This economics view post is contributed by the editor of JC Economics Essays
The Budget and Committee of Supply Debates 2017 in Singapore had many economic policies announced. However, one major announcement stood out and generated a lot of debate, including many negative views – yes, the water price hikes, especially the figure of 30%.
In summary, the issue here is that the price of water in Singapore is set to increase by 30 per cent in two phases, from 1 July 2017 onwards.
This economics view post argues that while some may say the hikes are not justified, the reality is that the water price hikes are based on sound economics and are needed, necessary, and important for Singapore’s survival.
Before we delve into economic terms like "LRMC" and "pricing" and "infrastructure", there are of course, non-economic arguments based upon reasoning about Singapore’s strategic imperatives and our fundamental vulnerabilities.
Singapore’s Deputy Prime Minister Teo Chee Hean said, rather clearly, that water is critical to Singapore's survival, and Singapore has adopted a strategic approach in planning for its water supply. It may not be a very well-known fact that water is tied rather closely to Singapore’s sovereignty, a significant reflection that water is critical to Singapore’s survival. According to the National Library Board, the Separation Agreement signed between the governments of Singapore and Malaysia on 9 August 1965 guaranteed the 1961 and 1962 water agreements.
As DPM Teo went on to say, "Our struggle to make sure our people have water, is the struggle for Singapore's survival and independence… To make sure that we could survive, preserve our independence and thrive, we have taken a strategic approach to planning for water supply.”
This strategic argument reflecting the importance of water has actually led to concrete steps taken to reduce Singapore's dependence on imported water and raise Singapore's water security.
To reduce Singapore's dependence on imported water from Malaysia, the government has increased the size of the local water catchment area (in other words, reservoir water) and to build up water supply from non-conventional sources, namely NEWater (in other words, reclaimed water or less glamorously, “sai chui” in Singapore local parlance) and desalinated water (in other words, treated seawater), by setting up water treatment plants in various parts of Singapore. In total, these form the four national taps of Singapore.
The real success of the four national taps came in 2011. When the 1961 water agreement with Malaysia expired, Singaporeans did not face a disruption in water supply, and the event passed almost unnoticed.
DPM Teo went on to argue that, in the same vein, Singapore must prepare now for 2061 when the second water agreement with Malaysia, which currently meets half of Singapore’s water needs, expires. Besides preparing for the future, DPM Teo also warned of a more immediate worry (at least in the near term). Johor's Linggiu Reservoir is only one-third full and there is a danger of it failing in prolonged dry weather – and the water is needed by both Malaysia and Singapore.
Other than the fact that the water source is under stress, while bilateral ties are sound today, where in recent years Singapore and Malaysia have shared a good relationship, what would happen if climate change and increasing water scarcity makes it challenging and difficult politically for Malaysia to export water to Singapore?
However, let us turn to the economics and look at the issue from an economics perspective.
While housing, healthcare, and education are subsidised in Singapore, because they are essentially merit goods, it was argued in Parliament that water has to be priced fully because consumers must feel the price of water to realise its value. It is a sound economic principle that the ones using the water should be the ones to pay for it. In other words, the Minister of the Ministry of Environment and Water Resources, Masagos, is essentially right in terms of economic reasoning – water is not a merit good and should not be subsidised, whereas there are foregone positive externalities to society or there would be under-consumption of goods such as housing, healthcare, and education if they were not to be subsidised by the government.
Now for the pricing itself, beyond the economic principles.
Minister Masagos said in Parliament that even with the impending 30 per cent hike in water prices, the price of water here will fall short of the Long Run Marginal Cost (LRMC) — which is the increase in cost of producing an additional unit of water, over the long run, arising from increasing production.
In other words, he argued that the increased price of water will bring up the pricing to nearer the true LRMC of water.
With the 30 per cent increase, the price will be close to, though slightly lower than, the price of the next drop of water or LRMC. This is the best way to emphasise the scarcity value of water, because the price will fundamentally reflect the long run cost of the next drop of water – and this is based on economic reasoning. If the price is equal to the LRMC, production would be allocative efficient - a concept familiar to economics students, where the price reflects the additional (i.e., marginal) cost of production.
In other words, he argued that the increased price of water will bring up the pricing to nearer the true LRMC of water.
With the 30 per cent increase, the price will be close to, though slightly lower than, the price of the next drop of water or LRMC. This is the best way to emphasise the scarcity value of water, because the price will fundamentally reflect the long run cost of the next drop of water – and this is based on economic reasoning. If the price is equal to the LRMC, production would be allocative efficient - a concept familiar to economics students, where the price reflects the additional (i.e., marginal) cost of production.
In Parliament, it was revealed that the LRMC of water comes from the costs of NEWater and desalination. And between the two, Singapore will have to depend more on desalination – which is more expensive than NEWater – to meet increasing water demands, as there is a limit to recycling used water in the NEWater plants. For example, three more desalination plants will be built by 2020.
And why are the relatively cheaper NEWater plants not being used instead? The answer is that as the proportion of water being reclaimed for NEWater increases, waste water becomes more concentrated, thus becoming difficult and even more costly to treat.
In addition, it also costs the government more to build new and replacement pipes to deliver water - thus adding to the LRMC.
In the final analysis, while there are actually solid strategic reasons for raising the price of water to build critical infrastructure to ensure Singapore’s future, the price hikes are based on sound economics.
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