Expert Commentary

Comparing price and non-price approaches to urban water conservation

2014 and 2009 studies from U.C. Riverside, Yale and the Harvard Kennedy School on the relative merits of policies to encourage efficient use of scarce water resources.

Lawn sprinkler

Much of the American West has always been dry country, and global warming may make things even worse in the future: California is struggling through a years-long drought that could become a decades-long “mega-drought,” even as the region’s population continues to grow. This has increased tensions between urban and rural water users, particularly as groundwater supplies fall to historically low levels.

With the need to conserve water growing ever more urgent, a wide range of options are being explored, from voluntary efforts to mandatory restrictions. Prescriptive regulations can include policies such as limiting outdoor watering or requiring the installation of low-flow fittings. Market-based approaches involve adjusting water prices according to reservoir levels.

A 2009 paper by Sheila M. Olmstead of Yale and Robert N. Stavins of the Harvard Kennedy School explored the relative merits of prescriptive and market-based conservation approaches. The paper compares the policies’ ability to achieve water conservation goals as well as their cost-effectiveness, distributional equity, enforce-ability and political feasibility. It found that using prices was more cost-effective than rationing because it allows households, industrial facilities and rural customers to adjust water use based on their different costs and benefits. On average, a 10% increase in the price of water was found to reduce residential demand by between 3% and 4%.

A 2014 study in the journal Land Economics, “The Residential Water Demand Effect of Increasing Block Rate Water Budgets,” provides additional insight on these questions, including the effectiveness of “tiered pricing,” in which per-gallon prices increase as usage levels rise. The authors — Kenneth A. Baerenklau, Kurt A. Schwabe and Ariel Dinar of the University of California, Riverside — refer to this as a “fiscally neutral increasing block rate water budget price structure.” The theory is that such structures would increase the incentives for conservation among customers who use large amounts of water, while sparing those who consume less.

The theoretical basis for price-based mechanisms is “very strong,” the authors state, and a notable example is the EPA’s Acid Rain Program, established as part of the 1990 Clean Air Act amendments. “A handful of papers have now established the parallel theory for water conservation, and statistical studies have generated empirical estimates of the potential economic gains from a shift from technology standards and rationing to market-based approaches.”

The study’s findings include:

  • Tiered water pricing was found to reduce demand by approximately 17%, achieved gradually over more than three years. The savings were achieved in a way that was less costly than prescriptive approaches and more equitable. “The gains from using prices as an incentive for conservation come from allowing households to respond to increased water prices in the manner of their choice, rather than installing a mandated technology or reducing specified uses.”
  • Tiered pricing addresses an equity concern of market-pricing programs: The allocation of a scarce resource by individuals’ willingness to pay (WTP), and thus the possibility of pricing out poorer people. Flat rates — where every gallon of water is priced the same — provide little incentive for well-off individuals or companies, who are less price-sensitive, to reduce their use. Increasing the per-gallon rates as consumption rises incentivizes heavy users of water without penalizing those who are already conserving, and results in greater savings overall.
  • Market-based systems were found to be less costly to households than watering bans and other methods: In a study of 11 urban areas in North America, “for the same aggregate demand reduction as that implied by a two-day-per-week outdoor watering restriction, a market-clearing price would result in gains of about $81 per household per summer, about one quarter of the average household’s total annual water bill.”
  • Watering bans and other prescriptive methods come with significant associated costs: Earlier research found that two-day-per-week sprinkling restrictions in Perth, Australia, cost approximately $100 per household annually, while a complete ban on outdoor watering imposed per-household costs ranging from $347 to $870. Similarly, “mandatory water restrictions in Sydney, Australia over a single year in 2004–2005 resulted in economic losses of $235 million, or about $150 per household, about one half the average Sydney household water bill in that year.”
  • Evidence is mixed on the effectiveness of prescriptive water-consumption programs. For example, “summer 1996 water consumption restrictions in Corpus Christi, Texas, including prohibitions on landscape irrigation and car washing, did not prompt statistically significant water savings in the residential sector.” Experience in California in 2014 found that voluntary limits were even less effective: Water agencies with mandatory reduction programs saw a 5% drop in use, while those with voluntary programs saw consumption rise 4%.
  • Standards-based regulations — for example, requiring that a particular technology be installed to reduce water use — “can actually dampen incentives to innovate, locking in whatever is state-of-the-art when the standard is passed.”

A 2015 story in the New York Times explores the U.C. Riverside study through the lens of two U.S. cities, Fresno, Calif., and Sante Fe, N.M. While both cities have faced drought conditions, Fresno has been reluctant to raise water rates, and so favored watering bans and other approaches. Sante Fe instead went with an aggressive tiered-rate approach: The difference between the water bill of a family of four that used 50 gallons per person per day and one that used 150 per day could be as much as $229. The result has been a 20% decrease in the city’s total water consumption, even as the population has increased by 10%.

Keywords: water, municipal, conservation, cap-and-trade, market-based conservation, California, local reporting

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