Tragedy of the Non-Commons: A Case Study of Water Policy in Austin, TX

UT-Austin economics professor Daniel Hamermesh argues that the water shortage problem in Austin, TX “could readily be solved by pricing the water sufficiently high to ensure that we get through the drought with water to spare” (see Grazing the Non-Commons).  I wholeheartedly agree with Professor Hamermesh, and I would like to follow up his comments on the Freakonomics blog with my own.

Since 2007, Austin has been subject to so-called Stage 1 Water Use Restrictions.  Under Stage 1, residents are legally entitled to use their automatic sprinkler systems before 10 a.m. and after 7 p.m. two days per week (the actual days of the week depend upon whether one has an even-numbered or odd-numbered residence).  Violations of this schedule are Class C misdemeanors, with each instance punishable by a fine of up to $500.  Starting August 24, Austin will be under Stage 2 Water Use Restrictions, which limits the use of automatic sprinkler systems to Saturdays (for odd-numbered residential addresses) and Sundays (for at even-numbered residential addresses) before 10 a.m.

The manner in which water use is priced (with a nonlinear pricing schedule that is increasing in the volume of water usage) motivates most consumers to conserve.  However, I suspect that the prospect of a $500 fine and Class C misdemeanor citation probably affects the timing of water use more than it affects volume for most consumers.  In spite of the (rather compelling) economic incentives to conserve which derive from nonlinear pricing, apparently the City of Austin still finds it necessary to impose these highly restrictive rationing constraints. As Professor Hamermesh noted in his blog posting, the Austin American Statesman went so far on Monday as to publicly shame the top 10 users in June and July 2009 in a front page article. This seems like a market failure to me, and my “inner economist” suggests that a better way to mitigate this externality (rather than impose such draconian water use restrictions) would be to make the pricing schedule sufficiently convex so that even members of the top 10 club would sit up and take notice!

I suspect that like Professor Hamermesh, most Austinites will abide by the timing restrictions on watering.  However, it is also very likely that many (if not most) Austinites will set their sprinklers to run longer each session now that watering can only occur once rather than twice per week.  The problem with the policy is that it primarily addresses timing incentives, and not the real problem, which is over-consumption.  It remains to be seen whether private actions (running sprinkler systems longer per “legal” session) don’t end up making matters even worse than they already are.

What are the odds that the Public Health Option will be passed into law by the end of this year? maintains an actively traded market for futures contracts which pay 100 points (where 1 point = $.10) in the event that a specific contingent event occurs and 0 points otherwise. Thus, prices represent “risk neutral” event probabilities. I have written previously about how useful prediction markets can be in assessing political events such as election outcomes (e.g., see Prediction markets assessment of the Presidential Election from October 26, 2004 and Preliminary assessment of the accuracy of the Intrade State-by-State contracts from November 5, 2008) and Supreme Court confirmations (e.g., see SC.CONFIRM.ALITO from November 6, 2005), as well as other kinds of contingent events such as the state of the economy (e.g., see What are the prediction markets saying about the economy? from April 10, 2009), etc.

Currently (as of August 19, 2009), the Intrade market gives the Public Health Option a 36% chance of being passed into law by the end of this year (the closing price yesterday, on August 18, was 32 Intrade points).  The contract is called US.GOVT.HEALTHPLAN.DEC09, and it has been trading ever since June 12, 2009. The highest price recorded for this contract was 51.5 Intrade points (at the contract’s inception on June 12, 2009), and the lowest price recorded was 14.1 Intrade points (on August 17, 2009, after it appeared that the Obama administration might be willing to compromise on the public option in favor of non-profit health cooperatives).  Here’s the complete time series since contract inception on June 12:

For more information concerning the topic of “prediction markets”, I recommend an article entitled “Prediction Markets“ by Justin Wolfers and Eric Zitzewitz that appeared a few years ago in Journal of Economic Perspectives (Vol. 18, No. 2 (Spring 2004), pp. 107-126).

Assorted Links (8/19/2009)

Here’s a list of articles that I have been reading today (organized by topic):

Economics and Public Policy

  • It’s Costing the Gov $600K to Create Each Job, by Casey Mulligan
  • Why AT&T Killed Google Voice, by Andy Kessler
    WSJ: “Telecom operators are yesterday’s business. It’s time for a national data policy that encourages innovation.”
  • Obama, In Rich Irony, Can’t Afford To Wage War On Nation’s Wealthy, by W. Michael Cox
    IBD: “Barack Obama’s political fate depends on a group of Americans he hasn’t done much to cultivate — the rich.”
  • Brokers Aren’t Responsible for Bad Bets, by Charles Schwab
    WSJ: “To take the risk out of investing you’ll have to take Americans out of the market.”

Health Care Reform

  • What are health care co-ops?, by Tyler Cowen
  • ObamaCare Is All About Rationing, by Martin Feldstein
    : “Overspending is far preferable to artificially limiting the availability of new procedures and technologies.”
  • The Death Book for Veterans, by Jim Twoey
    WSJ: “Ex-soldiers don’t need to be told they’re a burden to society.”
  • ‘Death Panels’ Just A Rumor? Go Ask Ezekiel, by Thomas Sowell
    IBD: “There was a time when rushing a thousand-page bill through Congress so fast that no one has time to read it would have provoked public outrage….”
  • What Do the U.S. and Turkmenistan Have in Common?, by Freakonomics
    Freakonomics: “Foreign Policy came up with a list of “The World’s Worst Healthcare Reforms”. Keeping company with Russia, China, and Turkmenistan is the good old U.S. of A.”