Water Service Subsidies and the Poor: a Case Study
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Centre on Regulation and Competition WORKING PAPER SERIES Paper No. 112 WATER SERVICE SUBSIDIES AND THE POOR: A CASE STUDY OF GREATER NELSPRUIT UTILITY COMPANY, MBOMBELA MUNICIPALITY, SOUTH AFRICA Julia Brown June 2005 ISBN: 978-1-905381-11-5 Further details: Centre Secretary Published by: Centre on Regulation and Competition, Institute for Development Policy and Management, University of Manchester, Harold Hankins Building, Precinct Centre, Oxford Road, Manchester M13 9QH, UK Tel: +44-161 275 2798 Fax: +44-161 275 0808 Email: [email protected] Web: www.competition-regulation.org.uk 1 WATER SERVICE SUBSIDIES AND THE POOR: A CASE STUDY OF GREATER NELSPRUIT UTILITY COMPANY, MBOMBELA MUNICIPALITY, SOUTH AFRICA Julia Brown 1. INTRODUCTION In many countries water has been historically considered a “free” resource of unlimited supply that is managed by the state. Users did not pay for the true cost of supplying water and often paid only for a proportion of the cost of transferring, treating and disposing of water i.e. its use was heavily subsidised, (Calder,1999:57). Recent reform of the water services sector in both the North and South has been strongly influenced by neo-liberal views, which have radically altered the provision of water services. The new guiding principles for water services management recognise water as an economic good that should be priced to reflect its true cost because water subsidies distort the market and do not encourage efficient use of water, an important consideration in water scarce countries. It is argued that whilst subsidising infrastructure development and water in many countries was seen as a ‘pro-poor’ policy it was actually anything but, because it was largely the middle classes that benefited. It is suggested that the poor are already obliged to treat water as an economic good. The poorest sections of society are often not connected to mains water and waste water services and have been forced to buy water from street vendors for a relatively high price, whilst the middle classes enjoyed the benefits of subsidised water, (DFID,2001:31). Private sector management practices also advocate efficiency, and cost recovery is to be pursued. The state should no longer be viewed as having a monopoly over service provision; private sector participation (PSP) and even the privatisation of water service provision is promoted as an alternative. Cost recovery refers to the process by which the service provider (state or private company) recoups all, or the majority of the costs associated with supplying a service (including the operating costs, maintenance costs and infrastructure costs). The difference between public and private service providers is that private companies would expect to generate a surplus amount above the actual costs of supplying a service ie profit for their shareholders. In comparison public owned companies are not usually under pressure to generate a profit, (McDonald,2002:18). 2 The effective operation of any cost recovery model is dependent on the following three factors, without which any programme would be rendered ineffective . First, the ability to measure consumption at the household level “regularly and accurately” is a fundamental component of any cost recovery model; meters 1 can be used for water services which record the number of kilolitres consumed (electricity: number of kilowatt hours) – “without meters it is virtually impossible to apply marginal cost pricing”). Second, the operation of a payment collection system (postal/payment system) is equally important, and this requires an effective administrative system. Third, where consumers do not pay their bills there need to be mechanisms to force payment ie credit control measures. Consumers can be threatened with restrictors in the pipes or even to be cut off for a temporary period, which with repeat ‘offenders’ could result in the permanent removal of infrastructure to prevent illegal reconnections. The most drastic measure in the arsenal would be legal action resulting in the eviction from one’s home for non-payment, (MacDonald,2002:19). The pricing structure is fundamental to any cost recovery policy. The first important consideration is whether usage can be measured accurately. In the case of water and water- borne sewage and electricity, usage can be measured volumetrically 2. Providers are able to recoup costs by charging the end user the “(full) short-term marginal cost of production 3 plus a proportion of long-term operating and maintenance costs” of the bulk infrastructure required to produce the water and distribute it. These costs can be determined in a number of ways, the most common i.e. the orthodox model based on a downward sloping marginal cost curve; based on economies of scale, users who consume high levels of water are charged less per unit than those whose usage is low. (McDonald,2002:18). Whilst in economic terms this model makes sense it is not an equitable system because lower end users, typically low income households, are in effect being “penalised”. In effect water for essential uses such as drinking, cooking and washing is priced more highly than water for non-essential or luxury use. This system also does not encourage water conservation, an important consideration in a water scarce country like South Africa. Progressive block tariffs are another model on which a pricing structure can be based. This model is the inverse of the previous model because unit costs increase with consumption levels, in theory making low levels of consumption (blocks) ‘more affordable’ or even free. 1 Whilst the literature implies the necessity of meters for cost recovery, in fact cost recovery can be pursued without meters, as in the UK, where in general consumers are charged a flat rate. 2 It is more difficult to measure services such as refuse collection. 3 Volumetric rate for the marginal cost of every kilolitre of water consumed. 3 This model is more equitable 4 because low end users/low income households are not penalised to the same extent. Progressive block tariffs also provide an incentive to curb non- essential water consumption i.e. encourage water conservation. Cost recovery has become the general model for water service delivery but it is likely that there will always be an element in most societies for whom affordability is an issue. Mitlin argues that affordability can be an issue at several levels. Where services have been extended research has shown that not all households are able to afford the connection fees and of those that have been able to connect many may be unable to pay regular bills. Affordability is also an issue with regards to investments in infrastructure. Both public and private companies have found extension targets difficult to meet in part because of the predicted low return on the investment. It is suggested that both private and public companies are likely to face similar challenges. The question is how can the needs of those in extreme poverty, i.e. equity, be accommodated in a model of delivery where the true cost of water is charged and cost recovery is pursued? It is argued here that there is a need to create a space where commentators can engage in an informed discussion over the role of subsidies. There is very little literature 5 on the existence, operation and financing of subsidies in the water services sector. This dearth could be down to the continued focus on the ‘public- private’ (ideological) debate in water service provision 6. These discussions to date have tended to be rather narrow in their focus and have yet to explore in any depth the role of subsidies. Donor agencies have also been reluctant to engage in a discussion on subsidies in any real depth because support for subsidies could be seen to run counter to their support for viewing water as an economic good and cost recovery mechanisms. Even if there is recognition of the need for subsidies if the poorest segment is to be served, there does not appear to be a universally accepted model about the form the subsidy should 4 However, equity can actually be compromised if the block tariffs are not steep enough. If the blocks increase too steeply, however, this could actually penalise those households that have a low income but many dependants. The tariff needs to be carefully planned, based on a knowledge of usage patterns and income levels of consumers. Another consideration is that very steep rises could discourage high level use: while this has conservation benefits, the tariff levels have to be set carefully or the provider could lose valuable income which is required to subsidise lower level usage. 5 One of the few papers that describe subsidy systems in operation is that of Andres Gomez-Lobo and Dante Contreras (2000). 6 There is still considerable interest and resistance in some quarters to the involvement of the private sector in water services as well as the sustained criticism over the ‘commodification’ of water. Some academics are fiercely opposed to cost recovery in water services and even advocate the decommodification of water services, arguing that water services should be viewed as being a public good. An example of this is the McDonald and Pape collection which will be discussed in Section 2. 4 take. The important question is how can subsidies be targeted so that it is the poor that accrue the benefits and not the middle classes, and so that costs are minimised and access to water services improved? Can a targeted subsidy system be used in conjunction with a cost recovery model, or are they incompatible? Chile and Colombia have employed a cost recovery model of service delivery but they also recognise the need for a subsidy system to improve the access of the poor to water services; they have, however, used different mechanisms to target the poor.