When Cities Run Dry: Equilibrium Effects of Water Scarcity in Cape Town

Cape Town faced an unprecedented water crisis from 2015-2018, bringing the city to the brink of Day Zero, when municipal water supplies would run dry. In response, the city implemented dramatic water price increases (4x for commercial users, 6x for domestic users) alongside conservation campaigns. This crisis provides a unique natural experiment to study how cities can optimally manage scarce resources during emergencies.

This research proceeds in three phases. First, analyse the direct effects of Cape Town's pricing policies using granular utility data and tax records to understand how different sectors, neighbourhoods, and groups responded to price shocks. Second, investigate the indirect equilibrium effects, that is, how water constraints rippled through the labour market, affected firm location decisions, influenced residential mobility, and created spillovers between sectors. These general equilibrium effects are crucial but often overlooked in policy design. Third, develop a structural model of the city that incorporates these empirical findings, allowing for the simulation of alternative policy approaches. The model will account for issues like mobility frictions that may influence optimal policy design. By comparing the welfare effects of different pricing schemes, quantity restrictions, and targeted interventions, we can identify more effective approaches to urban resource management.

The ultimate goal is to translate these insights into actionable policy recommendations. Working with the City of Cape Town, the researchers plan to design and implement a pilot program testing optimised pricing structures informed by our equilibrium analysis. This research addresses the growing challenge cities worldwide face as climate change and urbanisation intensify resource constraints.