The U.S. economy depends on a well-functioning water infrastructure. America’s water systems support 55 million acres of irrigated farmland, 315 million domestic users of water, and a $16 trillion national economy. Commercial industries ranging from manufacturing to information technology to retail rely on readily available access to water; without it, the profitability of these companies and the livelihoods of their employees are threatened. In sum, our long-term prosperity depends on satisfying the U.S. economy’s thirst for water while also protecting the environment.
The U.S. water infrastructure—including dams, reservoirs, aqueducts, and distribution pipes—is aging and is ill-equipped to efficiently handle current water needs. Almost 40 percent of the pipes in our water distribution systems are at least forty years old. Some key infrastructure predates World War I. In fact, about one fifth of the piped water in this country is lost to leaks and system inefficiencies, wasting about 7 billion gallons (26.5 billion liters) of treated water every day.
The continued deterioration of the nation’s water systems is just one of many threats to the viability of America’s water supply. The population is growing and is expected to reach 400 million by 2050. This will place pressure on the water infrastructure despite continued gains through water conservation. Climate change will further threaten water supplies in some parts of the country; it is likely to shift weather patterns and thin snow packs in the West. In coastal zones the impacts of climate change will be felt through stronger storms and coastal flooding that could put the reliability of urban water supply systems at risk. Higher temperatures will also raise evapotranspiration rates, further increasing agricultural water needs. Finally, rapid depletion of groundwater reservoirs has threatened, permanently in some locations, water users’ ability to draw on long-standing water reserves. In the future, we will need to do more with less.
New technologies can help better allocate water in the face of scarce supply. Innovation can provide additional water, increase the productivity of existing water sources, and make conservation measures easier and cheaper. For example, advances in recycled water and desalination can provide additional sources of water that are better insulated from drought and from other supply-related pressures. Furthermore, new water technologies and improvements in the management of groundwater aquifers and complex river systems can further improve drinking water quality.
While there is great promise in new technologies, the potential for innovation in the water sector has barely been tapped. Investment in the water sector totaled only $1.5 billion in 2012—a small amount when compared to other industries, such as clean energy, where investment amounted to $69 billion during the same year. Similarly, patent levels have remained relatively constant over the past decade in water subsectors such as purification, whereas the number of patents in the clean energy sector has increased rapidly.
The relatively low levels of innovation in the water sector are due to a host of barriers that drive down incentives to invest. Pricing policies fail to pass on the full cost of water to consumers, and limit water suppliers’ revenue to invest in innovation. Outdated and inflexible regulations encourage the continued use of status quo technologies instead of new advances. For example, California requires that industrial plants using recycled water be inspected by the Department of Health Services, despite the remote chance for human contact with that water. In addition, limited mechanisms for raising capital hinder development of new technologies. Industry conservatism, the inherent long lifespan of water infrastructure, and system fragmentation also inhibit innovation.
In a new Hamilton Project discussion paper, the authors propose three policies to overcome barriers to innovation in the water sector. First, the authors seek to reform water pricing policies to encourage conservation and unlock a steady revenue stream that can be used to fund new innovation. Second, they recommend that state and local governments conduct a systematic review of their regulatory practices, focusing on rewriting policies that conflict between levels of government or fail to incentivize innovation. As part of this government policy reform, they propose that select states establish water innovation offices to promote innovation friendly policies and spur new research and development. Finally, the authors recommend instituting a surcharge on water use to raise revenue for capital investment.
THE CHALLENGE
The past two centuries witnessed a series of fundamental innovations in the water sector, generally driven by health or environmental concerns. In the early nineteenth century advances in water treatment enabled the delivery of safe, clean drinking water to growing U.S. cities, helping protect populations from contaminants causing contagious diseases. The invention of sewage treatment plants in the early twentieth century led to greater protection of rivers, lakes, and other aquatic ecosystems. Passage of the Clean Water Act of 1972 (and its 1977 amendments) and the Safe Drinking Water Act of 1974 required further improvements in wastewater treatment and water quality in the final quarter of the twentieth century, along with marginal changes in the technology used for drinking-water treatment. Since then, however, technological change in the sector has generally stagnated even as the complexity of delivering clean water—especially during times of scarcity—has grown.
Sluggish innovation in the water sector exacerbates the challenges posed by scarce water supplies. Despite the need for more innovation, several factors hinder the development of new technologies. There are three sets of challenges to innovation in the water sector that can be mitigated by thoughtful policy interventions: (1) pricing issues, (2) regulatory hurdles, and (3) insufficient access to capital.
For several reasons, water pricing is often not reflective of the costs of obtaining and transporting water. First, many water users, particularly in the agricultural and industrial sectors, are either charged a constant price regardless of the amount of water they use or are charged a fixed rate per unit of water, and neither of these pricing schemes reflects the rising costs of delivering greater amounts of water. Second, the available revenue raised from water bills is often insufficient to cover the costs of infrastructure maintenance, such as keeping purification systems up to date and maintaining pipes. Third, the lack of sufficient revenue can make needed investments in new water-saving technologies unaffordable, with no dedicated revenue stream to repay development costs. Fourth, water prices seldom reflect the costs of environmental damage—what economists call a negative externality. For example, low stream flows due to over-extraction of river water damage environmental habitats and deplete resources for water-dependent industries, such as fishing.
Current regulations can also serve as a barrier to innovation and lock organizations into existing technology. Even where regulations are justified, new technologies often face administrative costs stemming from the need for permits or other forms of regulatory approval that existing technologies do not face. However, in some cases regulations can directly promote the adoption of new technologies by discouraging the use of existing technologies. For example, the federal Clean Water Act requires that the U.S. Environmental Protection Agency set performance standards for industry to employ the best available technology or its equivalent, incentivizing water utilities to innovate by finding more cost-efficient ways to meet the standards, where possible.
The mostly public nature of the water industry is an initial barrier to available capital. Public entities such as cities or water districts commonly rely on bonds, issued at low interest rates, to fund new projects. These bonds are typically paid back using new revenue generated from the project or by tapping into the locality’s general fund. However, rising operation and maintenance costs as well as declining revenue threaten these funding sources and can even affect bond ratings, further increasing the cost of new projects. This challenge is especially problematic for localities considering new technologies such as desalination that might already present riskier rates of return than established technologies.
The authors note that there are additional factors inherent to the water industry that contribute to its conservative approach to investment, but that cannot be readily addressed by policy reform. For example, the long lifespan and large scale of water infrastructure—e.g., dams and pipes that last for decades and are expensive to replace—bias the water industry toward incremental upgrades over more-innovative technologies. Water systems are also highly fragmented: there are more than 150,000 systems in the United States, most of them quite small. This decentralized landscape slows the diffusion of new technologies and leads to the classic public goods problem that arises when the entity that outlays the initial costs of an investment does not capture all the benefits. For example, if a local supplier adopts water recycling or desalination, it might benefit an entire region. However, the supplier who assumes the initial costs may not reap all, or perhaps even most, of the benefits. This leads to a situation where no individual actor has the proper incentives to invest to the level that would be socially beneficial. The result is that, absent effective coordination, the amount of investment is too low from a public perspective. An additional reason for conservatism in the industry is the potential for water impurities to cause great harm to individuals. Public health concerns often trump virtually any other consideration, leading water suppliers to be reluctant to employ and experiment with new technologies. Still, the authors contend that much progress can be made by addressing the barriers to innovation that result from inadequate pricing mechanisms, regulatory hurdles, and insufficient access to capital.
A NEW APPROACH
Innovation in the U.S. water industry is incremental and fragmented. In the second half of this policy brief, Ajami, Thompson, and Victor propose increasing innovation in the water sector by addressing the challenges presented by inadequate water pricing, obstructive regulations, and the lack of public-sector financing to raise capital for new projects. Addressing these challenges would unlock new funding sources and opportunities for the water industry, while also establishing a regulatory environment more conducive to innovation, prerequisites for addressing the nation’s water needs. ◆
This policy brief is based on the Hamilton Project discussion paper, “The Path to Water Innovation,” which was authored by Newsha K. Ajami, Stanford Woods Institute for the Environment; Barton H. Thompson Jr., Stanford Woods Institute for the Environment and Stanford Law School; and David G. Victor, University of California, San Diego. To learn more about this proposal, read the full paper at www.hamiltonproject.org.

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MODERN PUMPING TODAY, May 2015
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