Do economics and water mix?

Posted on: July 2017

Colin Green

Colin Green is Emeritus Professor of Water Economics at the Flood Hazard Research Centre, Middlesex University. In 2003, John Wiley published his ‘Handbook of Water Economics’; he is now finishing an ‘Introduction to the Political Economy of Water Management’.

Over many years of giving introductions to economics to water specialists, I learnt that the best way of discouraging them from zoning out was to start by asking how many of them disagreed with at least one of the following statements:

•    Astrology offers greater intellectual rigour than economics.
•    Accountancy provides greater intellectual excitement than economics.
•    Economics speaks with less moral authority than Adolf Hitler when he advocated vegetarianism.

My experience has been that only about 1 in 20 of those asked disagree with any of the statements.   So, to these groups of water specialists, economics is perceived to be no more than a dubious form of double entry book-keeping.   What has gone wrong, and why has adding economics to water not delivered useful insights?  The answer I argue lies in the first and third statements, both of which I find it difficult to disagree with.  The intellectual problem in economics is that it has made many lazy assumptions of convenience and then applied the derived theory as a Procrustean Bed onto which reality is forced; the result is many torn joints together with chopped off heads and feet as the inconvenient reality is forced to fit the rigid frame of the theory.  Three examples of such assumptions of convenience is that individuals and firms always make optimal decisions; that the rates of savings and investment are in a homeostatic relationship; and that fixed costs can be ignored in determining prices.  Instances of chopped off heads and limbs include change, conflict, collective action, justice, economies of scale, and doubt.

Conversely, political economics has the potential to offer enormous intellectual excitement as, at its centre, is the question: how can we make ‘better’ choices?  Answering this question requires uncovering the nature of choice, what stakeholders mean by ‘better’, and how ‘better’ choices can be made.  In turn, this means unpicking such issues as why choice is necessary and what do we mean by value and cost.  But orthodox economics has further failed water management in a number of other ways:

• It does not address the physical nature of water management; that catchments and aquifers are highly connected systems, notably having both directionality and time dimensions; that it is what is entrained in the water column that determines it utility for different purposes; that water is heavy and incompressible; and its availability is subject to a high degree of variability over time.
• It does not address the economic characteristics of water management; that it is highly capital intensive so that a key problem is how to raise capital at the lowest cost, and to make the most effective use of that capital.  There are also strong physical economies of scale so concentration often means lower costs, and variable costs frequently fall or remain constant as output rises until the capacity of the system is approached. 
• Orthodox economics claims to be an ethics free zone, whilst in reality many ethical claims are implicit in orthodox economics. Unless the stakeholders also believe that all choices can be made without any ethical concerns such as morality, justice and legitimacy, orthodox economics omits possibly major aspects of choice.  If you ask me to kill my children, ‘how much will you pay me?’ is not one of the morally acceptable answers.  Orthodox economics claims to be able to determine the ‘optimal’ courses of action, a claim which combines the maximum of hubris and impertinence. 

Social economics and the water industry

The social role of economics is to help the stakeholders to make what they consider to be ‘better’ choices including the means of implementation.  It should seek to help by identifying the nature of choice itself, some of the possible courses of action to adopt and the consequences to the economy of each of those options.  Political economists should be able to help them explore what they mean by ‘better’ and ways of resolving their conflicting views. One of the implications here is that economists have to work in an inter-disciplinary and trans-disciplinary context.

The particular areas of choice in water management of greatest concern are provisioning, including potable water and wastewater collection and treatment; behavioural change, notably demand management; retro-fitting SUDS; and allocation - sharing the available resources so that the best use is made of them.  Orthodox economics defaults in each case to arguing for a ‘market’ like approach, although it proves quite difficult to define what are the defining features of a market.  Given that over history, the predominant mode of provisioning has been through different forms of collective action rather than by either ‘market’ or government provision, a key question is: what drove the adoption of this form of provision?  An assumption in orthodox economics is that pricing can simultaneously enable full cost recovery and induce behavioural change.  This I have argued is akin to attempting to cross-bred lions and zebras in the hope of a savannah full of gambolling zebons and libras; the result is instead some very contented lions and piles of bones.  In a capital intensive industry, the security of the revenue stream influences the cost of capital where such fixed costs vary between 50-90% of total costs.  Revenue security can be provided by having a high standing charge but this results in a weak incentive to the consumer to reduce consumption.  It is necessary therefore to look for different mechanisms for the two different problems.

Given that pricing has proved to be remarkably ineffective in changing water usage, two key questions are: why is pricing so ineffective, and what tools would be more effective?  Why, for example, has Sainsbury’s managed to reduce water consumption by 50%?  Why is household per capita consumption 30% lower in Belgium than in the UK?  Conversely, the introduction of a 5p charge for plastic bags was immediately followed by an 85% drop is demand; how did this occur? What are the differences, or even the similarities, between water services and plastic bags?  So central concerns of economics have to be why does change occur, what are the barriers to change and the appropriate incentives to overcome those barriers, as well as how to cope with external changes and to learn from experience.  Whilst orthodox economics centres on stability, useful economics has to centre on dynamics.

The question of what is uncertainty has been left indeterminate, including whether it can be handled through the means of probability calculus.  The general assumption is that anything which can be treated as a number bounded by 0 and 1 can be treated as a probability. Thus, we may be seeking in some cases to multiply apples by clouds.  So part of the problem with defining uncertainty is that we are unclear what we mean by a probability.  Given the centrality of both uncertainty and probability in choices, a sustained effort to define what we mean by both is necessary.  In addition, whilst probability is typically treated in terms of a frequency distribution, the problem in water management is commonly to manage in the face of variations over time, including seasonal variations and climate change.

Consequently, to date, the mixing of economics and water has often been akin to what happens when an oil tanker sinks. Whereas political economics can be both exciting and useful in helping stakeholders to address difficult and critical problems.