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MEXICO CITY, March 18, 2006—Subsidies for utility customers are popular among policy makers and the general public, yet despite persistent belief that subsidies favor the poor, a new World Bank study, Who Benefits from Water Utility Subsidies?, shows that they actually tend to benefit the middle class and well-to-do.
“Over one billion people lack safe water,” said Jamal Saghir, World Bank Director for Energy & Water. “Lowering barriers to access and improving service to the poor is central to efforts to reduce poverty.”
According to the study released during the 4th World Water Forum being held in Mexico City, March 16th – 22nd, utility subsidies, which are often promoted as a way for expanding coverage and making services affordable for the poor, often miss the mark.
The sample includes 32 programs from 13 water utilities as well as a similar sample of electricity utilities. Most of the programs involve quantity-based subsidies, which are equally common in the water and electricity sectors.
Subsidies are widespread
Consumer utility subsidies are an ever-present feature of water services around the world. Global surveys indicate that the vast majority of water utilities charge tariffs substantially below levels required for full cost recovery. Nearly 40 percent of utilities worldwide do not even cover operating and maintenance costs. Average water tariffs in low-income countries stand at about a tenth of the level applied in high-income countries.
Subsidies provided to utility customers can be a significant drain on the public treasury. The most striking examples come from the countries of the former Soviet Union. But water subsidies remain an important drain elsewhere. In India, drinking water subsidies have been estimated at 0.5 percent of GDP. Part of the drain is caused by implicit subsidization due to generalized underpricing of the service and asset mining.
Types of subsidies and their impacts
There are two broad categories of explicit utility subsidies—consumption subsidies and connection subsidies. Consumption subsidies, or quantity-based subsidies, reduce the charge for consuming water service; while connection subsidies are a one-time reduction in connection charges.
A survey of tariff structures in Latin America, Africa, and Asia found that roughly three-quarters of utilities include some form of quantity-based consumption subsidy. Consumption subsidies are available only to those households connected to the network. This means that many poor households are often excluded from subsidy programs.
How well do subsidies perform?
Recent case studies have questioned the common belief that subsidies benefit mostly poor households. This study goes beyond individual cases to systematically examining the targeting performance of consumer utility subsidies across a wide range of developing countries.
“The results are sobering. Most subsidies do not effectively target the poor,” said Saghir. “The quantity-based subsidies practiced by about 80 percent of water and electricity utilities surveyed are starkly regressive. In fact, poor households capture only half as much of the value of the subsidy as they would if the subsidies were distributed randomly across the entire population. Many poor households are therefore excluded from subsidy programs altogether because they are not connected to the network.”
Quantity-based subsidies: nearly always regressive
The study finds that quantity-based subsidy programs are not effective in targeting the poor, especially where access to the network is less than universal. Almost invariably, the well-off benefit disproportionately from such programs. Only 2 of 26 quantity-based subsidy cases come close to achieving even a neutral subsidy distribution; the rest are all regressive. This means that all, or virtually all, residential customers receive a subsidy, and richer consumers receive more than poorer ones. In most water programs studied, the poorest 40 percent of the population receive only 5-20 percent of the subsidy benefits.
Why do quantity-targeted utility subsidies perform so poorly?
· Poor households are less likely than other households to be connected to the network. Households that lack access to utility service are unable to benefit from any consumption subsidy.
· Differences in consumption between the poor and better off households are less than they are often assumed to be.
· Even in the cases when the poor do consume less than better off households, various common features of tariff structures often fall heaviest on those who consume the least. Fixed charges mean that households that consume very small quantities may face a much higher unit price than larger consumers. Moreover, failure to apply full cost recovery tariffs to households consuming at higher levels means that even large consumers benefit from subsidization to a substantial degree.
Connection subsidies: a better way to reach the poor?
The major access differential between poor and non-poor households, according to the report, suggests that connection subsidies may be a more effective way to reach the poor. Assuming that all unconnected households were both offered and accepted subsidized connections, the distribution of benefits from connection subsidies is nearly always progressive —meaning lower income households receive more subsidies than higher income households.
However, this is based on the assumption that, in introducing connection subsidies, unconnected households at each income level will connect at the same rate. In practice, that assumption is unlikely to hold, because utilities often face constraints in expanding their networks into poor areas, and, even where networks are already present, many poor households face nonfinancial obstacles to connecting – such as not having legal title to the property they occupy.
The study notes that despite sizeable consumption subsidies, only 20–30 percent of poor households in Africa connected to utility networks even when networks were available. Unless those rates can be substantially improved, connection subsidies will continue to disproportionately benefit the non-poor, particularly in Sub-Saharan Africa.
Overcoming the limits of subsidies: an action agenda
Because the majority of the existing water and sanitation services are captured by the non-poor, most households would see their bills rise if subsidies are eliminated or restructured. In fact, the bulk of any price increase would be paid by non-poor households.
Saghir adds, “Resistance against price increase often comes from middle income groups.” It is not surprising that moving towards cost recovery has proven to be politically difficult. The political dimension of tariff policies has to be better understood. The key is to convince the public that they will feel the benefit of improved service.”
The study concludes that utility subsidies are best seen as one part of a package of measures to ensure access to utility services for the poor. Depending on the circumstances, other measures may be more promising, either in combination with or instead of current subsidies. Other measures that are promising to extend services to the poor include:
· Reducing the costs of service, through efficiencies in operating and capital expenditures, or by improving revenue collection, would benefit all consumers.
· More frequent billing and elimination of minimum consumption requirements and fixed charges could ease cash-flow problems faced by low-income households. Other options include prepayment, financing connection costs, and providing devices that help households control their consumption.
· Legal restrictions often work against the expansion of services to the poor. These restrictions include technical norms that oblige utilities to use inappropriate high-cost technologies, legal-tenure requirements that prevent services from being extended to peri-urban neighborhoods, and regulations restricting the services provided by small-scale providers. Relieving these restrictions would widen service access by the poor.
· To the extent they can be more accurately targeted to the poor, other measures of social protection may achieve redistributive goals better than utility subsidies.
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