JFleck and Francis argued here that David Zetland’s proposed solutions to California’s water dilemmas are over-simplified. JFleck gave a quote of Zetland’s as an example.
[T]he solution to this problem is obvious. Lower demand. If you need a hint on how to do that, I can tell you in 3 minutes, or you can just go and RAISE PRICES.
Later, in the comments, Zetland wrote:
I’ve explained these ideas many times, but perhaps they are counter-intuitive to you all, perhaps because it involves unfamiliar ideas that have not been brought to bear in water — ideas from economics.
The combination of those quotes is particularly galling, because I am well familiar with the ideas from economics. Learned them from the same professors as Dr. Zetland, in fact. That’s why I know that the idea of lowering demand by raising prices is a great over-simplification, and in fact only sounds compelling because of an unfortunate pun. To economists, “demand” is how much of something people want at a price. Raise the price, and people are unwilling or unable to buy as much of it as they would at a lower price. But to laypeople, “demand” sounds more like “heart’s desire.” Those are not the same thing at all, and “heart’s desire” is what humans who use water are interested in, and our political system set up to respond to.
Here’s an example to illuminate the difference. Imagine a boy saw Lassie at an early age. The images were seared into his heart. He wants a collie. A collie is his heart’s desire. He dreams of his collie, yearns to take long walks with his collie, whom he will name “Lassie.” He wants to brush her and nap with her. However, this is not a wealthy boy, and a purebred collie is more than his family can afford. At $700 per adorable puppy, he can’t justify the purchase over necessities for his family. If collies were $20 each, he could get one. An economist would say that his “demand” for a collie has gone down as the price increased. But any human would see that his heart’s desire remains; the boy yearns for the dog as much as ever. He doesn’t get a collie at $700 per puppy, but he doesn’t want one less.
This distinction is why solving “demand” by raising prices is a trivially stupid solution. Yes. At $5,000 per acre-foot, I would buy far less than I do now, and have less of the amenities that water provides me. My “demand” would go down. But my heart’s desire wouldn’t change. I would miss my garden and my fruit trees. I would crave a long shower. I would wish I could play in sprinklers with children. Those desires would be an ache to me. Or, perhaps there are uses for water that are important cultural markers, like lining streets with jacarandas or eating meat regularly. We could (and may well) cut those out. But we will be a different people when we do. That may be fine; that may be the people we should always have been in this region and climate. But if an economist saw that and thought nothing more than “Success! Higher prices decreased demand!”, she would have vastly over-simplified that transition to a different cultural identity.
(Besides those things, which are actual experiential uses for water, I have a whole set of uses for water that have nothing to do with “heart’s desire” or “demand”. I want my clothes clean and my shit removed, but if that never involved a drop of water, I wouldn’t care one bit. If magic fairy dust made my dishes clean, I wouldn’t miss filling a sink with warm soapy water. My water usage is set by my need to have certain things happen; the price of water isn’t going to change my needs for sanitation, and water has properties (very solvent, odor reducing) that are extremely handy for sanitation.)
The reason that people don’t immediately latch onto “Raise prices! Decrease demand!” as a solution is not that they don’t understand economic ideas. Rather, they intuitively understand that not being able to afford something at a high price doesn’t mean that your heart’s desire goes away. They know that using water is a close and intimate human experience (think of the best shower you ever took), and is deeply interwoven into culture (stupid, stupid lawns imitating the English Manor). Before they blithely agree to make those unaffordable to any but the wealthy, they want to get used to the idea (change their heart’s desire to native plants, for example) or believe in a crisis that makes it necessary. People care about their heart’s desire, not demand at a price, and in a democracy, politicians and their agency staff are going to care about heart’s desire too, lest they be un-elected. It is very true that in coming scarcity, people’s heart’s desires for using water aren’t going to be met, and we need to figure out how to spread that injury out (or change their heart’s desire, get “buy-in” first). But saying that “demand will go down at a high price” is an accurate statement that misses the real problem, the ache of unfulfilled heart’s desire. If it weren’t a pun between economic jargon and common English, the concept of using price to change “demand” would be relegated to its proper place as one possible tool to address a part of the complex problem.
LATER: Some editing for clarity.
Yes, yes. There is plenty of slack in the system, people who are using water in ways that reflect carelessness, not heart’s desire. Raising the cost of water may be the way to end those. I’m fine with that. I don’t even support all forms of heart’s desire. If it is someone’s heart’s desire to watch the light play off the water as it runs down the gutter, I am not sympathetic.
On the public record 
Not even if a kid sends a paper boat floating along down the gutter?
These things are SO COMPLICATED!
Then you must have also learned that demand can shift in, so that you decide to NOT want a Lassie, or a short shower.
That’s a very powerful way to reduce water consumption (I discuss the difference in my book, TEoA), but it’s NOT RELEVANT when so much water in the SW is used on lawns. Prices can work in Vegas in a way that they will not work in Singapore or Sydney.
Interestingly, water managers are trying to shift demand in (to change habits) when the easier way to reduce Q_demand may be higher prices.
It’s about using the right tool for the right problem.
Can we keep separating the concepts of “demand” and “heart’s desire” for this discussion? That’s the whole point.
People’s “heart’s desires” can totally change. The boy can watch this video, and realize he only ever wanted that cat. People can decide they hate lawns and want chaparral. But that doesn’t happen because of price. That happens because they have new information and new emotions.
When “demand” changes because of price, people simply don’t get what they want. They have unfulfilled “heart’s desire.” Then they vote out Boards of Directors. (They may also find that they can cut out a whole lot of waste they never cared about, and that is great.)
JFleck and Francis objected to your oversimplifying, and I do too. Raising prices is a partial solution to part of the problem; it creates other problems (like conflicting with a cultural identity). In the real world, challenging cultural identity, through prices or any other approach, is going to get tumultuous fast.
Then you must have also learned that demand can shift in, so that you decide to NOT want a Lassie, or a short shower.
There is a very big difference between deciding not to want something and deciding that you can’t afford what you want. Using the same word, “demand,” for both hides that difference. But that difference shows up again at the next City Council meeting.
I don’t consider David’s market-based bias to be based on an ‘oversimplification’ of the problem…I’m also not enamored with his All-in-Auctions mechanism. However, it seems to me that he’s made an effort to propose an allocation mechanism that recognizes institutional constraints (legal, political, whatever) without completely conforming to them.
It seems to me if we’re going to follow francis’s lead and roundly reject suggested solutions that don’t conform to the current political climate, then we’re not going to be left with many options. Bi-lateral negotiation, moral suasion, and command-and-control are about the only tools to deal with shortage that we will have at our disposal if we just accept legal & political barriers to water markets…and I’m not wild about any of these mechanisms (but then again, I’m an economist…the worst kind of economist really because I’ve never been to a single public meeting…and I rarely vote).
JFleck writes:
“But to be in any way relevant, you have to show how that solution might be effectively implemented given the existing legal, institutional and political framework,”
and I couldn’t disagree more. The existing institutions created the current problem. These institutions are going to have to evolve. Shouldn’t somebody be thinking about what this evolution should look like?
I get that we’re not going to rewrite Western water law anytime soon (but judge Wanger did recently thumb his nose at the ESA so I guess stranger things could happen). But we’re also not getting any ‘new water’ anytime soon so we probably need to be thinking about smarter ways to use what we have. To me this means making the costs of current institutional constraints explicit (by, among other things, exploring the efficiency, equity, and distributional properties of mechanism that don’t conform to these constraints) and allowing the public to decide if it’s willing to bear this cost.
Btw: a couple of Australian economists have been exploring the equity and efficiency properties of an auction mechanism that respects existing property rights regimes. Your readers might find these interesting:
Click to access wp2008-06.pdf
Click to access wp2008-07.pdf
Click to access wp2008-09.pdf
best,
aaron
aaron –
To paraphrase Kurt Vonnegut, I’m sure the captain of the Titanic would have preferred that there were no icebergs in the North Atlantic. But there they were.
Which is to say, it’s fine to say that the institutions currently in place are the ones that got us into this mess, and therefore we need new institutions. But the fact remains that these are the institutions that remain in place. Political actors will continue, rightly, to act on behalf of the values and interests of their constituents.
I would agree that the institutions need to evolve to solve the current set of problems, but that’s stating the obvious. It is in the nature of institutions to succeed or fail based on their ability to evolve to changing situations. I’m simply arguing that proposals aimed at aiding success need to recognize that the icebergs are out there, and they aren’t going away, that political actors will continue to act on behalf of the perceived values and interests of their constituents, and the solution space has to be bounded by that reality.
We’ve got to thread our way through the icebergs.
John,
If we have any lingering disagreement here (and I’m not sure we do, I think I’m cool with just about all your main points) maybe it’s in division of labor.
You (and other pragmatists who I’m sure are doing good and underappreciated work in water management) may need to bound your solution space but I’m under no such obligation…I’m free to imagine a world without icebergs (or more appropriately, one where the icebergs exist in different places). And I think this is the way it should be. We need pragmatic people who say things like, “policy proposals A and B can be compared but policy C is irrelevant because out-of-basin transfers are illegal.”
But we also need people to ask, “how would A and B compare to C if we relaxed the interbasin transfer constraint and allowed water to move to its highest marginal value product? What would that world look like?” You might call that a straw-man, I call it a counterfactual. The degree to which it is a credible counterfactual probably depends on how robust the rule structure of no out-of-basin transfers is.
I used to think the ESA was pretty untouchable but I’ve seen an awful lot of analysis lately stating that ESA related diversion limitations cost ag. producers $X million or $Y billion. Is this analysis (how did you put it…) irrelevant because it doesn’t conform to existing legal constraints? Is ‘ammend the ESA’ a credible counterfactual scenario? At least one federal judge and a CA senator seem to think so.
…or maybe timing is the issue here: I suppose I can see where “proposals aimed at aiding IMMEDIATE success”, or designed for immediate adoption should be bound by institutional reality. But when Crocker and Dales proposed emission permit trading to internalize air pollution externalities in the late 60s there were significant institutional barriers to cap-and-trade (perhaps not explicit legal barriers but barriers nonetheless). Can we dismiss such a policy proposal as not aimed at aiding success or irrelevant because it doesn’t respect those institutional barriers? I suppose in a sense the Crocker and Dales proposal was dismissed since it took the EPA another 20 years to implement it (or something very similar) under the Clean Air Act. Maybe there’s some kind of lesson there.
kind regards,
aaron
It’s an oversimplification because water demand is relatively inelastic. Increase the price of water and in practice water use remains much the same; households look for other items of expense on which they may retrench. So an increase in the price of water leads to reduced demand for food, clothing, transportation or entertainment, but not a reduction in demand for water.
For a while, so long as there is considerable waste, I think water demand may have some elasticity. It does eventually harden. There were a lot of rate increases over the past three years. I very much hope someone was keeping track and creating real-life elasticity curves.
There are good papers out there with real elasticities, and they vary from -0.1 to -1.2.
I agree with most of what Aaron is saying, since he’s understanding my point.
I agree that “demand” is a bad word for “heart’s desire” — not nearly so romantic or unquestionable — but that’s what demand *is*. If you want to be careful then just separate “demand” (the curve and where it’s situated) from “quantity demanded,” which refers to moves up and down THAT curve based on price.
I am pretty shocked that you’re unwilling to see that I am tracking the difference, and wonder why you want to wave your hands of “heart’s desire” as if there’s no human choice involved. Or did you not cover the connection between preferences-choices-demand when you did economics?
Well, when you say things like:
“[T]he solution to this problem is obvious. Lower demand. If you need a hint on how to do that, I can tell you in 3 minutes, or you can just go and RAISE PRICES.”
It suggests that you aren’t doing a fine-grained analysis of what people respond to. An answer that acknowledged the complications would sound more like:
To a first approximation, people in the elastic piece of a demand curve, before they’ve reached the emotional portion of their water use, will likely respond to raising prices by cutting back their water use (assuming there aren’t barriers to doing so). That gets complicated fast, and further, there are extensive political problems (like voter revolts and recalls). But if you have some time, I’d love to explain it to you.
By coincidence, I just saw this:
The most that price can really do is enhance motivation to act. If we get the prices right, it does not make it any easier for the person who does not have a vehicle, or is physically disabled, to get down to the hardware to pick up a programmable thermostat. It just makes them feel more anxious about the fact that they ought to be doing it. How do we make it easier for people to make the transitions over to these other behavioral choices?
That only addresses barriers, but truly, getting people to change their water use is far more complex than you’ve conveyed in your comments. Further, the problem is not that we don’t understand economics. The problem is that economics doesn’t capture much of what happens in the real world very well.
I think you’ve veered off into a less useful discussion.
I’m confused by this talk of a singular “heart’s desire” driving demand since I know that my personal demand curve for anything is made up of an aggregate of all my “heart’s desires”. Sure, I can talk about how much I want a singular thing, but if it has no context (alongside all the other things I want) then it has no real meaning. Would I really like that Collie or would I prefer to make my car payment this month? We rank our hearts desires all the time and decide accordingly – that’s why we have lay away plans. And demand curves.
Furthermore, I don’t believe adults are so inflexible that they can’t recognize a useful trade.
So while the boy in the analogy wanted a Lassie, as an adult he would probably settle for a pound rescue Collie mix.
“My water usage is set by my need to have certain things happen; the price of water isn’t going to change my needs for sanitation, and water has properties (very solvent, odor reducing) that are extremely handy for sanitation.)”
I’m sure that we all agree with this, but don’t rate setters take this into account with tiered rates?
I take back the inelasticity of water demand. I was thinking of urban demand (which is, I think, relatively inelastic: I’d believe -0.1). But ag demand is probably more elastic: farmers can switch crops (or even take land out of cultivation) if water price rises make the thirsty crop they’re growing uneconomic.
wow, my name taken in vain here too? Dear OTPR, you are as usual correct — as a society we choose not to subject water prices to economic forces. That is a deeply embedded societal choice.
Dr. Z is welcome to try to undo it, but a large part of my comments at his and Fleck’s blog has been trying to get him to recognize that, for the most part, nobody wants to pay market prices for water. The reason his ideas don’t have more traction is that the water managers he’s trying to persuade understand full well that their constituents have made their preferences perfectly clear, and they are willing to live with the terms of the water shortages imposed on them (so far) rather than suffer higher prices.
[Edited very slightly by OtPR. Sorry, Francis.]
Well, higher prices would mean:
people would switch out their lawns
meat would get more expensive
people would have to pay attention to leaks
people would take longer showers or shallower baths.
That is what people think is a shortage now! That’s what they don’t want to do. Telling them that the demand and supply lines now intersect so there isn’t a economic shortage doesn’t mean anything to them. They care about the indicators that show up in their personal lives; they can tell that they no longer have a lawn.
They’re wrong about what we’re able to do with water in the future, but they don’t like it no matter how the news gets to them. They don’t like it when they see bill inserts and op-ed asking them to conserve, and they don’t like it if no one says a word but water gets more expensive. Until their hearts change, they’re going to resist all of it. And their resistance is potent, because of all the levers of local democracy.
Francis, most people do not want to pay market prices for water or anything else. They want a deal, or even better, something for nothing. That’s just human nature, and no reason to dismiss price rationing as a way to maximize the value of a resource wanted by many, in different places, for different purposes. “Raise prices” is a bad idea if it means some all-knowing authority arbitrarily sets a price. But we can change demand patterns while benefiting both the agricultural sector and the environment by letting a more transparent market re-allocate such water as people are willing to trade.
With that in place, we can then look intelligently at “plumbing” solutions, understand their true costs and benefits, and decide if we need them or not.
For all the hand-wringing about farm water going to cities, the entire M&I demand in our state is a fraction of the full yield from our water projects. Several dozen Sandridge type deals make a lot more sense than desalination or new dams, and would still be a tiny portion of agricultural water.