Water-Storage Capacities versus Water-Use Efficiency: Substitutes or Complements?

We investigate the economic relation between two common approaches to tackling water scarcity and adapting to climate change, namely expanding water-storage capacities and improving water-use efficiency. We build, analyze, and extend a simple model for capacity choices of dams, incorporating stochastically dynamic control of water inventories and efficiency in water use. We show that expanding water-storage capacities could encourage water users to improve water-use efficiency and improving water-use efficiency could increase optimal dam sizes even if water-use efficiency improvement decreases the water demand. The possibility of complementarity is numerically illustrated by an empirical example of the California State Water Project. Our analysis implies that, if complementarity holds, resources should be distributed in a balanced way between water-storage expansions and water-use efficiency improvement instead of being concentrated on one side with the other side being ignored