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Supply Side vs. Demand Side Solutions for Adapting to Climate Change: The Case of Mexico City Water

Friday, February 17, 2017 8:19
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The NY Times has published an excellent piece about Mexico City’s water challenge but a nuanced read of the piece reveals two key points.  The piece ignores demand side management.  The word “water price” does not appear in the long piece and no economists are cited.  Instead, this is an engineering piece focused on the ecological damage that has taken place in Mexico City when a large population uses an increasingly scarce resource that is becoming more scarce because of climate change.  For some facts about Mexico City’s water prices read this.

Here is a Direct Quote (from the 2nd cite, not the NY Times piece):

The city’s complex and aging hydraulic infrastructure suffers from numerous failings. Twenty-nine water treatment plants are supposed to assure the suitability of water for normal use, but some 40% of the processed water is lost either to leakage in the primary and secondary networks or to people who do not pay for it. The city has only one industrial-sized wastewater treatment plant, and although more than 94% of households in Mexico City are connected to sewage lines, little of the wastewater is treated.2 The 21 small sewage-processing plants only effectively handle about a tenth of the total discharge. Most of the wastewater is carried out of the city through a drainage system to the Mezquital Valley east of the capital, where it is supposedly dedicated to forage crops and animal use. But an alarming volume of the untreated water is used to irrigate fruits and vegetables that are then shipped to city markets.

Unlike those in most other urban areas in Mexico, water fees for domestic users in the capital are based on a progressive rate that rises as water use increases. This system, introduced in 1994, was supposed to reduce subsidies and encourage a culture of economy in water use. In absolute terms, however, water rates in Mexico City and throughout the Central Valley are scandalously low. When compared to 13 other large metropolitan areas in Mexico, residential consumers in the capital pay only 72% of the resulting average. Users of the base amount pay only a flat administrative fee of about US$1.00 for the service.
Although larger water users do pay more for their water, the rich spend a substantially smaller proportion of their incomes for the service than do the poor. Because poorer families tend to be larger and several households often draw their water from a single water meter, their usage exceeds the minimum, so they are charged more than the corresponding flat rate. Consequently, these groups incur much higher real costs than do upper-income groups who usually do not consume more than the allotted minimum. Commercial water users—including industrial plants and service providers—pay up to 600% more for small volumes of water, but once their consumption reaches the highest rate bracket they pay virtually the same rate as households. Ironically, those without regular service are dependent on tanker trucks for delivery and end up paying substantially more, both in absolute terms—cost per gallon—and in relation to income.
So, how will Mexico City adapt?  I say use the price mechanism and raise prices for the rich and poor but give the poor an income transfer to compensate them for the higher market prices they will face. By raising water prices, this will encourage demand side conservation, the demand for water efficient durables and market suppliers will start to market them in Mexico City. Let capitalism work!
For more on my thinking read my San Francisco Chronicle editorial from last year.
To adapt to climate change, we must unleash the basic economics of scarcity and allow prices to rise when scarcity increases.
Those who seek a free lunch and don’t want prices to rise use the poor’s well being as a “human shield” to block such price increases.  Let me walk through the algebra for how to protect the poor.
Suppose there are 2 poor people and 20 non-poor people in a society.  Suppose that each poor person consumes 100 gallons of water a day.  Let the price of a gallon of water rise from 1 cent a gallon to 50 cents a gallon.  This is just an example to help you think this through.  I realize that poor people do not spend $1 a day on water.
In the short run, each poor person’s expenditure on water would increase from;
100*.01 = $1 a day to 100*.5 = $50 a day.
To allow the two poor people to consume their original bundle at the new prices,  $98 dollars will need to be transferred to the two of them.  If you tax the 20 people,  98/20 or $4.9 a day each then we are back in equilibrium.


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