Water reform: An economic wellbeing view
At a glance
- Economics focuses on how any proposed policy or infrastructure decision, including water reform, makes people’s lives better.
- The water reform process is well underway, but there are still open-ended questions about how economic and financial regulation will be balanced against water quality regulation, and who makes the final call.
- The proposed merger of water utilities and billions in extra spending funded by water customers raises further questions about how we will decide which projects get prioritised, and how we will demonstrate they improve quality of life.
- Finally, there are questions to consider over what councils will do with lower debt and lower revenue streams when water utilities are spun off.
Following the closure of the two-month council water reform engagement process on 30 September, the government is working through and considering the feedback received. This will enable it to determine the next steps and any change to the current reform proposals, including an economic water regulator to complement Taumata Arowai (the environmental regulator established earlier this year) as well as the proposed merging of water providers in New Zealand (predominantly run by councils) into just four water providers.
In considering this second leg of the proposed regulation, it is useful to highlight that economics asks how a policy or infrastructure decision will make people’s lives better. At a personal level, even something small like when your partner asks you to do the dishes and you would prefer to watch TV, you trade off the consequences of your choice. And so it is with water or any other resource. Not every action is a good one, so we must understand the costs and benefits a decision unlocks.
Every decision in life including those undertaken by government has costs and benefits to the environment, human health, finances, the climate and other resources.
Water reforms have met with lively reception, with support from industry operators and suppliers contrasting particularly with elected officials and the public. This complexity of views is reflected in the many questions to consider as the regulator(s) begins its work and as decisions are made on amalgamation. This paper outlines some of those fundamental questions from the perspective of an economist, whose job it is to ask and answer these questions for clients across New Zealand and Australia.
The headline question for the regulator and for amalgamation is the same: how does this make people’s lives better? But some of the details are quite different for the two components, which warrants a separate discussion.
First, how will economic regulation make people’s lives better?
The water quality regulator, Taumata Arowai, has been established and is anticipated to officially begin its work toward the end of this year. The case is strong for a regulator to ensure minimum standards that ensure drinking water does not make us sick. But how will commercial and economic imperatives, currently outside the mandate of Taumata Arowai, and likely to be the domain of a separate regulator, be balanced?
In a financially and infrastructure unconstrained world, we might all agree that everyone should be on reticulated water, and that water should all be “completely pure”. However, money is limited and water reform is just one of many pressing issues facing our country. In our constrained world, questions about trade-offs loom large. For instance:
- How will water quality (Taumata Arowai’s domain) and financial and economic imperatives (the domain of a separate economic regulator) be traded off?
- Who gets to makes the final call on how these trade-offs are balanced, and on what basis?
- What would be the marginal cost of getting that next (or last) water consumer to a certain level of water quality, and is that justified against the health benefits it would create for that consumer?
On this last point, for instance, if the cost of adding the 95th percentile of water consumers to the reticulated network is $200,000 per household, will a non-reticulated solution be acceptable, at a fraction of the cost?
Second, how will amalgamation make people’s lives better?
The proposal for amalgamation is more contentious. Many are intrigued at estimates suggesting the water reforms will mean bills as low as one sixth of what they would otherwise be. Undoubtedly, regulators holding water service providers to both quality and economic standards can spur efficiencies, but that is not an argument for amalgamation, just a regulator.
Simple maths says that when you merge small geographic areas with large populations (cities), and large geographies with low populations (rural areas), you get a subsidy in the direction of the sparsely populated areas. That’s not necessarily bad - it’s how countries work. But we do need to be explicit about this question of who bears the cost.
But there are other, even bigger questions than the average water bill.
Chief among these, perhaps, is who will pay for the estimated $120-185 billion in new water infrastructure estimated to be needed over the next 30-40 years. That one is easy to answer. It won’t be money that materialises from thin air. Water consumers, taxpayers and ratepayers, who are generally the same people, will ultimately pay over the long term. If that expenditure is needed to ensure the right water quality that does not make people sick, then that’s fair enough. But this spending means other questions become important, like:
- How will we decide which projects within the $120-185 billion envelope will get funded first?
- How will we determine the actual improvements in quality of life that these projects generate, to avoid arbitrary target-setting?
- If investment decisions are made on targets rather than outcomes, how do we make sure we don’t have people subsidising large projects in other parts of their water utility area that deliver limited genuine benefits in terms of improved health or resilience?
What will councils do with freed up debt capacity and lower revenue?
A final question stemming from amalgamation warrants separate attention. At the stroke of a pen, councils will be freed from (in some cases) mountains of water infrastructure debt. But most will also have a large revenue stream (the water component of a rates bill) removed. The Department of Internal Affairs estimates that the vast majority of councils will be financially better off through shedding water-related debt.
The removal of water assets and debt from council balance sheets will give most councils options. They could reduce rates so their residents end up paying roughly the same for remaining council services and water as before the changes, or they could opt for larger effective rates increases (i.e. they could choose not to reduce rates bills as much as the reduction in water revenues they receive) and/or add more debt.
If councils go with the second option, whereby they allow overall costs for water and rates to rise faster for their residents, more questions are raised:
- How will councils decide which new projects justify the extra spending that puts rates up?
- Will these projects be to fill the widespread infrastructure deficit given the reduced need for councils to invest in water infrastructure, or could the money be spent on any new idea?
- If the funds are repurposed to other infrastructure, how will councils make sure the benefits of that infrastructure justify the increased total costs to ratepayers?
- Will the suddenly-improved financial position disincentivise councils from taking other actions they would otherwise have taken (and still should), such as raising development contributions to reflect the true cost of development?
How will Councils preserve this additional financial capacity and ration it judicially over the longer term?
Where to from here?
Action to encourage the cost-effective provision of safe drinking water is encouraged, and we are entering an exciting new phase for water in New Zealand. But there are many unanswered questions we need to tackle together to make sure any changes create the best outcomes for New Zealanders. The ongoing engagement through this reform programme and the parallel Te Arotake i te Anamata mō Ngā Kaunihera/Review into the Future for Local Government will be critical to unlock the answers.