Since rates in the water sector seldom reflect full cost recovery, how can you convince citizens to accept higher prices (given their willingness to pay)?

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[Response by Sophie Trémolet and Diane Binder, June 2009]

An increase in prices to move towards full-cost recovery mostly intervenes in the case of the introduction of private sector participation (although the financial viability of state-owned enterprises SOEs is receiving increasing attention). Tariff levels may increase because of cost recovery requirements of commercially-driven operators and the necessity of financing quality improvements. In the case of SOEs, state budgets cannot support the expense of generalized industry subsidies in times of tight fiscal situations. Tariff structures may also be readjusted as direct or cross-subsidies disappear, either as an explicit policy or the consequence of market forces. However, when tariffs have been maintained for a long time at an artificially low level through subsidies, increasing tariffs to cost covering levels cannot be done in a precipitated manner for risk of antagonizing water consumers, as it happened for instance in Cochabamba in Bolivia when the private operator was finally ousted out of the country following massive riots triggered by a sudden tariffs increase.

The increase in tariffs will affect all consumers, albeit in different ways. Customers who are already connected to the network, and who have been enjoying the benefits of subsidized prices, are often resistant to tariff increases. On the other hand, those not served by the utility may prefer that the utility expand coverage, as the higher tariffs charged by the utility are often going to be cheaper than the tariffs charged by alternative providers. If network tariffs were to increase but would allow them at the same time to be granted access to the network, this would result in a net gain for those customers who were not previously connected, in terms of convenience, quality and price1.

Good reform requires careful planning and smooth transition, which includes the following steps:

  • Effective consultation with stakeholders, including customer representation: involving customers in the analysis and the decision will result in greater acceptance of decisions once they are made.
  • Demand-responsive approach: decisions must be made on quality standards and on network coverage, and on how the improved service will be financed. This requires analyzing various cost-quality options and consult customers to see which option they prefer depending on their preferences and willingness to pay.
  • Closely monitor the operator’s performance, and make sure that changes in tariffs are introduced along side improvements in service quality. However, the contracting authority may offer a transition period at the beginning of the contract, during which the operator can collect additional information (critical for informing decisions on tariffs and quality standards) with no immediate pressure to improve quality.
  • Determine the level of subsidies and set tariffs at levels that are acceptable both for a commercially driven operator and for customers, and differentiate tariff levels depending on the ability to pay of consumers.
  • Define achievable targets for cost-recovering tariffs. Whilst it is broadly acknowledged that tariffs in the water sector should cover operations and maintenance costs, it appears difficult that tariffs also cover all capital investment costs2 (repair and extension of network). Rather than recommending full cost recovery, donors are now recommending sustainable cost-recovery from tariffs, taxes (i.e. government subsidies) or transfers (from external sources) to cover costs3. They argue that if government transfers are secure and consistent, they can be considered as an appropriate source to cover costs and limit the need to increase tariffs recovered from customers.

 

Resources

Capitalization, Regulation and the Poor: Access to Basic Services in Bolivia
 Discussion Paper No. 2001/34, World Institute for Development Economics Research, United Nations University, Helsinki, July 2001.
Barja, Gover and Miguel Urquiola

Approaches to Private Participation in Water Services: A Toolkit
PPIAF, the World Bank Group, 2006.
PPIAF and The World Bank

Footnotes

  1. Poor consumers who are not connected to the network are often served by independent providers (SSIPs) and pay more for a lower standard of service.
  2. The market structure of the water sector is quasi-monopolistic and large amount of capital is sunk in the construction of infrastructure. See In an industry where an aging network and generation capacity constraints lead to poor service delivery, to what extent should consumers contribute towards capital expansion? for more details.
  3. See OECD report.