I’d like to thank the members of the subcommittee on energy and power for the opportunity to testify today on HR 623, “The Plumbing Standards Improvement Act of 1999.” My comments this afternoon will attempt to put the discussion in context by addressing the underlying realities of water markets. The plumbing standards at issue are but a small thread within the larger tapestry of national water policy, and an understanding of that policy is necessary to judge the merits of HR 623. In brief, while there is a legitimate concern about water availability, over-consumption is an artificial phenomenon — a product of misguided public policy. Appliance standards — such as those targeted for elimination by HR 623 — are incapable of remedying the underlying causes of water scarcity and, moreover, introduce further distortions and inefficiencies in water markets. In fact, there are striking parallels between water and energy markets (and between water and energy policy) that serve to illuminate the underlying issues at stake in the debate over HR 623. In my judgement, passage of “The Plumbing Standards Improvement Act” would move policy in the right direction.

The Anatomy of Present Water Markets

Water is delivered to consumers either by public entities or private companies regulated by public utility commissions. The questions of how much water to deliver to consumers — and what price to sell it — are likewise determined by political entities, not by market agents. Unfortunately — perhaps inevitably — governmental agents have directed water to politically powerful interests (primarily western agriculture) and under-supplied water to less politically powerful interests (urban consumers). Moreover, water prices have been kept artificially low.1

Scarcity and shortage has been the inevitable result.2

Government has reacted — not by raising its price — but by mandating conservation, primarily on the less politically influential (the agricultural industry, which consumes 80–90 percent of all water withdrawn for human use,3 has been generally immune from such strict conservation mandates). The plumbing fixture mandates of the 1992 Energy Policy Act are a primary example of the kind of technical, engineering fixes employed to manage water supply and demand.4

The above story should sound familiar. In fact, water policy today is a virtual carbon copy of energy policy in the 1970s. The water industry, like the energy industry, is one of the nation’s largest — and most heavily regulated — businesses, delivering a life-sustaining resource crucial to the economy.5

Then, as now, government rationalized centralized control over the resource on the grounds that it was too important to leave to the marketplace, too scarce to be allocated by the cold logic of the invisible hand, and too riddled with market failures to be efficiently traded without government oversight.6

Then, as now, government restrained prices and controlled resource 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 by mandating conservation.

What the Energy Experience Can Teach Us About Water Policy

America should have learned a few very important things about economics from the energy experience of the 1970s. First, when government regulations keep prices below market-clearing levels, shortages inevitably follow. Shortages are an artifact of public policy, not geology.8

Second, government agents cannot direct resource production, price, or allocation decisions as efficiently as can market actors.9

When the tangled web of energy regulations were relaxed or eliminated in the 1980s, scarcity vanished. Subsequent supply disruptions did not usher in the scarcities or inconveniences of the 1970s even though the disruption of 1990 was as larger or larger than those of the 1973 and 1979.10

Third — and most relevant to HR 623 — mandatory conservation measures are a poor substitute for accurate price signals. It was rising prices — not mandatory conservation — which ultimately led to increases in energy efficiency in the 1970s and 1980s.11

The only way to avoid shortages is to rely on free-market pricing and allocation.12

Consumers circumvent mandatory conservation technologies by increasing consumption at the margin (the well-known “rebound effect“13or procuring through indirect channels the resource being denied them. Their behavior seems to be in agreement with M.A. Adelman’s argument that “energy conservation for its own sake regardless of price is the talk of the madman in Dr. Strangelove, obsessed with his ‘precious bodily fluids.’ ”14

Finally, government directed conservation investments are unlikely to improve upon those that would be made if consumers were faced with correct market signals.15

Looking back at the mandatory energy conservation standards of the 1970s, MIT analysts observe that:

An error common to the programs was the concept that it was wrong to consume, rather than that we should consume wisely in view of the higher price of energy. For example, a goal was that we should consume less, even where less meant also less comfort, less productivity, and fewer goods and services — regardless of the cost effectiveness. The mistake was in presuming that conserving less energy was the goal, and that the goal had an intrinsic value. The blunder lives on today in the mandates of virtually all state energy agencies (emphasis in the original).16

In fact, the energy experience indicates that conservation mandates and subsidized efficiency will not even achieve the goal of reducing net consumption.17

HR 623: A First Step

Given the weak theoretical case for the plumbing standards established in the 1992 Energy Policy and Conservation Act (EPACT), consumer complaints about mandatory low-flow toilets and showers should be heeded by this Congress. HR 623 is indeed worthy of support.

Yet the underlying problem that motivated passage of those standards should not be dismissed lightly. Conservationists are right to fret over the excessive consumption of water in the United States. Yet there is no reason for panic. Total water consumption has declined over the past 20 years despite growth in population and national GDP, and per capita use today is lower than at any time since 1965. Absolute water consumption is about where it was in 1975.18

Steep projections of future needs are flawed in that they confuse need with demand.19

Harvard’s Peter Rogers thus “sees no water crises at present in either water quantity or water quality.“20

As far as the future, Rogers notes;

The United States could have a water crisis or just a modest increase in demand. Which forecast should be used? … If the regulators leave water sellers free to make water prices more nearly represent the marginal cost of supply, and if realistic pricing policies are pursued in cases where the supply has to be controlled by government, then the forecast crisis will never take place.21

Conservationists have identified a worrisome malady, yet their diagnosis of the problem and their prescription for recovery are incorrect.

Water markets — like the energy markets before them — need a dose of market discipline. Water supply, allocation, and pricing decisions should be left to market actors with limited interference from government. The old rationales for government control over the water industry are not persuasive either theoretically or empirically.22

Consumers have proven quite responsive to changes in water prices and water markets have been shown to work quite well when released from regulatory constraints.23

This is particularly true in acute drought conditions, when government price controls are most counterproductive.24

While state and local governments are primarily responsible for the municipal provision of water, the federal government should assist by eliminating to the greatest degree possible its own interventions in the water economy. Greater reliance on market pricing could be introduced to federal water project entitlements.25

Allowing water transactions between consumer groups would also greatly facilitate the development of water markets.26

The Commerce Clause could even be invoked to facilitate a break-up of state regulation.27

Accurate price signals will surely induce Americans to conserve. Some consumers may willingly install the very low-flow shower heads and toilets targeted by HR 623. Others may decide that they value long, vigorous showers more than they value green lawns. More importantly, accurate price signals will reach the greatest sources of water waste and over-consumption — the agricultural industry — and even modest reductions in use would overwhelm the potential gains from residential conservation.28

America should learn from the mistakes of the 1970s and free water provision and consumption from regulatory control.

NOTES:

1. Although present water charges are on average about half what they would be in a free market, the disparity between regulated and market price varies by consumer. Municipalities charge about $1 per 1,000 gallons while industry and agriculture pay only 10 cents per 1,000 gallons. Contrast those prices with bottled water, which sells at about $4,000 per 1,000 gallons. Peter Rogers, America’s Water: Federal Roles and Responsibilities (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 the most capital-intensive industry in America and, in terms of annual capital expenditures, ranks only behind electricity and petrochemicals. The federal government alone employs over 90,000 people in ten cabinet departments, two major independent agencies, and 34 smaller agencies to oversee 25 separate water programs governed by more than 200 sets of federal rules, regulations and laws. State and local governments employ and additional 50,000 regulators 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 Out of the Bottle: World Oil Since 1970 (Cambridge: MIT Press, 1996, pp. 11–39). Stuart Burness and James Quirk have likewise noted that “Often, what appears to be a shortage of water is actually the manifestation of restrictions on water rights transfer.” “Water Laws, Water Transfers, and Economic Efficiency: The Colorado River,” Journal of Law and Economics 23, April 1980, p. 133.

9. “Price controls and allocations produced the gasoline waiting lines which were ‘made in the USA,’ not by the Arabs. They were made much worse by set-asides: first for farmers, then justice required them for truckers, etc. The result was more hoarding and less supply.” M.A. Adelman, “The World Oil Market: Fact and Fiction,” Policy Analysis, Cato Institute, forthcoming. For an extensive treatment, see Bradley 1996, pp. 1815–1910.

10. Robert L. Bradley, “What Now For U.S. Energy Policy? A Free Market Perspective,” Policy Analysis no. 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 Robert Pindyck, “What to Do When Energy Prices Rise Again,” The Public Interest 65, Fall 1981, pp. 59–70 and Richard Gordon, An Economic Analysis of World Energy Problems (Cambridge, MA: MIT Press), 1981.

13. Economists are well aware of the fact that improving technical energy efficiency reduces the cost of, and thereby tends to increase the consumption of, goods and services that use energy. The degree to which energy efficiency gains will lead to increases in energy consumption depends upon the elasticity of demand for each of the effected energy service. Unfortunately, “the rebound effect seems important for services with a significant conservation potential but negligible for services with a minor conservation potential in terms of kWhs” (Franz Wirl, The Economics of Conservation Programs (Boston: Kluwer Academic Publishers, 1997, pg. 31, 139). The rebound effect applies to firms as well. For empirical documentation of the rebound effect, see David Greene and L.A. Greening, “Energy Use, Technical Efficiency, and the Rebound Effect: A Review of the Literature,” Report to the Office of Policy Analysis and International Affairs, U.S. Department of Energy, December 1997. For a review of the literature regarding the rebound effect and automobile transportation, see David Greene, James Kahn, and Robert Gibson, “Fuel Economy Rebound Effect for U.S. Household Vehicles,” Energy Journal 20:3, 1999, pp. 6–10.

14. Adelman 1993, p. 495.

15. As Nobel Laureate F.A. Hayek has noted, “An economic actor on average knows better the environment in which he is acting and the probable consequences of his actions than does an outsider, no matter how clever the outsider may be.” F.A. Hayek, “The Use of Knowledge in Society,” American Economic Review 35, 1945, pp. 519–530. For a review of public versus private decision-making in the energy economy, see generally Wirl, pp. 119–142.

16. Thomas Lee, Ben Ball, Jr., and Richard Tabors, Energy Aftermath: How We Can Learn From the Blunders 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 main reason water consumption has dropped over the past 20 years is that (1) effluent charges were imposed on industry (providing an incentive to reduce water discharges and thus water consumption itself), (2) stricter water quality regulations provided an incentive to recycle discharges, and (3) reductions in agricultural demand reduced irrigation needs. Rogers, pg. 126, 147.

19. “Demand” is a function of economics, the quantity of water that consumers are willing to purchase at various prices. “Need” is a projection of future trends based 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 Rogers concludes that “First, the market seems to work quite well in allocating scarce water, specifically in the West. In fact, it works better than most economists themselves would have predicted only 10 years ago. Second, water consumption is clearly price responsive. The problem is finding some reasonable second-or third-best pricing schemes … In sum, while economic analysis and economic thinking by no means solve all the problems in the field, water managers and consumers must apply them if a coherent water 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 governments that in an emergency there has got to be a ‘fair allocation at reasonable prices,’ is possibly the greatest single aggravating force 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 in ameliorating the worst effects of the 1987–1993 drought are clear testaments to the dramatic gains can that can be achieved by simply allowing 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 the dictates of distributive politics. The result has been water often not available where it is most needed or desired and wasted or abused where it is available.” Reallocation of water rights by the Bureau of Reclamation, the Army Corps of Engineers, the Tennessee Valley Authority, and the Soil Conservation Service would prove a major step in the right direction.

26. Ibid., p. 154.

27. For a comprehensive federal agenda for reform, see Anderson and Snyder. For a discussion of how the Commerce Clause might be used to constrain state and local regulation of the industry, see Paul Ballonoff, Energy: Ending the Never Ending Crisis (Washington: Cato Institute, 1997), pp. 73–102.

28. Rogers (pp. 31–32), notes that irrigated 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 inefficiency is far greater in that sector than any other.