Not so bad in our estimate…

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The University of California ARE Update published a short study that found that the drought emergency regulations adopted by the State Water Resources Control Board were only 18% more costly than the most “efficient” standards. In May 2015, the State Water Resources Control Board adopted Resolution No. 2015-0032 which imposed restrictions to reduce water use by local agencies by 4 to 36 percent depending on their circumstances. Northern California agencies were to reduce usage by 16.2 percent on average, while Southern California utilities were to reduce by 22.5 percent. In the end, Northern California utilities far exceeded their target with a 23.3 percent reduction, and Southern California’s just missed theirs with an average of 21.4 percent. M.Cubed conducted the economic study of the regulations, and found that the insurance benefits were likely substantial enough to justify the costs.

The real headline of the study should be “Drought regulations remarkably efficient!” Given that the regulations were developed in just a few months and that they were done on a prospective basis with uncertainties and unknowns (e.g., the price elasticities referenced in the study), missing the mark by only 18% is truly remarkable. In comparison, the California Air Resources Board may have missed the mark by more than 100% in setting out its AB 32 Greenhouse Gas Reduction Scoping Plan in 2008 by relying too heavily on mandated measures such as renewables generation and certain types of energy efficiencies instead of more effective market based measures.

Nevertheless, the study appears to the make mistake of making the classic economist’s joke “sure it works in practice, but does it work in theory?” Consumers are chastised for behavior that doesn’t fit the fitted values for price elasticities. The study compares the mandated and achieved reductions and notes that achieved reductions were more even across agencies than the mandates. Agencies with lower mandates achieved higher reductions, and those with higher mandates fell short on achievements. Instead of questioning the original price elasticity estimates–and such estimates commonly have a wide range and are often situation specific–the report just plows ahead as though these theoretical results should have driven human behavior.

The more interesting question the researchers should have asked given the consistent patterns in achieved versus mandated reductions is what factors caused these agencies to diverge from the mandates. Geography is clearly only part of the reason. It also appears that there is not as much “demand hardening” at the low end of use, and a higher premium put on water uses at the upper end. These factors have implications for how we should modify our price elasticity estimates.

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