Expensive urban water infrastructure, such as desalination plants, have been built in several Australian cities over the past decade, but much of this would not have been needed if a more flexible approach to the pricing of water had been adopted.

That’s according to an economic analysis undertaken by Dr Hugh Sibly from the Tasmanian School of Business and Economics, who has spent much of his career analysing the determinants of consumer economic behaviour.

Water consumption rates can be a pressing issue in times of drought, and Dr Sibly’s research has shown that the traditional, inflexible methods of regulated water pricing are either less effective or less fair than adopting flexibility in setting the volumetric rate (price per litre) and connection charges for urban water.

The idea is to raise the volumetric rate of water and correspondingly lower the connection charge during a drought.

Dr Sibly’s research shows that for many people, aligning an economic incentive – the fact that you will save money during a drought if you use less water – with a feeling of doing the right thing, leads to reduced consumption, and can result in a more efficient use of water during a drought than the use restrictions.

“You align people’s intentions with incentives,” he said. “If you tell people there’s a drought, so they’re going to be charged more for water they use, you can say, ‘Not only is it a good idea to use less water, but you’ll save money as well.’”

Dr Sibly says the current water pricing system – in which price per litre is kept relatively low during a drought and the connection fees remain correspondingly constant – was designed in an era when water shortages weren’t as critical.

“When you go back through history, when cities were smaller and the population was lower, we had such big dams that it was possible to have water that was free,” he said.

But as our population grew, water has become relatively scarcer, yet the price is still really, really low during drought periods.

Surprisingly, Dr Sibly’s economic modelling shows that the average consumer wouldn’t be worse off if price per litre increased.

“The low usage consumer, who is the one you want to pat on the back and say, ‘Thank you for being so good and using less water,’ will be much better off. And the high usage consumer will be worse off,” he said.

This is because the reduction in the connection charge is bigger for the low usage consumer than their increased water usage charges. And the reverse is also true for the high usage consumer.

Dr Sibly says the sooner such a policy can be introduced the better. It’s better to have good policy established, rather than attempting to manage a crisis when next major drought to hits. 

“When the Millennium Drought started in the early 2000s, I could see there were people saying, ‘We need more desalination plants,’ and ‘We need more infrastructure,’” said Dr Sibly.

As an economist, I realised that you could spend billions of dollars on infrastructure, or adjust the volumetric rate. One would cost you billions of dollars, and the other would cost you nothing.

To pay for idle desalination plants, many people’s water connection fees have increased by hundreds of dollars per year. This investment could have been delayed, at least until the next drought appeared imminent. The money saved by doing so could have been used more effectively for other purposes.

Predicting the effect of the proposed pricing scheme is relatively straightforward, says Dr Sibly.

“It’s fairly standard economic theory – you only have to assume a simple thing such as, if price goes up, people use less. If you understand the law of demand, then you can demonstrate all the things I’ve described about water.”

The more difficult thing to do, he adds, is to understand how people feel about that. That’s what Dr Sibly is now working to figure out.

“This is one of those difficult things to get a handle on. Suppose you change water pricing – it’s hard to know how people are going to react,” he said. This question is part of his future research.

“One of the things we could do in experimental economics is pre-test that policy in the lab, running through scenarios and financial incentives aligned with water usage, and seeing how the participants respond.”

Find out about studying Business and Economics at the University of Tasmania here.