Water Scarcity and Economic Growth

Thomas Hertel and Jing Liu

Purdue University

Presented October 2, 2014 to the

OECD CIRCLE Workshop

Paris, France

Three perspectives on water scarcity and economic growth

• Water as a publicly provided good, with reuse, but subject to congestion (Barbier, 2004)

• Water as a conventional input into the national production function (in the tradition of Solow)

• Water in a global CGE model (allocative distortions, second best effects and terms of trade changes)

Water as a publicly provided good with congestion

• Optimal growth model • Firms draw on common pool of water;

however, marginal productivity declines with increasing withdrawals (congestion)

• Cost of withdrawal rises at increasing rate

• Optimal rate of water utilization maximizes economic growth rate (Fig.1)

• Empirical results • Focus on 163 countries during 1990’s

• Positive elasticity of growth wrt water withdrawals (10% rise boosts growth rate from 1.3% to 1.33%)

• Most countries could increase growth rate by boosting water withdrawals

• Just 10% face extreme water scarcity

• However, sub-national story is surely different

Water as a conventional input into national production function: y = f(K,W)

• Central issue is the potential for substituting accumulating human and physical capital for water, summarized by

• If then, as K/W rises, water’s share of GDP will rise, eventually limiting growth

• If then, as K/W rises, water’s share of GDP will diminish and growth will not be constrained, as increasingly abundant capital is used to improve water efficiency as well as enhance available supplies of water to the economy

• But is an abstract concept – how can this be captured in a CGE model? It is determined by four different components:

• Sector level technologies

• Inter-sectoral responses to water scarcity

• Consumers’ willingness to substitute away from water intensive goods

• Potential for recycling/reuse and desalinization

• Calculating implied value of from CGE-water models would be a useful component of any assessment of impact of water scarcity on growth

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1

Water and real income growth in a global CGE model

• Direct cost to economy of reductions in water availability depends on marginal value product of water in the CGE model; appropriate valuation of water, by sector/use is critical

• In many economies there are large (even 100x!) divergences in the MVP of water by sector; this opens the way for large second best effects in the face of any exogenous shock, provided it results in water reallocation

• Water scarcity can lead to reallocations across distorted sectors which can improve, or exacerbate losses (Liu et al. find the latter)

• Terms of trade effects can also be significant as the price of water intensive goods rises; welfare impact depends on geography of trade

Irrigated Agriculture: The Dominant Water Use

• Each calorie produced requires roughly 1 liter of water through crop evapotranspiration; feeding the world each year requires enough water to fill a canal 10m deep and 100m wide encircling the globe 193 times!

• Four-fifths is rainwater, one-fifth is irrigation water; accounts for 70% of global freshwater withdrawals

• Irrigated area accounts for nearly 20% of cropland and 40% of production

Groundwater irrigation has become increasingly

important

• Accessible without large scale

government initiatives at low

capital cost (although high

operating costs)

• Offers irrigation on demand

• Reliability in time and space: low

transmission and storage losses

• Drought resilience; surface water

not available during drought

• If undertaken in areas with high

recharge rates, then it is also

sustainable

But most rapid growth has been in

arid areas with low recharge rates

8

Source: cited in Burke and Villholth

There is substantial scope for increasing water use

efficiency in agriculture, given appropriate incentives

• Improving delivery of water to plants: Global irrigation efficiency = 50%

– But not all losses are really lost – reuse of water further downstream

– Improved irrigation efficiency can also increase total use: ‘Jevons’ paradox’

• Increasing ‘crop per drop’: Water use efficiency of crops themselves

– Can be achieved by reducing non-beneficial evaporative losses and limiting deep

percolation of rainwater

– Also by boosting grains share of total biomass, limiting pest damage, and improving

drought tolerance

– Small-scale farms can boost production with less than proportionate rise in water

use; for commercial scale operations, tend to rise in equal proportions

Evidence of conservation in the face

of scarcity: The Australian experience • Drought in 2002/3 led to a 29% drop

in water usage in the Murray-Darling

Basin

• However, water used in irrigated rice

production dropped by 70%

• Early modeling work failed:

– predicted only modest declines in

irrigation water usage

– Missed the potential for:

• Shifting land to rainfed

production

• Shifting rice production to

other regions

• Required significant modification of

the TERM-H2O CGE model

Flexibility facilitated by water trading: when water is

available, produce rice. When it is scarce, sell water

rights instead of growing rice! (Will Fargher, National

Water Commission)

Increasing irrigation scarcity will alter the geography of food trade

Irrigation. reliability index =

actual water consumption / potential irrigation demand

Red color means potential irrigation demand is

less satisfied by actual irrigation consumption

Source: Liu et al. GEC, 2014

Focus on India results…

As output falls, consumers substitute low cost imports for domestic crops, exports & production decline

Source: Liu et al. GEC, 2014

Water use in power generation • Hydropower consumes water through

evaporative demand

• Water for cooling is key water demand

• World Bank report highlights adverse

impacts of water scarcity: – “In the past five years, more than 50% of the world’s

power utility and energy companies have experienced

water-related business impacts. At least two-thirds

indicate that water is a substantive risk to business

operations.”

– In India, South Africa, Australia and the United States,

power plants have recently experienced shut-downs due

to water shortages for cooling purposes.

Water use in power generation • Hydropower consumes water through

evaporative demand

• Water for cooling is key power demand

• World Bank report highlights adverse

impacts of water scarcity: – “In the past five years, more than 50% of the world’s

power utility and energy companies have experienced

water-related business impacts. At least two-thirds

indicate that water is a substantive risk to business

operations.”

– In India, South Africa, Australia and the United States,

power plants have recently experienced shut-downs due

to water shortages for cooling purposes.

• Projections for India suggest that power

sector’s share of water use could rise

from 4% today to 20% in 2050 – primarily

for cooling; abstracts from potential for

installation of water efficient capacity

Residential, commercial & industrial uses

• Residential demands well-studied:

– Avg price elasticity of demand in industrialized countries = -0.4

– In developing countries, households draw on multiple sources of water: tap,

wells, tankers, vendors, rain and surface water – it is complicated!

• Urban formal: tap water – as with rich countries

• Urban slums: inadequate water and sewage svces; price is often time

• Rural consumption: household labor required to collect water

• Commercial sector is heterogeneous, difficult to assess: assume

same behavior as residential demands

• Industrial demands vary greatly by industry:

– Water often self-supplied – hard to monitor

– Industrial steam is important source of demand for both water and energy;

conservation of energy leads to reduced water use

– Scope for water savings, given incentives: elasticity= -0.15 to -0.6 depending

on sector

Environmental demands (in-stream use)

• Requirements depend on total volume as well as high/low flows

• Portion of flow reserved for environmental purposes varies from 10% (IFPRI’s

IMPACT-WATER model) to 50% (IWMI – see map below)

Water Supply • What is the relevant spatial unit for supply? Global models focus on river

basin; take inputs from hydrological model

• Reuse of water is key:

– Seckler et al. suggest that reuse will be one of the most important

sources of supply in the coming decades

– Main barrier to reuse is pollution; therefore pollution control is source

of water supply

• Luckman et al study reduced water availability in Israel emphasizing

reuse

– seven different types of water separately, breaking out: freshwater,

seawater, brackish groundwater (all natural resources), which can be

converted to potable water, brackish water and reclaimed water via

some production process; also allow for desalinization

– 50% reduction in freshwater costs economy 0.2%GDP

• Rules for allocation across sectors are critical

Research Challenges & Priorities • Main barrier to global CGE modeling of water scarcity is data availability: not broken out

in the typical social accounting matrix:

– Break out activities by river basin

– Identify physical volumes by use – draw here on hydrological models

– What price? Marginal value product varies widely across and within sectors

• Important to distinguish different types of water: endowments, outputs, byproducts and

intermediate inputs along with associated technologies

• Putty-clay treatment to capture impact of new investments on efficiency

• Need to establish links to hydrological models which:

– Ensure that laws of gravity are enforced!

– Incorporate impacts of infrastructure development and depreciation

– Deal with temporal and spatial variation

• Important to accommodate alternative allocation rules (e.g., M-D Basin water reforms)

– How will scarcity be accommodated?

– Which sectors have priority?

– Will scarcity lead to institutional reforms?