10 Mar 2009

Missing the Pond for the Drops

The title of this post is my reformulation of "missing the forest for the trees," and the subject of the post is a new report from the Pacific Institute.

In Water Scarcity and Climate Change: Growing Risks for Businesses and Investors, the PI assesses the various risks to water supplies that companies should consider (climate change, water quality, etc.) and how companies can prepare or react (water foot printing, etc.)

Two ideas dominate the report: Higher prices are a "regulatory risk" and water footprinting should be used to identify vulnerable points AND counter political pressure.

Unfortunately, the report does not cover two major economic points:
  1. How low prices lead to shortages.
  2. How shortages (and subsequent rationing) reduce reliability and magnify business losses.
These oversights are surprising to me, because PI co-produced the report for Ceres, "a national coalition of investors, environmental groups and other public interest organizations working with companies to address sustainability challenges," and water shortages are surely not sustainable.

(If the report was prepared by a pro-business group in a developed country [like this one], I'd be less surprised -- because these groups worry more about prices than rationing.)

If I was preparing this report, I would note that rationing is a business risk and suggest that businesses support higher prices as a means of increasing reliability. Since businesses can pass higher prices through to customers, they are preferable to business interruptions caused by rationing.

These oversights are perhaps predictable -- none of the four authors have economics degrees. Unfortunately, PI made the same mistake (failing to consider economic incentives) when they implied that farmers are "not conserving enough." I hate to say it (again), but these reports spend too little time on ponds and too much time on drops.

I suggest that some of the organizations listed in Appendix C ("Collective Action Tools and Initiatives for Corporate Water Stewardship") get some advice from economists familiar with supply and demand of natural resources.

Bottom Line: The biggest risk that businesses face in the water sector is the risk of shortage and rationing, and the easiest way to avoid that risk is to ensure that water prices reflect water scarcity.

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