FEATURE
ECONOMIC TALES: THE IRONY OF THE DIAMOND-WATER PARADOX By Renee Gomez
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he diamond-water paradox, also known as the paradox of value, is one of economics’ most well know fairy-tales, told to young economists crowded around the lecture board in Econ 101. This tale is a fable, told to teach budding economists a very important lesson: namely, the concepts of scarcity and marginal utility. On upon first hearing, the story seems obvious. Question: why are diamonds considered more valuable than water when water is essential to life? Answer: diamonds are scarce, and water is not, therefore one would place more value on the next diamond obtained. Simple enough, right? Except, perhaps the stars’ roles should be swapped, because as the truth behind the story shows, so-called scarcity of a resource is a function of management more than natural occurrence – and the effects on pricing and valuation can be messy.
Question: why are diamonds considered more valuable than water when water is essential to life? Answer: diamonds are scarce, and water is not, therefore one would place more value on the next diamond obtained. For example, our underdog here is water, assumed to be boundless whilst actually being disturbingly limited. Indeed, whilst the world’s surface is 70% covered in water, only 2.5% is fresh, and of this freshwater only 0.3% is easily accessible (Earthwatch, 2005). In practice, only 0.007% of the world’s water is available to 6.8 billion people (National Geographic, 2020). Even then, we still have enough for everyone to access, yet we feel the pinch of the water crisis. This crisis has two faces: physical scarcity and economic scarcity. Physical scarcity occurs in arid regions such as the Middle East, where there is not enough water to physically meet demand – although this can be managed with the right infrastructure in place. Receiving the right infrastructure can be difficult however, due to factors ranging from cost to incompetence: thus, economic scarcity occurs. 18
Physical scarcity occurs in arid regions such as the Middle East, where there is not enough water to physically meet demand – although this can be managed with the right infrastructure in place. For decades, there has been a trend of governments allowing poor infrastructure that leads to a lack of access to clean water and inefficiency in its supply. Take for example Mexico City, a land where it’s amazing downpours are enough to hydrate its 21 million inhabitants – and one where over half of its pipes are over 60 years old, leading to 40% of its water being wasted (NPR, 2018). The lack of infrastructure for capturing its heavy rains is due to the government’s unfocused urban development. Poor demand-side management isn’t unusual either; in Australia, rules put in place to manage the Darling River system have allowed irrigators to extract excess water (SBSNews, 2019), whilst in Mexico, farmers – the largest water consumers – have historically been allowed tax exemptions (OECD, 2004). Consumers utilize water as a free resource, whilst suppliers make it an economic good – a good with a degree of scarcity and therefore an opportunity cost. This is known as ‘the tragedy of the commons’ and reflects two issues: the first being that the market mechanism for pricing water is broken, and the second that in order water’s cost to be as low as possible, this man-made scarcity must be dealt with. So, what of the story’s champion, diamonds? They are not even in the top 10 list of rarest gemstones. They are one of the most common gems in the world. Recently, it has been revealed that in the 1970s Russia had found diamond reserves in the Popigai crater that could supply the market for 3000 years (Mining Technology, 2012). Their total supply in the earth’s crust is limited of course, but no more so than most natural resources. More myths about diamonds abound, such as their supposed value as longterm investments – in fact, a diamond loses 50% of its value as soon as it is bought from a jeweller (Priceonomics, 2013). Unlike gold and other commodities, it is neither liquid (easily
