International Water Resources AssociationWater International, Volume 27, Number 1, Pages 98–104, March 200298Water as an Economic Good and Demand ManagementParadigms with PitfallsHubert Savenije and Pieter van der Zaag, IHE Delft, The NetherlandsAbstract: In certain circles, demand management is seen as one and the same thing as economicpricing. This thinking is stimulated by the Dublin principle that water should be considered an eco-nomic good. But is this reasoning correct? Is economic pricing an adequate means to reach moredesirable levels of demand? There is considerable misunderstanding about what the concept of water asan economic good implies. In this paper it is argued that water pricing should primarily serve thepurpose of financial sustainability through cost recovery. Moreover, in water pricing, adequate atten-tion should be given to equity considerations through, for example, increasing block tariffs. Instead ofeconomic pricing there is a need for defining a reasonable price, which provides full cost recovery butwhich safeguards ecological requirements and access to safe water for the poor. Giving a reasonableprice to water has the additional benefit that it sends out a clear signal to the users that water should beused wisely, but the prime target of water pricing remains cost recovery. A major argument of neo-classical economists is that economic pricing of water will facilitate the re-allocation of water fromsectors with lower added value (such as agriculture) to sectors with a higher added value (such asurban water use). However, the value of alternative uses of irrigation water is often grossly over-esti-mated. Adequate and effective regulations may suffice in order to achieve the optimal allocation of waterresources.Keywords: Water pricing, Dublin Principle, demand management, financial sustainability, costrecovery.Water as an Economic GoodSince the Dublin conference on Water and the Envi-ronment (ICWE, 1992) it has become generally acceptedamong water resources managers that water should beconsidered an economic good (the four Dublin principles,see Table 1). However, what this entails is not all that clear.The problem is not with the terminology; it is the interpre-tation that causes confusion. One can distinguish twoschools of thought (Van der Zaag and Savenije, 2000). Thefirst school maintains that water should be priced at itseconomic value. The market will then ensure that the wa-ter is allocated to its best uses. The second school inter-prets “water as an economic good” to mean the processof integrated decision making on the allocation of scarceresources, which does not necessarily involve financialtransactions.The latter school corresponds with the view of Green(2000) who posits that economics is about “the applicationof reason to choice.” In other words, making the rightchoices about the allocation and use of water resourceson the basis of an integrated analysis of all the advantagesand disadvantages (costs and benefits in a broad sense) ofalternative options.The concept of Integrated Water Resources Man-agement (IWRM), in line with the first Dublin principle,implies the following four aspects (Savenije and Van derZaag, 2000):• considering all physical aspects of the water resourcesat different temporal and spatial scales (the integrityof the hydrological cycle and the related quality as-pects);• applying an inter-sectoral approach, recognizing all theinterests of different water users (including environ-mental, social. and cultural requirements);• giving due attention to the sustainability of water useand the rights of future generations;• involving all stakeholders, at all levels in the manage-ment process, giving due regard to women.These four aspects, each in a different way, are atvariance with the first school’s interpretation that “wateris just another economic good that needs to have an eco-nomic price.”The first aspect of IWRM states that water is notdivisible into different types or kinds of water. It may begroundwater at some stage, at a later stage it will becomeWater as an Economic Good and Demand ManagementParadigms with Pitfalls 99IWRA, Water International, Volume 27, Number 1, March 2002surface water. Earlier in the water cycle it was rainfalland soil moisture. But it all remains the same water. Useof soil moisture diminishes the availability of groundwater;use of groundwater diminishes the availability of surfacewater, etc. Thus any use of water affects the entire watercycle. Since water is a resource vital to life for whichthere is no substitute, for water no choice exists betweenresources. The only choice to be made is how to allocatewater, and finding the most efficient way of using it. Wa-ter, then, is fundamentally different from other economicgoods. If one needs energy, for instance, one can choosebetween solar, wind, hydropower, fossil fuel, nuclear power,etc. If one needs vitamins, one can choose between dif-ferent kinds of fruit. The market mechanism works al-most naturally for such kind of goods. With water that isnot the case. One cannot easily choose another type ofwater without tapping the same resource.Related to this first aspect is the temporal variability.The availability of the resource depends on climatic vari-ability, but also on land use and human interference, some-times hundreds of kilometers away. Also demand variesover time, both in the short and long term, as the structureof the economy and population changes. Later in this pa-per, an example of the significance of this temporal varia-tion is presented.The second aspect of IWRM, to consider and bal-ance all sectoral interests, limits the applicability of neo-classical economic principles also. There are importantwater uses that have a high societal relevance, but a verylimited ability to pay, particularly the environmental, social,and cultural requirements. Yet most, if not all, societiesrespect these interests. Decisions on water allocation ap-pear to be taken seldom on purely “economic” (using theword in the interpretation of the first school) grounds. Onthe contrary, governments generally take decisions on thebasis of political considerations with strong considerationsfor social, cultural, and sometimes environmental interests.Of course, economic and financial considerations are anintegral part of these decisions, but they seldom are theoverriding decision variable. This pragmatic approach isin agreement with the second school