Economists: Let Market Set Price of Water in California Drought

On Monday, an appeals court in California ruled that tiered water rates are unconstitutional. This decision will affect more than two-thirds of the water providers in the state, which use pricing schemes to encourage conservation. These water providers will need to move to a uniform pricing structure, which could increase rates for water-intensive businesses throughout the state.

Meanwhile, the IGM Economic Experts Panel took a poll on the issue, and the majority agrees that such a pricing change would bring positive economic effects to the state.

Californians would be better off on average if all final users in the state paid the same price for water—adjusted for quality, place and time—even if, as a result, some food prices rose sharply and some farms failed.

Nearly seventy percent of the panelists either agreed or strongly agreed that a uniform pricing structure for water would, on average, leave Californians better off. Many of the panelists cited benefits such a change would bring that could not be achieved by other means: “Equal prices imply that all final users will value the last gallon they use the same,” said Oliver Hart of Harvard. “[That] ensures efficiency. Consumer rationing does not,” he said.

However, some panelists saw the “on average” part of the statement to be problematic. “‘On average’ hides some serious adverse consequences for some people,” said Larry Samuelson of Yale.

“There would be losers and serious adjustment costs, not all economic,” said Richard Schmalensee of MIT. “It is hard to be confident about ‘on average,’” he said.

Farmers, it appears, will be doing most of the adjusting, but not so much that the industry will collapse, said some panelists. “[The change] does not have to bankrupt farmers,” said David Autor of MIT. “The Coase Theorem applies,” he said.

“The marginal value of water differs greatly across uses,” said Kenneth Judd of Stanford. “Change in food output will be small; farm use would not decline by much,” he said.

The panelists who remained uncertain were unconvinced that better results “on average” are really achievable. “There would be winners and losers,” said Robert Hall of Stanford. “A better policy would engineer a roughly Pareto improving change,” he said.

Although the state has ruled tiered pricing to be unconstitutional, it is unlikely that consumers will accept the change without protest. But perhaps market pricing of this increasingly scarce commodity will encourage more conservation and wiser usage, not just in California but across the nation as well. Then again, perhaps not.