January 3, 2008

Moderator: Welcome to Southeastern Economic Perspectives, an occasional podcast from the Federal Reserve Bank of Atlanta. We're talking today about water with Atlanta Fed research economist Chris Cunningham and Mark Risse, professor of agricultural engineering at the University of Georgia. Dr. Cunningham specializes in political economy and urban economics, and Dr. Risse studies water quality and supply issues in Georgia and around the Southeast. We're talking first with Chris Cunningham. Thanks for joining us today, Chris.

Chris Cunningham: Thanks for having me, Charles.

Moderator: Chris, first off, what are some of the potential long-term economic implications of water scarcity?

Cunningham: Well, the obvious conclusion is that it's a check on future growth. Water permits will be harder to obtain for new construction, and that could potentially limit the Atlanta metro area's long-term growth.

Moderator: What about manufacturers and other types of companies when they're evaluating places to locate new facilities? Would the water supply be a factor there?

Cunningham: Almost assuredly, but it's hard to believe that firms that are going to be that sensitive to the price of water are going to have a long-term future in a metropolitan area of 5 million people. The firms that are here, that are going to stay here, and that will be attracted here are firms that need to be here. They need access to the upstream and downstream suppliers, the services of professionals, and distribution networks. That's the real engine; that's the conglomerative force. And assuming that we can continue to house those new workers and support those industries, I think that's probably more of a concern.

Moderator: Well, you mentioned Atlanta, and obviously it does seem to have the most serious problems in the Southeast right now. What are some the things that can be done in the reasonably near term?

Cunningham: I'm actually somewhat optimistic about Atlanta's ability to respond to this scarcity. In fact, Georgia, overall uses more water on average than the average American. So there is tremendous room to conserve, to use water more efficiently, both in agriculture and at the household level. The first step in doing that, of course, is creating the right incentives for people to conserve. Typically, the way we price water now is based on a sort of falling long-run marginal cost. This is standard undergrad economics. This makes the water supplier a natural monopolist, and you tend to want to charge high prices to those who have very inelastic demands, such as households, and charge very low prices to those who are very sensitive to it, such as manufacturers and agriculture. Now all of a sudden, we're in a period of water scarcity and the situation is reversed: We're actually trying to modify behavior. And in that situation, it actually might be very prudent to increase prices on those who are in some ways the marginal consumers of water. Agriculture that is growing crops—that we're in other ways already subsidizing—we'd ideally be able to bid the water away from them.

Moderator: So are higher prices really the most effective incentive to conserving water?

Cunningham: Well, you know, a standard textbook answer would be yes, although I'd have to say I'm quite amazed by the power of social coercion. It seems that neighbors who wouldn't say a word about you cheating on your wife are happy to rat you out for watering your lawn in the middle of this crisis. Whether that is a sufficient check on water usage is to be determined. But as an economist I have to come out and say that yeah, the price of the commodity should reflect its cost of procuring it, and raising the price should be the most efficient way to do it.

There are certain challenges. Consumers with some of the most inelastic demand are probably pretty wealthy people and may not be that responsive to the price. And of course, we certainly have equity considerations. Most likely the way to do this is either with a graduated tariff structure, which is already being implemented in many local water authorities, or setting a high rate but then refunding at a certain allocation, so that the median water user is left unharmed, and the heavy consumers are paying a substantial premium for that extra water.

Moderator: What are some in innovative ideas that we might see governments try to help people conserve or to incent people to conserve water or, on the other hand, also to expand the water supplies?

Cunningham: I think we need to think about how we treat water as a commodity, or don't. You know, a common expression in the Western states is that water flows towards money. Now that, I think, has some populist undertone to it, but it's actually a case for efficiency there. Cities that need the water are able to bid it away from the agriculture users who can, for the right price, be persuaded to grow something else, a drought-resistant crop. And that is efficient in an economic sense. We do not have the same legal structure here, and it makes it much more difficult for the needy municipalities, who have a very high demand and place a high price on that water, to exchange their need for those of agriculture users or manufacturers. The infrastructure's just not there in a legal sense to do that. I think there's talk of reforming that, and that is probably a useful direction to go in.

I think the future probably lies in, again, trying to bid away water from some of the marginal users in our existing drainage basin or going to other nearby drainage basins that could be persuaded to share. Tennessee, I think, has a lot of water, and it's not that far away. In 1901, L.A. built an aqueduct 300 miles to get its initial water. And if they could do it then and continue to grow to a city that's 10 million now, I think there are much more practical solutions at hand.

Moderator: Well, what are some of the other things we can learn from the Western states, Chris? They obviously have a long history of dealing with water scarcity.

Cunningham: One possibility is consider changing the permitting process or adding additional impact fees that consider the harm done to the overall watershed of new construction. That's an externality that an economist would want to place a Pigovian tax on and would want to try to align the incentives of developers with that of the community as a whole. But of all of this is somewhat problematic given the downstream claimants on the water. So as much as we conserve, but for the water that goes into our landscaping, all the water that we use comes back out through the treatment process. And so one could be forgiven for saying, "Well, the more I conserve, the more they're just going to have to release from Lake Lanier in order to satisfy the downstream claimants on that water." And that is a problem that's even somewhat more thorny. How do we incentivize all parties that have claims on this water to work together to conserve it? And it's not so clear that right now that those rights are well allocated.

Moderator: For another perspective we turn now to Mark Risse of the University of Georgia. Thanks for being with us, Dr. Risse.

Mark Risse: No problem. Happy to do it.

Moderator: All right, Mark. First off, are we likely to see actual water rationing in metro Atlanta, to have times during the day when water service might actually be turned off? Is that what this could come to?

Risse: I wouldn't be surprised if that happened next year. Every indication that I get from our state climatologist is that were going to probably have a dry winter. We will get some rainfall, and it'll seem like we're getting enough water, but we're probably not going to get sufficient rain to refill our reservoirs, and I'm expecting that next summer it's going to get worse than it did this summer, and that local governments...some of them will be more prepared than others. I wouldn't be surprised if we saw rationing or some sort of more severe conservation plan in the next year.

Moderator: Well, longer term, Mark, how much of the answer to this water scarcity problem is about expanding supply and how much is about reducing use?

Risse: First off, we've got to look at conservation and conserve as much water as we can, and there's lots of ways we can do that. And that's not going to be enough. We're not going to be able to continue to grow with just conservation. We're going to need to look at other methods such as building reservoirs and storing some of the water we do get in the winter for times when we don't get as much as we need, and even interbasin transfers: moving water from areas where we have it to where we don't have it. And then the fourth one that I don't think many people talk about that I think is important is looking at changing the areas where we're growing. We're growing in metro Atlanta, where we don't have enough water; there's plenty of other areas of the state where we don't have as many water problems, and they may be more suitable for future growth.

Moderator: Mark, are there business opportunities in this? In other words, are there ways folks out there who are going to see their business expand who are helping companies and maybe even individuals figure out how to better conserve water?

Risse: Oh, yeah. I get calls from those every day. Everything from the people that manufacture condensate systems, that will recycle the the condensed water out of your air conditioner back into your toilets for flushing, to people that are looking at gray water reuse, where the water from your sinks or bathtubs might be able to be stored and used for irrigation. We've got a whole industry around the development of cisterns that might take the water that's coming off your roof and store it in a gigantic tank underground and allow that to be reused. And then you've got the whole consulting industry associated with business and industries. We're actually seeing water conservation positions being created within the industry, where they hire a person whose primary job is to look at how can we conserve water, and often the industry can save enough water that they can pay this person's salary with the savings. City and county governments are the same way. I don't know how many governments around Georgia now have water conservation coordinators, but I know the cities of Athens and, I believe, Savannah both have a paid position called the water conservation coordinator for those communities. And I imagine we're going to see more of those popping up. There's businesses, there's private sector consulting, and there's government positions that are all going to be created, and I think they're all needed as well.

Moderator: As bad as this drought is, Mark, is it in some ways an opportunity for hydrologists, people in your field, to use as a very useful kind of laboratory to try some things or to advance the science?

Risse: I would say for people in my field that the drought's causing a lot of attention to be placed on the issue and a lot of what we do in academia or in research and policy development. It's going to take so long that we're not really going to affect this drought, but it's building an understanding in the general public and with the policy makers that maybe some of the stuff we do is really important and needs to be taken a bit more seriously so that future drought impacts are minimized.

I was in a meeting yesterday with some folks in industry, and they were trying to figure out how to respond to the drought from a totally different perspective. Because the water they're getting to their plants now is of lower quality, they're beginning to have to figure out, "How do I need to change my treatment system?" These were specifically poultry plants, and because the reservoirs that their water is coming from have been pulled down, they've got higher levels of manganese and higher levels of iron in the water that's coming into the plant. So they have to change their processing methods based on the water they're getting to the plant. Now, if you would have asked me before this drought occurred whether a poultry processing plant's going to have to change their processes because of this drought, I would have never guessed that impact. And so we're learning a lot through the drought of what these impacts could be.

Moderator: Well, Mark, thanks a lot. We really appreciate it. It was interesting.

Risse: OK, well, thank you.

Moderator: This concludes our Southeastern Economic Perspectives podcast. Again, we've been talking with Mark Risse of the University of Georgia and Atlanta Fed research economist Chris Cunningham. Thanks for listening, and please return for more podcasts. If you have comments, e-mail us at podcast@frbatlanta.org.