10 Apr 2012

The value of water

Addendum: Consider Umwelt when you consider values (hover your mouse over the cartoon).
In my book, I mention "value" over 200 times and the "value of water" 12 times. When discussing value, I use the phrase "personal subjective value of water" to remind readers that the value of water varies among individuals, unlike the cost of providing that water or the price that's charged for it -- whether it comes in a bottle, in a cubic meter to the tap or a megaliter/acre-foot down an irrigation ditch.

These ideas -- explained in Chapter 1 [free sample chapter PDF] -- are related to the economic concept of a "demand curve" that describes how our value of water (or any other good) changes according to how much of it we have. Thus, we put the highest VALUE on the first unit of water we receive, a lower value on the next unit, and a lower value on the unit after that.

These values form a downward sloping demand curve that "exists" before we even talk about price or cost.

When a price is given for the good, then we consume as much of it as we can AS LONG AS THE VALUE TO US exceeds its price. Some people will consume more than others at the same price (liters of bottled water, length of shower, etc.)

The total SUBJECTIVE PERSONAL value of that consumption to us is then the difference between the value of what we consume and what we pay for it, or the area under the demand curve.* This figure shows value in the blue triangle:**

The most important lesson from this little example is that nobody knows how much value you get from that consumption. It's even arguable that YOU do not know the value of how much you consume, since you do not often face the choice of "how much is that first litre of water worth to me" in a true auction/market environment.

Maybe you say "a lot" and others would agree, but "a lot" means different things to different people, and THAT statement leads me to this RFQ (via KC and AL):
Value of Water to the U.S. Economy: Call for Papers and Request for Quotes
Under contract to the U.S. Environmental Protection Agency Office of Water, Industrial Economics, Inc. is seeking proposals from independent experts for the development of papers on (1) water's contribution to the U.S. economy, (2) current capabilities to analyze and estimate this contribution, and (3) the steps necessary to improve our understanding of water’s economic contributions.
Although this contract has been awarded, money will be spent, and values will be discovered estimated guesstimated made up, I'd like to point out that none of these numbers will mean anything in two ways:
  1. I may not agree with numbers that YOU give for the value of water used to grow a tomato, fabricate a silicon chip, etc.***
  2. Even if we agree on values, then those estimates will be wrong. Real values are based on personal choices, not the price paid or cost of delivery.****
I'm willing to bet that there's no policy recommendation to take, even if (1) happens, either because different values of water will not lead to reallocations (that's a political decision) or because those "values" may be wrong, which means that reallocations may lead to a LOSS in total value of water in use.

What do I recommend instead? Set up mechanisms that make it easier for us to reconcile our values of water, so that water ends up going to highest and best use. There's NO NEED to know values, just a need to reconcile them. These are scarcity-adjusted, full cost water prices (in the case of urban water service) or markets for water (in the case of irrigation or bulk municipal water). I've discussed these endlessly in this blog, but they are also discussed in Chapters 1 and 5, respectively, in my book.

For more on these issues, I suggest that you (and the EPA!) look at this report from the European Environmental Agency: "Towards efficient use of water resources in Europe," which relies on a discussion of "value" that I was very happy to criticize in Marseille. Here's the MP3 [60 min 21 MB] of the whole presentation and my slides [PDF].

My main point (see the slides) is that the EEA needs to set a minimum water flow to protect the environment, then use market mechanisms to allocate water to economic uses (urban, industrial, agricultural).

Bottom Line: The EPA should not waste its money (our money!) to "measure" water's contribution to the US economy. It should work on improving the ways we allocate water, to reconcile our PERSONAL SUBJECTIVE VALUES in a way that maximizes our water wealth.
* And above the price line, since the value under that price line is cancelled by the money we have to give up to get those units.
** If yo wonder why price/value (the independent variable and the outcome) is on the vertical axis and quantity (the dependent variable) is on the horizontal axis (the economic "norm"), then read my article [PDF] on the problems with that.
*** Note that a correct way to value water in use is NOT to divide total value by amount of water (that would make "lawyer water" far more important than "strawberry water"), but to evaluate the relative contributions of water and other inputs -- something that's very complex and not worthwhile, compared to pricing water correctly and letting people use as much as "makes sense" to them.
**** Economists agree that people buying a last unit "on the margin" pay a price that's at or just below their value for that LAST unit, but there's no way of knowing the value of earlier, "inframarginal" units.