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2/15/05 THE VALUE OF WATER Michael Hanemann University of California, Berkeley 1. Introduction 2. What is Economic Value? How is it Measured? 2.1 The Meaning of Economic Value 2.2 Non-market Valuation and Water 3. Is Water Different? 3.1 Water as a Private Good, Water as a Public Good 3.2 The Mobility of Water 3.3 The Variability of Water 3.4 The Cost of Water 3.5 The Price of Water 3.6 TheEssentialness of Water 3.7 The Heterogeneity of Water 3.8 The “Average instead of Marginal” Fallacy 3.9 The Benefits of Water 4. The Problem of Water References

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1. Introduction There is a widespread perception among water professionals today of a crisis in water resources management. Water resources are poorly managed in many parts of the world, and many people – especially the poor – lackaccess to adequate water supply and sanitation. Moreover, this is not a new problem – it has been recognized for a long time, yet the efforts to solve it over the past three or four decades have been disappointing, accomplishing far less than had been expected. In addition, in some circles there is a feeling that economics may be part of the problem. There is a sense that economic concepts areinadequate to the task at hand, a feeling that water has value in ways that economics fails to account for, and a concern that this could impede the formulation of effective approaches for solving the water crisis. My own personal assessment is that the situation is somewhat more complex than critics suggest. On the one hand, as environmental economics has evolved over the past forty years, it hasdeveloped a conceptual toolkit that I think is well suited for dealing with many of the issues of water supply and water resource management. On the other had, economists sometimes slip into older ways of thinking and characterize economic value in terms that are inadequate or misleading. Moreover, even among economists there is an inadequate appreciation of the complexities of water as an economiccommodity; these render it distinctive from other commodities and they contribute to the explanation of the current crisis in water. This paper examines the economic concept of value and some related notions as they apply to water, at least partly in light of these concerns. It consists of two main sections. Section 2 reviews the economic concept of value, explains how it is measured, and discusseshow this has been applied to water in various ways. Section 3 takes on the debate regarding whether or not water can or should be treated as an economic commodity, and discusses the ways in which water is the same or different as other commodities. The paper ends with a few concluding observations in Section 4.

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2. What is Economic Value? How is it Measured? Is economic value measured bymarket price? If an item has a price of $x, is this also the amount of its economic value? Most people assume the answer is yes, and economists sometimes also make this statement. For example, the following passage equates the economic value of water with its market price: “Water has economic value only when its supply is scarce relative to demand. Whenever water is available in unlimited supply, itis free in the economic sense. Scarce water takes on economic value because many users compete for its use. In a market system, economic values of water, defined by its price, serve as a guide to allocate water among alternative uses, potentially directing water and its complementary resources into uses in which they yield the greatest total economic return.”1 If it were true that economic valueis measured by market price, this would imply that only marketed commodities can have an economic value. Items that are not sold in a market – including the natural environment, and public goods generally – would have no economic value. If this were so, economic value would indeed be a narrow concept and at variance with many people’s intuitive sense of what is valuable. In fact, however,...