Philip Fletcher, Chairman of the water regulator Ofwat, was our guestat a Power Lunch in Westminster yesterday, and chose as his theme to talk about Ofwat's strategic view of the water industry.

There are certainly some big challenges. £80 billion of new investment since privatization has led to a third less loss from leakages and burst pipes, and higher standards which are very nearly 100% effective. But there are mounting problems in terms of the resource itself. A rapidly growing population, particularly in the South East of England, has led to over-abstraction of water – while some places, Wales and the North-West, for example, have the stuff in abundance. If the climate change view is correct, we could be facing more floods, but also more droughts too, putting even more pressure on some places. But we still have ten regional (regulated) monopolies who have very little incentive to move water from where it is plentiful to a neighbouring region where it is scarce. This strikes me as an obvious job for markets. in the Western United States, where water resources are scarce and dry years make them even scarcer, markets have sprung up to shift the stuff to where it is most urgently needed. Why not here too? We need to put a price on water itself – a price to create market signals to shift the raw resource around. At present, water firms pay for abstraction licences, but the price is related more to the administrative costs than any notion of scarcity.

To its credit, Ofwat has been thinking about getting more market thinking into the water business, as evidenced in its report on sustainability last month. But inevitably there are political issues. Market economists might say that people in areas of scarcity should simply pay higher bills, and people in areas of abundance pay less. But there are many poor families in the shortage areas, and many of those are large families who use a lot of water. So there are social issues to deal with. And people still seem to assume that water should be free because it falls out of the sky – ignoring all the treatment and delivery and wastewater removal and treatment costs – so, like road pricing, they don't relish the thought of paying, or paying more, for something that they have long regarded as free. If the pressures of population, climate and the rest are real, though, the long-term future must be obvious. We need more markets in water.