Assessing the Economics of Natural Resource in a Changing Environment

In spite of its quantitative and qualitative relevance to natural resource use, industrial water demand has not received much attention in the past. This is also true for industrial water use in Germany, which showed a decrease of water abstractions and freshwater intake during the last decades. This development was accompanied by an increase of the efficiency of water use due to a more widespread application of water recycling within the variety of industrial water use purposes. However, although the industrial sector reduced its pressure on freshwater resources, firms might face new challenges caused by a change of climatic and hydrologic conditions with impacts on the availability of water supplies. In an environment with potentially declining water supply reliability, water resource managers require information on industrial water demand patterns. This comprises the responsiveness of industrial water users to a change of water prices and the ease of substitutability of other inputs for water resources. Ultimately, price responsiveness and input substitutability are two important indicators of the flexibility of industrial firms to adjust to changing environmental conditions. To shed some light on this neglected area, this work departs from an economic approach by interpret-ing the demand for water as a derived demand within the overall use of inputs for industrial production and derives key economic characteristics of industrial water demand for both the medium and short run. The analysis primarily uses firm-level data obtained through a survey in the German part of the Elbe River Basin. Own-and cross-price elasticities as well as elasticities of substitution are derived in a medium-run translog cost functionframework with fixed capital input. Both freshwater intake and wastewater demand are found to be price responsive in the medium run, although the price elasticities for these inputs are in an inelastic range. Moreover, water related inputs are substitutesto both labour and materials. These findings indicate that water pricing can be an effective means of improving further the efficiency of industrial water use. A refined analysis by subgroups of firms reveals that especially large volume users and self-supplied firms are relatively sensitive to changes of water related cost. A different picture emerges in the short run when water is a rather fixed input into production that cannot easily be substituted under drought conditions. From sce-narios of summer water shortages as presented to the firms in the Elbe River Basin, it can be concluded that plant managers put a high priority on maintaining production even under severe drought conditions. The responses indicate that especially firms with cooling and consumptive uses of water face potentially large output losses and additional cost. Therefore, water is valued relatively high in the short run and, under drought conditions, available supplies would be directed to the core uses, accompanied by efforts to access own water sources or to buy in water externally. These findings are crosschecked in a modified cost function framework with water as a quasi-fixed input into production.