Economics of Water Management

by

Xueqin Zhu

• LAST REVIEWED: 15 January 2015
• LAST MODIFIED: 15 January 2015
• DOI: 10.1093/obo/9780199363445-0024

Introduction

Water is a scarce natural resource. It is not only used as an input to economic activity such as irrigation, household and industrial water use, and hydropower generation, but also provides ecosystem services such as the maintenance of wetlands, wildlife support, and river flows for aquatic ecosystems. Water has been recognized as an essential economic good for its use in economic activity. However, we are facing increasing water quantity and quality problems as a result of population growth, economic development, and climate change. The quantity problem is closely related to water scarcity (increasing demand and declining supply) for the competing use of water resources or damages from floods in river basins, while the quality problem is related to water pollution, which could be caused by negative externalities. These negative externalities cause negative impacts on water users. Economics has been playing an increasing role in both quantity and quality management. As economics is a science about optimal allocation of scarce resources, economic instruments such as prices can adjust demand and supply and deal with externalities. Before the 1970s, water resource management was focused on increasing the water supply, mainly by means of engineering solutions. Since the 1970s, governments and researchers have increasingly been focused on demand management measures, including voluntary water transfers, water markets, and water pricing to limit water demand. As such, economics of water management has evolved as a branch of environmental and resource economics. The basic economic principle in managing water resources is that we need to balance the demand for water and the supply of water resources, which can theoretically be achieved through price signals in water markets. This has led to the emergence of water markets and water pricing. However, water is not a standard private good, because of its physical attributes. The provision of water in the natural environment also follows hydrological cycles. Precipitation, evaporation, and runoff determine water availability in the different seasons at different locations of the globe. Natural water can have specific characteristics related to the questions of whether it is rival or non-rival for the users and whether the users are excludable or non-excludable from its use. All these special features of water resources imply that we may need to manage water resources by means of interventions that go beyond the simple economic system. Therefore, integrated water management, which integrates the economic system and the natural water systems within a broad perspective of socioeconomic, institutional, political, legal, ecological, and cultural characteristics, has become a common option in water resource management.

General Overviews

The studies discussed in this section provide general overviews of the economics of water management and introduce the basic concepts of economics used in water management regarding both quantity and quality. Water has been used for different purposes for human society, such as irrigation for agriculture, hydropower generation, household and industrial water use, and environmental purposes. As water is a scarce resource, the allocation of the resource aims to achieve the balancing of demand and supply. The first rigorous economic conceptualization of water demand and supply is believed to have been developed by the French water engineer Jules Dupuit in 1844, as discussed in Ekelund and Hebert 1999. An influential paper on conservation of natural resources in the field of environmental and resource economics is Krutilla 1967. Water demand has increased as a result of expanding urban growth, changes in agriculture, and increasing concern for the environment. The general economic concepts (e.g., demand and supply as well as markets) can be found in the most commonly used economics textbook, Varian 2010, which has been updated in recent decades. The purpose of economic analysis of water resource management is to provide useful information for water policy design aiming at sustainable allocation and quality conservation of water. Good examples can be found in Griffin 2006, Shaw 2005; Young 2005 (cited under Water Quantity and Quality Management), and Convery 2013. In particular, economic models are useful tools for water policy design (see, e.g., Batten 2007 and Braden and van Ierland 1999).

• Batten, D. F. 2007. Can economists value water’s multiple benefits? Water Policy 9:345–362.

  DOI: 10.2166/wp.2007.020

  Clearly discusses why water is not an ordinary economic good and its special attributes (essential and scarce but fugitive, bulky, mostly non-substitutable, and as input for ecosystem) and reviews some economic methods to assess water’s benefits (e.g., cost-benefit analysis, water-value flow analysis, input-output models, computable general equilibrium models).

• Braden, J. B., and E. C. van Ierland. 1999. Balancing: The economic approaches to sustainable water management. Water Science and Technology 39:17–23.

  DOI: 10.1016/S0273-1223(99)00082-7

  A very concise and clear paper on the economic approach as one of balancing competing objectives to the management of water resources and systems. Provides very clear economic concepts and a framework for sustainable choices concerning water supply, wastewater treatment, irrigation, and watershed management.

• Convery, F. J. 2013. Reflections—Shaping water policy: What does economics have to offer? Review of Environmental Economics and Policy 7.1: 156–174.

  DOI: 10.1093/reep/res017

  The paper reviews the extensive and evolving literature on the economics of water policy; explains some history of cost-benefit analysis, non-market valuation, water pricing, and water markets; and highlights how economics can contribute to water management, particularly the role of cost-benefit analysis in assessing water supply measures.

• Ekelund, R. B., and R. F. Hebert. 1999. The secret origins of modern microeconomics: Dupuit and the engineers. Chicago: Univ. of Chicago Press.

  This is a very popular and debatable book on the history of economics which emphasizes the contributions of French engineers, particularly Jules Dupuit, to the development of neoclassical microeconomics (the first rigorous economic conceptualization of water demand and supply and cost-benefit analysis in building bridges).

• Griffin, R. C. 2006. Water resource economics: The analysis of scarcity, policies and projects. Cambridge, MA: MIT Press.

  A comprehensive textbook on economics of water resources. The focus of the book is on water quantity. Chapters 7 to 11 (water marketing, water pricing, demand analysis, supply analysis, and modeling with demand and supply) are the core of the economic analysis for water quantity management.

• Krutilla, J. V. 1967. Conservation reconsidered. American Economic Review 57.4: 777–786.

  An original and influential paper on conservation of natural resources, which has set much of the research agenda of environmental and resource economics in the past forty-five years. Develops the original concept for preserving the natural environment and the initial idea for the option value of a natural resource in cost-benefit analysis.

• Shaw, W. D. 2005. Water resource economics and policy: An introduction. Cheltenham, UK: Edward Elgar.

  A modern textbook about the allocation of water resources and related issues, such as law, water quality, residential water supply, agricultural water use, risk and uncertainty in supply and demand of water, groundwater, environmental services of water, and the role of dams in regulating floods and droughts.

• Varian, H. R. 2010. Intermediate microeconomics: A modern approach. New York and London: W. W. Norton.

  A solid and very popular microeconomics textbook for economics students. All the useful economic concepts, such as consumer and producer behavior and market equilibrium, are well elaborated.