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Written by Dr Matthew Agarwala

Water and Natural Capital

Wealth Economy Research Leader Matthew Agarwala on the challenges of water and natural capital accounting. This post accompanies the launch of the Oxford University Press Food, Water and Society Handbook.

The term ‘natural capital’ provides both a powerful metaphor and an organizing conceptual framework for viewing nature through the economists’ lens. For some, such a proposition brings smirks, sneers, and ‘moral’ objections. Water is a human right. Nature is not for commodification. For others, ‘nature as capital’ unleashes a range of possibilities, including the opportunity to use the tools and lessons of economics to understand and manage environmental change.

Here, my primary interest is in how we manage water in modern society. It’s a problem that has vexed philosophers and economists for millennia. Adam Smith is often credited with proposing the ‘water and diamonds paradox’, though both Copernicus and Plato raised similar issues in their day. The paradox juxtaposes the high price of diamonds (which are superfluous to human needs) against the low, often £0 price of water, which is a universal necessity for life. The answer, it turns out, lies in relative scarcity and the notion of marginal value. Given a choice, most of us would accept the Kohinoor over a bottle of water, but conduct this experiment in the middle of the Sahara and the results may differ.

Despite our familiarity with water, it is actually a deeply misunderstood and mismanaged resource. Even the simple questions have complex answers. Is it a renewable or non-renewable resource? Is it a public or private good? Is it exclusive and rivalrous or can the same water be ‘used’ by multiple interests? What does it mean to ‘use’ water?

The reality is that some water is renewable in certain places over specific timescales, but many parts of the world rely on ‘fossil water’ – ancient underground aquifers with essentially no recharge. Quality counts, too. Coastal aquifers can be renewable, but over abstraction can induce saline intrusion, permanently contaminating what was once a renewable source of freshwater.

The public or private nature of water depends on laws, management practices, and enforcement mechanisms. But managers must be careful not to confuse abstraction with consumption. A factory that withdraws water from a river for cooling but returns it to the source without contamination cannot be said to ‘consume’ water in the same way that crops do during evapotranspiration. However robust our legal contracts and management practices may be, water’s tendency to flow downstream, percolate beneath the surface, or simply evaporate into thin air has earned it the title of ‘fugitive resource’[i].

To think of water stored in lakes and aquifers as stocks is fairly straightforward. Although rivers and precipitation are (literally) flows, meteorologists and hydrologists can still estimate roughly how much will pass through an area during an accounting period so they too can be considered part of the capital stock. So how about flows of environmental goods and services generated by water stocks? These can obviously include water made available for irrigation and drinking, but also the provision of recreation, aesthetics, waste dilution, and transportation services. Of course, moving from the conceptual idea of water as a natural capital stock generating flows of environmental goods and services to actually utilizing this in some meaningful way is a big step.

One of the greatest challenges is how to best value water as a capital asset, or even value the flows of services it provides[ii]. This has proven so difficult that most natural capital assessments resort to (rather unsatisfying) simplifications and shortcuts. These include assuming that the value of water is fully captured in the market prices for land, but not attempting to partition it explicitly[iii]; omitting water from the analyses altogether until reliable methods or data are made available[iv]; or incorporating biophysical (rather than economic valuation) models of water resources within modelling exercises that value other ecosystem services[v].

Despite the considerable challenge of valuation, water accounts are increasingly important tools for achieving sustainability and economic goals. Australia’s environmental-economic (and especially water) accounts are among the most advanced in the world. South Australia’s Natural Resources Management (NRM) Act tasks NRM Boards with developing Water Allocation Plans to allocate water access rights whilst ensuring that an ‘equitable balance [is] achieved between environmental, social, and economic needs for the water’[vi]. To achieve this balance, NRM Boards conducted scenario analyses to assess the economic impacts of different potential allocations. This relied on industry-level (agriculture, commercial, domestic, etc.) data for water use, its value-added, and employment. Data from the Australian Bureau of Statistics meant that NRM Boards in South Australia could publish sector level scenario analyses and, following public consultation, select water allocations that balance environmental, social, and economic needs. However, annual fluctuations in rainfall and commodity prices can significantly affect water’s value-added across sectors such as mining and agriculture. Thus, a long time series of these accounts is needed in order to give a more accurate picture of water’s added value to each industry. South Australia provides a clear example of how water accounts can be used to develop policies that improve the balance between the needs of the environment, society, and the economy. It is important to note that such accounts can also be useful in less developed countries, even when these possess fewer resources for environmental stewardship.

Since the 1980s, deforestation and erosion led to increased water scarcity in many of Colombia’s small and medium-sized river basins[vii]. In response, the Government of Colombia introduced ‘Water Use Fees’ to raise funds for watershed management and restoration. A national minimum fee of 0.78COP/m3 was introduced, although regional authorities could increase this in their respective jurisdictions. This was a remarkably low fee (for example, it is only one-fifth of the equivalent fee in Costa Rica) and by 2014 it became apparent that the fees were failing to raise enough revenue to support investments in watershed management and conservation. In fact, they failed even to raise enough revenue to cover the administrative costs of billing and collection.

The question then facing the Government was whether raising fees could achieve the objective of  financing watershed conservation projects, and what impact this would have on various sectors of the economy. To assess this possible impact, the National Department of Planning (DNP) combined national water accounting with Columbia’s existing social accounting matrix (SAM). By doing so, the DNP was able to model the macroeconomic impact of changes in the water use fee. Because the SAM included all divisions of relevant stakeholders, it was also possible to conduct sectoral analyses. These analyses showed that increasing the minimum water use fees to 3COP/m3 and 10COP/m3 for agriculture and industry respectively would have negligible impacts on output and water abstractions, but would generate substantial funds for water management and watershed conservation investments.

These examples reveal two key insights into the use of natural capital accounts for water. First, valuation remains a key challenge, but does not prevent biophysical accounts from revealing ways to improve water management and economic outcomes. Second, and perhaps more importantly, water management is an economic priority, but it is not exclusively an economist’s task. As the great Professor Tony Allan emphatically reminds us, “we don’t live in economies, we live in political economies”[viii]. 

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Matthew Agarwala's blog on 'Water and Natural Capital' accompanies his chapter in the OUP Handbook of Food, Water and Society, launched in London on Tuesday 17 December. Read more

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[i] Ciriacy-Wantrup, S. V. and Bishop, R. C. (1975) Common property as a concept in natural resources policy. Natural resources journal, 15(4), 713.
[ii] Keeler, B. L. (2012) Linking water quality and well-being for improved assessment and valuation of ecosystem services. Proceedings of the National Academy of Sciences, 109(45), 18619–18624.
[iii] World Bank (2011) The changing wealth of nations, Washington, DC. The World Bank.
[iv] UNU-IHDP and UNEP (2012) Inclusive wealth report 2012: Measuring progress toward sustainability. Cambridge, UK: Cambridge University Press.
[v] Bateman, I. et al. (2014) UK National Ecosystem Assessment—Follow on: Economic value of ecosystem services, UNEP-WCMC.
[vi] South Australia Natural Resources Management Act (2004).
[vii] WAVES. (2017) Better policy through natural capital accounting: Stocktaking and ways forward. 7th WAVES Annual Partnership Meeting Edition. Washington, DC: World Bank.
[viii] Agarwala, M., and Allan, J. J. A. (2014) Sustainable development of water resources. In: G. Atkinson, S. Dietz, E. Neumayer, and M. Agarwala (eds.). Handbook of sustainable development. Cheltenham, UK: Edward Elgar.

  • About the author

    Dr Matthew Agarwala, Project Leader: The Wealth Economy

    Matthew Agarwala is an environmental economist interested in wealth-based approaches to measuring and delivering sustainable development. The pace of globalisation, innovation, and social, environmental, and economic upheaval leaves no doubt: 20th century statistics can’t capture 21st century progress. Matthew joined the Bennett Institute’s wealth economy ...   Learn more

    Matthew Agarwala