I'd like to thank the members of the subcommittee on energy andpower for the opportunity to testify today on HR 623, "The PlumbingStandards Improvement Act of 1999." My comments this afternoon willattempt to put the discussion in context by addressing theunderlying realities of water markets. The plumbing standards atissue are but a small thread within the larger tapestry of nationalwater policy, and an understanding of that policy is necessary tojudge the merits of HR 623. In brief, while there is a legitimateconcern about water availability, over-consumption is an artificialphenomenon - a product of misguided public policy. Appliancestandards - such as those targeted for elimination by HR 623 - areincapable of remedying the underlying causes of water scarcity and,moreover, introduce further distortions and inefficiencies in watermarkets. In fact, there are striking parallels between water andenergy markets (and between water and energy policy) that serve toilluminate the underlying issues at stake in the debate over HR623. In my judgement, passage of "The Plumbing StandardsImprovement Act" would move policy in the right direction.
The Anatomy of Present WaterMarkets
Water is delivered to consumers either by public entities orprivate companies regulated by public utility commissions. Thequestions of how much water to deliver to consumers - and whatprice to sell it - are likewise determined by political entities,not by market agents. Unfortunately - perhaps inevitably -governmental agents have directed water to politically powerfulinterests (primarily western agriculture) and under-supplied waterto less politically powerful interests (urban consumers). Moreover,water prices have been kept artificially low.1
Scarcity and shortage has been the inevitableresult.2
Government has reacted - not by raising its price - but bymandating conservation, primarily on the less politicallyinfluential (the agricultural industry, which consumes 80-90percent of all water withdrawn for human use,3 has been generally immune from such strictconservation mandates). The plumbing fixture mandates of the 1992Energy Policy Act are a primary example of the kind of technical,engineering fixes employed to manage water supply anddemand.4
The above story should sound familiar. In fact, water policytoday is a virtual carbon copy of energy policy in the 1970s. Thewater industry, like the energy industry, is one of the nation'slargest - and most heavily regulated - businesses, delivering alife-sustaining resource crucial to the economy.5
Then, as now, government rationalized centralized control overthe resource on the grounds that it was too important to leave tothe marketplace, too scarce to be allocated by the cold logic ofthe invisible hand, and too riddled with market failures to beefficiently traded without government oversight.6
Then, as now, government restrained prices and controlledresource allocation to protect and/or subsidize various consumers.Acute scarcity was the natural result.7
Then, as now, government responded not by freeing prices but bymandating conservation.
What the Energy Experience Can Teach Us AboutWater Policy
America should have learned a few very important things abouteconomics from the energy experience of the 1970s. First, whengovernment regulations keep prices below market-clearing levels,shortages inevitably follow. Shortages are an artifact of publicpolicy, not geology.8
Second, government agents cannot direct resource production,price, or allocation decisions as efficiently as can marketactors.9
When the tangled web of energy regulations were relaxed oreliminated in the 1980s, scarcity vanished. Subsequent supplydisruptions did not usher in the scarcities or inconveniences ofthe 1970s even though the disruption of 1990 was as larger orlarger than those of the 1973 and 1979.10
Third - and most relevant to HR 623 - mandatory conservationmeasures are a poor substitute for accurate price signals. It wasrising prices - not mandatory conservation - which ultimately ledto increases in energy efficiency in the 1970s and1980s.11
The only way to avoid shortages is to rely on free-marketpricing and allocation.12
Consumers circumvent mandatory conservation technologies byincreasing consumption at the margin (the well-known "reboundeffect"13or procuringthrough indirect channels the resource being denied them. Theirbehavior seems to be in agreement with M.A. Adelman's argument that"energy conservation for its own sake regardless of price is thetalk of the madman in Dr. Strangelove, obsessed with his'precious bodily fluids.'"14
Finally, government directed conservation investments areunlikely to improve upon those that would be made if consumers werefaced with correct market signals.15
Looking back at the mandatory energy conservation standards ofthe 1970s, MIT analysts observe that:
An error common to the programs was the concept that itwas wrong to consume, rather than that we should consumewisely in view of the higher price of energy. For example,a goal was that we should consume less, even where less meant alsoless comfort, less productivity, and fewer goods and services -regardless of the cost effectiveness. The mistake was inpresuming that conserving less energy was the goal, and that thegoal had an intrinsic value. The blunder lives on today in themandates of virtually all state energy agencies (emphasis in theoriginal).16
In fact, the energy experience indicates that conservationmandates and subsidized efficiency will not even achieve the goalof reducing net consumption.17
HR 623: A First Step
Given the weak theoretical case for the plumbing standardsestablished in the 1992 Energy Policy and Conservation Act (EPACT),consumer complaints about mandatory low-flow toilets and showersshould be heeded by this Congress. HR 623 is indeed worthy ofsupport.
Yet the underlying problem that motivated passage of thosestandards should not be dismissed lightly. Conservationists areright to fret over the excessive consumption of water in the UnitedStates. Yet there is no reason for panic. Total water consumptionhas declined over the past 20 years despite growth in populationand national GDP, and per capita use today is lower than at anytime since 1965. Absolute water consumption is about where it wasin 1975.18
Steep projections of future needs are flawed in that theyconfuse need with demand.19
Harvard's Peter Rogers thus "sees no water crises at present ineither water quantity or water quality."20
As far as the future, Rogers notes;
The United States could have a water crisis or just amodest increase in demand. Which forecast should be used? …If the regulators leave water sellers free to make water pricesmore nearly represent the marginal cost of supply, and if realisticpricing policies are pursued in cases where the supply has to becontrolled by government, then the forecast crisis will never takeplace.21
Conservationists have identified a worrisome malady, yet theirdiagnosis of the problem and their prescription for recovery areincorrect.
Water markets - like the energy markets before them - need adose of market discipline. Water supply, allocation, and pricingdecisions should be left to market actors with limited interferencefrom government. The old rationales for government control over thewater industry are not persuasive either theoretically orempirically.22
Consumers have proven quite responsive to changes in waterprices and water markets have been shown to work quite well whenreleased from regulatory constraints.23
This is particularly true in acute drought conditions, whengovernment price controls are most counterproductive.24
While state and local governments are primarily responsible forthe municipal provision of water, the federal government shouldassist by eliminating to the greatest degree possible its owninterventions in the water economy. Greater reliance on marketpricing could be introduced to federal water projectentitlements.25
Allowing water transactions between consumer groups would alsogreatly facilitate the development of water markets.26
The Commerce Clause could even be invoked to facilitate abreak-up of state regulation.27
Accurate price signals will surely induce Americans to conserve.Some consumers may willingly install the very low-flow shower headsand toilets targeted by HR 623. Others may decide that they valuelong, vigorous showers more than they value green lawns. Moreimportantly, accurate price signals will reach the greatest sourcesof water waste and over-consumption - the agricultural industry -and even modest reductions in use would overwhelm the potentialgains from residential conservation.28
America should learn from the mistakes of the 1970s and freewater provision and consumption from regulatory control.
1. Although present water chargesare on average about half what they would be in a free market, thedisparity between regulated and market price varies by consumer.Municipalities charge about $1 per 1,000 gallons while industry andagriculture pay only 10 cents per 1,000 gallons. Contrast thoseprices with bottled water, which sells at about $4,000 per 1,000gallons. Peter Rogers, America's Water: Federal Roles andResponsibilities (Cambridge: MIT Press, 1993), pg. 1, 186.
2. Terry Anderson and Pamela Snyder,Water Markets: Priming the Invisible Pump (Washington:Cato Institute, 1997), p. 7.
3. Ibid., p. 18.
4. Rogers, pp. 101-103.
5. The water industry is by far themost capital-intensive industry in America and, in terms of annualcapital expenditures, ranks only behind electricity andpetrochemicals. The federal government alone employs over 90,000people in ten cabinet departments, two major independent agencies,and 34 smaller agencies to oversee 25 separate water programsgoverned by more than 200 sets of federal rules, regulations andlaws. State and local governments employ and additional 50,000regulators and consultants. Rogers, pg. 4, 15-16, 239-241.
6. Ibid., 49-53
7. Robert L. Bradley, Jr., Oil,Gas, and Government: The U.S. Experience (Lanham, MD: Rowman& Littlefield, 1996), pg. 465-532, 629-710, and 1605-1694.
8. M.A. Adelman, The Genie Outof the Bottle: World Oil Since 1970 (Cambridge: MIT Press,1996, pp. 11-39). Stuart Burness and James Quirk have likewisenoted that "Often, what appears to be a shortage of water isactually the manifestation of restrictions on water rightstransfer." "Water Laws, Water Transfers, and Economic Efficiency:The Colorado River," Journal of Law and Economics 23,April 1980, p. 133.
9. "Price controls and allocationsproduced the gasoline waiting lines which were 'made in the USA,'not by the Arabs. They were made much worse by set-asides: firstfor farmers, then justice required them for truckers, etc. Theresult was more hoarding and less supply." M.A. Adelman, "The WorldOil Market: Fact and Fiction," Policy Analysis, Cato Institute,forthcoming. For an extensive treatment, see Bradley 1996, pp.1815-1910.
10. Robert L. Bradley, "What NowFor U.S. Energy Policy? A Free Market Perspective," Policy Analysisno. 145, Cato Institute, January 29, 1991, p. 2.
11. "Energy Security White Paper:U.S. Decisions and Global Trends," American Petroleum Institute,Washington, 1988, pp. 83-85.
12. Robert Hall and RobertPindyck, "What to Do When Energy Prices Rise Again," The PublicInterest 65, Fall 1981, pp. 59-70 and Richard Gordon, AnEconomic Analysis of World Energy Problems (Cambridge, MA: MITPress), 1981.
13. Economists are well aware ofthe fact that improving technical energy efficiency reduces thecost of, and thereby tends to increase the consumption of, goodsand services that use energy. The degree to which energy efficiencygains will lead to increases in energy consumption depends upon theelasticity of demand for each of the effected energy service.Unfortunately, "the rebound effect seems important for serviceswith a significant conservation potential but negligible forservices with a minor conservation potential in terms of kWhs"(Franz Wirl, The Economics of Conservation Programs(Boston: Kluwer Academic Publishers, 1997, pg. 31, 139). Therebound effect applies to firms as well. For empiricaldocumentation of the rebound effect, see David Greene and L.A.Greening, "Energy Use, Technical Efficiency, and the ReboundEffect: A Review of the Literature," Report to the Office of PolicyAnalysis and International Affairs, U.S. Department of Energy,December 1997. For a review of the literature regarding the reboundeffect and automobile transportation, see David Greene, James Kahn,and Robert Gibson, "Fuel Economy Rebound Effect for U.S. HouseholdVehicles," Energy Journal 20:3, 1999, pp. 6-10.
14. Adelman 1993, p. 495.
15. As Nobel Laureate F.A. Hayekhas noted, "An economic actor on average knows better theenvironment in which he is acting and the probable consequences ofhis actions than does an outsider, no matter how clever theoutsider may be." F.A. Hayek, "The Use of Knowledge in Society,"American Economic Review 35, 1945, pp. 519-530. For areview of public versus private decision-making in the energyeconomy, see generally Wirl, pp. 119-142.
16. Thomas Lee, Ben Ball, Jr., andRichard Tabors, Energy Aftermath: How We Can Learn From theBlunders of the Past to Create a Hopeful Energy Future(Boston: Harvard Business School Press, 1990), p. 61.
17. Wirl, pp. 185-206.
18. Rogers, pp. 34-35. The mainreason water consumption has dropped over the past 20 years is that(1) effluent charges were imposed on industry (providing anincentive to reduce water discharges and thus water consumptionitself), (2) stricter water quality regulations provided anincentive to recycle discharges, and (3) reductions in agriculturaldemand reduced irrigation needs. Rogers, pg. 126, 147.
19. "Demand" is a function ofeconomics, the quantity of water that consumers are willing topurchase at various prices. "Need" is a projection of future trendsbased upon present price signals. Ibid., pp. 125-131.
20. Ibid., p. 199,
21. Ibid., p. 131.
22. Anderson and Snyder, pp.49-53.
23. Harvard's Peter Rogersconcludes that "First, the market seems to work quite well inallocating scarce water, specifically in the West. In fact, itworks better than most economists themselves would have predictedonly 10 years ago. Second, water consumption is clearly priceresponsive. The problem is finding some reasonable second-orthird-best pricing schemes … In sum, while economic analysisand economic thinking by no means solve all the problems in thefield, water managers and consumers must apply them if a coherentwater policy is to emerge in the United States." Rogers, p. 150.See further Anderson and Snyder, pp. 8-12.
24. Concludes oil economist M.A.Adelman, "The almost unquestioned major premise among governmentsthat in an emergency there has got to be a 'fair allocation atreasonable prices,' is possibly the greatest single aggravatingforce in making disruptions worse then they need be." M.A. Adelman,The Economics of Oil Supply (Cambridge: MIT Press, 1993),p. 516. The success of the Drought Water Bank in California inameliorating the worst effects of the 1987-1993 drought are cleartestaments to the dramatic gains can that can be achieved by simplyallowing market transactions in water. Rogers, pp. 8-10.
25. Rogers (p. 187) argues that"federal water project development has proceeded unevenly,inefficiently, and inequitably. It has been driven largely by thedictates of distributive politics. The result has been water oftennot available where it is most needed or desired and wasted orabused where it is available." Reallocation of water rights by theBureau of Reclamation, the Army Corps of Engineers, the TennesseeValley Authority, and the Soil Conservation Service would prove amajor step in the right direction.
26. Ibid., p. 154.
27. For a comprehensive federalagenda for reform, see Anderson and Snyder. For a discussion of howthe Commerce Clause might be used to constrain state and localregulation of the industry, see Paul Ballonoff, Energy: Endingthe Never Ending Crisis (Washington: Cato Institute, 1997),pp. 73-102.
28. Rogers (pp. 31-32), notes thatirrigated agriculture, located primarily in the 19 western states,consumes four times as much water as all other consumers combined.Anderson and Snyder (pp. 8-12) conclude that the water inefficiencyis far greater in that sector than any other.