Beyond Water Stress: Structural Adjustment and Macroeconomic Consequences of the Emerging Water Scarcity

Most studies assessing the aggregate water scarcity at the country or regional level are based on indices like per capita water availability or “water stress”, defined as a ratio between water demand (or consumption) and some measure of (sustainable) freshwater supply. Although these indices are useful indicators to highlight how severe the water scarcity problem may be in different areas, they say nothing about whether, how and how much the society can adjust to lower levels of water availability. By contrast, in a previous study (Roson and Damania, 2015), we found that scenarios of economic development that have been recently proposed to support the scientific analyses of climate change (the Shared Socioeconomic Pathways) have ignored water availability. The underlying assumptions of sustained economic growth, especially for developing countries, would imply an excessive consumption of water, even when substantial improvements in water efficiency are envisaged. This paper addresses the issue of assessing what changes in the economic structure, consumption patterns and trade flows would be induced by the emerging constraints on water availability, considering also the effects of water inter-industrial reallocation policies. To the best of our knowledge, this is the first contribution in the literature analyzing such macroeconomic, system-wide consequences of water scarcity. To this end, we identify three different ways through which a “potential excess demand for water” would be absorbed. First, water saving technologies and policies could be put in place, possibly accelerating an ongoing tendency of improved water efficiency. Technologies and policies could be costly, though, so their implementation would be justified only when the implicit (shadow) value of water gets sufficiently high. Ideally, the different options could be ranked in terms of economic efficiency, from the lowest to the highest unit cost, and those whose unit cost (possibly including external costs) falls below the shadow value of water (increasing as the water gets scarcer) should be selected. In practice, however, the technological response to the water stress is much more complicated, as a variety of factors (technical, political, institutional, safety, etc.) ultimately affects the choice among the different technology options. We therefore base our analysis on a qualitative index of technology potential for a number of potentially water-stressed macro-regions. Second, when actual water availability turns out to be lower than what would be required for production and consumption purposes, consumers’ utility diminishes and productivity in water-using industries declines. Even in the absence of a formal market for water resources, scarcity is transmitted as a price signal, and a structural adjustment (reallocating water using activities in time and space) takes place within the economic system, alleviating the overall impact of the negative shock for the economy. The same process leads to a semi-automatic, market driven improvement in the aggregate water efficiency or productivity (water per unit of output), whose magnitude – however – depends on a series of specific characteristics of the economic system under consideration. To capture this intra-regional water reallocation process, we thereby construct an index of “market flexibility”, on the basis of numerical simulation experiments. Finally, after improving water efficiency through technology, policy or market-mediated adjustment, some excess demand for water resources is likely to remain, meaning that the actual delivery or consumption of water will still fall short of the desired level. Cuts in water consumption, in turn, imply a diminished utilization of a key production factor for many industries, bringing about reduced production volumes and productivity. The ultimate impact on industrial productivity depends on the marginal product (in real terms) or on the marginal value (in value terms) of water. We estimate the marginal value of water for 15 industries and 14 world macro-regions, assuming a relationship between average and marginal value of water. That relationship relies on two parameters, which are calibrated on the basis of the findings of an econometric study conducted by Moolman, Blignaut and van Eyden (2006), who computed the marginal value of water for five categories of fruits in South Africa. We therefore employ a global computable general equilibrium model to carry out a set of numerical simulation experiments, proceeding as follows: 1. We project economic development scenarios based on Shared Socio-economic Pathways 1 and 3 for the years 2050 and 2100; 2. After estimating the industrial usage of water per unit of output and its evolution over time, we translate the projected industrial output into the corresponding potential demand for water, necessary to sustain the production level growth; 3. We compare such potential water demand (including direct municipal use) with an estimate of sustainable water consumption, by region, based on forecasts of water runoffs as obtained by a global hydrology model, developed at the University of Maryland, which also considers climate change impacts on water resources; 4. For those regions in which potential demand exceeds sustainable supply, we appraise how much of the gap can be covered trough enhanced water efficiency, realized by technological solutions and intra-regional reallocation of economic activities; 5. The remaining part is interpreted as cuts in water delivery. The cuts are applied at the industrial level, according to various policies. For instance, proportionally or by considering the relative economic returns on the industrial water usage; 6. The reduction of water availability at the industrial level is converted, through the corresponding marginal value of water, into reductions in industrial (multi-factor) productivity; 7. The changes in productivity are inserted as exogenous shocks in a global CGE model; 8. Results of the CGE model in terms of income, economic structure, trade flows and welfare are assessed, in order to highlight the macroeconomic implications of the emerging water scarcity and the relative effectiveness of the alternative policies of water allocation among different economic sectors. This study complements an earlier research on the same topic by explicitly introducing estimates of the marginal value of water, which are specific to industries and regions, as well as by allowing for a differentiated response in water stressed regions in terms of structural adjustment and technology implementation capability. A draft, with some missing sections, is available (uploaded).