An Incentive Mechanism for Decentralized Water Metering Decisions

Abstract

Metering water consumption has been long advocated by economists in developing countries as a way to curb waste and prevent resource depletion. However, very few of these economists have studied the inefficiencies brought about by universal metering or the conditions under which decentralized water metering decisions are optimal. The decision where to install water meters generally rests on either the consumer or the company providing the service. This paper shows that if left unregulated, both the consumer's and the company's decentralized water metering decisions are sub-optimal. This is because the firm when installing meters, does not take into account the fall in consumer surplus and the consumer, when voluntarily installing a meter in his dwelling, does not take into account the effect of his decision on the company's profits. To solve this externality problem and make the decentralized decision optimal, an incentive mechanism is proposed. The mechanism works through a series of Pigouvian taxes imposed by the regulator on the party creating the externality. By means of these taxes, externalities are internalized and both the consumer and the company reach the socially optimal solution in a decentralized way. The implementation of this mechanism in practice is materialized through a Coasian property rights approach where the parties involved reach the efficient solution by bargaining over welfare gains. The party installing the meter has to buy the "right to meter" from the metered party by fairly compensating him thus internalizing the externality and reaching the efficient outcome. To illustrate the incentives involved in metering water consumption, the rate structure and metering policies of two water concessions in Argentina are studied: Buenos Aires and Cordoba. Conclusions and policy recommendations are drawn from the theory and the two practical cases.

Keywords: Water metering, water consumption metering, water pricing, water rates

JEL Classification: L95