The Diamond-Water Paradox: Why is it important to consider?

This #TechnicalTuesday Chris Bell discusses the Diamond-Water Paradox and its parallels and links with Multi-Capitals Framework.

My colleagues and I often discuss how precious water is, how we as society perceive its value and what value it actually gives to society. This has further been accelerated after reading the WWF report, “High Cost of Cheap Water: The true value of water and freshwater ecosystems to people and planet.” The report highlights the often overlooked and undervalued importance of water and freshwater ecosystems. It emphasises that water has a multifaceted value that goes beyond its market price, and it explores the broader implications for both society and the environment.

When I was carrying out research on the water industry for a project, I came across the Diamond-Water Paradox, I found this theory to be thought provoking and interesting, particularly when considering how we value water and the parallels to Environmental, Social and Governance (ESG) factors. In this article, I will explore the Paradox, links to frameworks and thoughts on what we can do to improve in this area.

What is the Diamond-Water Paradox?

The Diamond-Water Paradox is a well-known economic concept that was first introduced by the classical economist Adam Smith in his work, "The Wealth of Nations." This paradox illustrates the difference between the market value (price) of something and its utility or importance to individuals.

The basic concept is that diamonds are relatively scarce and have a high market price due to their rarity and desirability for uses like jewellery. However, in terms of their practical utility or importance for human survival and well-being, diamonds have very limited value. In other words, they have high market value but low utility. Water, on the other hand, is essential for human survival and has immeasurable practical utility. However, because water, in comparison, is more abundant and easily accessible in many parts of the world than diamonds, its market price is relatively low. In economic terms, water has high utility but low market value.

To expand further, it illustrates that value is not a one-dimensional concept. It shows that two goods, diamonds and water, represent the multidimensional nature of value. Diamonds have value in terms of aesthetics, symbolism, and luxury, making them highly desirable for certain purposes, such as jewellery. However, their utility in satisfying basic human needs is limited. Water, on the other hand, is indispensable for human life and well-being. Its value extends beyond its role as a beverage or for irrigation; it is crucial for health, sanitation, agriculture, and ecosystems. This multidimensionality of value implies that goods and services can have different forms of value, such as economic, environmental, social, and cultural, and these values can coexist or even conflict.

The Diamond-Water Paradox challenges traditional economic theories, particularly the labour theory of value, which suggests that the value of something is directly related to the amount of labour required to produce it. Instead, the Diamond-Water Paradox highlights that value is subjective and can be influenced by factors other than labour inputs. It also underscores the idea of marginal utility, where the value of something is determined by its additional (marginal) utility, rather than its total utility.

This has important implications for understanding consumer choices, pricing of goods and services, and resource allocation. For me, it serves as a foundation for the concept of subjective value, which recognises that individuals assign value to goods and services based on their personal preferences and needs.

The concept is central to modern economic thought and has wide-ranging applications that are significant to reflect upon and understand because it challenges conventional economic thinking. It has far-reaching implications for how we understand market factors and the role of culture and scarcity in shaping economic decisions and public policy.

The Multi-Capitals Framework and links to the Paradox

In order to help with sustainable water management, the water industry and wider environmental management industry uses the Multi-Capitals Framework, which is an approach that recognises and accounts for the various forms of capital that are essential for water sustainability. These forms of capital extend beyond the financial to also encompass natural, human, social, manufactured, intellectual, cultural, and other types of capital. It encourages a holistic view of decision-making, considering not only economic value but also the broader impacts.

It acknowledges the subjective nature of value, similar to the Diamond-Water Paradox. Just as the Paradox emphasises that the value of diamonds and water is subjective and context-dependent, the Framework recognises that the value of different forms of capital can vary depending on the perspective and goals of stakeholders.

They also share common themes around sustainability and societal well-being, and they both have implications for resource allocation. For example, the Paradox underscores the challenge of allocating resources based on their value and utility, while the Framework provides a structured approach to allocating resources across multiple forms of capital, considering their diverse values and roles. Importantly, the Framework provides a structured way to integrate these principles into water management decisions, aligning with modern concepts of value and utility.

The Parallels to ESG and Cultural change

By utilising the Multi-Capitals Framework, and recognising its parallels to the Diamond-Water Paradox, the water industry can make informed, balanced, and responsible decisions that address ESG concerns that will protect water and identify its value. This approach helps ensure that water resources are managed sustainably, that communities have equitable access, and that regulatory and governance practices align with ESG principles.

The Framework and Paradox can also be used in the water industry as a powerful tool for driving cultural change, where water is perceived to be undervalued by society. By applying these principles in the context of cultural change, the water industry can help society recognise and respect the cultural significance of water, leading to more inclusive, sustainable, and culturally sensitive practices. This can drive cultural change by fostering greater awareness and appreciation of the value in water management decisions and organisational culture.

At the beginning I mentioned the WWF report (“High Cost of Cheap Water”), which emphasises the need to recognise the true value of water and freshwater ecosystems. It calls for a shift in how water is valued and managed to ensure the well-being of both people and the planet, and it provides policy recommendations to address the challenges associated with water mismanagement and undervaluation.

By considering these factors, we can highlight the value and utility of environmental and social resources and how they may be undervalued or mispriced in financial markets or by society. We need to do more, and we can do more, with ESG underscoring the importance of recognising the long-term and societal impacts of resource allocation, and the role of governance and regulation in addressing market failures and promoting sustainability. The Diamond Water Paradox helps serve as a reminder of the subjective and multidimensional nature of value, which is a central concept in the ESG framework and crucial to water protection.