Home > Uncategorized > Water. Or: applying the ‘Coase-theorem’ outside Chicago

Water. Or: applying the ‘Coase-theorem’ outside Chicago

Not energy but ‘clean water’ might become the largest future economic bottleneck for an ever-growing human population. Will this be solved by introducing ‘markets’, as suggested by neo-liberal ‘Chicago’-economists who state to be inspired by Ronald Coase who, according to them, proved that markets are more efficient at solving properly priced ‘externalities’ than firms or governments? Let’s first analyse what Coase really wrote:

From these considerations it follows that direct governmental regulation will not necessarily give better results than leaving the problem to be solved by the market or the firm. But equally there is no reason why, on occasion, such governmental administrative regulation should not lead to an improvement ineconomic efficiency. This would seem particularly likely when, as is normally the case with the smoke nuisance, a large number of people are involved and in which therefore the costs of handling the problem through the market or the firm may be high.


And this caveat is, when you think about it, not just about a large number of people. It is also about power, rents, rigged prices, culture, historical circumstances  and a whole bunch of other variables. ‘Water’ is a case in point . For a long time (thousands of years) water management (drainage, irrigation, flood protection, drinking water, pollution) has led communities to establish all kinds of communal institutions (not just governments!) to guarantee socially desirable outcomes. And we’re still learning, like in New Orleans. Markets and prices can indeed play an important role in solving some of the water problems we have. But ill-defined property rights and markets might as well aggravate the problems (I was really flabbergasted when I discovered that many houses in the privatized UK do not have water meters – the government-owned water companies in the Netherlands take great care that even house boats have meters! And let’s not even start about the epic difference in sewer maintenance in the UK and the Netherlands – no Victorian sewer systems behind the Dunes). About the complexity of the situation two lengthy quotes from:

(A) A 1997 article by Mason Gaffney about failures of the Californian water management system and the devastating consequences of efforts to ‘neo-liberalise’ supply and demand without taking al kinds of rents, subsidies and conflicting uses into account.

(B) A recent blogpost on the website of the Worldwatch Institute about some present improvements in Californian water management (which are large and by consistent with the ideas of Gaffney – though some people seem to be compensated for the loss of water use subsidies, something he warns about)

Ad (A):

We can multiply the value of output from limited natural water supplies by allocating them to higher uses. To this end we need a market in raw water, but existing markets work badly, for several reasons. Sellers are undermotivated, absent taxes or debt. Free groundwater subverts the pricing of surface water. Loss of elevation, and damage from effluents, and instream uses are not charged for. Obsolete subsidies abound; obsolete entitlements dominate allocation. Some trades extinguish public rights. Rent-seeking distorts allocation. Needed public agencies have been sub verted by organized land speculators … water, in many areas, has been used as a “yield-cutting substitute”—a term I have had to coin for lack of standard  theoretical treatment of what should be a basic tool of economic analysis.  Water is such a potent substitute for labor and capital that more water often  means lower yields from each acre. The productivity of water is measured,  not in higher yields, but in lower labor and capital costs that raise net rents in spite of loweryields. I am not aware that farm production economists have ever faced up to this phenomenon and its implications … All of this leads to a wonderful corollary: You can tax water withdrawals without hurting the water-based California economy. A simple solution to many of our intractable water problems would be a severance tax on water withdrawals. Legally, if you can regulate it you can tax it. A tax, properly gauged, is an economic price charged by the owner of water (the State of California) for using its scarce property. If the market champions, along with Chicago-School economists and allied “new resource economists,” were more thorough in their support for the price system (and less mistrustfulof the taxing power of legislatures), they would boost this application of basic price theory with all their influence and talent. … Environmentalists see economists as ignoring or trivializing their form of demand for water. Demands for instream uses, recreational uses, fishing, wildlife, saltwater repulsion, amenities, protection against non-point pollution, drainage, abatement of common pests like mosquitoes, public health, aquifer management and protection are often ignored by the economist (Gaffney, 1989). Too many economists are guilty as charged. Economics should deal with how best to meet all human wants, including those listed plus amenities, pure water, sustained resource supply, watershed protection, public health, and conservation. Many water marketeering economists, however, think only of maximizing GNP measured in the old fashioned way developed during World War II for war’s emergency purposes and never revised. Worse yet, some others are totally oriented to property and politics and don’t even follow the market. They write only of sustaining farm land values, disregarding the cost to fish, wildlife, and the taxpayers. The writings of Professors Buchanan and Tullock offer a convenient philosophical basis for such a myopic attitude (Buchanan and Tullock, 1975). Others, however, are developing an environmental and resource economics.

Ad (b):

As world population grows, meeting the demand for clean freshwater can be a serious challenge, especially for arid and semi-arid cities such as Los Angeles and Dubai. According to a report published in Water Policy earlier this year, cities around the world are struggling to access the water they need to support continued growth.

Half of all cities with populations greater than 100,000 are located in water-scarce basins.

According to UN Water, world population is projected to grow from 6.9 billion in 2010 to 8.3 billion in 2030 and to 9.1 billion in 2050. At the same time, urban population will increase by 2.9 billion, to a total of 6.3 billion in 2050, as a result of urban population growth and movement into urban centers. Growth in cities has led to a dramatic increase in urban water use; since 1950, global water use in cities has increased five-fold as a result of increasing domestic and industrial demand.

To meet the growing demand for water, many cities—such as San Antonio, Adelaide, Phoenix, and San Diego—have had to supplement the use of local water resources with significant water imports from major rivers or aquifers. As a result, urban water use has contributed to the depletion of many important freshwater sources, such as the Colorado, Yellow, and Amu Darya rivers, and resulted in significant ecological damage.

In response to increasing water scarcity, some cities are promoting innovation, efficiency, and conservation in water use. For example, the city of San Diego—which is largely dependent on the depleted Colorado River—has taken steps to promote conservative use of local water resources and decrease reliance on imported water by diversifying local water supplies. In San Diego, these measures have included the development of a water recycling system, a desalinization system, urban conservation policy, and, most notably, an urban-rural water conservation partnership in which the city compensates farmers in surrounding areas for implementing agricultural water conservation measures.

According to Water Policy, San Diego’s agricultural conservation partnership is an innovative model worthy of consideration by other cities … San Diego’s model is innovative in that it frees up water for metropolitan consumption by addressing inefficiencies in the region’s most water-intensive sector. According to the San Diego County Water Authority, agricultural conservation measures are expected to provide 37 percent of city water supply by 2020.

Agriculture is also the most water-intensive sector at the global level. According to the UN Food and Agriculture Organization (FAO), irrigation is responsible for about 70 percent of global water use, and a significant amount of water waste. According to the FAO, as much as 60 percent of water withdrawn for irrigation often does not reach the crop. A global reduction in agricultural water consumption of 15 to 20 percent would make more water available than all the water consumed in cities and industries today.

By helping nearby farmers consume less water more efficiently, cities could free up a new source of local water supply, improve the efficiency of water-use in agricultural production, and improve the overall efficiency of crop production. More efficient water use could, in turn, potentially improve the price and reliability of agricultural products, which could benefit farmers and consumers alike

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Categories: Uncategorized
  1. Paul Schächterle
    September 4, 2013 at 8:19 pm | #1

    Well as far as I understand the “Coase theorem” it is quite the neoclassical concept. It is basically saying all private contracts are “efficient” because every “rational“ person will only trade if the advantage of the contract is higher than the disadvantage.
    All the real problems are defined out of the way. The main point defined away by Coase is: what are the starting conditions or in other words what is the initial distribution of property rights? That is the absolutely crucial question for any legal considerations.
    So as far as I can see the Coase theorem does not prove at all that governmental regulation can be substituted by “the market” (which is btw. also a form of governmental regulation).
    From a legal standpoint the Coase theorem is of particularly low value also because there are (a lot of) rights that people will not trade and/or should not trade and can not be measured in monetary units.

  2. merijnknibbe
    September 4, 2013 at 9:35 pm | #2

    :Largely agree. That’s why I quoted Gaffney, who does pay quite some attention to the initial distribution of rights. Coase himself, however, would also largely agree with you. He does not assume that rational parties are able to negotiate (market) agreements without due government imposed institutions which enable this, while he also mentions that negotiating can be extremely time consuming and costly. To quote him again:

    “All solutions have costs and there is no reason to suppose that government regulation is
    called for simply because the problem is not well handled by the market or the firm. Satisfactory views on policy can only come from a patient study of how, in practice, the market, firms and governments handle the problem of harmful effects”

    He is clearly of the opinion that some problems might be solved by introducing markets while we do have to pay attention to the losses of polluting companies which have to curtail production – but he surely and absolutely does not see markets as a panacea.

    The famous article is however quite uneven and simplistic.

  3. Ken Zimmerman
    September 4, 2013 at 10:32 pm | #3

    Let’s not forget that Coase, like most economists had a limited intelligence and very limited insight. Or as Einstein might frame it, Coase lacked wisdom. For example, Coase never seems to have recognized that almost all the conditions within which markets must function have already been defined before hand by actors not directly involved in the markets, often not even in the same historical period as the markets.

  4. Newtownian
    September 5, 2013 at 4:24 am | #4

    An interesting feature of water relevant to economics, which isn’t mentioned, is that supply is high variable and this plays havocs with efficient market operation. Two cultural illustrations are Brecht’s ‘The Good Woman of Szechuan” which was used to promote scientific socialism (‘To dream the Impossible Dream… jingle, jingle jingle) and the verses in an Australian poem that every schoolchild learns – that include “I love a sunburnt country, a land of sweeping plains, of rugged mountain ranges, of droughts and flooding rains..”. There is more but the main bits people always remember are the last two because we deal with all the time, and i) unlike food you cant import surplus but rather deal with it via rationing systems, ii) climate change makes it likely that such boom and bust will be experienced more and wider. The solution proposed is more market stuff but recent experience shows what rubbish this is.

    During the 2002-2010 ‘Millennium Drought’ the Australian market and politics went mad with water recycling, desalination schemes based on new membrane technologies (whose cost is mostly in the energy incidentally) and of course ‘PLANS’ driven by ‘the Market’ and well as a number of rational fears for the future. And believe me it was a close run thing – although this is now forgotten a mere 3 years later.

    Then the drought broke with much flooding and predictably we were left with a whole bunch of white elephants and a premium payment to the private sector for bugger all – the science and engineering support networks meanwhile are collapsing – but rather than being precautionary, water use policies being put in place its – ‘lets party’. Meanwhile the private builders were not fools and made sure the community had to buy their water at exorbitant prices with all the attendant energy use.

    Separately the floods caused wide damage not because we didn’t understand the why the flooding happened and will happen again – but because the Market had said its ok to build on the flood plain of the Brisbane River because you only need to make money in the short term, and there are enough dummies we can con in the short term to buy flood plain houses because of the upstream dams – and the land is cheap. Of course everyone including the insurance industry fell in line – the result was they were only saved by a national government tax. Does this sound like New York? This second aspect illustrates how the market is able to change the rules of the game (e.g. flood plain development controls) so as to be able to push through irrational development because they can rationally make money off. And the public picks up the cost.

    There are many well understood alternatives to this boom and bust madness, in particular moving to low water use technologies and policies which minimize the need for responding to the droughts and flooding rains – as was done once – and not building in flood plains – or doing it appropriately at the owners risk. But no the market says we need to guarantee continuation of the pointless of madness of boom and bust and acts of god (creative destruction) because our natural resource utilization irrationality has been deemed the most efficient system available. To which I say ‘Bollocks’.

  5. sergio
    September 5, 2013 at 4:45 am | #5

    Invisible Hand, Utility, Aggregate Production Function, Total Factor Productivity, Transaction Cost, Household Production Function, etc. How many abstract, false and useless concepts introduced, formalized, calculated and of course promoted as “scientific”! How many Theorems and Laws which do not work in reality invented?

    The most important one question they failed to answer is What is Money? Because in non-monetary world not only these concepts but economics itself would not exist.

    • Newtownian
      September 6, 2013 at 12:55 am | #6

      It is curious isn’t it. You take a concept (money) which appears to be one of many emergent tools with diverse uses developed by complex but extremely young human societies. Then you claim its variables/factors/attributes are as invariant and fundamental to the structure of the universe and physical constants like the speed of light in a vacuum, Plank’s constant etc. and relationships which can be expressed in mathematical form such as gravity.

      The whole process is just like the old earth air fire and water (and variants thereof) of the ancients.

      Basically you start with the society and systems within which you exist and isolate some interesting possibly useful working concepts which have a pithy sound that suggests gnosis (a bit like the old POU of the medicos – pyremia of unknown origin – i.e. someone has a temperature but we don’t have a clue why).

      Then you ascribe metaphysical attributes to your concepts thereby fixing them in the starry sky.

      Then you construct an industry/cult to further support and justify your conclusions and get lots of resources from the plebs to support your development of further rationalizations. If you are really smart you construct a dodgy mathematical framework like Claudius Ptolemy did with his epicycles which allows your unimaginative inheritors to keep the bull going for another 1500 years.

      Meanwhile the real sciences remain constantly dissatisfied with their part explanations and keep applying laugh tests – to if not achieve a final theory of everything – then at least harmonize what appear to be disparate/puzzling knowledge concepts – and when they do that is when you hear the cry Eureka.

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