Water

normally set building standards that require the provision of toilets and connection either to a sanitation service or an appropriate on-site treatment of the waste. When there is no effective building control and, especially when informal settlements are involved, a way to efficiently engage with communities needs to be found.

When water is used for public purposes, such as the maintenance of a wetland for biodiversity or recreational benefits, access is usually provided for free and funded by the government

through

taxation. Usually, this is efficient as the beneficiaries are numerous and not easily identified. Moreover, there is no congestion problem; many people can benefit without detracting from the benefit received by others.

When water supply (consumption) is for private benefit, however, use by one person typically excludes use by another.

In such situations, the efficient strategy

is to make water available to those who want it at – at least – the full cost of supply. Then, every water user has a greater incentive to use water efficiently. But this simple observation fails to consider important equity considerations that are discussed in the next section.

When water supplies are scarce, the efficient strategy is to price access to water at the marginal cost of supplying the next unit of water (Beato and Vives 2010). Costs increase as more and more water is produced. The efficient charge is equal to marginal cost – the cost of producing the next unit of water. Typically, this cost rises as more and more water is supplied.

When water supplies are scarce and no more water can be accessed by, for example, more desalination or recycling, economic theory would suggest the need for a scarcity charge.

When water supply is abundant, however, water pricing theorists face an interesting dilemma. As more and more water is supplied, the cost per unit of water supplied declines. Moreover, the cost of supplying the next unit of water is less than the average cost of supply. The result is a regime where, if water charges are set at marginal cost of supply, the revenue collected will not be sufficient to cover average costs - the water supply business will go bankrupt unless the supply charge is set above average long run cost of supply and/or a government makes up the shortfall (Beato and Vives 2010).

The question of whether or not a government should fund any revenue shortfall experienced by a water utility depends upon its capacity to collect revenue from other sources. When institutional capacity to collect revenue is strong, the most efficient charge is one that charges all users in proportion to the metered volume of water taken. When institutional capacity is weak, however,

it may not be possible to do this. Before volumetric charges can be introduced, meters must be installed and revenue collection procedures established.

Finally, it is necessary to differentiate between day-

to-day operating costs and the cost of ensuring that sufficient money is set aside to fund infrastructure upgrades and maintenance, ecosystem restoration and to ensure an adequate return on capital. The former is sometimes known as the “lower bound cost” and the latter as the “upper bound cost”.

As a general rule, the faster any system shifts to lower bound cost and then onto upper bound cost, the more efficient, the more sustainable and more innovative water use will be. When institutional capacity is strong, the most efficient strategy is to set a price that is the greater of marginal cost and average cost. Mechanisms other than water pricing policies should be used to transfer income to disadvantaged households and businesses.

Financing access for the poor In an environment where a large number of children die as a result of lack of access to adequate water, what is the right tariff to set? Western Jakarta provides an illustrative case study. Some 37 per cent of the people living in Western Jakarta do not have access to a reliable mains water supply. Most of these people are poor and either buy water from carts operated by water vendors or collect it from an unhygienic source. Those forced to buy water from a cart pay up to 50 times the full cost of providing water access to a mains water supply. In addition, they incur the costs linked with poor quality and inadequate volumes of water. Government policy, however, requires the poor be provided access at a highly subsidised price so, in practice, those poor people who get access to mains water are supplied it at a price that is 70 times less than the price paid to water vendors. Since the government cannot afford to pay this subsidy, it is actively discouraging the water utility from making water available to these people (Fournier et al. 2010). The poor who receive access to reliable subsidised water benefit, but this assistance is of no benefit to the 37 per cent of people who do not have access to a reliable mains water supply. Table 4 shows the tariff structure used in Western Jakarta.

South Africa provides a different perspective on the question of what tariff to set. In 1996, South Africa devolved responsibility for water management to local government and then introduced a policy that required local governments to provide a basic amount of water to all people free of charge, using funds redirected from central government. As a result, the proportion of the population without access to a reliable water supply has dropped from 33 per cent to 8 per cent (Muller 2010). Whether or not the same, or more, progress could have been made if users had been required to pay the full cost

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