Why the economics of water is so hard with Prof Michael Hanemann

The Future Dams project is pleased to present Professor Michael Hanemann, Arizona State University to discuss why the economics of water are so hard.
Economists typically analyse water issues using the same theoretical models they apply to other commodities. Like all theoretical models, those economic models simplify reality in order to focus on the key questions. However, the models become useless, even counterproductive, if they oversimplify, if they omit elements that are essential to the issue being considered. That happens frequently with economic analyses of water. Water has some distinctive features that are often overlooked or omitted in economic analyses - physical, attitudinal and legal features.
Because of its distinctive physical characteristics - water flows, its quantity is variable, the same molecule can be used sequentially for different uses by different people, in some uses it functions as a private good, in others as a public good, some of its uses (especially in agriculture) are only intermittent - water is a very heterogeneous commodity. Water is an entangled commodity - because of externalities associated with the use of water; because the supply of water (especially surface water) involves shared infrastructure that is jointly financed; and because of legal property rights which make water something of a communal good. More than any other commodity, water raises issues of equity.
Water also arouses strong feelings among the public that place real constraints on how it is provided and financed. In consequence, conflict is almost endemic in water; so is underpricing. Water economics needs to be more about bargaining and less about optimisation. Analysing the economics of water with a narrow focus on aggregate efficiency is usually misguided and often counter-productive.