Eric Crampton admires the water management work of John Raffensperger and Mark Milke and hopes that it can provide the basis for substantial change in New Zealand

Eric Crampton admires the water management work of John Raffensperger and Mark Milke and hopes that it can provide the basis for substantial change in New Zealand

By Eric Crampton*

Peter Jackson took a few liberties with Tolkien’s text for the Lord of the Rings films. Most of them, I didn’t like. But one addition I rather liked came at the start. Frodo complained that Gandalf had arrived late, and Gandalf replied that a wizard is never late – nor is he early. He arrives precisely when he means to.

I’m not sure whether John Raffensperger and Mark Milke are wizards or not, but their book, Smart Markets for Water Resources, is precisely what is needed, and has arrived precisely when it is needed. So, maybe we should upweight the chances that they are wizards.

And I was very pleased to be able to help launch their book at the University of Canterbury last week.

Raffensperger and Milke’s book takes on what’s arguably one of the biggest environmental and economic problems facing New Zealand. How do we make sure that water is allocated properly across competing uses?

It’s not a small problem.

Just think about controversy around water bottling plants. The plants draw criticism for all kinds of reasons. But one of more pertinent worries is that bottlers aren’t paying for water. Now that isn’t really the case: if you buy land that has an existing drawing consent, you’ve already paid for the water. It was bundled into the price of the land you purchased. But that isn’t obvious to critics. Neither is it obvious that bottling water is really the same as irrigating: irrigated water does have some flow back into aquifers or into streams – though sometimes with added unwanted nutrients.

The bottom line is that it’s hard to tell whether water is more valuable being consumed by cows and turned into dried milk powder and nitrogen-rich rivers, or more valuable being put into bottles and shipped to places that are happy to pay a premium for New Zealand water.

If you don't know what your inputs are really worth, it's hard to know the real value of your product. Whether you build cars or make milk powder, that can cause problems.

When Germany reunified after the fall of the Berlin wall, legend has it that a West German auto executive emerged weeping from a Trabant car plant. Why? The value of the engine-block iron and the other materials going into the plant was higher than the value of the cars coming out the other end.

But nobody in Soviet-era Germany really knew it, because nobody really knew the value of those inputs. Building Trabants destroyed value.

How low does the price of milk have to be before it would make more sense to leave out the middle-cow?

It is a tough question to answer, and especially where water allocation is set by consent rather than through markets. East Germany allocated iron by something not that different from consents, rationing scarce resources across various industrial uses, and wound up making cars that were worth less than the inputs that went into them.

New Zealand allocates scarce water by consents, and hopefully does a better job of it. Trabants were ghastly; New Zealand milk is delicious. But it would be nice if the rivers were cleaner and if the aquifers weren’t getting nitrates in them.

Enter the excellent Raffensperger and Milke book.

Economics has a lot of sceptics. But one area that the critics have to concede to economics is market design and auctions. Al Roth’s designed markets have saved lives by helping allocate kidneys in transplant exchanges – and he won the Nobel for it. And the auctions Nobel-laureate Ronald Coase helped design for FCC spectrum have generated billions in value. And New Zealand’s spot electricity markets have been a great success.

Raffensperger and Milke take economists’ experience in market design, operations research’s specialisation in optimisation algorithms, and a deep understanding of underlying issues in hydrology to build smart markets for water.

The basic approach works as follows.

You start with a map of the underlying hydrology and river systems. From that, you know what the effects are of drawing water from different places – how it affects river flow, aquifers, and neighbouring wells. Those hydrological features get built into a smart market system. Then you decide on the environmental constraints that must be satisfied in any water allocation. The volume of water in adjacent rivers can be set as a flow constraint. And you can set constraints so that the aquifer pressure close to the ocean outfall is high enough to prevent salinity incursion.

All of those things should already be there in any decent water management system anyway – or at least any water management system where drawing pressure has been strong enough that use has to be constrained.

Then you turn to water users. Some people have existing consents; others might want to draw water but have no existing consents. People then submit their bids to the system, saying (for example) that if the price is $1 per unit, they want to buy a megalitre this period, but if the price is $2 they might want to sell back into the system some of their existing consent. The system runs the optimisation, figuring out the solution that provides the highest overall value of water.

The prices generated by the system provide a ton of information, and well beyond what you might expect. Most obviously, we find out whether it makes more sense for the next megalitre of water to go into pastoral irrigation or into water bottling plants. But we also find out a lot more than that. It would also tell you how expensive it would be to increase river flow by decreasing irrigation in different catchments. And that value can then sensibly inform discussion about the levels of those constraints.

A political moment is building for substantial change to water management. I hope that that change can be built on this work. But we also need to build on one aspect that Raffensperger and Milke only hint at: markets in water quality, as well as water quantity.

Canterbury has an existing water trading scheme. It isn’t a smart market, but it’s a start in water trading. If we look to Taupo, they’ve built a nutrient management regime that allows farmers to trade in nitrogen emissions, with a cap on emissions for the catchment as a whole. That too isn’t a smart market system, but it’s a start.

In our next research programme, The New Zealand Initiative will be looking at ways of combining smart markets in water allocation with smart markets in effluent. New Zealand led the world when we shifted to sustainable fisheries with the Quota Management System; we can do it again for water management.

Thankfully, John and Mark have already done much of the heavy lifting. Their book has arrived just when it’s needed. Now it’s up to the rest of us to run with it.


*Eric Crampton is chief economist at The New Zealand Initiative, which provides a fortnightly column for interest.co.nz

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God help us if we model our water management on our fisheries management.
The QMS was introduced following potentially disastrous collapse of targeted species with snapper, crayfish, hapuka etc. down to less than 10% of their natural level. They have not recovered and are now considerably worse with hapuka effectively extinct on our northern coast, crayfish now longer have a viable breeding population in the Hauraki Gulf. The knock on environmental effects are, in many ways worse with rocky shorelines stripped bare from overgrazing by kina and marine birds and mammals under serious threat. Clearly the inshore quotas are well in excess of safe limits with a common consensus among independant experts being that it should be halved. http://www.nzherald.co.nz/nz/news/article.cfm?c_id=1&objectid=11643654
The regulator (MPI) is captured by big fisheries interests and apparently taking their orders from them; what are the chances the same thing would happen to water?

Good point about the regulator being caught. In a traditional Athenian style democracy you would expect the hobby fishermen to out muscle the smaller number of commercial fishermen. But in our democracy the political parties are effectively financed by businesses (some wealthy voters are not in business but most are) - so commercial fishermen can afford lobbyists and even commercials on TV.
For water the two sides are better balanced. The water market proposed would let the farmers pay for water when it is needed - dry days and allow the bottling plants taking water every day pay different amounts depending on the weather.
However I'm not sure the system would work because of the different attitudes to quality - a farmer just wants water for irrigation - a little extra nitrogen would probably do him good but the bottlers must have perfect water. I think this may be impossible to balance - even markets have limitations.

Yes, so true about the lobbyists and, of course, you need to keep in mind that NZ Initiative are a big business lobby group so no surprises there. The dodgy seafood industry are running a propaganda piece on TV at present; a series of lies and false impressions from start to finish but nicely timed to influence the public pre election. All of these forces are lined up to channel the wealth of our natural resources into private hands. Any feigned concerns about the environment and the rights of the public need to be seen for what they are; complete and utter bullshit..

You miss one big thing with your neo-liberal drivel, ". People then submit their bids to the system, saying (for example) that if the price is $1 per unit, they want to buy a megalitre this period, but if the price is $2 they might want to sell back into the system some of their existing consent. The system runs the optimisation, figuring out the solution that provides the highest overall value of water."

Water is essential, hence as an essential to life it should not be priced at the highest bidder wins.

Just why drivel like this article is even given air time mystifies me.

"Water is essential, hence as an essential to life it should not be priced at the highest bidder wins."

Food is essential - we let the market dictate the price of that..
Energy is essential - we let the market dictate the price of that, too.
Actually, we let the market dictate the price of the vast majority of private consumption goods and it works pretty dam well.
If you don't like the neo-liberal system, go to Cuba, or Venezuela, or North Korea and see how well planned economies work.

Actually, as one who does not like the neo-liberal approach I would rather go to Norway or Sweden, why do you lot never, ever use Scandinavian countries to illustrate your point. Oh that's right, they are very successful, always top the world's happiest people list and have never fully embraced neo-liberalism.

Interesting perspective...
How has Scandinavia not embraced a neo-liberal economy?
Electricity is courtesy of Nord Pool.
Oil is traded on the free market.
Food prices aren't regulated.
They have relatively low corporate taxes for developed nations.

Nord Pool includes in its ownership the Swedish govt and the Finnish, only about 30% of it is private holdings. While oil is sold on the free market, Statoil is at least 70% state owned, so what on food prices, they have very high personal tax rates and sovereign wealth, hardly a neo-liberal paradise.

Oh so these government interests dictate the market price then, do they?
Or is it purely just ownership stake?

It doesn't matter that the governments have investments in these businesses. Sure it's not pure neo-liberal ideology, but it's counteracted by the fact that ALL governments invest in private assets. Mentioning this does not at all further your argument when you consider this fact.

So, again - all else, pretty much equal, the determining factor is personal taxation. Your idea is that if we tax everyone more, they'll be happier?

They'll never choose successful European examples of a healthy socialism-capitalism balance for a couple of reasons: 1) it doesn't align with the "slippery slope" idea that if you introduce an element of socialism, you become communist instantly, and 2) it doesn't fit the narrative that socialism = bad and neo-liberalism = good.

Just as they'll never choose Somalia or the Democratic Republic of Congo as exemplars of capitalism, and they'll never, ever, ever admit that much of their personal wealth springs as much from the benefits they received from NZ's earlier socialism as much as its current neo-liberalism.

So you're saying that if the DRC and Somalia introduce very high personal tax rates, they will become a socialist paradise like Scandinavia?
Interesting.

Whoooosh, point missed.

I think you miss the point.
The one economic difference about Scandinavia and Anglo/American ideology is high personal taxation/socialised costs of what should be private liabilities.
So, your premise must be on the basis that if we tax individuals more, they'll be happier and more successful.

The fact of the matter is that if you look at the wealth of these countries, it is bouyed by one thing - resources.
They heavily subsidise business and personal costs.
Norway is one of the most expensive places in the world to live.
They have huge personal debt burdens.
Their wealth (unsurprisingly) decreased and flat-lined for years in the face of rising personal taxation.
A huge amount of them now want more right wing focused policy.

If you think this s a recipe for success, more fool you.

You clearly missed my premise if that's what you think it was.

Oh, so your premise is the much more logical assumption that we don't do things because the idea sort of sounds like something. And once we jump on that train, it's an express to full blown socialism.
Great argument.
Sorry, initially I gave you more credit than what the comment deserved.

I'll tell you something for free.
It isn't because of that. It's because socialism is a crappy idea in theory and a categorically crappier idea in practice.
Sure, there are merits to certain aspects of it, but the reason no country wants to transition to it is because the one true certainty it represents is that it will make everyone poorer.
The one thing people always forget about socialism is that it is really hard to generate wealth when you don't have high value natural resources and wealthy people.

It seems you're putting up arguments and railing against them, all on your own.

My point was that choosing Venezuela, Cuba, North Korea etc. as exemplars of socialism is as sensible as choosing Somalia, Democratic Republic of Congo etc. as exemplars as capitalism.

But, err...have at it, absolutely have a two sided conversation with yourself on the evils of socialism.

Okay, choose any places where full blown socialism works. I thought they were pretty good examples seeing as they are the purest instances we have.
As I have highlighted, Scandinavia is not a good example.

As far as I'm aware, markets function perfectly fine in the DRC and Somalia. It's definitely not the market's fault that things are so crappy there. Socialism would make it a hell of a lot worse.
I'd actually attribute it more to the hangover of rule by those great european regimes that you so idolize.

As far as I'm aware, markets function perfectly fine in the DRC and Somalia. It's definitely not the market's fault that things are so crappy there.

AHA! You seem to have stumbled upon the point.

This is why to critique examples of socialism, you'd be best placed to actually choose examples of socialism (and the same with capitalism, as you've highlighted here).

Not sure if you've picked up, but most people - myself included - are centrist rather than veering heavily to the Left or Right. We're aware that there are failings in so-called highly capitalist societies just as there are in so-called highly socialist societies, and that best results seem to be had when elements of both are combined.

So, your point is that markets function perfectly fine in the DRC?
And on the basis of that...?
I don't think you even know what your point is.

We are arguing about the merits of neo-liberal markets versus controlled markets - you know that, right?
I gave you examples of full blown socialism. For some reason you don't think they are appropriate. I concede Venezuela isn't a great example, but it shows pretty well what happens when you start that ball rolling.

I think you're back to having an argument with yourself about two theoretical positions, at this point. (NB. I quoted you above. Hope that helps.)

My point was simply (and only) that you can do better than resorting to straw man and slippery slope logical fallacies.

Yes, you made a blanket comment alluding to the fact that we don't quote socialist countries because of some fallacy about socialism = communism.
Great point. Very logical.

Err...yeah...okay, that was it. Definitely.

Dead right, no extremes work well or for long, balance is most definitely what is required and in this case it is the balance between capitalist and socialist we are talking. Maybe Pinochet's Chile would be a better example of the extreme right wing end of things.

nymad,

Sweden is rich,but not based on its oil or gas industries. The same applies to Denmark and while Holland is a large Gas producer,it has a very diverse economy. These Northern European countries generally believe in an economic model of somewhat higher tax rates,with comprehensive social benefits. As democracies,they could vote for an American model should they choose to do so-but most of them don't want that.
If you want the American model,you are welcome to it-and more fool you.

You are joking, right?
Sweden and Denmark are huge exporters of minerals and natural resources.
The Pharmaceuticals and chemicals they produce are largely a function of this too.
Like I have said, their whole ability to sustain socialist ideology is on the basis that they have these factor endowments.

Yes, 'they' believe in a mixed model and have for a long time. However, if you cared to look at voting results over the past 40 or so years, you'd see that support for left wing parties has been falling substantially whilst support for right wing/more neo-liberal ideology has been increasing.

Its not neo-liberal policies right wing people are voting for it is conservative, fraidy cat ones, seeking some sort of hero to dig them out of the brown stuff.

I don't know that the analogy with food or energy is entirely valid; those things are produced by mans efforts and their cost reflects that.
There is no easy answer - the old tragedy of the commons issue but some things you simply can't put a price on. A healthy environment with rivers your kids can swim in and natural abundance in the sea and on the land are worth more than money to me and many others I'm sure. Seems like there is more and more pressure to exploit things to and beyond their limits; isn't it time we stopped treating the natural world as something to be plundered rather than protected as our knowledge obliges us to do.

Good points Steven - as a matter of interest how does China administer their water rights?

A deeply corrupt country; I'm not even sure the word "rights" is even appropriate.

True, very true. Actually my comment was intended as sarcasm to an earlier encounter with that contributor, but alas probably not subtle enough.

Nice to see intricate computational modelling being used to optimise a real-world problem. From my own tiny exposure to Operational Research a couple of decades ago as part of an MBA, I was subsequently rather disappointed that the use of this technique was so little used out in the world except for very large companies with very large and relatively fixed plants.

And as for the argument that 'water is a fundamental right', then the rejoinder is perfectly simple: build That into the model as a constraint along the lines that 'there are x individuals entitled to y cubic metres each over a stated time period, located at z nodes in the network - reserve that much capacity from the bid allocations'.

So the 'rights' argument is just another constraint on the equation to be optimised.....der....

That all sounds perfectly reasonable but the way powerful interests bend government to their will (as per the fisheries example) doesn't fill you with confidence for a fair outcome Capital will always want to corral resources for their own interests.
Aside from that and looking at the wider issues; here we are with our relatively modest population in a rich and pleasant country with some real issues over resources: rivers, urban spaces, pollution effects, water supplies and fisheries to name a few. You really do have to wonder at the wisdom of our current immigration policy's 33 year doubling time!

I now think the most responsible thing we could do as a country is say a flat no, from now on, to water being put into plastic single use bottles.