Reflections--Shaping Water Policy: What Does Economics Have to Offer?

This article examines the extensive and evolving literature regarding the economics of water policy. It offers policymakers a way of thinking and a set of skills to (1) identify the least-cost way to reach a particular water quantity or quality objective or set of objectives (e.g., cost effectiveness); (2) assess the benefits--both market related and nonmarket--and costs to society of alternatives (i.e., benefit--cost analysis); (3) understand the role of water prices (providing incentives for conservation and innovation, giving consumers freedom of choice, generating revenues), the level at which they should be set (long-run marginal cost), and the levels at which they are actually set; and (4) create markets for water within and between sectors, recognizing many preconditions must be met if water markets are to work effectively. The article advises policymakers that they can use economics to support the case for those investments and policy initiatives that are likely to yield substantial net benefits and to argue against those that are not, and that prices can be used to manage water resources efficiently. (JEL: H2, H3, Q2, Q3) Copyright 2013, Oxford University Press.