are causing the least impact.

A consumption tax might be a way to deal with this. In my area some things like natural gas are priced so that the rate increases when consumption is above a given level. This is supposed to penalize the McMansions. I have no idea if it actually influences behavior.

In many instances it turns out that the biggest users of resources are businesses and the rate structure works the other way for them. Discounts for large consumers.

I don't see any mention of where the rest of the water is going. A comprehensive conservation policy should cover everything.

[joshua corning]

If the price of water was allowed to rise sufficiently in response to drought conditions (i.e., a supply reduction) water consumption (i.e., quantity demanded) would fall during a drought.

I was at a water district meeting where guy in a wheel chair complained about his water bill being to high after he filled up his pool. He said he was on a fixed income and it was unjust that he should be charged overage.

Good article by the way John.

[joshua corning]

This is a variation of the old issues about using taxes to control behavior.

Not really sure this is a tax issue...less water means higher prices. The problem seems to be that water utilities, because they are public, refuse to adjust their prices to market demands.

[Tim Haab]

Hey, nice post...it's about time someone explained some economics around here.

[Eric H]

A drought in Carolina?! Those people don't know what it is!

John, I'm glad you're tackling this. I had a running debate with the local city's public relations guy on this topic. The city tried alternating days, report-your-neighbor watches, and all sorts of other C&C tactics, but *not* raising prices. Luckily, rain returned before it became a crisis (that year). In the next county over, they raised prices dramatically and people started talking about pulling out the Kentucky Blue Grass and using xeric plants (which I'm doing anyhow).

In both places, the cities simultaneously subsidized new real estate development. They chose not to charge the developers for new water distribution and sewage, paying for it out of general funds instead. Isn't it irrational to introduce command & control of an increasingly scarce resource on one hand, and to subsidize the use of it on the other? Seems like some sort of failure ...

Robert;
"This is a variation of the old issues about using taxes to control behavior."

I think these are properly labeled "usage fees", not taxes. All prices control behavior.

"Usage [fees] for necessities always impact the poor more."

Your point is valid: that's one argument for using increasing block pricing for water. There isn't a wikipedia article, so I'll do my best from memory (I guess I'll drag out the Tietenberg and make a wiki article tomorrow).

"Increasing block pricing" (IBP) means that you charge one rate (probably very low) for a usage level corresponding to minimal use (probably the average use during the winter months, i.e. human consumption for drinking & cooking), a higher rate per gallon for the next block, and increasingly higher per-gallon rates thereafter. Thus, the lawn waterer will pay the same for the first X gallons and considerably more for the lawn water (e.g. up to 2X). The lawn & pool owner will pay the same for the first X gallons, considerably more to water his lawn (2X), and dramatically more to fill his pool (3X). Perhaps the first X gallons cost $Y/gallon, the next X gallons cost $2Y/gallon, and the next X gallons cost $4Y/gallon. Or something like that. Everyone pays the same for "necessities" (although even poor Americans are drinking impressive quantities of bottled water these days), but the extravagant users pay extravagant prices. The outcome is theoretically potentially efficient, even though you probably don't agree with the definition of efficiency.

"In many instances it turns out that the biggest users of resources are businesses and the rate structure works the other way for them. Discounts for large consumers."

WARNING: Probably true for large businesses, completely the opposite for small ones. The city, county, and state pillage my wife's one-woman business, charging her *double* for services even though she probably produces much less trash (most of her "waste" is recycled), uses less water, and produces less sewage than most houses. This has been her experience in two states and several cities.

"A comprehensive conservation policy should cover everything."

That's a little utopian, isn't it? Where are these omniscient regulators coming from?

[robertdfeinman]

Eric H:
When I said biggest businesses I meant biggest. How much water does a refinery or paper mill use? Now compare this to your wife's small enterprise.

It may be that small firms are unfairly penalized, but that's because they aren't organized and don't have any political clout. Most merchant's groups seem to focus on keeping streets looking nice and parking, not national tax policies.

As for my remark:
"A comprehensive conservation policy should cover everything." I don't see any mention of big brother.

I think it is government's role to codify policy. In a democracy this is supposed to represent the will of the majority. If it doesn't, then the democracy is defective in practice.

Having laid down a policy there are many mechanisms available for enforcing/promoting it. Not all of these involve the government.

Currently we do have a national policy we just don't call it that explicitly. It is to support a strong military/police sector and to use our international power to obtain resources and finished goods at prices favorable to us. The people, in general, agree with this. No pol is suggesting that there be laws put in place limiting McMansions or SUV's.

Some of us think this is shortsighted, but so far we haven't had much influence on elected officials, even if there is increasing discussion taking place elsewhere.

[Eric H]

"When I said biggest businesses I meant biggest."

But you didn't say "biggest businesses", you said "...the biggest users of resources are businesses..." I wanted to carefully circumscribe what was being said.

"'A comprehensive conservation policy should cover everything.' I don't see any mention of big brother."

You don't have to say "big brother": the word "policy" implies a management plan. In this case, by the government.

I'm not sure I understand where you are going with the rest of your statement: first you say democracy is defective if it doesn't enact the will of the majority, then you say that the people generally agree with the current de facto policy, now you want to change that "shortsighted" policy. Why do you want to thwart the will of the majority? Isn't that anti-democratic of you? In what way is it substantively different than what the current administration is doing? I think they call it "leadership", though I'd call it "misguided" or worse.

I think what you're getting at is that the majority isn't always correct; the short form of that argument is Federalist X, a longer form is Buchanan & Tullock's Calculus of Consent. I might be inclined to agree with you, but I think you need to be very circumspect about how you approach this.

[joshua corning]

Why do we need all this fuss about setting up regs and price fixes?

Just sell the water utility and let the market conserve the resource.