The economics of water scarcity
Summary
Focus
Water is essential to the economy – as a necessity for human, animal and plant life and as a complementary input into production, alongside capital and labour. As a common good, water can be over-exploited, with consequences for the environment, society and economic activity. Water scarcity is already a significant risk across many countries.
Contribution
Using Aquastat data, we document water use, available freshwater resources and water scarcity across different continents and countries between 1990 and 2020. We then employ a simple model with water as a complementary input to both labour and capital. Water use increases production, but water scarcity increases marginal costs, as firms and workers require water that is harder to reach or in inconvenient locations. We estimate panel regressions of this model, controlling for water scarcity and other observable variables such as GDP per capita and fixed effects for country and year. Climate scenarios show the risk of much more severe water shortages in the future, threatening its sustainable use.
Findings
Our regressions show that water use is associated with higher economic output. But water scarcity is associated with lower real GDP growth and investment, and higher inflation. A one standard deviation increase in water scarcity reduces growth of output by 0.12–0.16% and of fixed investment by 0.39–0.42%, while increasing consumer price index inflation by 2.9–3.5%, depending on the water scarcity measure. The reduction in growth is larger for industries with higher water consumption, such as vehicle manufacturing. Several measures of water scarcity and different methodologies such as quantile panel regressions provide similar results. Projections for water stress in 2080 show large areas of the globe with extreme levels of water scarcity, including Central and North America, Southern Europe, the Middle East, India, China and some regions of South America, Africa and Oceania. This could have important economic implications.
Abstract
In many countries around the world, water scarcity could become a macroeconomically relevant concern. As a key input into production processes (agriculture, power generation and industrial use) and a common good, water resources risk being overexploited. Regressions with panel data for 169 countries between 1990 and 2020 show that, while water use is positively correlated with output, higher water scarcity is associated with lower gross domestic product growth and investment, and higher inflation. In contrast, water use efficiency is associated with higher gross domestic product growth and lower inflation. Climate scenarios show risks of much more severe water shortages in the future, threatening its sustainable use. This could impose higher costs on individual sectors and on the economy, reducing output and pushing up prices. Water availability and use could thus become an area for economists and central banks to monitor in the context of climate change, economic forecasting and monetary policy.
JEL classification: L95, Q25, Q50
Keywords: water scarcity, efficiency, tragedy of the commons, climate change, natural resources
