Water stress is a defining planetary issue of the 21st century. How can we apply economic tools to provide sustainable water solutions? A new study by TSE’s Céline Nauges draws on global evidence to explore the principles and practice of water pricing and markets. Here, she offers six clear policy recommendations to help decision-makers strike the right balance between conservation, efficiency and fairness.
Why is water allocation such an urgent problem?
The world is facing a water crisis driven by population growth, economic development, and climate change. Freshwater withdrawals are rising, putting stress on ecosystems, food and energy security, as well as human well-being.
The challenge is to allocate water efficiently and fairly across competing needs, often in contexts where supply and demand are mismatched in both space and time. This is especially important in agriculture, which accounts for about 70% of global water use.
Why do we need to rethink how water is priced?
In most places, water is severely underpriced. What we pay for water rarely reflects its full economic, environmental, or social cost. In both the Global North and South, the result is overuse, inefficiency, and underinvestment in water infrastructure.
It’s not just about raising prices – it’s about designing policies that send the right signals to users, encourage innovation, and protect vulnerable populations. When prices reflect scarcity and environmental costs, they encourage conservation and efficiency.
Water pricing doesn’t mean a privatization drive, in which we abandon public service or fairness. It means making smarter use of limited resources .
What makes water pricing so difficult to get right?
Water pricing must balance multiple objectives. It needs to cover fixed and variable costs – such as capital investment, maintenance, treatment, and distribution – as well as reflecting environmental impacts and societal ones like affordability. Estimating long-run and indirect costs is particularly difficult, especially where data is poor or missing .
Politically, it’s hard to raise water prices due to concerns about fairness, especially in low-income areas or where services are unreliable. There’s also often strong resistance from agricultural lobbies and other entrenched interests.
Why do you recommend simpler pricing structures?
Complex tools like increasing block tariffs (IBTs) aim to promote conservation and equity, but they often fail on both fronts. In many cases, wealthier households benefit more from subsidies, while poorer users – especially those without access to piped networks – get left out.
We recommend using a simple volumetric price that reflects marginal cost. That way, the price signal remains crystal clear. Separate instruments can be used to achieve other goals, such as addressing fairness concerns with targeted rebates or vouchers for low-income households.
How can we encourage sustainable water markets?
Markets can efficiently reallocate water to higher-value uses, based on traders’ willingness to buy or sell water rights. However, strong governance is essential for markets to deliver on their promise, avoiding negative outcomes such as social injustice, pollution, or market power abuses. Governments must separate regulatory functions from service provision, invest in data systems to improve monitoring, and ensure that property rights and enforcement are fair and transparent.
Formal water markets are more common in higher-income countries like Australia, Spain, and the US. In many Global South countries, informal markets fill the gaps. Rather than trying to replace informal markets overnight, we argue for supporting and improving them, while gradually building up formal regulatory and governance frameworks. The approach must be tailored to local institutional capacity and social context.
POLICY PROPOSALS
1. Value water properly
To ensure efficient allocation, water prices must reflect operational and capital costs, as well as scarcity, environmental impacts, and local conditions.
2. Use one tool per objective
Avoid complex pricing schemes that aim for many goals. Use simple tariffs alongside separate tools like cash transfers for poor households.
3. Don’t rely on pricing alone
To improve its effectiveness, combine water pricing with social norms, education campaigns, rebates, restrictions, and other demand management tools.
4. Property rights matter
Fair and transparent allocation of water rights is essential. Global South countries may be in a position to get this right before implementing markets.
5. Support water trade
Boost formal markets and set extraction caps. Where only informal markets are feasible, help them function more equitably and efficiently.
6. Governance is critical
Invest in regulation, monitoring and enforcement. Separate provision and compliance, with independent audit and review.
In most places, water is severely underpriced. What we pay for water rarely reflects its full economic, environmental, or social cost. In both the Global North and South, the result is overuse, inefficiency, and underinvestment in water infrastructure.
