Urban water pricing: Equity and affordability

March 12th, 2012

Dr. Noel Wai Wah Chan, The Australian National University, Australia

Social equity was traditionally one of the main objectives of urban water pricing. Policy design today focuses increasingly on different goals: economic efficiency, financial sustainability, and cost recovery. Accordingly, equity and affordability concerns have diminished in prominence. By and large, the dominant view globally is that water prices must increase to fund the expansion of water services delivery networks.1 The situation in many developing countries is urgent in this regard: insufficient infrastructure constrains the provision of water and sanitation services to the poorest communities.

Clean drinking water and adequate sanitation are fundamental to the well-being of individuals and society as a whole. It is estimated that every US$1 invested in improving water and sanitation services in developing countries yields social benefits of between US$5-US$46.2 In that context, it would appear that the social benefits of providing water free of charge significantly exceeds the social costs. This was once a commonly held rationale for providing water for free or lifeline (i.e. low initial price) tariffs for water services.

A significant shift in perceptions occurred following the release in 1999 of a landmark OCED study.3 This global review of water and sanitation services, their coverage, metering issues, and tariff structure found that most countries, both developed and developing, set water prices below the economically efficient level. Consequently, many water and sanitation service providers held a financially unsustainable position: revenue could not cover the cost of provision. In addition, increasing water scarcity and its effects, such as water-use conflicts and rising water pollution necessitated a new approach to policy recognising supply constraints. Urgent global reform to urban water pricing was recommended; otherwise, the water-related Millennium Development Goals would be out of reach. The policy response in developed countries, at least, was substantial. A similar OECD survey in 2010 confirmed that most OECD member countries have since reformed their water pricing structures and raised prices significantly.1

Despite the general shift towards greater economic efficiency, the notion of socially equitable and affordable water delivery retains influence over pricing. Since most urban water service providers are government-owned or regulated, water and sanitation pricing and planning decisions will always be politically and socially sensitive issues that transcend market-based decision making. The policy response to the decade long Australian drought that ended in 2010 provides several insights. Rather than following economic rationale and raising prices, authorities in all major metropolitan cities chose to impose water restrictions because community opinion dictated that this was the most equitable way to share the responsibility of conserving water. Studies have shown that this approach generates considerable social welfare costs, including: opportunity cost of time spent complying with restrictions, constraint on water-related activities and amenities, loss of green space, and even psychological health problems.4 Other studies show that greater economic efficiency and, hence, higher social welfare can be achieved through raising water prices during periods of low water supply to achieve the same reduction to total water consumption.5 Despite this evidence, water utilities and social organisations continue to support the community preference for restrictions over price rises.

Instead of using water prices to control demand, all Australian State Governments have developed water supply augmentation projects, such as desalination plants, dam expansions, and grey water recycling projects. In order to fund these infrastructure projects, water prices will, in a somewhat perverse situation, increase substantially in the coming years and consumers will be burdened with higher water bills. For instance, domestic water prices in Melbourne will increase by 60% from 2009 to 2013, and in Sydney they will rise by 31% over the next four years. It is highly questionable whether these supply augmentation decisions will actually bring about equitable and efficient outcomes, especially as the drought is over and these projects are being built at a time of high rainfall and flooding. Economists argue that resistance to higher prices in times of scarcity has encouraged inefficient decision-making that is now causing prices to rise in a time of excess supply.

The current rise in water prices in Australia is raising concerns about ‘water poverty‘.6 There are two dimensions to ‘water poverty’. The first is related to water provision and accessibility, especially with regards to the situation in developing countries and the links to: well-being, hygiene, health, social and economic development, gender equity, and education opportunities.2 The second dimension is related to affordability of water and sanitation services. ‘Water poverty’ is technically defined as occurring where the household expenditure of water (including sanitation services) is equal to or more than 3% of disposable household income (or total household expenditure).7 At the broad level of society, affordability is typically a concern affecting developing and transitional (or ex-Soviet Union) economies; however, it is also a significant concern for low-income households in some OECD countries, such as the Czech Republic (3.5%), Hungary (4.2%), Mexico (4.2%) and Poland (7.9%).1

There are two ways to achieve social equity and affordability in urban water pricing: tariff structure policy and social income support policy. For tariff structure policy, it is argued that water should be charged at a very low price for the essential amount of water for drinking, food preparation, domestic cleaning, and sanitation purposes. Increasing block tariffs (IBT), or lifeline tariffs with a very low price for the first block of water consumed, are advocated to achieve social equity. IBT has become a common water tariff structure among OECD countries in recent times.1 In Australia, all major cities except Sydney use IBT as the water tariff structure. Most employ a three tiered block structure, whereas Perth employs 5 tiers. IBT is also used in Hong Kong, with the first tier free of charge and price rises occur up the subsequent three tiers. About 15% of Hong Kong domestic households do not pay any water charges. The average water price for domestic households is HK$47 per month in 2010/2011; equivalent to around 0.3% of average monthly household expenditure.8

Despite the prevalence of IBT, it is highly questionable whether this pricing structure achieves equitable outcomes. IBT does not account for household size and therefore punishes low income households with many members or those of low socio-economic status whom share accommodation and water meters. On the other hand, higher income households with few members benefit from the IBT structure. To achieve more equitable outcomes, some countries, such as Belgium and Malta, adjust their IBT structure for household size.9 However, the downside is that substantial administrative costs are incurred to maintain databases on household sizes and monitor and enforce compliance.

Income support and payment assistance policies provide an alternative option for achieving social equity and efficient water pricing. Well-designed policy may achieve both objectives; poorly designed policy may achieve neither. An example of the latter situation exists in most Australian cities, except Sydney, where water utilities employ IBT pricing and eligible low income households (usually existing social security recipients) receive concessional rates, in the form of both fixed supply fees and volumetric charges up to a high threshold. However this arrangement is neither efficient nor equitable due to the complex eligibility criteria. Consequently, many eligible households do not participate in the current concession scheme.10 In the United Kingdom, where a similar system operates, income support for water bills is assessed on a case by case basis and assistance payments typically lag economy-wide inflation and rising water prices.9

A policy package where economic efficiency, financial sustainability, and social equity are all achieved would combine a well-designed two-part tariff with targeted social policy. The two-part tariff involves: a fixed supply charge, to recover the cost of providing the infrastructure and services; and a variable charge, which is equivalent to the marginal cost of providing additional amount of water and sanitation services. The requisite social support policy is either a rebate on the fixed supply charge that reflects household size and income, or a payment to households through tax and transfer systems. Despite being economically and socially efficient, it is unlikely that this policy design could be achieved in a single reform process. The political ramifications of water pricing decisions would compel an adjustment period for society to accept the benefits of this water pricing reform. Reform would have to be achieved in a gradual, consultative process that educated stakeholders gradually. Water tariffs and social security are independently administered by separate agencies in most countries; therefore a defined utility and concession framework would need to be developed to ensure that equity, efficiency, and sustainability could be achieved concurrently.

References:

1. OECD (2010), Pricing Water Resources and Water and Sanitation Services Paris, OECD Publishing.

2. Hutton, G., Haller, L. and J. Bartram (2007), ‘Global cost-benefit analysis of water supply and sanitation intervention’, Journal of Water And Health, 5, 481-502.

3. OECD (1999), The Price of Water: Trends in OECD Countries Paris, OECD.

4. Grafton, R. Q. and M. B. Ward (2010), ‘Dynamically efficient urban water policy’, Centre for Water Economics, Environment and Policy Research Paper 2010-13, Canberra: The Australian National University.

5. Grafton, R. Q. and T. Kompas (2007), ‘Pricing Sydney Water’, The Australian Journal of Agricultural and Resource Economics, 51, 227-241.

6. Wilcox, E. and P. Harris (2011), ‘Water poverty – a crisis in the making?’, Marchment Hill Consulting, Available at http://www.marchmenthill.com/qsi-online/2011-06-18/water-poverty-a-crisis-in-the-making-.

7. Fitch, M. and H. Price (2002), Water Poverty in England and Wales, Chartered Institute of Environmental Health.

8. Hong Kong Water Supply Department (2011), 2010-11 Annual Report, Available at http://www.wsd.gov.hk/filemanager/common/annual_report/2010_11/pdf/09.pdf.

9. OECD (2003), Social Issues in the Provision and Pricing of Water Services Paris, OECD Publishing.

10. Harmer, J. (2009), Pension Review Report, Pension Review Taskforce, Department of Families, Housing, Community Services and Indigenous Affairs, Commonwealth of Australia.

Noel Wai Wah Chan is a PhD researcher at the Crawford School of Economics and Government, Australian National University. Her research focuses on the efficient design of urban water pricing policy to address sustainbility, efficiency, and equity concerns.

The views expressed in this article belong to the individual authors and do not represent the views of the Global Water Forum, the UNESCO Chair in Water Economics and Transboundary Water Governance, UNESCO, the Australian National University, or any of the institutions to which the authors are associated. Please see the Global Water Forum terms and conditions here.