Fluctuations in supply are a fact of nature. When that fluctuation is
in water, it poses a particularly acute problem for some - as in the
As water is essential, and from nature, it is often regarded as a
(free) public service. While there is no doubt that some water needs just
have to be met, it rarely justifies tying the pricing hand behind your
back. Using price to match demand to the supply available would avoid the
need for water restrictions such as those being introduced in Melbourne
this week. Higher prices would also stimulate investment in water supply
and distribution. By contrast, under-pricing water guarantees that
shortages are exacerbated and funds for investment limited.
In most markets, an excess of demand over supply leads to a price rise
– conserving use and financing substitutes and new technologies. A bad
grape season in France means that Beaujolais prices will be higher,
encouraging more production next year. Any pub that served beer at less
than cost would quickly find itself simultaneously running dry and going
Even so, periodic variability in supply should not create crises if the
rationing mechanisms used instead of price are perceived as fair and
predictable. Urban users accept the need for restrictions if they are not
frequent. Commercial users such as farmers could take out insurance, or
more likely self-insure, against the possibility of a bad year. A
profitable farming activity would require that the good years compensate
for the bad, with last year’s good crop compensating for this year’s
poor one - which will see a winter crop harvest of less than half last
year’s bumper crop.
In fact it is not the variable supply per se that is the real problem.
It is the possibility that as currently priced there is just not
enough water; that for a number of regions demand is consistently
This situation of shortage is not because supply has been stagnating.
In the last 50 years the storage capacity of large Australian dams has
increased fourfold. Rather, demand has grown even faster, placing
consistent and increasing pressure on water resources. The cheapest
sources of supply are utilised first, so that in many regions the options
for significant increases in supply are limited or costly or both.
Part of the problem is that water is priced permanently below the cost
of supply, particularly for much irrigation water. This is being addressed
under the National Competition Policy reforms, whereby the States are
making progress towards full-cost pricing of water. Progress is slow,
however, because of the very real social costs involved in changing land
use away from low-value crops (per volume of water input).
An increase in the price of irrigation water would help to redress the
balance between demand and supply. The price increases would be
significant in areas currently facing "chronic" water shortages,
and would signal that current land uses may not be economic in such
regions. The allocation of water property rights, and institution of water
trading, would also help, since those endowed with tradable water rights
would have an asset from which they would seek to earn the best income.
Allocation of these rights would create new wealth, which if captured by
government could assist with problems concerning the environment and
This raises a further issue, which lies at the heart of Australia’s
long-term water problem. It is the fact that water use by one user often
imposes external costs on others. Some of these "externalities"
have already been dealt with - for example, untreated waster water used to
be dumped in rivers and seas. Now users have to pay for the cost of
treating their waste before it is released back into the environment.
In Australia the big externalities are rising salinity and river
degradation. Salinity is an "external cost" because excessive
water use on one property causes rising salinity and land degradation in
another. Similarly, those chopping down trees do not currently bear the
consequences for rising dryland salinity. While the NCP water reforms are
making some progress in ensuring users face the direct costs of water
supply, the external costs remain unaddressed.
Again, pricing is likely to be an important part of any solution. By
increasing water prices to reflect the costs imposed on the environment
and other users Australia can ensure that water usage decisions are in the
nation’s best interests. Until then, a valuable resource will continue
to be squandered.
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