The Economics of Protecting Public Health: Internalizing Risk in Physical Asset Investment Decision-Making in the Water Sector

Investments in physical assets in the water sector serve as a critical mechanism to protect public health by mitigating risks associated with water-borne diseases. As water utilities manage vast infrastructure networks, their decision-making processes must carefully consider the balance between financial costs and the protection of public health.

Internalizing risk in these investment decisions is essential because it ensures that the long-term health outcomes of the public are factored into the management of water infrastructure. This essay explores the internalization of risk in investment decisions related to physical assets in the water sector and describes the economic substitution of public health risks with physical assets, thus creating an optimal safety barrier to prevent water-borne outbreaks.

The Importance of Internalizing Public Health Risk in Water Sector Investments

The management of water supply systems inherently involves the management of public health risks, most notably the risk of contamination that could lead to water-borne diseases such as cholera, typhoid, or dysentery. Water utilities, as physical asset-centric industries, must continuously invest in maintaining, upgrading, and possibly expanding their infrastructure to minimize these risks. However, investment decisions often come with trade-offs, where financial resources must be balanced against the need to protect public health.

Internalizing risk in decision-making means that water utilities must not only consider the direct financial costs of physical assets but also take into account the potential costs associated with public health risks. For instance, investing in a new water treatment facility may come with a significant upfront cost, but this investment serves as a crucial safety barrier that control public health risks. By internalizing these health risks into their decision-making frameworks, utilities are effectively substituting the public health risk with physical assets, thereby enhancing the safety and reliability of the water supply.

The Economic Substitution of Public Health Risks with Physical Assets

In the context of water utilities, physical assets—such as treatment plants and pressurized water distributions systems —act as barriers that reduce the likelihood of contaminants entering the water supply. From an economic standpoint, the substitution of public health risks with physical assets involves using infrastructure investments as a means of reducing the probability and impact of health risks. This process is described as an economic substitution, where the utility opts to allocate financial resources toward physical assets to prevent water-borne diseases rather than incurring the costs associated with health outbreaks and remediation.

The economic rationale behind this substitution is rooted in the principle that the marginal cost of investing in physical assets should equal the marginal benefit of reducing public health risks. Therefore, it is in the public interest that a water utility weighs the costs of infrastructure investments against the expected reduction in health risks. For example, upgrading a water treatment plant may have a high cost, but if it significantly reduces the risk of a widespread water-borne outbreak, the investment is justified in terms of both public health benefits and long-term financial savings such as avoiding emergency response costs.

Technical Substitution of Risk as a Function of Price Ratio for Assets and Risks

The technical substitution of risk in the water sector is a function of price ratio for physical assets and risks, which is optimized when it equals to the negative ratio of productivity factors for risks and assets. It can be expressed in the following equation:

• Pa: the cost of physical assets (e.g., treatment plants, pressurized pipelines, etc).
• Pr: the cost associated with public health risks (e.g., healthcare costs from water-borne diseases, costs of emergency response).
• Ma: the marginal productivity of physical assets in reducing risk (i.e., how effectively an additional unit of investment in assets reduces the probability of contamination).
• Mr: the marginal 'productivity' of residual risk that is economically unwise to further reduce

The equation illustrates that the price ratio between physical assets and public health risks is optimal when balanced with the negative ratio of the marginal productivity of risk reduction through assets versus other interventions.

Optimizing Investment Decisions Using the Technical Substitution of Risk

When optimizing investment decisions, the goal is to find the balance point at which an incremental cost increase of an investment in physical assets returns an equal amount of cost reduction in terms of public health risk. If the price of physical assets is relatively low compared to the cost of public health risks (i.e., Pa/Pr is low), it is more efficient for the utility to invest in physical assets to create a robust barrier against contamination. Conversely, if the price of assets is relatively high compared to the cost of risks, the utility would be inclined to accept more residual risk that it would manage with improved operational protocols, health surveillance, and emergency preparedness, etc. without incurring significant capital expenditures. In this case, the marginal productivity of risk management strategies other than asset investment might be higher, allowing the utility to manage risk more cost-effectively.

Creating a Safety Barrier through Investments in Physical Assets

The substitution of public health risks with physical assets ultimately creates a safety barrier that protects the public from water-borne diseases. By investing in infrastructure that prevents contamination, water utilities reduce the probability of exposure to harmful pathogens. This is especially important in aging water systems where deteriorating pipes, outdated treatment plants, or insufficient capacity can increase the likelihood of contamination.

Investments in physical assets, such as upgrading filtration systems, installing advanced sensors, or replacing corroded pipelines, act as preventive measures that safeguard public health. By creating this barrier, utilities can effectively lower the incidence of water-borne diseases, reducing both the direct and indirect costs associated with public health risks.

Conclusion

Internalizing public health risks in decision-making related to investments in physical assets is essential for protecting public health in the water sector. Water utilities must carefully balance the costs of physical infrastructure with the risks posed by water-borne diseases, using economic principles to optimize investment decisions.

The rate of technical substitution of risk, as a function of the price ratio for assets and risks, provides a valuable framework for understanding how utilities can allocate resources efficiently to manage risk. By making strategic investments in physical assets and leveraging their marginal productivity in reducing risk, water utilities can protect public health while ensuring the long-term reliability of the water supply system. In doing so, they fulfill their role as stewards of public safety and providers of essential services to communities.