New Delhi | Agastyaa Gupta: Economics is the study of how humans make decisions under conditions of scarcity. In this context, scarcity refers to "the basic fact of life that there exists only a finite amount of human and nonhuman resources which the best technical knowledge is capable of using to produce only limited maximum amounts of each economic good." (Samuelson 1980) If the conditions of scarcity didn't exist and an "infinite amount of every good could be produced or human wants fully satisfied ... there would be no economic goods, i.e. goods that are relatively scarce." (Samuelson 1980)

Scarcity can refer to material goods (i.e. money), immaterial goods (i.e. time), manmade products (i.e. consumer goods) and natural resources (i.e. land). Water is one such natural resource that is bound by the limits of scarcity. Water has not only been recognised as an essential economic good, but also an important input to other economic activity. It is crucial for irrigation, household and commercial water use, hydropower generation, and other ecosystem services such as aquatic ecosystems and wildlife support.

Increasingly, we are facing rising shortages of this precious and scarce resource as a result of climate change, population growth, economic development, and misuse. These factors not only increase demand, but also decrease supply.

As a science about the optimal allocation of scarce resource, the field of economics plays a crucial role in understanding and managing water resources, both in terms of quantity and quality. Economic instruments such as voluntary water transfers, water markets, and water pricing can all help to limit demand and ensure that it is balanced with available supply.

(Agastyaa Gupta)

However, because of its physical attributes, water is not a standard private good. It has variable availability depending on seasons and climate in various locations across the globe. As a basic resource necessary for life, there are also ethical questions of whether users can be excluded from its use. Therefore, water resource management must also integrate perspectives ranging from economics and environmental management, to legal, political, and socioeconomic perspectives, to grapple with the complex array of questions posed.

This research paper attempts to provide an overview of the economics of water management, and introduce the basic concepts within the field.

Water Scarcity - Globally & in India

In light of ecological factors like climate change, and demographic factors like population growth and urban expansion, most countries are placing unprecedented pressure on water resources. According to the World Bank, the world will face a 40% shortfall between forecast demand and availability of water supply by 2030; and by 2025, approximately 1.8 billion people will be living in regions or countries with absolute water scarcity. (World Bank 2017) Furthermore, feeding a population expected to exceed 9 billion by 2050 will lead to a 15% increase in water withdrawals for agricultural activity. (World Bank 2017)

As an agro-economy, with more than 50% of the population directly involved in agriculture, India is one such nation that will bear the brunt of water shortages. Though India has made improvements over the past decades in its drinking water systems, especially in urban areas, one major area of concern is the lack of replenishable water resources. As a major grain producer, India relies heavily on its aquifers for this water-intensive crop, which depletes the groundwater supply. Rural and agrarian communities have little choice but to drill wells to access groundwater, further depleting water resources.

To deal with these complex and interlinked water challenges, countries must improve the way they manage their water resources, for example, by investing in natural and man-made infrastructure, instituting legal and regulatory frameworks, and implementing incentives like water pricing to decrease demand and better allocate, regulate and conserve water resources.

Economic & Policy Interventions

When water supply is plentiful and can keep pace with or outmatch demand, water policies tend to be simple. As populations grow and economies expand, however, water resources evolve from an "expansionary" phase to a "mature" phase. (Randall 1981)

A water sector in the "mature" phase is characterized by rising marginal costs of providing water and increasing interdependencies among users. It is in this phase that conflicts over scarcities and external costs also arise. These conflicts reach a level of complexity that they typically require management systems to resolve disputes and allocate water resources among users.

This section attempts to examine which water policies work or fail and assesses the advantages and disadvantages of economics approaches to public water policy.

To improve water resource management, one must first recognise that the water sector is linked to the national economy. A country's overall development strategy, including its use of macroeconomic policies such as fiscal, monetary and trade policies, should take the crucial role of the water sector into account, for example through expenditure on infrastructure such as irrigation or dams. Another example is trade policies that impact exports, particularly water-consuming crops. With greater demand for these crops comes a greater incentive to invest in the necessary irrigation.

Throughout the world, water is treated as more than a simple economic commodity, because it is essential to life. In many societies, water carries special cultural, religious and social values. As one researcher observed, "the sacredness of water as a symbol of ritual purity exempts it somewhat from the d**ty rationality of the market". (Boulding 1980). As a result, it is often removed from competitive market allocation mechanisms. Some religions, such as Islam, even prohibit water allocation by market forces.

It is widely acknowledged that access to water is a basic human right. This connection between water and human life is often most pronounced in arid regions, where crop irrigation is essential to food production. However, the focus on water's life-giving status tends to obscure the fact that, in most developed societies and urban areas, only a tiny fraction of water consumption is actually for drinking and preserving life, with the larger portion being used for convenience and comfort. In the arid western United States, for example, per capita water withdrawal by households frequently exceeds 400 litres per day, about half of which is used to irrigate lawns and gardens. Most of the remainder is for flushing toilets, bathing and washing cars. (FAO 2021)

Water has two additional features - its bulkiness and mobility - that further complicate management efforts. Water's value per unit of weight tends to be relatively low. Unlike petroleum, which demands a higher market price, the costs of transporting and storing water are generally high relative to its economic value. In crop irrigation, water may yield additional economic values of less than $0.04 per tonne of water. (FAO 2021) The evasive nature of water, which flows, evaporates, seeps and transpires, makes it difficult to establish and enforce exclusive property rights, which are the basis of a market economy.

Groundwater and aquifer management is another aspect of water management often complicated by the aggregate impact of the actions of many individuals. Even though each individual's action may have a negligible impact when taken alone, the sum total has a much more profound impact. For example, in South Asia, one tube well for irrigation has nominal effect on the total water supply; but thousands of tube wells can quickly deplete an aquifer. Establishing effective policies from a top-down level to regulate these many individual decision-makers is exceedingly difficult for economists and policymakers. This is sometimes referred to as "common pool problems", where individually rational resource use leads to a non-optimal result for users as a collective whole. (Gardner, Ostrom, Walker 1990)

Common pool problems arise when there are three conditions present:

1. Large numbers of users withdraw a resource

2. The actions of individual users bring about suboptimal outcomes from the group's perspective

3. There exists an institutionally feasible strategy for collective resource management that is more efficient than the current situation (Ostrom 1990)

Common pool problems occur when there is an "open access" framework, and users draw resources according to the rule of capture. There is no interest to conserve for the future, and individual self-interest leads to overexploitation.

In order to address these challenges, most countries rely on a mix of market policies and direct government interventions. Competitive markets have the potential to self-regulate, and allocate resources (in this case, water supplies) efficiently; producers and consumers - acting in their own self-interest - naturally arrive at the price at which available supplies are allocated. . In such competitive markets, government intervention can be minimised, and the government's primary role becomes to emphasize incentive structures and to establish rules that govern property rights or enforcement of contracts.

In the case of market failures, however, when incentives offered to individuals or firms encourage behaviour that does not meet efficiency criteria, the public sector may intervene to influence water provision and allocation. (FAO 2021)

One such example of this market failure is externalities, where the actions of one impose negative external costs on others. In order to protect affected individuals, governing bodies can impose regulations, taxes, subsidies, fees or technical standards. An example of this is the "polluter pays" principle, which requires producers to pay the "full" cost of their production process, including externalities such as polluting water. (FAO 2021)

While a free market is the most efficient system for allocating resources, market imperfections can accentuate disparities. In these situations, government investment in water infrastructure projects provides and important mechanism in supporting human welfare and economic development.


As our world moves to ever larger populations and demands for water as both a life-giving resource and medium of economic activity, the area of water resource management will remain an interesting and relevant area for the application of economic theory and econometric tools. A complex problem, this field will be best addressed through interdisciplinary approaches that include engineering, environmental management, and other sociocultural fields that can take into account the complex nature of this increasingly pressing challenge.

Posted By: Aalok Sensharma