Using Price Signals to Better Manage Water Use

19 April 2018
By Kevin Counsell

Over the past year, the issue of water pricing has risen to prominence in New Zealand, largely as a result of debate during the country’s 2017 general parliamentary election. The main issue has been whether price signals, in the form of water charges (also referred to as “taxes” or “royalties”), can help in managing scarce water resources.

In this article, NERA Senior Consultant Kevin Counsell discusses the merits of using water charges as a price signal relative to the merits of an alternative economic instrument of water trading. In principle, the two regimes are different means of getting at the same purpose: both provide a price signal that is faced by water users, which creates incentives for the efficient use and allocation of water among its different uses. However, the two regimes may not necessarily achieve the same outcomes in terms of efficiency. There may also be other objectives each regime achieves or leaves unachieved. Therefore, it is important to define exactly what the objective from a water price signal approach is, before determining the preferred way to achieve that objective.

Water charges of the sort proposed during the election campaign can raise revenue that could be earmarked for environmental purposes. However, it can be difficult to set these charges at a level that best encourages efficient use and allocation of water. Indeed, economists often consider that a desirable objective is to maximize economic efficiency, and a well-designed water trading regime is better at achieving this than a water charging regime. In this way, a price can be established to send a valuable signal to water users as to how much water to use and in which way it should be applied, ultimately contributing to a more beneficial use of what is one of our most important natural resources.