The Economic Approach to Environmental and Natural Resources, 3e

Renewable Resources and the Environment Part III

Introduction • In the history of the United States, water has always played an important role, but it was not viewed as scarce. • Water was abundant in the East and even though much of the West was semiarid it did not limit the growth of the population. • Because water use in the US was not been managed to prevent or mitigate increasing scarcity, as we moved into the latter part of the 20th century, important water problems developed. • This chapter examines the growing scarcity of water resources in the US and the world and examines policy to address this scarcity.

Introduction • Four distinct problems have arisen that affect the availability of water. • First, in many areas of the country the use of water exceeds the rate at which it is being replenished. • Second, many activities use water as an input, and when the water is returned to surface or groundwater, its quality is diminished. • Third, many activities use surface or groundwater as a means to dispose of waste, creating water quality problems. • Fourth, degradation of ecosystems weaken their ability to store water and modulate the drought/flood cycle.

Hydrological Cycles • The hydrological cycle refers to the movement of water from the atmosphere to the ground and then its evaporation and return to the atmosphere. • Water vapor in the atmosphere condenses and falls to the ground in some type of precipitation (rain, snow, sleet, etc.). • Some of the precipitation lands directly in surface water and some on land. • In the United States, on average, 66 percent of the precipitation returns to the atmosphere directly by evaporation; 31 percent runs off to rivers, streams and lakes; and 3 percent seeps underground.

Hydrological Cycles • Forests and other terrestrial ecosystems play a very important role in the hydrological cycle. • Leaves and stems of trees break the impact of the rain, slow its decent, allowing more of the moisture to be absorbed in the ground. • Additionally water flows down the trunk of the tree and continues along the roots deep below the ground. • The net effect of the forest is to allow more of the rainwater to become groundwater and less to immediately enter streams and rivers.

Nutrient Cycling • The nutrient cycle refers to how the basic nutrients (nitrogen, potassium, and phosphorous) move through the ecosystem. • When organisms die and decay, the nutrients are released in the soil or water and become available to plants, which absorb them. • The plants are then eaten by other organisms that absorb the nutrients and the cycle continues. • Problems arise when additional organic wastes from human activity are introduced into the ecosystem.

Nutrient Cycling • Processes that break wastes down into basic nutrients also remove dissolved oxygen, essential for aquatic life, from the water. • In addition, nutrients can contribute to algae blooms that block light from penetrating the water. • When the algae die, their decay further contributes to the decline in dissolved oxygen. • If all the oxygen is depleted, then the decay process shifts from bacteria that operates in the presence of oxygen to bacteria that operates in the absence of oxygen, which leads to the "rotten egg" smell associated with polluted waters. • Agricultural run-off, suburban run-off, paper plants, food processing, stock yards, and discharge from sewage treatment plants are among the most significant anthropogenic sources of nutrients.

Water Consumption • As you recall from Chapter 1, within the resource taxonomy there are three categories: • renewable resources, in which the stock regenerates itself, • resource flows, where a never-ending flow comes from a nondepletable stock and • exhaustible resources. • Water, in general, meets the definition of a renewable resource, where the evaporation from the oceans and other water sources creates the precipitation that replenishes the oceans. • Water in riverine systems can be viewed as a resource flow. • Some water resources can be viewed as exhaustible because the rate of growth of the stock is small in relation to the use of the water. • "Fossil water," which is water that has accumulated slowly in underground aquifers over millions of years is an example of an exhaustible resource.

Water as an Input to Production and Consumption • If the flow of a river is much larger than the withdrawals of water to meet consumptive and productive needs, and if uses of water are benign, then there will be no resource allocation problem, even if the water is available at zero cost. • However, if the flow of water is not capable of meeting all needs at any point in time then a shortage will develop. • At a price of zero, quantity demanded of water is greater than amount available and as price rises, the least valuable needs will be left unsatisfied. • If price is continually raised, eventually quantity demanded will equal the amount of water available.

Water as an Input to Production and Consumption • Figure 15.1 illustrates how essential scarcity is in determining price. • In this figure g0 represents the daily volume of water that may be removed from the river. • The cost of extraction is zero. • Demand is represented by D1. • Under these circumstances, all the demand that exists at zero price will be satisfied. • However, if Demand increases to D2, all the demand at zero price cannot be satisfied. • As demand increases, the opportunity cost of consuming the fixed flow of water increases, which is reflected in the increased price.

Water as an Input to Production and Consumption • Property rights must be well defined in order for a market and a price to exist. • Price will also reflect the marginal cost of producing water. • The cost of producing water takes the form of purification, transportation, etc. • If property rights are not well defined or other conditions result in market failure, then the price will be too low and this will lead to shortage as illustrated in Figure 15.2. • Here, the price at which quantity demanded equals fixed quantity supplied is p0, but a price of p1 would lead to a shortage equal to g1-g0.

Water as an Input to Production and Consumption • In eastern and Great Lakes states, water resources can be viewed primarily as resource flows, where most cities and agricultural areas depend on surface water or groundwater that is generally replenished by normal rainfall. • One mechanism that often leads to urban water problems is the process by which water is priced and distributed to customers. • This is usually done by either a regulated water utility or a municipal water company. • In both cases there are political or regulatory forces that push the price of water below its opportunity cost.

Water as an Input to Production and Consumption • When water is provided by a regulated monopoly, the monopoly is allowed to charge a price that yields a reasonable rate of return on their capital investment. • The scarcity value of water is not incorporated into the price, only the scarcity value of the other inputs used in purifying and distributing water. • If the price of water is below the opportunity cost, a shortage will develop and other means will have to be used to allocated the water. • There is no guarantee that these alternative methods will result in an efficient allocation of the water.

Water as an Input to Production and Consumption • Alternatively, if a city elects to provide distribution of water as a city service, political pressures may keep rates low, again allowing no mechanism for reflecting the value of alternative uses. • When consumers of water in an apartment building pay a rate based upon use by the entire building (average price) rather than an individual rate (marginal price) there is no strong incentive to conserve use. • Even if water is priced according to marginal willingness to pay, there may still be market failure if the pricing structure does not reflect the ecological opportunity cost of water. • Two basic ways to reflect the ecological opportunity cost of water include a government tax on water use or the purchase of water rights by NGOs where the water is left in the stream.

Water as an Exhaustible Resource • Water resources in western states are better described as exhaustible resources particularly in those states overlying the Ogalla Aquifer and other slowly recharging aquifers. • The economic analysis of water as an exhaustible resource is very similar to the analysis of water as a resource flow, only there is an additional opportunity cost. • The first opportunity cost is the cost of not having water for another current use, the contemporaneous opportunity cost. • The second is the opportunity cost of not having the water available for future use, which results from current use depleting the stock available, which is called the intertemporal opportunity cost. • An efficient allocation of water would require that the price reflect both contemporaneous and intertemporal opportunity cost.

Water and Property Rights • In the United States property rights to water are a big issues in the Western US where most rights are defined on a state-by-state basis. • Appropriation-based water rights make water available for use by anyone who can apply it to a beneficial purpose. • Priority goes to the user who establishes his or her appropriation-based rights first. • Initially these rights were nontransferable but increasing demand for water has led western states to make them transferable. • This has created a market for water and the potential to use market mechanisms to protect ecological uses of water.

Degrading Uses of Water • There are three types of uses that degrade water quality. • The first is when removal of water from surface water bodies or groundwater aquifers generates ecological damage. • Heavy water withdrawal in the coastal area of southern Florida has lead to saltwater intrusion into the aquifer. • The second is when a direct consumer of water uses it and returns it to hydrological cycle with wastes and contaminants. • An example would be residential use of water which adds human wastes: even when treated, the water has a higher level of nutrients which can cause ecological damage. • The third type of use is represented by activities that generate wastes that are directly deposited into or make their way through natural mechanism such as run-off from rainfall. • An example would be rainfall run-off that carries pesticides from agricultural fields.

US Policy Toward Water Pollution • U.S. policy toward water pollution has historically focused on large point sources of pollution. • Point sources of pollution are those where the pollution enters the water body at a specific point, such as the end of an effluent discharge pipe. • One of the major thrusts of attempts to reduce water pollution was a program to reduce the impact of the discharge of municipal sewage. • As late as the 1960s, many small cities did not have a water treatment plant and dumped raw sewage directly into rivers and lakes. • This time period also saw inadequate treatment in the larger cities and as a result, there was severe degradation of virtually every river that flowed through a metropolitan area. Lake Erie, which was particularly hard hit, became incapable of supporting aquatic life.

US Policy Toward Water Pollution • Amendments to the Clean Water Act required all municipalities to develop and upgrade their sewage treatment facilities. • This included both primary (removal of suspended particles) and secondary treatment (breakdown of organic wastes). • Programs were designed so that the federal government would pay 75 percent of the costs of the facility, and the local government would be responsible for the remainder of the construction costs and for operating costs. • The primary reason for the federal government involvement was that the social benefits to the nation of treating a community’s wastewater was greater than the social benefits to the community.

US Policy Toward Water Pollution • Because the federal government subsidized construction but not operation of these facilities, local governments tended to favor a capital intensive design which lead to a non- optimal mix of inputs in production. • Construction of these plants were completed in the 1970s and they had a rapid effect on water quality. • One result was the recovery of many of the polluted river systems, including Lake Erie.

US Policy Toward Water Pollution • The subsidized improvements in municipal sewage treatment plants were required by the Water Pollution Control Act of 1972, the Clean Water Act of 1977, and 1977 and 1978 amendments to the Clean Water Act (CWA). • These acts, based on command and control techniques, also focused on other large point sources of pollution, such as paper plants, food processing facilities, and other industries. • The National Pollution Discharge Elimination System (NPDES) made all discharges illegal unless authorized by NPDES. • Polluters were required to use best practical technology (BPT) for conventional pollutants and best available technology (BAT) for toxic pollutants. • BPT allows for the consideration of cost of the technology, BAT does not.

US Policy Toward Water Pollution • Economic incentives have not been employed to deal with water quality problems. • While it would be feasible to develop a system of marketable pollution permits, it would require more interstate cooperation, since all the major river systems span several states. • The use of command and control policies created the same types of problems discussed earlier in Chapter 3. • The Clean Water Act and associated amendments have not been completely successful in meeting the legislative goals of restoring and maintaining the chemical, physical, and biological integrity of the nations’ water. • There has been some mixed success in reduction of organic wastes from point source polluters. • However, where nonpoint pollution is a major problem, the water quality remains poor.

US Policy Toward Water Pollution • Nonpoint source pollution, is associated with agricultural, urban, and suburban run-off. • Recently new regulations have been developed requiring farmers to institute "best farming practices" to control nutrient run-off and soil erosion. • Agriculture remains one of the largest contaminators of water resources in the parts of the US and in developing countries. • Even though some progress has been made in controlling organic pollutants, the problem of toxic pollutants has not been similarly reduced. • Many areas with healthy fishing populations also have prohibitions against consumption of the fish due to the high levels of contamination by toxins such as PCBs, mirex, dioxin, and heavy metals.

International Water Issues • The water problems in other countries (particularly developing countries) may be more severe than in the United States. • The primary water problem in developing countries is the contamination of water by untreated human waste. • This is true not just in villages, but also in very large urban areas such as Rio de Janeiro, where large slums intensify the waste problem. • This is not just a third world problem. In the Po River Valley in northern Italy, many cities (including Milan) dump untreated wastes into the river. • The Mediterranean Sea suffers from extreme water pollution problems which are expected to increase as North Africa becomes more industrialized.

Transfrontier Externalities • One of the major problems associated with water extraction and water pollution in Europe, Asia, Africa, and Latin America is transfrontier externalities. • The water consumption and waste disposal activities of one country affect water availability and water quality in neighboring countries. • This is particularly true in the Middle East, where geographically small countries overlie common aquifers and where rivers such as the Jordan River and the Tigris-Euphrates River drain several countries. • These transfrontier externalities cannot be internalized without international agreement. • The United States has longstanding agreements with Canada concerning water use and water quality in boundary areas, and a special commission to deal with Great Lakes issues. • Agreements with Mexico are being developed.

Agriculture and Water Quality in Developing Countries • Problems with deforestation, over-tillage, tillage of hillsides, heavy use of dangerous pesticides, and run-off of fertilizer has seriously affected water quality in many developing nations. • One of the most degrading uses of water is the irrigation of agricultural fields because irrigation can lead to the rapid depletion of groundwater and reduced flows in rivers. • In addition, repeated soaking of the soil and the evaporation of the water in the soils draws salts from lower levels of the soil and deposits them in the top layers of the soil, where they adversely affect many of the crops. • Large withdrawals from a river can result in destruction of the aquatic systems, which is the case for the Aral Sea in the former Soviet Union, where the flow of the river draining into the sea was reduced so much that the fisheries within the sea were destroyed.

Summary • Although the earth’s surface is three-quarters covered by water, uncontaminated water is a scarce resources. • Many market failures, including externalities, nontransferable property rights, and poorly conceived regulatory practices contribute to the scarcity. • From a US and international perspective, one critically important policy change would be to price water so that it included its full opportunity cost. • This would include the opportunity cost of both current and future uses of water, as well as the costs associated with reductions in the quality of water resources.

The Economic Approach to Environmental and Natural Resources, 3e