Chapter 03

Towards a new economics of water

Key takeaways

Water provides critical environmental functions and services that support all life. The Action Plan from the United Nations Water Conference in 1977 recognised water as a human right. It is also an essential input in economic activity, with no close substitute.

New assessments indicate a concerning global trend of near-universal water stress: few people reside and few cropped acres exist in locations that have no water-resource-related stresses.

A significant portion of the global population (about 2.9 billion people) and 55% of the world’s food production are in areas experiencing drying or unstable trends in total water storage.

Where irrigation is prevalent, its drying impact overwhelms that of climate change. In some areas, the influence of irrigation on the drying trend is more than twice as strong as the climate effect.

Between 40% and 60% of terrestrial rainfall originates from land, with forest and natural ecosystems making significant contributions. Deforestation and other land-use changes disrupt these moisture flows, potentially exacerbating water scarcity in affected areas. These result in significant growth losses (0.5 – 0.7 percentage points) in affected areas, suggesting that the consequences of deforestation have been underestimated.

The poorest 10% of the global population reside in locations that receive 70% of their annual precipitation from land-based sources. Consequently, they are highly vulnerable to upwind land-use changes, over which they have little or no control.

While the supply of water is becoming less stable, demand is rising exponentially with increases in living standards and demographic change. Water withdrawals have increased at twice the rate of population growth in recent decades. Constraints on the supply of water translate into slower economic activity. New modelling suggests a high human toll under a business-as-usual scenario, including:

GDP decline

High-income countries are projected to experience a median 8% GDP decline, while lower-income countries could face a drop of 10-15%. These losses are larger than those projected by climate economic models that neglect the critical role of water.

Human capital loss

The lack of access to safe water and sanitation exacerbates these economic impacts, disproportionately affecting poorer communities, women, and children

Trade disruptions

Virtual water exports are projected to decline, leading to a shift in export patterns. Water-stressed, lower-income countries heavily reliant on agriculture bear the brunt of these disruptions.

Agriculture consumes much of blue and green water globally, and has a disproportionate impact on the availability and sustainability of land and water resources. The magnitude of direct and indirect subsidies accruing to water users in agriculture is vast and likely exceeds USD 630 billion per year. Empirical estimates indicate that: (1) perverse subsidies distort cropping patterns and lead to water-intensive crops being grown in arid and semi-arid regions; (2) subsidies to forest-frontier products have promoted deforestation in the tropics; (3) nitrogen fertiliser subsidies are responsible for 17-20% of nitrogen pollution from runoff; and (4) such subsidies are regressive. Findings support a growing literature that highlights the unintended consequences of policies that neglect economic incentives.

Recommendations

Four dimensions of water call for a fundamental shift in the way that freshwater stresses are assessed and managed: (1) the public-good character of freshwater functions and services; (2) the interconnectedness of global change and local freshwater supply, and the resulting uncertainties; (3) the geographic interweaving of freshwater sourcing via atmospheric moisture flows; and (4) the increasing demand for freshwater due to rising living standards and population growth.

Water is often mismanaged due to perverse incentives and inappropriate policies. Policy incentives are seldom aligned with the economic, social, and environmental values that water services provide, while subsidies often encourage water-intensive industries to locate in regions where water is already scarce. When the supply of water is increased without corresponding incentives, demand rises to meet the new level of supply, resulting in a higher level of water dependence and inefficiency.

Model results illustrate that improving resource allocation – whether tariffs or other means – renders production and consumption activities more responsive to water scarcity and opportunity costs. These effects would ripple through the economy with positive feedback to water availability and long-term sustainability. Adjusting water tariffs to reflect externalities and scarcity to address market failures and scarcity constraints is pro-poor, benefiting water-stressed lower-income countries more than higher-income countries.

Sound water stewardship can go a long way towards mitigating the adverse effects of shifts in water availability in the face of climate change. Aligning economic incentives to reflect the value generated by green and blue water could yield a triple dividend:

Economic efficiency and resilience. Water-related impacts of climate change can be largely neutralised, improving climate resilience.

Equity. Economic benefits accrue mainly to the poor.

Environmental sustainability. Resource depletion is mitigated, safeguarding the environment.

As global populations rise and water supplies are disrupted by land-use change, the challenges will worsen, calling for urgent and bold reforms, and new policies that can address pressures of such scale and magnitude. Three overarching policy principles can lead the world to greater water security through efficiency, equity, and environmental sustainability.

Principle 1: Value water for the essential services it provides.

Managing water stresses will require discouraging waste and allocating scarce water resources between sectors to obtain greater benefits. This could be achieved through infrastructure and regulation, or through better incentives such as pricing and trade. Any policy regime would need to include safeguards to assure access for poor households and environmentally sustainable and prudent uses.

Principle 2: Establish absolute limits to ensure sustainability.

Acknowledging that the economy is embedded in the biosphere, and that blue and green water systems are generally renewable but also finite, implies that there are absolute limits to the amount of water that can be safely and sustainably consumed. For blue water, this implies limits on the amount of water that can be withdrawn and on the concentration of pollutants in freshwater. For green water, this will mean protecting the sources of supply (forests and wetlands) with incentives and policies to conserve the moisture held in soils.

Principle 3: Develop policy packages to promote synergy.

No single policy can achieve the multiple goals of efficiency, equity, and environmental sustainability. Policy packages will need to address the trade-offs that emerge. Complementary policies are needed to address distortions in related sectors that can stymie reform. For instance, subsidies to water-intensive industries would undermine the effectiveness of water prices in regulating demand. While these policy reforms will be demanding, the consequences of inaction will be far higher.

Towards a new economics of water

Key takeaways

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