WAT E R G L O B A L P R A C T I C E Doing More with Less Smarter Subsidies for Water Supply and Sanitation Luis A. Andres, Michael Thibert, Camilo Lombana Cordoba, Alexander V. Danilenko, George Joseph, and Christian Borja-Vega About the Water Global Practice Launched in 2014, the World Bank Group's Water Global Practice brings together financing, knowledge, and implementation in one platform. By combining the Bank's global knowledge with country investments, this model generates more firepower for transformational solutions to help countries grow sustainably. Please visit us at www.worldbank.org/water or follow us on Twitter at @WorldBankWater. About GWSP This publication received the support of the Global Water Security & Sanitation Partnership (GWSP). GWSP is a multidonor trust fund administered by the World Bank’s Water Global Practice and supported by Australia’s Department of Foreign Affairs and Trade; the Bill & Melinda Gates Foundation; The Netherlands’ Ministry of Foreign Trade and Development Cooperation; Norway’s Ministry of Foreign Affairs; the Rockefeller Foundation; the Swedish International Development Cooperation Agency; Switzerland’s State Secretariat for Economic Affairs; the Swiss Agency for Development and Cooperation; Irish Aid; and the U.K. Department for International Development. Please visit us at www.worldbank.org/gwsp or follow us on Twitter #gwsp. Doing More with Less Smarter Subsidies for Water Supply and Sanitation Luis A. Andres, Michael Thibert, Camilo Lombana Cordoba, Alexander V. Danilenko, George Joseph, and Christian Borja-Vega August 2019 © 2019 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW, Washington, DC 20433 Telephone: 202-473-1000; Internet: www.worldbank.org This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. Rights and Permissions The material in this work is subject to copyright. Because The World Bank encourages dissemination of its knowledge, this work may be reproduced, in whole or in part, for noncommercial purposes as long as full attribution to this work is given. Please cite the work as follows: Andres, Luis A., Michael Thibert, Camilo Lombana Cordoba, Alexander V. Danilenko, George Joseph, and Christian Borja-Vega. 2019. “Doing More with Less: Smarter Subsidies for Water Supply and Sanitation.” World Bank, Washington, DC. Any queries on rights and licenses, including subsidiary rights, should be addressed to World Bank Publications, The World Bank Group, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2625; e-mail: pubrights​ @­worldbank.org. Cover design: Bill Pragluski, Critical Stages, LLC Photos: Cover: Mirva Tuulia Moilanen/World Bank; Bart Verweij/World Bank; Alexander Danilenko/World Bank; Chris Terry/World Bank Overview left pages: Logga Wiggler/Pixabay; Monica Wise/SOIL; Allison Kwesell/World Bank; Alfribeiro/Getty Images Overview right pages: World Bank; John Hogg/World Bank; Curt Carnemark/World Bank; World Bank Chapter 1, World Bank; chapter 2, World Bank; chapter 3, Danilo Pinzon/World Bank; chapter 4, World Bank; chapter 5, World Bank; Appendix A Luis A. Andres/World Bank; Appendix B, Chris Terry/World Bank; Appendix C, Arne Hoel/World Bank; References, Almin Zrno/World Bank Contents Acknowledgments vii Overview xi Abbreviations xxiii Chapter 1  Setting the Stage 1 1.1  Water Supply and Sanitation Subsidies: Definition and Rationale 2 1.2  Dominant and Emerging Service Delivery Models 4 1.3  A Classification of Subsidies 6 1.4  How Are Subsidies Funded? 11 Notes 15 Chapter 2  The Challenges of Current Water Supply and Sanitation Subsidies 19 2.1  Subsidies Are Pervasive 19 2.2  Subsidies Are Expensive 22 2.3  Most Subsidies Are Poorly Targeted 31 2.4  Most Subsidies Are Not Transparent 36 2.5  Most Subsidies Are Distortionary 38 Notes 41 Chapter 3  Designing Effective and Efficient Subsidies 45 3.1  Understanding the Context 45 3.2  Defining Policy Objectives 50 3.3  Identifying the Target Service(s) and/or Population(s) 51 3.4  Selecting the Funding Source 62 3.5  Designing the Subsidy 62 Notes 66 Chapter 4  Designing an Effective and Efficient Subsidy Reform Package 69 4.1  Mechanisms to Complement Subsidies 69 4.2  Building Political Coalitions to Support Reform 76 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation iii 4.3  Communications Strategies for Reform 77 4.4  When to Design a Subsidy Exit Strategy 78 Notes 79 Chapter 5  Key Takeaways 81 Notes 83 References 85 Appendix A  Related Background Papers and Case Studies 93 Appendix B Methodology for Estimating the Magnitude of Networked Water and Sanitation Subsidies 97 Appendix C  Building Political Coalitions to Support Reform 105 Boxes 2.1. Increasing Block Tariffs 20 2.2. Why Are Time-Bound Subsidies Rarely That? 23 2.3. Various Ways to Calculate Cost-Recovery Levels 25 2.4. How Do Our Estimates Compare with Other Approaches? 28 2.5. Materiality of Subsidies for the Poor: Networked Water Services in Ten Countries 35 2.6. Subsidies and Resiliency to Economic and Political Shocks: The Case of South Sudan 39 3.1. An Improved Approach to Measuring WSS Affordability 48 3.2. Community-Led Total Sanitation 59 4.1. A Successful Communications Strategy: The Case of Iran 78 Figures O.1. Estimating the Magnitude of Subsidies: Two Approaches xv 1.1. Categorization of Subsidies 9 B2.1.1. Summary of Tariff Structures Implemented, by Utilities in Various Regions  20 B2.2.1. Life Cycle of a Subsidy Regime 23 2.1. Costs of Water and Sanitation Service Provision 24 2.2. Magnitude of WSS Subsidies, by Region 28 2.3. Estimating the Magnitude of Subsidies: Two Approaches 30 2.4. Politically Motivated Allocation of Capital Grants for Infrastructure in Albania 31 2.5. The Percentage of (a) Water and Sanitation Subsidies and (b) Total Economic Expenditure that Accrue to Population Segments, Organized by Wealth Distribution (Decile), in 10 Countries 33 iv Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 2.6. Routes of Accountability in Service Provision 40 B3.1.1. The Access and Affordability of Service: Four Scenarios 49 4.1. Efficiency Improvements that Help Utilities Reach Financial Viability 73 Tables O.1. Economic and O&M Subsidies of Utilities Around the World xiii 1.1. Dimensions of Subsidies Intended to Expand Access to Water Supply and Sanitation Services 7 1.2. Dimensions of Subsidies Intended to Expand Consumption of Water Supply and Sanitation Services 8 1.3. Transfer Channels 12 2.1. Economic Subsidies and O&M Subsidies among Utilities 19 B2.3.1. Alternative Methods for Estimating Cost-Recovery Tariffs 25 2.2. OPEX and CAPEX Subsidies, by Region (2017 $ and Average % GDP) 27 2.3. Water Consumption Subsidies: Errors of Inclusion and Exclusion in 10 Countries 35 2.4. An Overview of Connection Subsidies 36 3.1. Pros and Cons of Subsidies for Water vs. Sanitation 52 3.2. Pros and Cons of Rural vs. Urban Subsidies 54 3.3. Pros and Cons of Subsidies for Networked/Sewered vs. Nonnetworked/On-Site Services 55 3.4. Pros and Cons of Access vs. Consumption Subsidies 56 3.5. Pros and Cons of Subsidizing Infrastructure on Household Premises vs. Off Premises 57 3.6. Pros and Cons of Supply vs. Demand Subsidies 60 3.7. Pros and Cons of Subsidies for Capital vs. Operating Expenditures 61 4.1. Subsidies and Complementary Policy Mechanisms for Improving Access and Consumption 70 4.2. Characterizing Subsidy Policy Benefits: Basic Framework 76 B.1. Average Unit Asset Base of 15 Chilean Utilities, Categorized by Size of Customer Base 98 B.2. Efficient Ratio of Employees to Customers 100 B.3. Estimated Price Elasticities in Water and Sanitation, by Study and Estimate 102 C.1. Characterizing Subsidy Policy Benefits: Basic Framework 106 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation v Acknowledgments This report was prepared by a World Bank team led Sanitation Specialist, Water GP), Martin Gambrill by Luis Andres (Lead Economist) and comprising (Lead Water Supply and Sanitation Specialist, Water Michael Thibert (Consultant), Camilo Lombana GP), William Kingdom (Lead Water Supply and Cordoba (Senior Water and Sanitation Specialist), Sanitation Specialist, Water GP), Joel Kolker (Lead Alexander V. Danilenko (Senior Water and Sanitation Water Supply and Sanitation Specialist, Water GP), Specialist), George Joseph (Senior Economist), and Jessica Anne Lopez (Operations Officer, Urban, Rural Christian Borja-Vega (Senior Economist), all of the and Social Development GP), Pier Mantovani (Lead Water Global Practice (GP). Water Supply and Sanitation Specialist, Water GP), The report draws on background papers, case Iain Menzies (Senior Water and Sanitation ­ studies, and additional contributions prepared Specialist,  Water GP), Yogita Mumssen (Practice by the following: ­ MacroConsulting (includ- Manager, Water GP), Aude-Sophie Rodella (Senior ing Martin  Rodriguez Pardina, German Sember, Economist, Water GP), Rachel Ort (Public Sector Laura Abramovsky, Julieta Schiro, and Gonzalo Specialist, Governance GP), Steven Schonberger Espiñeira), Juan Pablo Cuesta (Consultant), Juan (Director, Water GP), Pilar Maisterra (Manager, Agustin Echenique (University of Maryland), Strategy, Risk & Country Community), Maria Emmanuel Garcia (Consultant), Rachel Cardone Vagliasindi (Lead Economist, Energy GP), and (Consultant), Rebecca Gilsdorf, (Water and Miguel Vargas-Ramirez (Senior Water Supply and Sanitation Specialist, Water GP), Julio Gonzalez Sanitation Specialist, Water GP). The team also (Consultant), Jonathan Grabinsky Zabludovsky received helpful advice from external reviewers: (Consultant), Martin Hall (Communications Clarissa Brocklehurst (Water and Sanitation Officer, Water GP), David Martimortz (Toulouse Specialist), David Fuente (University of South School of Economics), Massimo Mastruzzi (Senior Carolina), Doreen Mbalo (GIZ), Tanvi Nagpal (Johns Governance Specialist, Governance GP), Gabriela Hopkins University), Regina Rossmann (GIZ), Lesley Mundaca (Consultant),  Shomikho Raha (Senior Pories (Water.org), and Sophie Tremolet (The Nature Public Sector Specialist, Governance GP), Kirstin Conservancy). Alona Daniuk and Isabel Junior pro- Conti (Young Professional, Governance GP), Suneira vided excellent administrative support, and Fayre Rana (Consultant), Johan Kruger (Consultant), and Makeig, superb editorial support. Stephane Straub (Toulouse School of Economics). The report has benefited greatly from the strate- Incisive and helpful advice and comments were gic guidance and general direction of the manage- received from Rajesh K. Advani (Senior Infrastructure ment of the Water GP including Guang Chen Specialist, Social, Urban, Rural and Resilience GP), (former Senior Director), Jennifer Sara (Global Alexander Bakalian (Lead Water Supply and Director), Richard Damania (Senior Economic Doing More with Less: Smarter Subsidies for Water Supply and Sanitation vii Advisor), Maria Angelica Sotomayor (Practice Mastruzzi (Senior Governance Specialist, Governance Manager), and Marianne Fay (Chief Economist, GP), and Stephane Straub (Toulouse School of Sustainable Development Practice Group). Economics). Peer reviewers were Marianne Fay (Chief Economist, This work was made possible by the financial con- GGSCE), Richard Damania (Senior Economic Advisor tribution of the Global Water Security & Sanitation and Global Lead of the Water, Poverty, and the Economy Partnership (GWSP), http://www.worldbank​ .org/en​ Global Solution Group, Water GP), Bill Kingdom (Lead / p r o g r a m s /g l o b a l -w at e r - s e c u r it y- s a n it at i o n​ Water and Sanitation Specialist, Water GP), Massimo -partnership. viii Doing More with Less: Smarter Subsidies for Water Supply and Sanitation Doing More with Less Water touches every aspect of development and flows through nearly every SDG. Solving many of the largest development challenges requires extending reliable access to safely managed Smarter Subsidies for drinking water services to 2.2 billion people, and safely managed Water Supply and Sanitation sanitation services to 4.2 billion. Most existing water supply and sanitation subsidies are: Pervasive Expensive Poorly Targeted Nontransparent Distortionary Common Governments An average of 56% Facilitate Contribute to across countries, spend around $320 of subsidies are rentseeking by inefficiency, threaten irrespective of region billion per year captured by the governments and service sustainability, or income level (up to 2.40% of wealthiest 20% of the service providers and encourage regional GDP) population, while a overexploitation mere 6% are captured of resources by the poorest 20%* Yet if well designed, subsidies can be powerful and progressive tools ensuring that all people benefit from water supply and sanitation services. Smart Targeted The majority of subsidies go to Measures to make water supply A communications strategy is essential water, urban, and networked and sanitation affordable for to build advance backing and for services. A better balance across those in need can ensure that successful implementation. water and sanitation, rural and no one gets left behind. Understanding the institutions, urban, and different types of Effective targeting is incentives, and interests that shape service can make subsidies increasingly possible through subsidy reform is vital to cultivating work harder. technological innovation. supportive political coalitions. Subsidies can encourage better When a subsidy is temporary, an appro- operational efficiency through priate exit strategy must include some performance incentives. form of support for the most vulnerable. A single instrument is unlikely Complementary policy measures can to attain all policy goals make scarce public resources go further. simultaneously. * Percentages from an analysis of 10 developing countries. Overview In 2010, the United Nations (UN) declared clean drink- and sanitation. And, most often, the poorest com- ing water and sanitation to be human rights. At the munities are located in regions and countries with time, the UN’s Millennium Development Goals limited capacity for public spending. Given that most focused on halving the number of people living with- subsidies are expensive, poorly targeted, nontrans- out access to improved water and sanitation services parent, and distortionary, it is urgent that policy by 2015. Then, in the fall of 2015, the UN adopted the makers reconsider how current spending is working, Sustainable Development Goals (SDGs). These raised and carefully target available resources to achieve the global ambition by aiming to “achieve universal the greatest impact. and equitable access to safe and affordable drinking In this report, we explore the question of how scarce water” and to “achieve access to adequate and equi- public resources can be used most effectively to achieve table sanitation and hygiene for all” by 2030. 1 universal delivery of WSS services. To inform our dis- As of 2015, about 29 percent of the world’s popula- cussion, we analyze subsidies in the sector, includ- tion was without safely managed drinking water, and ing their magnitude, their efficacy in achieving their about 61 percent without access to a safely managed policy objectives, and the implications of poor sanitation service (WHO and UNICEF 2017). The World design. We then provide guidance to policy makers Bank estimates that to realize the SDGs by extending on how subsidies can be better designed to improve safely managed services to these people would cost their efficacy and efficiency in attaining their objec- –30 (Hutton $114 billion a year over the period 2015­ tives. Finally, we discuss how to design a subsidy and Varughese 2016). 2 reform package that will have the best chances of The water supply and sanitation (WSS) sector remains success. heavily subsidized around the world, as it has been for decades.3 Despite the prevalence of subsidies and the What Are Subsidies? critical role that effective pricing plays in providers’ Subsidies are a subset of funding flows between gov- ability to deliver high-quality services, scant atten- ernments, service providers, and customers. Subsidies tion has been paid to how current WSS pricing struc- occur when a user/customer pays less for a product or tures and subsidies impede progress toward the service than the service provider’s cost, leaving a third SDGs. Although most subsidies are intended to party (e.g., government, other users, future genera- ensure that WSS services are affordable to the poor, tions) responsible for covering the difference. they often end up benefiting relatively well-to-do Subsidies may take the form of explicit financial households already connected to networked WSS transfers between two entities (e.g., a utility and a services. The poorest of the poor, who generally customer) or implicit transfers—such as nonpayment lack access to networked services, are left without for electricity or deferred maintenance—which occur their basic human rights to clean drinking water when products, services, or inputs are underpriced. Governments subsidize WSS services for a variety of directly to the user, who then uses it to pay the ser- reasons. Two may be highlighted as the most common: vice provider. • In the case of a supply-side subsidy, funds are chan- • Advancing equitable access to affordable WSS neled through the service provider or another ­services. Subsidies may be considered desirable if third party, which, in theory, passes the funds on they help poor or marginalized segments of a pop- to the consumer in the form of lower prices. ulation attain access to affordable WSS services. They may be used to facilitate access or Key Messages consumption. Based on an analysis of subsidies around the world, • Harnessing positive externalities associated with this report puts forward three key messages. First, WSS services. The widely documented societal current WSS subsidies fail to achieve their objectives benefits of WSS services include positive environ- due to poor design; they tend to be pervasive, expen- mental effects and improvements in people’s sive, poorly targeted, nontransparent, and distor- health—in particular, a reduction in infant mortal- tionary. Second, this poor performance can be ity—and an associated reduction in health-care avoided; new knowledge and technologies are mak- expenses. ing it increasingly possible for subsidies to cost less To frame our discussion, we have categorized WSS and help more. By moving beyond the design flaws subsidies using several criteria. First, we consider of the past, subsidies are a viable means of ensuring whether subsidies seek to expand access (e.g., by access to sustainable and safely managed WSS ser- covering connection charges, initial costs, specific vices for all. Finally, to successfully reform subsidies, assets, etc.) or ensure that a minimum level of con- a subsidy reform package, in addition to improved sumption is affordable. We then consider the subsidy design, is required. An effective subsidy intended beneficiaries and, if these involve a distinct reform package includes complementary policy subset of the population or customer base (e.g., poor measures, the building of a supportive political coali- households), the targeting mechanism used. tion, a communications strategy, and an exit strategy Depending on who ultimately pays for the subsidy— (where applicable). taxpayers, philanthropic organizations, or a particular group of present and/or future users—the mechanism of Message 1: Current WSS Subsidies Fail to Achieve Their Objectives Due to Poor Design; the transfer between payer and recipient may vary. To a They Tend to Be Pervasive, Expensive, Poorly large extent, the choice of funding mechanism will be Targeted, Nontransparent, and Distortionary. influenced by the type of service involved, and the While subsidies of WSS service provision are gen- technological and institutional setup of the sector. erally implemented in pursuit of worthwhile Here, we consider two basic funding mechanisms: objectives, poor design often undermines these • A demand-side subsidy involves a direct transfer objectives, rendering subsidies pervasive, expen- from the fund provider to the subsidized user. sive, poorly targeted, nontransparent, and distor- Generally, the government transfers money chapter  2, we present evidence on the tionary. In ­ xii Doing More with Less: Smarter Subsidies for Water Supply and Sanitation current state of subsidies within the WSS sector and subsidies or even to alter their design. And so, in discuss particular design elements that most often many cases, the level—and longevity—of a subsidy prove problematic. may be influenced by politicians’ unwillingness to charge consumers for the services they enjoy or to Subsidies Are Pervasive disrupt the status quo. Subsidies are prevalent across countries, irrespective The characteristics of networked WSS services make of region or income level. Table O.1 shows the preva- setting cost-reflective pricing difficult and allow utilities lence of economic subsidies4 and operation and to neglect asset maintenance, which in most cases they maintenance (O&M) subsidies among the utilities can do without affecting short-term service delivery. This included in the World Bank’s International leads to significant subsidization, which must be Benchmarking Network for Water and Sanitation funded down the road to avoid service disruptions. Utilities (IBNET) database. Only 14 percent of the Declining marginal costs due to large fixed costs make utilities listed in the IBNET database generate efficient pricing using marginal costs difficult, and such enough revenue to cover the total economic costs of pricing would not allow for full cost recovery anyway service provision, while only 35 percent of the utili- (since the marginal cost of service provision is lower ties are able to cover, at a minimum, the O&M costs than the average cost). Networked services’ high pro- of service provision. portion of shared costs gives their providers a large Such pervasiveness is due not only to the necessity of degree of discretion in setting pricing structures, which clean drinking water and adequate sanitation for health is often exploited to advance political agendas. Around and well-being, but also to the nature of networked 65 percent of the cost of supplying piped water, and WSS services. The construction of new infrastruc- 80 percent of the cost of sewerage systems, is for long- ture, the expansion or improvement of service to lived capital assets (which are likely to last 20–40 years households, and the reduction of tariffs are highly in the case of water, and 40–60 years for sewerage) visible to citizens. In many cases, public officials use (Komives et al. 2005). This means that in the short to subsidies to manage political support. Even where medium term, utilities may be able to function with a subsidies do not reach their intended beneficiaries, pricing structure that does not cover the full costs of they often become entrenched owing to the interests capital and neglects the maintenance of assets—a com- of the stakeholders who do benefit from them. mon occurrence in political environments where Reformers may find it difficult to reduce existing subsidies take the place of full cost recovery. ­ TABLE O.1. Economic and O&M Subsidies of Utilities Around the World Number of utilities % Number of utilities % No economic subsidy 220 14 No O&M subsidy 544 35 Economic subsidy 1,329 86 O&M subsidy 1,005 65 Total 1,549 100 Total 1,549 100 Source: Authors’ calculations based on IBNET data, which cover utilities in 147 countries. Note: IBNET = International Benchmarking Network for Water and Sanitation Utilities; O&M = operation and maintenance. Doing More with Less: Smarter Subsidies for Water Supply and Sanitation xiii Subsidies Are Expensive While our estimates of subsidies for operating expen- Since subsidies are the difference between the cost of diture are relatively straightforward—they predomi- service provision and the amount paid by users, defin- nantly represent explicit expenditures required to ing and estimating the costs of WSS services is funda- sustain service provision at current levels of efficiency mental to any analysis. When computing the costs of and quality—our estimates of subsidies for capital service, total economic costs (and, eventually, ineffi- expenditure (CAPEX) require additional nuance. ciencies, or slack) should be taken into account. Because of a lack of data on most countries’ direct These include operation and maintenance costs, expenditure on networked WSS services, our model depreciation, taxes, a fair and reasonable return on instead estimates the CAPEX required for the capital, and environmental costs. replacement of existing infrastructure. However, The cost of subsidies associated with the operations, there have been several recent attempts to extrapo- maintenance, and major repair and replacement of late direct expenditure from countries with more existing WSS infrastructure in much of the world comprehensive and transparent expenditure data to (excluding, notably, China and India) is an estimated regional, and even global, levels of expenditure. $289–$353 billion per year, or 0.46–0.56 percent of Prior estimations of global and regional direct CAPEX these countries’ combined gross domestic product for WSS services in low- and middle-income countries, (GDP).5 This figure rises, shockingly, up to 1.59–1.95 making use of data available from a limited number of percent if only low- and middle-income economies countries, are between 0.4 and 0.5 percent of GDP. are considered, an amount largely due to the capital When combined with our model estimates for OPEX, subsidies captured in our estimation. Subsidies of the use of the limited direct CAPEX data available operating costs account for approximately 22 percent results in total networked water and sewered sanita- of the total subsidy amount both in the full sample tion subsidies in low- and middle-income countries and for low-income economies separately. At $101– in the range of 0.75–0.95 percent of GDP. While these $124 billion per year, the region of Latin America and estimates are below our estimate of 1.59–1.95 percent the Caribbean has the largest amount of subsidies of GDP (also for low- and middle-income countries), (including both operating and capital subsidies), in such discrepancy is not unexpected given key differ- absolute terms and as a percentage of GDP. Annual ences between the two approaches followed. subsidy amounts by region range from 0.05 percent First, the use of direct expenditure significantly to 2.40 percent of GDP, and low-income economies underestimates the CAPEX subsidies provided to the are generally at the high end of this range. It is sector for existing infrastructure due to the deferral of important to note that our estimation does not maintenance—a phenomenon especially common in include either capital expenditure for infrastructure low- and middle-income countries. Second, while our expansion—which tends to be fully subsidized—or model accounts for the full costs of required major environmental costs. Therefore, the actual global repairs and replacement of existing infrastructure, it magnitude of networked water and sanitation subsi- does not account for expenditures toward infrastruc- dies is much greater than our estimation.6 ture expansion. In a steady-state situation whereby xiv Doing More with Less: Smarter Subsidies for Water Supply and Sanitation infrastructure expansion is limited, both estimates rarely achieve this goal, but instead tend to dispro- should be reasonably similar since actual direct portionately benefit the wealthy. Across the countries CAPEX would be exclusively—and comprehensively— we analyzed, consumption subsidies are regressive, covering the maintenance and replacement of exist- with the wealthiest households capturing the lion’s ing infrastructure. The two key differences between share. In fact, each decile of household income cap- these two approaches to subsidy estimation are tures a larger share of the total subsidy amount than depicted in figure O.1. the poorer decile below it. An analysis of how well subsidies target their Most Subsidies Are Poorly Targeted intended beneficiaries in 10 countries suggests that In the 10 countries we analyzed, an average of poor performance does not arise primarily from sub- percent of subsidies reach the wealthiest quintile of 56 ­ sidy design, but from two factors related to access. the population, while a mere 6 percent reach the poor- First, most WSS subsidies focus on networked est quintile.7 Subsidies designed to ensure a minimum services, even though the poorest communities ­ level of water consumption among poor households are typically in areas not serviced by networks. FIGURE O.1. Estimating the Magnitude of Subsidies: Two Approaches Actual subsidy of key cost Full model Hybrid direct expenditure/ components approach model approach Infrastructure expansion CAPEX from direct expenditure extrapolation CAPEX Infrastructure CAPEX from replacement model OPEX OPEX and OPEX and ine ciencies ine ciencies from model from model Ine ciencies Source: Authors’ compilation. Note: CAPEX = capital expenditure; OPEX = operating expenditure. The full model approach estimates CAPEX, OPEX, and inefficiencies using our model, which complements utility-specific data with estimates of the long-term incremental costs of efficient model utilities. The hybrid direct expenditure/ model approach, meanwhile, substitutes direct expenditure data in the place of the CAPEX model estimates, while maintaining the model’s estimates for OPEX and inefficiencies. Doing More with Less: Smarter Subsidies for Water Supply and Sanitation xv Second, even where poor households could connect overcome. This so-called informational asymmetry to a network, many do not do so because they cannot gives the utility a bargaining advantage that can lead afford the connection and/or consumption charges. to inadequate and inefficient services, inflated costs, The result is that many rich households are included or both. in the subsidy recipient pool, while even more poor Information asymmetries also exist in contexts households are excluded. This issue is particularly where several levels of government oversee the WSS pronounced in the five African countries analyzed, sector, as is common in most countries. For example, where errors of inclusion and exclusion fall between local needs are difficult for central authorities to 90 and 100 percent (with Nigeria’s error of inclusion observe and estimate, and this may result in subopti- being somewhat lower).8 mal levels of investment. Also, administrative com- plexity can provide cover for rent-seeking. For Most Subsidies Are Not Transparent example, central authorities may deliberately foster Many common approaches to subsidizing the WSS sec- opacity in intergovernmental allocations and the tor lack transparency; this allows some service provid- timing of transfers, in some cases influenced by ers to misuse scarce public resources, failing to benefit patronage politics at the local level. customers through improved service quality and/or reduced costs. A particularly opaque method of sub- Most Subsidies Are Distortionary sidization is general financial support to the service Poorly designed subsidies contribute to inefficiency, provider (through transfers to cover operational and may even threaten the sustainability of service. expenditures, direct funding of capital assets, tax Utilities may find themselves trapped in a vicious exemptions, subsidized prices for inputs, loan guar- circle whereby low prices lead to revenue losses and antees, and so on). Ideally, a government entity pro- required maintenance is postponed, leading to vides a subsidy with the intention that the service mounting losses. The maintenance needs of under- provider will pass it on to consumers in the form of ground piped networks in particular are difficult to improved services at lower costs. But since the ser- observe and monitor, and underinvestment in their vice provider is responsible for allocating the sub- maintenance is common. Inadequate maintenance sidy, much of the financial support may be captured shortens the life span of assets, reduces service qual- by the provider’s management and employees ity and coverage, and contributes to financial losses. instead of going toward the maintenance required to Subsidized tariffs do not reflect the true cost of a ser- sustain or improve the level of service. The custom- vice and therefore cannot provide signals that might ers, meanwhile, may scarcely benefit from the sub- encourage efficient production or consumption. By sidy, whether in the form of improved service quality affecting prices, subsidies distort economic agents’ or reduced costs, and may even observe a deteriora- choices. On the supply side, subsidies may discour- tion in service quality as maintenance is neglected. age utilities from increasing their efficiency by And since a utility possesses more information about improving collection rates and billing accuracy, for its cost structure and level of efficiency than any reg- example, or by reducing water losses. With a signifi- ulator, the lack of transparency is difficult to cant amount of funding coming from government xvi Doing More with Less: Smarter Subsidies for Water Supply and Sanitation transfers, utilities are less likely to hold themselves discuss the myriad factors and policy options that accountable to consumers, reducing their incentives should be considered along the way, therefore pro- to improve service quality. On the demand side, sub- viding a roadmap for policy makers to follow in sidized prices may discourage consumers from assessing their particular context and determining seeking more efficient providers or encourage over- ­ the most effective and efficient subsidy design. consumption in a context where cost-reflective What Is the Context? prices would encourage conservation. Policy makers should first seek to understand how Message 2: The Current Poor Performance of effective and efficient existing subsidies are at attain- WSS Subsidies Can Be Avoided; New Knowledge ing their underlying goals to make informed decisions and Technologies Are Making it Increasingly on how they should be reformed. In particular, they Possible for Subsidies to Cost Less and Do More. need to understand the magnitude of public Although current WSS subsidies tend to be perva- resources being expended, the ultimate beneficiaries sive, expensive, nontransparent, distortionary, and of those resources, the public’s perception of the poorly targeted, such poor outcomes are not a given. subsidy and any opportunities for misappropriation, Well-designed subsidies are indeed an important and the subsidy’s adverse impacts on sector perfor- and necessary policy instrument for decision mak- mance and resource allocation. Using this informa- ers, who can use them to effectively and efficiently tion, policy makers can then improve subsidy design attain their objectives and avoid the adverse impacts to avoid existing pitfalls. of the past. In chapter 3, we provide guidance to pol- Subsequently, a political economy lens should be used icy makers on improving the efficacy and efficiency to assess the sector’s institutional and financial structure, of WSS subsidies. the reasons behind an unsatisfactory status quo (where Improving the efficacy and efficiency of subsidies applicable), and opportunities to improve and propel requires careful consideration of five key questions: subsidy reform. Efforts to reform subsidies have had 1. What is the context? widely varied results across countries, with successes 2. What are the policy objectives that the subsidy seeks often predicated on reformers’ ability to understand to achieve? and strategically overcome political barriers. An assess- ment of (i) the WSS sector’s institutional structure and 3. What are the target service(s) and/or population(s)? (ii) how subsidies are currently organized allows for a 4. How will the subsidy be funded? better understanding of the prospects for reform. 5. What subsidy design will be most effective and Where a subsidy is failing to achieve its intended objec- efficient? tives, a political economy analysis can determine the Since socioeconomic factors, WSS service delivery key institutional and policy-related bottlenecks that modalities, levels of institutional capacity, and fiscal explain its poor performance. Finally, attention can be space vary substantially from context to context, we turned to the future: identifying opportunities for do not seek to provide explicit recommendations on reform and developing strategies to overcome institu- what should be subsidized and how. Instead, we tional and policy-related bottlenecks. Doing More with Less: Smarter Subsidies for Water Supply and Sanitation xvii Finally, an up-front understanding of affordability target population or service will differ depending barriers to WSS service provision is imperative to the upon which objective is selected. Subsidies to subsidy design process. The number of households advance equitable access to affordable WSS ser- that cannot afford to access WSS services, their rela- vices seek to either reduce the cost of service to tive socioeconomic characteristics and geographic end users (i.e., ensure a minimum level of con- locations, and the gap between what each household sumption) or expand service areas to unserved can reasonably be expected to pay and the total cost populations (i.e., expand access). Meanwhile, the of service, in addition to any liquidity barriers, are all pursuit of positive externalities will lead to the pri- crucial data needed to answer four key questions: oritization of densely populated areas and sanita- tion services that have increased potential to 1. Is a subsidy required to advance equitable access to positively impact the environment and/or improve affordable WSS services? public health. 2. What service and/or population should be targeted? What Are the Targeted Service(s) and/or 3. What is the magnitude of the subsidy required? (The Population(s)? answer will help decide available funding options.) Upon selecting a policy objective, policy makers must 4. Which subsidy design options would be most effec- decide which service(s) and/or population(s) will be tive and efficient? targeted. As with policies in general, there is no one- A comprehensive analysis of affordability provides size-fits-all solution to the problems of inadequate the policy maker with important insights into which access to or consumption of WSS services: the most populations require support, and whether one-time suitable policy will depend on the specific goals to be access costs or recurrent consumption charges pose attained, the context in which it is to be imple- the greatest challenge to affordability. mented, and the resource constraints of the govern- ment and stakeholders. What Are the Policy Objectives? Any decision to subsidize a particular service, popu- The specific policy objectives that a prospective sub- lation, or cost in the WSS sector entails inherent trade- sidy seeks to attain largely dictate its design. As dis- offs that affect the efficient attainment of the chosen cussed above, the most common policy objectives objectives. Although subsidies with a policy objec- that WSS subsidies seek to attain are: tive to advance equitable access to affordable WSS • Advancing equitable access to affordable WSS services will, by definition, seek to benefit the poor services and marginalized, the decision to target, for exam- ple, a particular service (e.g., networked) or geo- • Harnessing positive externalities associated with graphic areas (e.g., urban) will establish the eligibility WSS services of particular segments of the population, even before A single policy instrument—no matter how inge- any selection of a targeting mechanism. In this niously designed—is unlikely to meet all policy objec- report, we provide an overview of trade-offs associ- tives simultaneously. In most cases, a subsidy’s ated with subsidizing: (i) water vs. sanitation, xviii Doing More with Less: Smarter Subsidies for Water Supply and Sanitation (ii) urban vs. rural areas, (iii) networked/sewered vs. cross-subsidizers. The difficulty in conducting this nonnetworked/on-site services, (iv) infrastructure estimation introduces the risk that the subsidy on household premises vs. off, (v) supply vs. demand, amount may exceed the revenue collected from the (vi) capital vs. operating expenses, and (vii) access cross-subsidizers, thus entailing a deficit. vs. consumption. Though these trade-offs are neatly What Design Will Be most Effective in the categorized to aid the process of analysis, it should Context? be noted that there is considerable overlap among After selecting the policy objective, the target ser- them, and their relevance will depend on the speci- vice(s) and/or population(s), and the means of funding, ficities of the case at hand. policy makers can turn their attention to the design of How Will the Subsidy Be Funded? the subsidy itself. As they do so, it is important to WSS subsidies can be funded by either taxpayers keep in mind the characteristics of well-designed (through government) or philanthropic funds, or subsidies: they should be well targeted, transparent, through cross-subsidization by charging other present and nondistortionary. and/or future users more than the cost of service Our goal is not to present a comprehensive catalogue (which can include users of an unrelated service subsi- of subsidy design options. Instead, we highlight three dizing users of WSS services). The choice of funding key strategies that have been proven, when well will largely be driven by the government’s fiscal designed and implemented, to improve the efficacy space, opportunities for philanthropic funding or and efficiency of subsidies: (i) the use of alternative concessional financing, and the potential for approaches to improve targeting, (ii) making subsi- cross-subsidization across users. dies conditional on performance, and (iii) decoupling Each type of funding source (government, other subsidies from service charges. users, or third parties) carries its own risks. Common methods of targeting WSS subsidies have Governments may fail to deliver the promised generally been ineffective at directing scarce public resources. This risk is borne by the customer in the resources toward their intended beneficiaries—the case of demand-side subsidies, or by the utility in the poor. Yet there are three main approaches that may case of supplier-side subsidies. Also, in many cases, be used to better target WSS subsidies to the poor. subsidies are part of the national budget and there- First, policy makers can subsidize poor households’ fore must be approved on an annual basis, implying connection/access to WSS services in contexts where a continuity risk for the funding of long-lived sunk connection rates are low, where the poor in particu- assets. When the subsidy is financed by underpricing lar lack WSS household connections, and where suf- an input generated by other sectors, this risk is also ficient infrastructure exists to service their present, since the subsidy depends on a government neighborhoods. Second, they can better identify policy that can be changed or reversed. In the case of poor households requiring consumption subsidies cross-subsidies, cost recovery requires an estimation through administrative selection, either using of user charges across the customer base to ensure a means-testing or readily observable factors strongly proper balance between subsidy recipients and correlated with poverty (e.g., location). Third, they Doing More with Less: Smarter Subsidies for Water Supply and Sanitation xix can provide a range of types of WSS services that are gaps. Furthermore, by decoupling subsidies from the most likely to reach everyone. The appropriate pol- service itself, the targeting of WSS subsidies is icy mix of these three pro-poor instruments will improved in contexts where a significant proportion depend on local conditions. We should stress that of poor households lack access, since poor house- although some improved targeting mechanisms may holds that either live outside the provider’s service entail additional administrative costs, these can be area or are unable to connect can now benefit from significantly reduced through the use of innovative the subsidy. technology or cost sharing with other government Message 3: To Successfully Reform Subsidies, programs. a Subsidy Reform Package of Four The conditioning of subsidies on well-crafted perfor- Complementary Elements (in Addition to mance targets that are tangible, transparent, verifi- Improved Subsidy Design) Is Required. able, and under the service provider’s control can avoid Subsidies do not function in isolation: any well-­ inefficiencies associated with traditional supply-side designed subsidy requires a number of additional subsides. Performance- and results-based contracts elements to facilitate its acceptance and improve its can be used in both public-public or public-private efficacy in both advancing equitable access to afford- contracts to improve performance by linking subsi- able WSS services and harnessing positive externali- dies not to individual expenditures, but rather to the ties. In chapter 4, we provide guidance to policy timely and quality delivery of verifiable outputs or makers on each of the four crucial elements of an results (Mumssen et al. 2018). Key performance indi- effective subsidy reform package: complementary cators, developed by the government or regulator, policy mechanisms, the building of supportive polit- may include standards for service continuity and ical coalitions, a communications strategy, and an water pressure; nonrevenue water reduction; meter exit strategy (where applicable). installation or service repair schedules; the volume of waste treated or reused; or for addressing con- Complementary Policy Mechanisms sumer complaints. Various policy mechanisms may be used to comple- The decoupling of subsidies from WSS access and ment subsidies, with the aim of improving WSS ser- consumption charges through the provision of cash vices’ access and affordability for the poorest segments transfers, whether conditional or unconditional, has of the population. As noted in the World Bank’s Utility the potential to improve the efficiency, transparency, Turnaround Framework, any sector turnaround and targeting of WSS subsidies. By avoiding the use of should begin with making service providers’ current the service provider as an intermediary, cash trans- operations and capital investments more efficient fers avoid the distortionary impacts on service pro- (Soppe, Janson, and Piantini 2018), therefore reduc- viders previously discussed. The service provider ing the amount of subsidy required. A number of remains accountable to meeting the needs of the additional mechanisms can be used to reduce customer, since it cannot depend upon direct trans- the amount of subsidy required to advance poor fers from the government to make up any funding households’ access to affordable WSS services. xx Doing More with Less: Smarter Subsidies for Water Supply and Sanitation For example, the costs of providing services may be understands the rationale for reform. By assessing reduced by involving community members in con- risks and opportunities early, informing the public in struction and management processes. Innovative accessible and engaging ways, and helping people technologies and approaches can support service understand the benefits of subsidy reform and how providers in more effectively targeting subsidies to these link to their own lives, policy makers can the poor and in overcoming financial, legal, or encourage public understanding—and, ultimately, administrative barriers to access. In some cases goodwill. where large benefits to particular user groups have become entrenched, the use of social safety nets may An Exit Strategy (Where Needed) be required to ease the burden of lost benefits as sub- An exit strategy is an important component of a sub- sidies are reformed. sidy reform package when the relevant subsidy is intended to be short term. When proposing a new Political Coalitions to Support Reform subsidy, policy makers should consider whether the To design feasible reforms and implementation plans, it conditions demanding the subsidy are permanent or is crucial to develop a strategy to both foster supportive likely to dissipate in the near future. If the conditions political coalitions and mitigate the impact of oppo- are temporary in nature, policy makers should nents. Broad and diffused interests tend not to be well develop a credible commitment mechanism that organized, whereas concentrated interest groups can helps the government exit when the time is right. mobilize more readily and effectively to advance A  reform likely to adversely impact the poor or an their narrower causes. It is therefore important for otherwise politically salient group might be designed policy makers to understand how interest groups in such a way that subsidies are removed gradually, might support or oppose government efforts toward in phases, over time. Some of the reform’s phases subsidy reform. This will depend on the level of 9 might include additional elements such as comple- organization and political power of the groups con- mentary sector or legal reforms, policies to tempo- cerned, as well as the ability of reformers to choose rarily compensate users for the loss of benefits, and political allies and to weaken or even win over the communication strategies, among others. The choice political influence of groups that could potentially and timing of these elements should be politically block a proposed reform’s implementation. informed. A Communications Strategy The SDGs for water supply and sanitation set out a Communication is a necessary investment that should transformational vision for the future whose be planned and implemented by professionals before, achievement will require substantial financial during, and after a reform’s implementation. Public resources. Given the scarcity of public resources reactions to subsidy reform programs are highly globally, it is more important than ever to ensure ­ contextual and dynamic. Reforms are successful that those public resources already allocated to the only where an informed and supportive public sector are used efficiently. Well-designed subsidies Doing More with Less: Smarter Subsidies for Water Supply and Sanitation xxi effectively advance the goal of equitable access to 4. The economic subsidy of a utility is calculated as the difference between revenue and the economic cost of service. The economic affordable, sustainable, and quality WSS services, cost of service encompasses all the economic resources deployed for while maximizing the targeting of the poor, promot- service provision, including the cost of not only O&M but also all cap- ital (depreciation plus return on capital), as well as costs imposed by ing transparency, and minimizing distortion. As operational inefficiencies. The methodology used to estimate the the financial sustainability of service providers economic cost of service provision for each utility in the IBNET data- base is discussed in detail in appendix B. improves, these public resources can be leveraged to attract complementary private resources to the 5. China and India were notably excluded due to insufficient data and the fact that their singularity makes estimates based on extrapolation sector. By moving beyond the design flaws of the impossible. past, subsidies are a viable means of ensuring access 6. As discussed in chapter 2, box 2.4, we estimate (using analysis by to sustainable and safely managed water supply and Fay et al. 2019) that global capital expenditure on WSS infrastruc- ture investment is approximately 0.4 percent of global GDP per year. sanitation services for all. This figure includes capital expenditure for infrastructure expan- sion—not included in our estimation—and some fraction of expendi- ture on infrastructure replacement—which our model captures in Notes full. Therefore, an estimate of the full magnitude of global subsidies in the sector would require adjusting our estimate upward by some 1. The SDGs focus on improving access to “safely managed” water and undetermined portion of this 0.4 percent of global GDP. sanitation services. To fit this definition, improved water services must be accessible on household premises, available as needed, and 7. Building on the methods of Komives et al. (2005) and Angel-Urdinola free of contamination. In the case of sanitation services, this would and Wodon (2011), we provide new estimates of the performance of imply that toilets separate their users from fecal content, which is piped-water consumption subsidies in terms of pro-poor targeting then disposed of in such a way as to avoid the contamination of soil or across 10 countries: Ethiopia, Mali, Niger, Nigeria, Uganda, El water resources. Salvador, Jamaica, Panama, Bangladesh, and Vietnam. 2. This estimate represents the capital expenditure required for infra- 8. Error of inclusion is measured by the percentage of all beneficiary structure expansion, and does not include the capital and operational households that are rich; error of exclusion is measured by the per- expenditures required to sustain existing services over that time centage of poor households that do not get a subsidy. Poor house- period. holds are defined as belonging to the first four deciles of the expenditure (or income) distribution in each country. 3. Although hygiene is a crucial component of what is often referred to as the water supply, sanitation, and hygiene (WASH) sector, our paper 9. Note that not all interest groups will be politically organized. focuses on subsidies supporting the delivery of services, and thus on Moreover, within governments themselves, officials may hold con- water and sanitation, to the exclusion of hygiene. flicting positions regarding subsidy policy. xxii Doing More with Less: Smarter Subsidies for Water Supply and Sanitation Abbreviations CAPEX capital expenditure CLTS community-led total sanitation GDP gross domestic product GLAAS Global Analysis and Assessment of Sanitation and Water IBNET International Benchmarking Network for Water and Sanitation Utilities IBT increasing block tariff O&M operation and maintenance OPEX operating expenditure SDG Sustainable Development Goal UN United Nations WHO World Health Organization WSS water supply and sanitation Doing More with Less: Smarter Subsidies for Water Supply and Sanitation xxiii CHAPTER 1 Setting the Stage The United Nations’ Sustainable Development Goals (SDGs) for 2030 represent a major shift in global ambitions for the quality and coverage of water supply and sanitation (WSS)1 services. Almost two decades ago, the United Nations’ Millennium Development Goals focused on halving the number of people liv- ing without access to improved WSS services by 2015.2 Today, the SDGs envi- sion all the world’s people as having equitable access to safely managed water and sanitation services,3 a more stringent technical standard, by the year 2030. In 2016 the World Bank estimated that it would cost the world’s nations approx- imately $100 billion a year in the period 2015­ –30 to attain this (Hutton and Varughese 2016). However high this estimate might sound, it does not even include the maintenance, repair, and replacement of existing infrastructure stock, or investment in climate-resilient infrastructure. These capital demands, coupled with sobering statistics on global rates of access to WSS services, underline a key fact: Securing the basic human rights of access to clean drink- ing water and sanitation depends on the effective and efficient use of scarce financial resources. The effective pricing of WSS service provision, a prerequisite for its sustainability, would serve to promote efficient water use among customers, generate sufficient revenue to maintain and replace existing infrastructure stock, and ensure access to the capital needed to expand services to underserved populations. Yet in spite of these benefits, the process by which high-income countries have achieved high levels of access to water and sanitation clearly demonstrates that domes- tic public finance, including targeted subsidies, has been and remains criti- market-led cally important to achieving universal coverage, even in strongly ­ economies (Fonseca and Pories 2017). Thus, funding the efforts needed to ­ attain the SDGs will likely involve a combination of user fees and public sub- sidies. The scarcity of public resources in general—and particularly in those regions where poor populations are concentrated—demand that such subsidies be well designed, transparent, and targeted. Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 1 The WSS sector remains heavily subsidized around vendors using taps or kiosks or providers of commu- the world, as it has been for decades. Despite the prev- nal latrines are often supported as acceptable short- alence of subsidies and the critical role that effective term alternatives to networked provision in pricing plays in providers’ ability to deliver high-­ unplanned and densely populated slums. In rural quality WSS services, scant attention has been paid communities, governments and development part- to how current WSS pricing structures and subsidies ners often construct hand pumps and small impede progress toward the SDGs. Although most piped-water schemes with little or no financial con- subsidies are intended to ensure that water and sani- tribution from the communities they serve. Some tation services are affordable to the poor, they often governments have also supported household-level end up benefiting relatively well-to-do households water and sanitation facilities, whether through already connected to networked WSS services. The “hardware” subsidies of latrine or borehole con- poorest of the poor, who generally lack access to net- struction, or “software” subsidies of initiatives seek- worked services, are left without their basic human ing to raise community awareness of the need for rights to clean drinking water and sanitation. And, 4 hygienic practices and facilities. most often, the poorest communities are located in In this report, we explore the question of how scarce regions and countries with limited capacity for pub- public resources can be used most effectively within lic spending. the WSS sector to achieve universal delivery of ser- Given that, as this report will show, most subsidies vices. To inform our discussion, we analyze subsidies are poorly targeted, expensive, nontransparent, and in the sector, including their magnitude, their effi- distortionary, it is urgent that policy makers reconsider cacy in their various objectives, and the implications how current spending is working, and carefully target of poor design. We then provide guidance to policy available resources to achieve the greatest impact. An makers on how subsidies can be better designed to example of the distortive nature of the most perva- improve their efficacy and efficiency in attaining sive networked service subsidies is their potential to their objectives. Finally, we discuss how to design a reduce service quality and performance. Tariffs subsidy reform package that will have the best implemented by water and sanitation service pro- chance of success. viders in most low- and middle-income countries tend to be insufficient to cover their operational, Water Supply and Sanitation Subsidies: 1.1  administrative, and capital management costs, Definition and Rationale including depreciation. In order to cover the result- Before exploring the current WSS subsidy challenge ing financial shortfall, service providers are g ­ enerally and the approaches that policy makers can take to compensated by the appropriate financial authority best move the sector forward, we begin with an over- through an ad hoc subsidy payment and/or neglect view of the economic rationale for subsidies, a classi- regular maintenance and other recurring expenses. fication of subsidies according to their particular When maintenance is neglected, the deterioration of characteristics, and a discussion of various assets is accelerated, causing a further reduction in approaches to funding them. service quality. Although not to the extent of networked WSS ser- What Is a Subsidy? vices, some nonnetworked services are also being sup- Subsidies are a subset of funding flows between gov- ported by government subsidies. For example, water ernments, service providers, and customers. Subsidies 2 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation occur when a user/customer pays less for a product or water or sanitation net- Subsidies occur when a service than the service provider’s cost, leaving a work. In such circum- user/customer pays less third party (e.g., government, other users, future gen- stances, subsidized erations) responsible for covering the difference. connection charges or for a product or service Subsidies may take the form of explicit financial the provision of financ- than the service transfers between two entities (e.g., a utility and a ing at subsidized interest customer) or implicit transfers—such as nonpay- rates may be considered. provider’s cost. ment for electricity or deferred maintenance— In the case of networked which occur when products, services, or inputs are WSS services, subsidies to network providers may sup- underpriced. port the capital expenditure required to expand these services to new customers. The provision of WSS ser- What Is the Economic Rationale for Subsidies? vices, particularly networked services, is character- Governments subsidize WSS services to achieve a vari- ized by strong economies of scale and scope (Tynan ety of policy objectives; the two most common are and Kingdom 2005). Economies of scale refer to the (i)  to advance equitable access to affordable WSS reduction in average costs as a system expands and services, and (ii) to harness the positive externalities ­ incorporates more users, while economies of scope associated with WSS services. 5 refer to the lowered costs of providing water and san- itation services together as compared with providing Advancing Equitable Access to Affordable each service separately. Under these conditions, sub- WSS Services sidizing infrastructure at the provider level, as well as Subsidies may be considered desirable if they help poor the connection charges of new users who would not or marginalized segments of a population attain access otherwise connect, can result in greater operational to affordable WSS services. If poor households are efficiency, leading to lower long-run costs. These less likely than rich households to have access to lower costs, in turn, render services more affordable water or sanitation services, then subsidizing their to all customers. In other words, financial transfers access costs may promote equity. Subsidizing con- from the government may be justified to increase the sumption may, in some circumstances, facilitate the size and coverage of infrastructure to a point where regular use of a minimum quantity of potable water economies of scale can be fully exploited. This ratio- required for drinking, cooking, and hygiene pur- nale, however, presupposes that the service provider poses. Similar arguments for fairness of access can is not losing money for every unit of water sold, which be applied to marginalized or historically excluded is often the case. groups (McCarthy 2019).6 The obligation to ensure the human right to water and sanitation, as declared Harnessing the Positive Externalities by the United Nations, can also serve as justification Associated with WSS Services for subsidies. Positive externalities may arise when the societal On the financial side, households’ lack of access to ­ benefits of increased consumption (or production) credit may offer a rationale for the use of subsidies to exceed the private benefits. If the consumption (or encourage investment in WSS services. Households production) of a good or service involves external- without access to credit may find they cannot afford ities, the resource allocation resulting from a to pay the up-front charges required to connect to a free-market equilibrium will be inefficient from Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 3 a social perspective. Specifically, there will be under- consumes and may choose to intervene by subsidiz- consumption of the good or service. To reach a more ing consumption (Komives et al. 2005). socially optimal consumption level, subsidies of pro- These arguments provide the economic rationale for duction or consumption may be introduced. subsidies to facilitate access to WSS services and their Access to improved WSS services has a strong, posi- adequate consumption, particularly among the poor. tive impact on human capital accumulation. WSS ser- When properly designed to achieve these specific vices underlie and impact all five indicators of the objectives, subsidies of WSS services can be valid World Bank’s Human Capital Index, which quanti- 7 instruments to achieve sectoral and social goals. fies the contribution of health and education to the productivity of the next generation of workers Dominant and Emerging Service 1.2  (Andres et al. 2018). The primary pathways for this Delivery Models contribution include positive environmental impacts The form that subsidies take in a particular country and improvements in health—in particular, a reduc- depends substantially on the particular models of ser- tion in the rates of diarrheal disease and child mor- vice delivery that they seek to support. This is because tality rates—and an associated reduction in each service delivery model presents its own unique health-care expenses (Alsan and Goldin 2019; institutional arrangement, level of state involve- Gamper-Rabindran, Khan, and Timmins 2010; Prüss- ment, cost structure, revenue streams, and degree of Üstün et al. 2008, 2014; Van Bueren and MacDonald competition, among other factors. 2004; World Bank Group 2018b; and Wolf et al. 2018). Service provision models may be categorized by the At the aggregate level, this translates into a lower technology employed and the management structure. incidence of water-related disease. The existence of In the WSS sector, the choice of model is influenced positive externalities implies that consumption by a variety of factors, including environmental and based on cost-reflective tariffs would be below the geographic conditions, political and institutional optimal level (as individual consumers do not inter- realities, population density, technical and financial nalize the positive impact on other potential capacity, and social acceptability. Water supply ser- consumers). vice models can generally be classified into two In addition, water and sanitation can be seen as broad categories: networked and nonnetworked. “merit goods” that would be underprovided—and Similarly, sanitation service models are typically underconsumed—if their supply were left entirely to classified as either sewered or on-site. For our pur- the market. This is because individuals tend to be myo- poses, networked water supply and sewered sanita- pic, often ignoring the long-term benefits of needed tion solutions will be grouped together, given their investments. A subsidy can correct this by inducing a many similarities. higher consumption level. Merit goods are defined as The provision of both networked water and sewered goods for which an individual’s consumption mat- sanitation services involves the use of piped networks. ters to society as a whole, not necessarily because of These are used to either distribute water to consumers any spillover effect on society (as in the case of exter- or collect wastewater from them. Such networks are nalities) but because it is central to the well-being of generally managed by a public or private entity that the individual. As a result, governments take an serves a large and fairly heterogenous group of users. interest in how much of the good each individual These users receive a service (the distribution of 4 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation water and/or the collection of human waste), as well wholly owned by the consumer or a community of as a product (the water itself). Networked distribu- consumers (e.g., community- or household-level tion and collection entail very high capital costs for water points and water schemes, pit latrines, and long-lived, specific assets—costs that need to be septic tanks, among others). Or a one-off payment recovered over the assets’ economic lives. Also, the may be for the one-time provision of a quantity service is provided on a continuous basis and has lit- of water (e.g., via kiosks and standpipes with tle or no substitutes, therefore facilitating the financ- pay-per-use arrangements, tanker deliveries, ing of these capital costs through their incorporation bottled or sachet water, etc.). No further trans- into recurrent user tariffs. actions are expected or required,  and no guar- The provision of nonnetworked water supply and antee of  continued service or functionality is on-site sanitation services may involve a variety of provided. technologies. For water supply, these technologies • Continuous service provision. Nonnetworked water include wells mounted with hand pumps or with and on-site sanitation services classified as contin- motorized pumps connected to standpipes, among uous exhibit a relationship between the service others. Processes involving rainwater harvesting or provider and the customer very similar to that in sand dams may be utilized. And water may be dis- networked water and sewered sanitation service tributed via tankers or sold in bottles or sachets, provision. Users are charged regular consumption among other options.8 In the case of sanitation, fees by a service provider that guarantees the human waste may be collected and possibly treated continued availability of service by asserting ­ on location, generally using either pit latrines or sep- responsibility for all associated maintenance and tic tanks. Small-scale, decentralized off-site collec- repair. For water supply, the technologies involved, tion and treatment solutions may also be applied. generally hand pumps or motorized pumps, are These are often grouped with on-site technologies the same as for many isolated systems. Yet in these since they operate at a similar scale. cases, the users are paying for a continuous supply For analytical purposes, we further divide the provi- of water using assets that they may or may not sion of nonnetworked water supply or on-site sanita- own, as opposed to paying for and managing the tion services into two categories: isolated and assets themselves. Although many communi- continuous. The distinction between these centers on ty-level water projects are intended to be sus- the nature of the relationship between the service tained through these regular consumption fees, provider and the consumers—does it involve dis- the collection of such fees is not very common in tinct, isolated transactions, or is it continuous? The practice. In recent years, several nonprofit and two categories may be summarized as follows: development organizations, such as Whave in • Isolated provision. Instead of regular payments to Uganda, have experimented with preventative a service provider that guarantee the continuous maintenance agreements, whereby communities availability of water supply or sanitation services pay regular fees to a local technician who ensures (as would be the case for networked water or the continuous functionality of a water facility ­sewered sanitation), the consumer makes one-off (Stites, Howe, and Akabwai 2017). More common payments to the provider. These may be for the con- examples include subscription water delivery struction, maintenance, or repair of infrastructure services through, for example, tanker deliveries. ­ Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 5 A regular fee is charged for a particular quantity of subsidies). It is worth mentioning that even untar- water delivered at regular intervals. Similarly, for geted subsidies are necessarily linked to a specific sanitation services, all or part of the sanitation service type. Thus, untargeted connection subsidies service chain may be provided continuously. ­ 9 will reach (all) future yet presently unconnected For  example, the initial investments in latrines/ users, while untargeted consumption subsidies will septic tanks may be isolated, while fecal sludge benefit (all) connected users. management is continuous. Additionally, a grow- Networked Water and Sewered Sanitation ing number of container-based sanitation service Services providers offer regular access to sanitation facili- Access and Consumption Subsidies. The first criterion ties (at home or in public spaces) that are continu- we use to categorize subsidies in the WSS sector is their ously managed in exchange for fees collected on a goal; a subsidy may seek to either (i) expand access or regular basis (either usage fees or monthly service (ii) ensure a minimum level of consumption. In this fees). Continuous service arrangements include way, supply-side subsidies that directly target a ser- those managed by communities, public (govern- vice provider’s expenditures are classified by ment) agencies, and private entities, including, for whether they lower the cost of connection and/or example, under management contracts. consumption for consumers. These expenditures can be divided into two types: capital expenditure 1.3  A Classification of Subsidies (CAPEX) and operating expenditure (OPEX). CAPEX In the previous two sections, we defined subsidies, dis- includes the costs of the acquisition, construction, cussed the most common rationales for their imple- installation, repair, or replacement of a service pro- mentation, and presented the dominant and emerging vider’s fixed assets, while OPEX includes all ongoing models of service delivery in the WSS sector. We will costs of providing service, including administrative now introduce a comprehensive framework for classi- costs such as billing and collections, staffing, and fying common types of WSS subsidies. We first classify customer outreach, as well as regular maintenance subsidies according to their purpose and design, of fixed assets.10 In the case of sanitation, invest- then discuss how they are generally funded, includ- ments in household containment options and sewer ing both the transfer mechanism and funding source. connections are categorized as expanding access To frame our discussion, we have categorized WSS whereas the remainder of the service chain is consid- subsidies using several criteria. First, we consider ered part of consumption. whether subsidies seek to expand access (e.g., by There are important differences between the two covering connection charges, initial access costs, regarding their prospective beneficiaries and fre- specific assets, etc.) or ensure a minimum level of quency of payment. First, the possible recipients are consumption (i.e., the regular use of a certain level of mutually exclusive: while access subsidies benefit service). We then consider the intended beneficia- only unconnected users, consumption subsidies ries, and the targeting mechanism used. These ele- benefit only those with a connection. Second, con- ments are outlined in more detail in tables 1.1 and 1.2. sumption subsidies are paid on a regular basis, while Subsidies are at the intersection of a service and a access subsidies are paid only once,11 hence implying user type (or all users, in the case of untargeted a lower administrative cost. 6 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation TABLE 1.1. Dimensions of Subsidies Intended to Expand Access to Water Supply and Sanitation Services Targeted subsidies Subsidized Subsidized costs Untargeted subsidies Explicit subsidies services Implicit subsidies Self-selection Administrative selection Connection Costs of connecting No connection charge ⇒ all Flat connection Lower connection charge for Lower connection charges based on: to network to existing network new customers charge ⇒ new customers providing labor or • Geographical discrimination ⇒ customers Subsidized interest rate for customers who cost materials ⇒ customers that who live in certain areas financing connections ⇒ more than average to choose to provide labor/materials Networked/sewered and nonnetworked/on-site • Means tests (or social connections) ⇒ all new customers that use connect  Subsidy to cover (part of) households classified as poor finance connection charges for a particular • Other qualifying customer characteristics service level or technical design ⇒ ⇒ customers meeting those characteristics continuous services customers that choose this service (e.g., pensioners or families with children) level or technical design On-premise Costs of adapting Subsidy to cover (part of) Subsidy to cover (part of) Subsidy to cover (part of) adaptation costs adaptation internal system adaptation costs ⇒ all new adaptation costs for customers based on: Doing More with Less: Smarter Subsidies for Water Supply and Sanitation (particularly for connections to the network providing labor or materials ⇒ • Geographical discrimination ⇒ customers sewage) that require adaptation customers that choose to provide who live in certain areas Subsidized interest rate labor/materials • Means tests (or social connections) ⇒ for financing adaptation ⇒ Subsidy to cover (part of) households classified as poor all new connections to the adaptation costs for different • Other qualifying customer characteristics network that use finance for service level or technical design ⇒ ⇒ customers meeting those characteristics required adaptations customers that choose this service (e.g., pensioners or families with children) level or technical design Initial costs Cost of constructing Installation free of charge ⇒ Flat fee for installation Subsidy to cover (part of) the Subsidy to cover (part of) costs based on: individual/communal all new users ⇒ new users whose cost/price of certain services or • Geographical discrimination ⇒ users who Nonnetworked/on-site services water facility (pump Subsidized interest rate for installation costs are a particular service level (e.g., live in certain areas installation, borehole financing new installation ⇒ higher than average only pit latrines or only shared • Means tests ⇒ households classified as excavation, etc.) all new users that choose to pumps) ⇒ poor use finance households that choose this • Other qualifying user characteristics ⇒ service level Cost of constructing users meeting those characteristics (e.g., Subsidy to cover (part of) pensioners, families with children, or those individual sanitation household costs of labor or without a latrine on premises) facility (e.g., latrine) materials ⇒ households that choose to provide labor/materials Source: Authors’ elaboration based on table 2.1 of Komives et al. (2005). Note: The users described after the symbol “⇒” are the intended beneficiaries of the subsidy. 7 TABLE 1.2. Dimensions of Subsidies Intended to Expand Consumption of Water Supply and Sanitation Services 8 Targeted subsidies Subsidized Untargeted Subsidized costs Explicit subsidies Doing More with Less: Smarter Subsidies for Water Supply and Sanitation services subsidies Implicit subsidies Self-selection Administrative selection Unmetered water Water/sewage costs Across-the- Flat fee per connection ⇒ The selection of metered or Reduced prices based on: services and flat for customers with board fee ⇒ all higher-volume consumers with unmetered services (or even • Geographical discrimination ⇒ rate sanitation no individual meter customers unmetered connections nonnetworked services like public customers who live in certain areas fees water taps) ⇒ customers using the • Means tests ⇒ households applicable service classified as poor Lower fees for low-pressure • Other customer characteristics ⇒ Networked/sewered and nonnetworked/on-site water services ⇒ customers with pensioners or families with children connections to low-pressure water services • Burden limit cash transfers ⇒ households whose utility bills and continuous services housing expenditure exceed a defined burden limit Metered water Water/sewage costs Across-the- Low collection rate with no Increasing block tariffs ⇒ low-volume Reduced prices based on: services and for customers with board price ⇒ all disconnection policy ⇒ all consumers with meters • Geographical discrimination ⇒ volume-based individual meters customers customers who do not pay their Volume-differentiated tariffs ⇒ customers who live in certain areas sanitation fees bills customers with metered private • Means tests ⇒ households Illegal connections ⇒ those with connections who consume less than x classified as poor illegal connections units per month • Other customer characteristics ⇒ Combined water and sewage Lower prices for low-pressure pensioners or families with children tariffs ⇒ customers with water water services ⇒ customers with • Burden limit cash transfers ⇒ and sewer connections connections to low-pressure water households whose utility bills and Single volumetric charge (when services housing expenditure exceed a costs vary by customer or time of defined burden limit use) ⇒ high-cost customers Water distribution Cost of service Reduced price for Single price when provision costs Reduced price for particular services Reduced prices based on: Nonnetworked/on-site (trucks, etc.) provided by water all users (water or vary across users ⇒ users in or a service quality level (e.g., only • Geographical discrimination ⇒ isolated services vendors sanitation) ⇒ all remote or otherwise costlier-to- water provided in 20-liter jerry cans) customers who live in certain areas users access areas ⇒ users that choose this service level Pit/tank emptying Cost of pit/tank • Means tests ⇒ households (isolated services) emptying classified as poor • Other customer characteristics ⇒ pensioners or families with children Source: Authors’ elaboration based on table 2.1 of Komives et al. (2005). Note: The users described after the symbol “⇒” are the intended beneficiaries of the subsidy. The costs that a user must pay to gain access to a beneficiaries are a distinct subset of the population water supply or sanitation service may involve connec- or customer base (e.g., poor households), then sub- tion charges, initial costs, or both. Connection charges sidies are targeted. The intended beneficiaries of typically involve a one-time payment for the installa- most targeted subsidy schemes in the WSS sector are tion of facilities needed to provide a consumer with the poorest segments of a population.12 access to a given service network (either water sup- If subsidies are not applied across the board (i.e., to ply or sanitation). Initial costs, similarly, involve a all populations), some sort of targeting is involved, one-time payment for the installation of facilities. whether explicit or implicit. Explicit targeting, in turn, However, instead of providing access to a network, may rely on either self-selection or administrative these facilities either directly provide water or selection (direct or indirect) mechanisms. sanitation services to the user, independent of a ­ Self-selection mechanisms rely on consumers’ selec- ­ network, or are facilities on household premises that tion of a service category (subsidized or nonsubsi- can be considered as prerequisites to network con- dized). This can be realized through product or nection (such as bathrooms, drains, plumbing, or fix- service differentiation. For example, a utility might tures such as toilets). provide networked water services via private con- Consumption subsidies take the form of reduced nections on household premises, or alternatively, (below cost) unit prices for users already connected to through public standpipes or through water kiosks the network. As consumption recurs over time, subsi- priced below cost. Self-selection can also be realized dies involve a continuous flow of resources to cover through price structures in which the unit price var- the difference between the cost of each consumed ies based on consumption—customers can effec- unit and the price paid by users. tively “self-select” different unit prices by altering their consumption. The logic behind increasing Consumer Targeting. The second and third criteria by block tariffs (IBTs) and lifeline tariffs rests on the which we categorize subsidies are (i) the intended ben- assumption that poor households consume less than eficiaries and (ii) the particular targeting mechanism rich ones (an assumption that, in many contexts, implemented. If the intended beneficiaries are an may prove false; see box 2.1). Self-selection mecha- entire population or a service provider’s entire cus- nisms carry a comparatively low administrative bur- tomer base, then subsidies may be considered untar- den for targeting. geted (figure 1.1). If, on the other hand, the intended Administrative selection, on the other hand, is based on a classification of consumers that relies on observ- able variables. Ideally, this classification should be FIGURE 1.1. Categorization of Subsidies based on consumers’ income or wealth and social characteristics, so that subsidies flow to those seg- Untargeted ments of the population that need them the most. For Subsidies Implicit Targeted Self-selection this purpose, means-tested subsidies, based on con- Explicit Direct sumers’ income or wealth, may be used. The use of Administrative this direct mechanism assumes that income/wealth is selection Indirect observable, and that an administrative system to Source: Authors’ compilation. monitor the scheme is in place. Unfortunately, Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 9 consumers’ wealth is seldom observable, so an piped-water schemes, as well as household-level san- indirect targeting mechanism is generally used. ­ itation facilities and campaigns to raise awareness of Indirect targeting relies on certain observable vari- the advantages of quality sanitation, may benefit from ables, such as geographical location or housing quality, subsidies (World Bank Group 2017a). that are used as proxies to measure consumers’ income The question of who or what should be subsidized or wealth. Thus, eligibility for a subsidy may be based depends on the nature of the service. In the case of on residence in a certain neighborhood or dwelling isolated service provision, both access and consump- type identified as poor. 13 Other mechanisms are tion subsidies will involve the subsidization of non- based on consumers’ characteristics (e.g., pension- recurring, one-off charges. Access subsidies typically ers, veterans, individuals with disabilities, female- involve a one-time monetary transfer, either directly headed households, the elderly, historically to the user or indirectly through a service provider, discriminated-against or excluded groups). As to subsidize the construction of either community- administrative selection mechanisms are based on or household-level water or sanitation facilities. an ex ante classification and selection of consumers, Consumption subsidies also involve a one-time they require an administrative system (usually a monetary transfer, either directly to the user or indi- costly one) capable of monitoring and verification. rectly through a service provider, to subsidize the See figure 1.3 for subsidy categories. one-time servicing or maintenance of existing facili- ties owned by the community or household (e.g., Nonnetworked Water and On-Site Sanitation maintenance or repair of water points and water Services schemes, one-time emptying/conveyance of fecal In addition to networked services, subsidies may be sludge, etc.), or the one-time provision of a quantity applied to nonnetworked water supply and sewered of water (e.g., through kiosks and standpipes with sanitation services involving alternative sources or sup- pay-per-use arrangements, tanker deliveries, bottled pliers. In urban and peri-urban neighborhoods (e.g., and sachet water, etc.). Therefore, consumption sub- unplanned and densely populated slums), water ven- sidies for isolated service provision differ from those dors may sell water from taps or kiosks; community for networked services, as they do not contractually block latrines may stand in for sewered sanitation. require a continuous flow of resources to subsidize Household-level costs to upgrade sanitation facilities recurrent costs. and interior plumbing to facilitate connection to net- Since the process of collecting payment for continu- worked water and sewered sanitation services can ous service provision strongly reflects that of net- also be subsidized. Other subsidies incentivize the worked service provision, subsidies for the two types safe collection, transport, treatment, and disposal/ of provision also share many of the same characteris- reuse of fecal sludge among various entities engaged tics. Access subsidies for water points and small in septic hauling (e.g., social enterprises that offer water schemes may include the subsidization of the container-based sanitation services or traditional sep- construction of community-level water or sanitation tic haulers). Public funds may additionally promote facilities. Consumption subsidies will involve a con- the development of new technologies for urban and tinuous flow of resources to cover the difference peri-urban areas that treat waste in-situ. In rural com- between the cost of each consumed unit and the munities, community-level hand pumps and small price paid by users. 10 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 1.4  How Are Subsidies Funded? simply be a change (increase) in a provider’s reve- nues or a reduction in its expenses (costs). Changes The costs of WSS subsidies are typically covered by one in revenue may be linked to tariffs that diverge from of two options: government funds (which in turn are the cost of service or general transfers. Cost reduc- funded by taxpayers), and funds that arise from tions may be due to either reduced input prices or charging other present and/or future users more than below-cost investments. The second is the origin of the cost of service. In low-income countries, there is the funds. Unlike demand-side subsidies, which can often an additional source of funds: philanthropic originate only from government or philanthropic funds, which include both grants and concessional funds, subsidies that involve the service provider as loans provided by other countries (either directly or the transfer mechanism can originate from govern- through international credit agencies), nongovern- ment funds, philanthropic funds, other present and/ mental organizations, and foundations. or future users, or other sectors (funds from other Transfer Mechanisms users or other sectors can both be categorized as cross-subsidies). In all these cases the transfer can Depending on who ultimately pays for the subsidy—­ follow a predefined rule or be the result of a later taxpayers, philanthropic organizations, or a particular decision to cover revenue shortfalls. group of present and/or future users—the mechanism of The interplay between the different transfer chan- the transfer between the payer and recipient may vary. nels and fund origins is depicted in table 1.3. To a large extent, the choice of mechanism will be influenced by the type of service involved, and the Funding Sources ­ector. technological and institutional setup of the s Government- and Philanthropic-Funded Subsidies. Here, we consider two basic funding mechanisms: Government and philanthropic organizations may pro- • A demand-side subsidy involves a direct transfer vide project-based support to directly fund, in full or in from the fund provider to the subsidized user. In part, infrastructure rehabilitation or expansion. This plain terms, the government transfers money type of funding, which is explicitly allocated to an directly to the user,14 who then uses it to pay the investment project, is generally more transparent service provider (whether for one-time or continu- than subsidies that support recurring costs. ous service provision). This mechanism is the In the simplest configuration of subsidies for recur- most transparent and arguably entails a minimum ring costs, the government or philanthropic organiza- distortion in resource allocation. Examples tion pays the service provider the difference between a include both conditional cash and in-kind trans- fully cost-reflective tariff and the amount billed to the fers directly to consumers. consumer. This requires defining cost-reflective tar- iffs for each customer category,15 and then choosing • In the case of a supplier-side subsidy, funds are one or several consumer categories (typically the channeled through the service provider or another poorest) to subsidize.16 third party, which, in theory, passes the funds on In an alternative arrangement, and one that is less to the consumer in the form of lower prices. transparent, the service provider receives general Two aspects of transfer mechanisms are worth high- funding support (direct fiscal transfers from govern- lighting. The first is the transfer channel, which may ment) to cover revenue shortfalls. In this case the Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 11 12 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation TABLE 1.3. Transfer Channels Origin of subsidies’ funding Government/philanthropy Cross-subsidy by other users Cross-subsidy by other sectors (This can occur only under the Transfer channel (This includes government and philanthropic funds assumption that the service provider is into the sector) in overall equilibrium) Explicit Implicit Explicit Implicit Explicit Implicit Transfers Government covers revenue Explicit charge to   Explicit charge to users   shortfalls through a predefined users feeds a fund of another service Changes in revenues mechanism or through a later used to complement feeds a water fund loan or direct transfer revenues Tariffs Government/philanthropy   Explicit cross-subsidy Shortfalls from One type of service   pays difference between cost- rule establishes the subsidized users subsidizes another reflective tariff and amount subsidy and the are recovered (e.g., electricity and invoiced to final user surcharge through charges to water) in a utility that other users combines services CAPEX Government/philanthropy Government (through its general   Common infrastructure Reduction in expenditures (costs) funds certain investment revenues) /philanthropy provide (i.e., dams) charged projects implicit guarantees to loans only to other sector users (i.e., electricity) OPEX Government provides inputs at Inputs with no market price Subsidy to water Utility accumulates market price (i.e., energy) at (raw water) provided at below input (i.e., energy) commercial debt with subsidized prices efficient costs is recovered through input providers charges to other users Taxes Water and sanitation utilities       are exempt from general taxes Source: Authors’ compilation. Note: CAPEX = capital expenditure; OPEX = operating expenditure. funding is not related to the tariffs of specified user Cross-Subsidization by other Users. Cross-subsidization categories but rather becomes an alternative source by other users, on the other hand, is generated within a of revenue that helps offset the cost of service. In provider’s operations. Broadly speaking, we define many cases, this funding is accompanied by govern- cross-subsidies as a pricing structure in which a group ment-imposed limits on tariffs charged to users. of customers is billed a tariff above the average unit Another form of this type of subsidy, usually granted cost of provision, while another group is billed a tariff by international donors through governments, is out- below the average unit cost of provision.19 In other put-based aid. This is a form of results-based ­ funding words, cross-subsidies are a way of paying for at least designed to enhance access to and delivery of infra- a portion of the costs of providing service to one group structure and social services for the poor through the of consumers, through a surcharge on another group. use of performance-based incentives, rewards, or For example, industrial customers may pay prices in subsidies. Output-based aid links the payment of aid excess of costs to subsidize residential consumption; to the delivery of specific services or “outputs” (e.g., high-volume or high-income consumers within the the number of poor households connected to the residential segment may subsidize low-volume or water network). Service delivery is contracted out to 17 low-income users in the same segment; or networked a  third party—public or private—that receives a sub- users may subsidize nonnetworked users.20 Cross- sidy to complement or replace the contribution subsidies will generally result from an explicit policy required of users. The service provider is responsible set by the government or regulator. for prefinancing the project and is reimbursed only However, the mere existence of a differentiated tariff after the services or outputs have been delivered and structure, whether for different consumer categories fully verified by an independent agent. 18 and/or different volumes of a good or service (as in the In recent years, innovative types of fundraising by case of increasing block tariffs), does not imply the governments and philanthropists have been proposed, existence of cross-subsidies. First, tariffs differenti- and in some cases, implemented. Solidarity levies, or ated by customer category may simply reflect a com- a small surtax on a specific industry or consumer mon costs policy (i.e., all customers are paying the item, help global partnerships raise funds within respective costs of their service provision). Second, high-income countries for use within particular sec- even where tariffs are differentiated, if all are below tors in low-income countries. This approach has the cost of service, then all are being subsidized; that been successful in the health sector: Unitaid, cre- is, there is no cross-subsidization because no con- ated in 2006 to raise money to combat HIV/AIDS, sumers are covering the cost of their service. tuberculosis, and malaria, is now largely funded by Thus, to summarize, cross-subsidies are a specific an airline tax. Such a surtax has been suggested for subcategory of price discrimination wherein a subset of bottled water to raise money for the water sector. consumers serves as the funding source for the subsidi- Another innovative approach, land value capture, zation of another subset of consumers. Even so, and allows governments to raise domestic funds. This regardless of the distinction, all differential pricing market-based approach allows governments to cap- policies will generally be perceived as forms of ture land price increases resulting from public cross-subsidy by the public. This is due to a lack of investments, which can then be used to fund public transparency in pricing—consumers are generally infrastructure (Nagpal et al. 2018). unaware of the difference between the true cost of Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 13 service and their billed rate. Consumers therefore water tariffs may be set beyond the rate required for assume that if they are being charged more than their cost recovery, with the resulting difference used to peers, they are paying more than the cost of their subsidize sanitation. Service providers or coopera- service. tives that provide services unrelated to water or san- Cross-subsidies are most commonly (and easily) itation—such as energy, telecommunications, or applied to networked services, because of the techno- solid waste collection—may also use this model of logical characteristics of networks. The provision of a funding. For example, consumers of non-WSS ser- continuous and regular service to a heterogeneous vices (e.g., telecommunications, energy) may be universe of users allows market segmentation and required to pay specific contributions to a water or price discrimination, since resale is not feasible at a infrastructure fund, which is then used to provide large scale. At the same time, since a provider of net- subsidies to the WSS sector. Or, as is common around worked WSS services is a natural monopoly, it is pos- the world, non-WSS service providers may be sible to charge some users tariffs above the direct required by governments to supply their services to (marginal/incremental) costs of serving them. WSS providers free of charge (e.g., energy, a key Providers of nonnetworked, continuous services can input into WSS service provision),22 implicitly subsi- also cross-subsidize across consumer categories; iso- dizing the sector. lated service provision, on If services are the other hand, offers Intergenerational Subsidies. Intergenerational subsi- limited space for cross-­ ­ dies do not involve a fund transfer but instead center underpriced today, subsidies.21 Where the on the underpricing or overpricing of current services, future generations will same company provides which affects future generations. If services are under- both networked and non- priced today, future generations will have to pay have to pay more than networked services, it can more of the service provider’s capital costs than their their share. set tariffs so that nonnet- share of the benefits would indicate, since payments worked users are, in toward those costs have been deferred (and assets effect, being funded by networked users. For exam- not properly maintained or replaced). In the less ple, in Burkina Faso, on-site sanitation is subsidized common case of overpricing, capital investment may via the proceeds of a sanitation fee levied on custom- be frontloaded such that the costs are not adequately ers receiving sewerage services (Trémolet, Kolsky, distributed across the life of an asset, so that future and Perez 2010). generations might theoretically pay less than their fair share. Cross-Subsidization Involving more than One Service Tariffs based on historic costs (assuming these rep- or Sector. A third alternative, and a second type of resent the value of the investment made by the com- cross-subsidy, is funding that originates from consum- pany) will ensure the economic viability of the service ers or providers of another service. In the case of provider but, if below replacement costs, do not companies that provide more than one service, it is reflect the economic cost of providing the service. A not unusual to find that the tariffs applied for one depreciation charge based on historic costs will not service are, in effect, funding the costs of another. cover the maintenance required to sustain the oper- For example, among networked service providers, ational capacity of a system.23 When depreciation 14 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation estimates are below replacement costs (as when the measures of human capital: (i) probability of survival to age 5, (ii) expected years of school, (iii) harmonized test scores, (iv) fraction of capital base is undervalued), this is in effect an children under 5 not stunted, and (v) fraction of 15-year-olds implicit subsidy: current users are paying less than surviving to age 60. the economic cost of the assets used to provide   8. In our classification, nonnetworked provision can also include small piped-water schemes that are managed by an individual, a them service. community, or a local public or private entity not classified as a Inefficient levels of maintenance similarly impose a utility. On account of this management structure, small piped-water schemes share many of the challenges associated with other types of higher cost on future users. If a financially constrained nonnetworked provision. utility does not properly maintain its assets, it short-   9. The sanitation service chain includes household containment (e.g., ens their useful life, driving up future investment toilets/latrines), emptying/conveyance of waste (through sewers or a requirements. So, even if user tariffs are covering functioning fecal sludge management system), treatment, and end use or safe disposal. current (subpar) maintenance costs, they are impos- 10. It is important to note that there is an inverse relationship between ing a higher cost on future users, resulting in an spending on OPEX and on major asset rehabilitation—the more that intergenerational transfer. maintenance is starved of funds, the greater the need for periodic rehabilitation, and vice versa. The institutional setting is also a factor deciding the classification of OPEX and CAPEX since the Notes outsourcing of certain tasks—for example, a build-operate-transfer   1. Although hygiene is a crucial component of what is often referred to contract for a treatment plant—turns, from the perspective of the as the water supply, sanitation, and hygiene (WASH) sector, our firm, a CAPEX (investment in the plant) into an OPEX (payments report focuses on subsidies supporting the delivery of services, and under the contract). thus on water and sanitation, to the exclusion of hygiene. 11. Since access subsidies partially cover the one-time connection   2. Improved drinking water sources are those which, by nature of their charges and/or initial costs required to gain access to the service, design and construction, have the potential to deliver safe water, access subsidies are, in theory, paid only once. However, some while improved sanitation facilities are those designed to service providers may permit customers to pay these access costs hygienically separate excreta from human contact. over time through their regular consumption bills. In this case, the service provider is effectively financing the one-time access costs,  3. To meet the criteria for having a safely managed drinking water which, if financed at below-market rates, constitutes an implicit service, people must use an improved source of water that is subsidy. (i) accessible on household premises, (ii) available when needed, and (iii) free from contamination. An improved sanitation facility is safely 12. As previously noted, subsidy schemes also sometimes target managed if it is not shared with other households and ensures that marginalized or historically excluded populations to address excreta is (i) treated and disposed in situ, (ii) stored temporarily and historical injustices. then emptied and transported to treatment off-site, or (iii) transported 13. As an example of geographic targeting, MajiData, an online database through a sewer with wastewater and then treated off-site. for Kenya’s water sector, contains data on more than 1,800 urban   4. Water and sanitation were recognized as human rights by the UN low-income areas in the 212 cities and towns of Kenya to improve General Assembly and the Human Rights Council in Resolution sector decision making and targeting of resources (http://majidata. 64/292 in 2010, and then again by the General Assembly in Resolution go.ke/). The Kenya Water Sector Trust Fund (WSTF), a Kenyan State 70/169 in 2015. Corporation under the Ministry of Water and Sanitation, assists counties in financing the development of water services in these   5. As discussed in chapter 2, in many countries, particularly those with marginalized areas (https://www.waterfund.go.ke/). weak institutions, government subsidies are not only allocated 14. Note that the fund provider could alternatively transfer money to based upon need, but also to advance political agendas by favoring the service provider, who then pays the user in the form of reduced particular groups. These decisions, informed more by political access or consumption charges. choice, may be undertaken under the guise of a legitimate rationale. 15. Cost-reflective tariffs may differ across customer categories,   6. For example, in March 2019, the Canadian government announced a generally stemming from differences in construction costs due to $4.7 billion budget allocation to ensure universal access to safe geographical or geological variation, or differences in service levels. drinking water for indigenous people on reserves within two years. For example, technologies such as condominial water and sewerage   7. The Human Capital Index was developed through the World Bank’s reduce the cost of networked service provision while potentially Human Capital Project, launched in October 2018. It combines five reducing the quality of service. Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 15 16. In addition to existing customers, customer categories to be different definitions of cross-subsidies. See, for example, Beato subsidized may include potential customers (i.e., households (2000). currently lacking access to the service). 20. There could also be a cross-subsidization from existing to new cus- 17. For example, a 2007 grant from the World Bank under the Global tomers, as when existing customers pay for the expansion of a water Partnership for Results-Based Approaches allowed Manila Water to supply network into unserved areas. install water service connections for customers in 45 urban poor communities at affordable rates (Rivera 2014). 21. But nonproportional cost allocations are sometimes found for capital expenditures at the community level. Additionally, isolated 18. Background paper 17 (prepared for this report; see appendix A) on-site sanitation services may be cross-subsidized across different highlights the World Bank’s significant experience with output- consumer categories. based aid through the Global Partnership for Results-Based Approaches (http://www.gprba.org). 22. The free provision of energy to WSS service providers is rarely an explicit policy, but instead stems from a reluctance to terminate 19. This definition is different from that of Faulhaber (1975), who service when WSS service providers fail to pay their energy bill. states that a cross-subsidy requires that a user or group of users pays less than the incremental cost and another pays more than 23. Furthermore, the return on capital, even if adequate from the the stand-alone cost. Also, the specific type of cost considered service provider’s perspective, will be less than the opportunity cost (average, marginal, stand-alone, incremental) gives rise to to society of the assets involved in service provision. 16 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation CHAPTER 2 The Challenges of Current Water Supply and Sanitation Subsidies While subsidies of water supply and sanitation (WSS) service provision are gen- erally implemented in pursuit of worthwhile objectives, poor design often undermines these objectives, rendering subsidies pervasive, expensive, poorly targeted, nontransparent, and distortionary. In this chapter, we present evi- dence on the current state of subsidies within the WSS sector and discuss particular design elements that most often prove problematic. 2.1  Subsidies Are Pervasive Subsidies are found in the water and sanitation sectors of nearly all countries. Table 2.1 shows the prevalence of economic subsidies1 and operation and maintenance (O&M) subsidies among the utilities included in the World Bank’s International Benchmarking Network for Water and Sanitation Utilities (IBNET) database. Only 14 percent of the utilities listed in the IBNET database generate enough revenue to cover the total economic costs of service provision, while only ­ percent of the utilities are able to cover, at a minimum, the O&M costs of 35  ­ ­service provision. TABLE 2.1. Economic Subsidies and O&M Subsidies among Utilities Number Number % % of utilities of utilities No economic subsidy 220 14 No O&M subsidy 544 35 Economic subsidy 1,329 86 O&M subsidy 1,005 65 Total 1,549 100 Total 1,549 100 Source: Authors’ calculations based on IBNET data, which cover utilities in 147 countries. Note: IBNET = International Benchmarking Network for Water and Sanitation Utilities; O&M = operation and maintenance. Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 19 BOX 2.1. Increasing Block Tariffs One of the most common types of subsidy, and maybe the most common for achieving distributional objectives—that is, for extending service to the poor—is the increasing block tariff (IBT). IBTs have long been common in low- and middle-income countries. Consumption levels are divided into brackets, with a different unit price applied within each bracket. The unit price charged in lower consumption brackets is lower (and may even be free) than the unit prices charged in higher consump- tion brackets. In theory, the IBT structure allows utilities to meet the goals of equity (through the lower brackets) and conservation (through the higher brackets). Lower consumption brackets are often subsidized heavily to allow low-volume consumers to take advantage of infrastructure services. The assumption here is that the poor consume less than the rich, and that lower prices for lower brackets of consumption will allow the poor to access enough water to meet their basic needs. At the other end, high-volume consumers pay a higher price, which is expected to be closer to the long-term marginal cost. Therefore, the effective implementation of an IBT requires insulation from political pressure to increase the size of the lower consumption blocks (thus benefiting a larger share of the population) and a functional metering system, both of which are often lacking in low- and middle-income countries. No database offers comprehensive data on the tariff structures in use globally. The most comprehen- sive sources of information are the IBNET tariff database and a survey of utilities conducted by Global Water Intelligence; about half the utilities covered in these two datasets use IBTs (figure B2.1.1). They are especially popular among utilities in Latin America (70 percent), the Middle East and North Africa (74 percent), and East Asia and Pacific (78 percent). FIGURE B2.1.1. Summary of Tariff Structures Implemented, by Utilities in Various Regions  100 3 3 1 33 3 4 6 90 60 134 34 73 80 20 70 70 60 656 Percent 50 284 26 40 149 452 113 30 70 20 18 10 104 18 12 5 5 18 7 2 11 0 SSA EAP ECA LAC MENA SAR North America and Western Europe Decreasing blocks Fixed charges Increasing blocks One block Other Source: IBNET tariff data (2018). Data for North America and western Europe are from Global Water Intelligence (GWI).  Note: Numbers within bars represent the number of utilities with the subject tariff structure. EAP = East Asia and Pacific; ECA = Europe and Central Asia; LAC = Latin America and the Caribbean; MENA = Middle East and North America; SAR = South Asia region; SSA = Sub-Saharan Africa. box continues next page 20 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation BOX 2.1. continued Despite their prevalence, there is an emerging consensus among policy researchers that IBTs are not an effective means of targeting subsidies to poor households.a This inefficacy is the result of three main problems. First, in both rural and urban areas within low-income countries, many poor households are not connected to the piped network, therefore rendering them ineligible to receive subsidized water. Second, the correlation between piped water use and income is low (Fuente and Bartram 2018), meaning that subsidies delivered through the lower blocks are poorly targeted. Third, poor households are more likely to share water from their connection with other households, leading them to purchase more water at prices within the higher blocks of the IBTs. Moreover, IBTs generally fail to encourage conservation through the higher consumption brackets. This results from the difficulty in understanding complex IBT tariff structures (Nauges and Whittington 2017) and the fact that customers tend to respond to average, not marginal, prices (Ito 2013). Source: World Bank Group 2018c. a. The World Bank has conducted and supported several early studies on the targeting of subsidies and municipal water services (e.g., Foster, Gómez-Lobos, and Halpern 2000; Walker et al. 2000; Komives et al. 2005; Banerjee et al. 2010; Angel-Urdinola and Wodon 2011). These, along with other research (Barde and Lehmann 2014; Whittington et al. 2015; Fuente et al. 2016) that uses a range of data sources and methods across several countries, seem to suggest that IBTs do not effectively target subsidies to low-income households. Why Subsidies Are So Prevalent constituents (Mason, Harris, and Batley 2013). For As mentioned earlier, there are sound economic justifi- the same reason, political actors may find it difficult cations for subsidizing WSS services that largely to reduce existing subsidies or even to alter their explain their pervasiveness. Given their ability to sup- design. Politicians’ unwillingness to charge custom- port important policy objectives, well-designed sub- ers for the services they enjoy, or to disrupt the sta- sidies are and will continue to be vital to the sector. tus quo, is one factor behind the commonly high Yet their prospective benefits highlight the need to levels of subsidies. As noted in World Bank Group better understand why poorly designed subsidies, in (2002: 1), even following a series of conferences in particular, are so common. the 1990s at which representatives of “many coun- Subsidies, notably poorly designed ones, are preva- tries accepted the principle that the poor were will- lent across countries of all regions and income levels, ing to pay for good quality services and therefore largely due to the political salience and visibility of should be charged for them, a long history of rural water services. This is due not only to the social water sector subsidiza- prominence of water and sanitation, but also to the tion posed significant Subsidies, notably nature of networked WSS services. The construction challenges in imple- poorly designed ones, of new infrastructure, the expansion or improve- menting this policy.” ment of service to households, and the reduction The obligation to ensure are prevalent across of tariffs can be directly attributed to the efforts of the human right to water countries of all regions politicians. In many cases, subsidies are a tempting and sanitation, as declared way for politicians to gain popularity with their by the United Nations, has and income levels. Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 21 further cemented the role of subsidies in the sector. across-the-board subsidization of services. This While bringing welcome attention to the plight of bil- explains the prevalence of significant state subsidies lions of people without access to safely managed to fund the provision of piped water in low-income water and sanitation services (WHO 2017), the UN countries and member countries of the Organisation declaration of this right has bolstered arguments in for Economic Co-operation and Development alike favor of subsidization, as efforts to charge full (Komives et al. 2005: 22). Even as costs may vary cost-reflective tariffs necessary for the sustainability across consumers, often differentiated by geographic of these services can be seen as exclusionary. location, a high proportion of costs are shared. Even where subsidies do not reach their intended This  gives providers a large degree of discretion in beneficiaries, they often become entrenched owing to setting pricing structures, which is often exploited to the interests of the stakeholders who do benefit from advance political agendas. them, especially where these stakeholders are able to In the short to medium term, utilities may be able to garner political support (box 2.2). These interest function with a pricing structure that does not cover groups may include, for example, industrial, agricul- the full costs of capital, and neglects the maintenance tural, and commercial consumers, and middle- and of assets. Around 65 percent of the cost of supplying upper-income households who disproportionally piped water, and 80 percent of the cost of sewerage benefit from access and low tariffs, as well as utility systems, is for long-lived capital assets that degrade owners and employees, who may capture part of the over decades while maintaining functionality (for an government transfers themselves instead of passing average of 20–40 years in the case of water, and them through to consumers in the form of lower tar- 40–60 years for sewerage; Komives et al. 2005). If iffs. In some cases, while in reality subsidies benefit 2 service is to be sustained, future generations will the wealthy, a lack of information, or its unavailabil- need to pay for the gap left by earlier tariffs, either ity to the public, may allow the perception to persist through increased taxes or tariffs, thus resulting in that subsidies benefit the poor. an intergenerational subsidy. The monopolistic cost structure of networked WSS Taken all together, the cost structure of networked services makes cost-reflective pricing difficult, which and sewered service provision means that politicians leads to significant subsidization. Networked services and other government officials, as well as utilities’ exhibit, in particular, declining marginal costs and managers and staff, can allocate costs and subsidies increasing returns to scale due to large fixed costs, based on political or private objectives, instead of eco- long-lived assets, and shared costs that are typically nomic and social objectives. This has severe conse- distributed across many consumers. High fixed costs quences for the long-term sustainability of water and make efficient pricing using marginal costs difficult, sanitation service provision, leads to inefficient use and such pricing would not allow for full cost recov- of scarce public resources, and often leaves the poor ery anyway (since the marginal cost of service provi- and marginalized behind. sion is lower than the average cost). Around the world, there are heated debates on how to imple- 2.2  Subsidies Are Expensive ment tariffs close to the marginal costs while ensur- Not only are WSS subsidies pervasive across all coun- ing that costs are recovered and that utilities remain tries, regardless of their income status, but they also financially viable. In practice, this often encourages tend to consume a substantial amount of a country’s 22 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation BOX 2.2. Why Are Time-Bound Subsidies Rarely That? Water supply and sanitation subsidies have a tendency to persist even when originally intended to be temporary. To better understand why this is the case, figure B2.2.1 depicts the basic life cycle of a sub- sidy regime as seen through a political economy lens. Subsidies may begin with modest purposes and at modest levels, as shown in the lower-right corner of the figure. In such a case, well-organized interest groups may realize that scaling up these levels would be to their advantage. As a result, the subsidy regime moves upward to the upper-right corner. Although standard political economy models would predict that a subsidy with large special interest benefits and small citizen benefits would have a stable outcome—an iconic example of special inter- est politics—there are many examples of subsidies that have become democratized as special interests realize the potential benefits. Political leaders—often goaded by the opposition or animated by fears of losing power—also recognize the benefits of providing a broad-based subsidy. The subsidy regime thus shifts left and becomes deeply entrenched. These are the most difficult cases for reformers because they have the highest costs and are animated by political forces—leaders who fear the loss of broad-based public support, and organized special interest groups that oppose any reduction. FIGURE B2.2.1. Life Cycle of a Subsidy Regime Beneficiary type and benefit size Citizen benefits are large Citizen benefits are small Entrenched Democratization of subsidy subsidy Special interest Reconcentration benefits are large special interests Ex Populist reforms Expanding te ns iv e re fo rm Special interest benefits are small Initial subsidy Source: Adapted from Inchauste, Victor, and Schiffer (2018). Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 23 scarce public resources. A discussion of their magni- (economic) costs. In accounting terms, these costs tude requires us to briefly introduce the types of include operating costs, debt interest and amortiza- costs associated with WSS service provision. tion, depreciation, return of capital, return on equity, and taxes (see box 2.3). Beyond these, all service The Costs of WSS Service Provision ­ providers present some inefficiencies that result in Since subsidies are the difference between (i) the costs additional, hidden, costs that should be taken into of service provision and (ii) the amount paid by users, account.5 An efficient level of regulation is assumed, defining and estimating the first element of the equa- which means that tariffs cannot be higher than the tion is fundamental to any analysis. When computing economic costs of service. If there are benefits above the costs of service provision, total economic costs the opportunity costs of capital, then users are, in (and, eventually, inefficiencies, or slack ) are taken 3 effect, subsidizing the service provider. into account. These include O&M costs, depreciation, 4 taxes, a fair and reasonable return on capital expendi- The Magnitude of Networked Water and Sanitation Subsidies ture, and also environmental costs. Figure  2.1 out- lines these costs, along with some examples. Subsidies tend to be heavily biased toward networked water and sewered sanitation service provision. As an Costs of Service at an Aggregate Level example, the 2017 Global Analysis and Assessment of The costs of service at the aggregate level can be Sanitation and Water (GLAAS) report found that, in expressed as the revenue required to cover the incurred 13 countries, urban WSS expenditure accounted for FIGURE 2.1. Costs of Water and Sanitation Service Provision Common costs Dams, aqueducts, networks, plants, etc. CAPEX Specific costs Meters, connections, etc. Common costs Management, IT, etc. Efficient costs Inputs Effective OPEX Energy, chemicals, labor, etc. costs Specific costs Meter reading, variable costs Env. Environmental costs Costs Resource costs and externalities Inefficiencies Source: Authors’ compilation. Note: CAPEX = capital expenditure; IT = information technology; OPEX = operating expenditure. 24 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation BOX 2.3. Various Ways to Calculate Cost-Recovery Levels ­ ervice. To set cost-recovery tariffs, it is necessary to first calculate the costs of providing s WSS services are funded by a mixture of revenues from the so-called three Ts: tariffs, taxes, and transfers (OECD 2009). Cost-recovery tariffs may be estimated as the total costs of service provision (i.e., including the depreciation and the profitability of the total capital employed), or some selected portions of these. Any costs not recovered through tariffs must be covered through a combination of ­ taxes and transfers. Common methods of calculating cost-recovery tariffs are summarized in table B2.3.1. TABLE B2.3.1. Alternative Methods for Estimating Cost-Recovery Tariffs Focus of analysis Definition Impact Operation and maintenance (O&M) Most basic definition of costs that can When the utility’s income does not costs. be adopted. cover O&M, each additional unit of sale produces losses. Financial costs (which include operating Financial sustainability criteria. By not covering the amortization expenses and interest and amortization Relevant from the point of view of a of its own capital the utility loses of third-party capital, or debt). lender. productive capacity. Financial costs and capital maintenance Revenues allow a company to Not recognizing the opportunity cost (depreciation of equity). maintain its productive capacity. of its own funds, the utility does not generate investment incentives. Service’s economic costs. Totality of economic costs. The system is economically sustainable. Each of these various methods can be found in various analyses of the WSS sector. In some cases, gov- ernment plans explicitly provide for the use of one method for determining the fees that users must pay. However, since the difference between revenue and the totality of economic costs constitutes a subsidy, any definition of cost recovery that does not cover the total economic cost should be interpreted as a level of subsidy. Source: Authors’ compilation. 76 percent of public WSS expenditure, and that glob- nonnetworked water and on-site sanitation services, ally, official development assistance of “large sys- our estimation focuses on networked water and sew- tems” (including large urban distribution networks ered sanitation services. and/or treatment facilities) accounted for three-­ Estimating subsidy levels for networked services at quarters of all official development assistance to the the global level is a daunting task. Subsidies may be WSS sector in 2015, which amounted to approxi- explicit or implicit, and come in a wide variety of mately $5.6 billion of the $7.4 billion flowing into the shapes and sizes. Utility-level data on costs are sector (WHO 2017). Given the pronounced bias of ­ generally either not available or highly unreliable. funding toward networked WSS services, a trend Given the data limitations, an estimation of the that likely holds true for subsidies as well, and the costs of providing WSS services efficiently across paucity of data on subsidies for decentralized, service providers requires a simple methodology Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 25 that makes use of only the most commonly avail- Bank’s four country classifications—high income, able variables. upper middle income, lower middle income, and low Superintendencia de Servicios Sanitarios (SISS), the income—allowing us to extrapolate to the remaining Chilean water regulator, has developed an effective countries based upon their estimated coverage rates methodology for estimating the tariffs of all utilities in of piped water and sanitation services. the country. Its use of an efficient (optimized) This method estimates the magnitude of subsidies ­bottom-up model provides valuable information on 6 associated with the operations, maintenance, and the greenfield capital investment needed for the 7 replacement of existing infrastructure, taking into provision of WSS services that, for the purposes of account each utility’s particular levels of inefficiency. the present study, we extrapolate to utilities in other For our purposes, operating expenditure (OPEX) countries. It is important to note that our methodol- includes that required for the utility to provide ser- ogy does not seek to benchmark these utilities vices at current levels of efficiency and quality, as against Chilean utilities. Instead, our decision to use well as for regular maintenance. Capital expenditure the efficient model developed by the Chilean regula- (CAPEX) includes that required for the major repair tor is predicated on its sophisticated and novel and/or replacement of existing infrastructure, spread framework for estimating costs and measuring out equally across an assumed 35 year design life of performance. 8 each asset. To compute an efficient WSS tariff for each utility It is important to note that our estimation does not with sufficient data for the period 2010–15 in the World include CAPEX for infrastructure expansion or environ- Bank’s IBNET database, we develop a methodology mental costs. Since infrastructure expansion tends to that complements utility-specific data with estimates be fully subsidized, the actual global magnitude of of the long-term incremental costs of efficient model networked water and sanitation subsidies is much utilities, as determined by the Chilean regulator. We 9 greater than our estimation. Environmental costs, then adjust this tariff to account for the relative which include any ecosystem degradation and deple- losses and labor inefficiencies of each utility to tion caused by either water abstraction or the result- obtain a full tariff, which allows a return compatible ing emission of pollutants, as well as the opportunity with a utility’s economic opportunity cost of capital costs of using a resource, must be taken into account (i.e., to be economically sustainable). The subsidies in any policy decision. Since the magnitude of these for each firm can then be computed as the difference costs will vary greatly from utility to utility on the between this cost-reflective full tariff and the effec- basis of a variety of technological, environmental, tive tariff that a utility charges.10 and societal factors, calculating an estimate of global In order to obtain countrywide subsidy amounts for environmental costs associated with networked those countries with partial representation in the water and sewered sanitation services is not cur- IBNET database, we extrapolate the results of those rently feasible and is beyond the scope of this report. utilities that are listed in IBNET to the rest of the coun- However, these costs should be assessed on a case- try, on the basis of 2015 WSS coverage rates estimated by-case basis through a thorough environmental by the Joint Monitoring Programme and population 11 impact assessment. data from the World Bank. Average per capita subsidy Because of a lack of data, China and India are both figures were then obtained for each of the World excluded from our estimations. Proportional to the 26 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation size and number of their utilities, both countries Table 2.2 disaggregates subsidies for The global subsidy have very little representation in IBNET; this, cou- CAPEX and OPEX across World Bank level was estimated pled with a lack of data from other sources, prevents regions. us from accurately extrapolating subsidies at the Subsidies of operating costs account at $289–$353 billion country level. As discussed in box 2.4, the estimates for approximately 22 percent of the total per year. of global water and sanitation subsidies put forward subsidy amount both in the full sample in Kochhar et al. (2015) include both China and India, and for low- and middle-income econo- using a comparable price gap approach. But we have mies separately. While our overall estimation is in line decided not to include these numbers in our global with existing literature, most studies systematically estimates since they are based on significant assump- underestimate CAPEX subsidies (e.g., no adjustments tions, different from those undertaken in our to the asset base or cost of capital are applied). With approach, that would reduce reliability. its inclusion of full cost-reflective tariffs, our approach Using our method, as outlined above, the global sub- is thus a better way to estimate hidden costs. sidy level was estimated at $289–$353 billion per year, At around $101–124 billion per year, Latin America or 0.46–0.56 percent of the countries’ combined gross and the Caribbean exhibits the largest amount of sub- domestic product (GDP). As a percentage of GDP, this sidy both in absolute terms and as a percentage of figure rises, shockingly, to 1.59–1.95 percent if only GDP (including both operating and capital subsidies). It low- and middle-income economies are considered, should be noted, however, that if China were included an amount largely due to the capital subsidies cap- in our analysis, the East Asia and Pacific region’s total tured in our estimation. These figures are in line with amount of subsidies would be substantially higher. previous estimates from the literature (see box 2.4). Previous estimates (see Kochhar et  al.  2015) that TABLE 2.2. OPEX and CAPEX Subsidies, by Region (2017 $ and Average % GDP) OPEX CAPEX Total OPEX CAPEX Total Region Subsidy Subsidy Subsidy Subsidy/GDP Subsidy/GDP Subsidy/GDP ($ billion) ($ billion) ($ billion) (%) (%) (%) World Bank geographical regions* Africa 4.1–5.1 17.2–21.1 21.4–26.1 0.24–0.30 1.03–1.25 1.28–1.56 East Asia and Pacific (without China) 5.0–6.2 18.0–22.0 23.1–28.2 0.22–0.26 0.78–0.96 1.00–1.22 Europe and Central Asia 13.1–16.0 45.6–55.8 58.7–71.8 0.33–0.41 1.16–1.42 1.48–1.81 Latin America and the Caribbean 23.4–28.6 77.8–95.1 101.2–123.7 0.45–0.55 1.51–1.85 1.96–2.40 Middle East and North Africa 10.2–12.5 37.6–46.0 47.9–58.5 0.35–0.43 1.31–1.61 1.66–2.03 South Asia (without India) 2.3–2.8 3.2–3.9 10.9–13.3 0.39–0.47 1.43–1.75 1.82–2.22 Advanced and nonadvanced economies (as categorized by IMF) Advanced economies 7.8–9.6 17.6–21.5 25.4–31.0 0.018–0.022 0.036–0.044 0.054–0.066 Nonadvanced economies 58.1–71.1 204.9–250.5 263.1–321.6 0.35–0.43 1.24–1.52 1.59–1.95 Total 66.0–80.7 222.5–271.9 288.5–352.6 0.11–0.13 0.35–0.43 0.46–0.56 Source: Authors’ compilation. Note: * Regional estimates exclude “advanced economies,” as categorized by the International Monetary Fund. CAPEX = capital expenditure; GDP = gross domestic product. IMF = International Monetary Fund; OPEX = operating expenditure. Estimates for East Asia and Pacific and nonadvanced economies exclude China, while estimates for South Asia exclude India. Estimates for nonadvanced economies exclude both China and India. Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 27 BOX 2.4. How Do Our Estimates Compare with Other Approaches? The most directly comparable estimate of subsidies was conducted by Kochhar et al. (2015). This similarly ­ odel follows a price gap approach by subtracting actual revenues from estimated costs. Instead of our m utility approach, however, the authors use a reference full cost-recovery price of $1 per cubic meter, which is taken from work done by the Global Water Intelligence in 2004 (GWI 2004) and is assumed to be the same for drinking water and wastewater. They then adjust this price for each country to account for three factors: (i) general price inflation that occurred between 2004 and 2012; (ii) lower labor costs in low- and ­ pproximated using data middle-income countries; and (iii) varying levels of water scarcity. Revenue is a on utility drinking water and wastewater tariffs for a sample of over 80 countries in 2012 from the GWI. The authors estimate that water and sanitation subsidies provided through public utilities were about $456 billion, or 0.6 percent of global gross domestic product (GDP), in 2012. Across regions, subsidies range from between 0.3 percent and 1.8 percent of GDP. Note that these estimates include China and India, the former with an estimate of around $130 billion, or about 1.5 percent of its GDP in 2012. Without China and India, this estimate becomes 0.5 percent of global GDP, or, adjusted for general price inflation from 2012 to 2017, $347 billion. Both of these numbers fall within our estimation range. FIGURE 2.2. Magnitude of WSS Subsidies, by Region 2.50 2.00 1.50 % GDP 1.00 0.50 0 a a) a a a ) ed ed ed a ic si ic ric in di c c yz lA r er an an Af Af Ch In al Am ra v v l. n an l. Ad ad nt xc er xc tin Ce s on th (e (e rie La or N ia d c nt an N As ou ci d pe Pa h an lc ut ro d Al st So an Eu Ea ia e As dl id st M Ea Source: Authors’ compilation. Note: GDP = gross domestic product. Bars indicate the midpoint of the estimation range, while the black brackets represent the full estimation range. World Bank regional estimates exclude countries classified as advanced economies by the IMF. Advanced and nonadvanced countries refer to these IMF classifications. Estimates for East Asia and Pacific and nonadvanced economies exclude China, while estimates for South Asia exclude India. Estimates for nonadvanced economies exclude both China and India. 28 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation used the price gap approach and included China provision at current levels of efficiency and quality— attributed the largest subsidies in nominal terms to our estimates of subsidies for CAPEX require additional Asia, at over $190 billion per year, of which 60 percent nuance. Because of a lack of data on most countries’ was in China alone (see box 2.4). Figure 2.2 displays direct expenditure on networked water and sewered the magnitude of subsidization as a percent of GDP sanitation, our model instead estimates the CAPEX by region. required for the replacement of existing infrastruc- Annual subsidies relative to GDP within regions ture. However, there have been several recent range from 0.05 percent up to 2.40 percent. The low- attempts to extrapolate direct expenditure from est rates are clustered in advanced economies (as countries with more comprehensive and transparent classified by the International Monetary Fund) and expenditure data to regional, and even global, levels the highest in Latin America. In figure 2.2, advanced of expenditure. economies were removed from their respective Prior estimations of global and regional direct CAPEX regions. If this had not been done, values for these on WSS services in low- and middle-income countries, regions would have been lower. making use of data available from a limited number of These results are in line with previous estimates: countries, are between 0.4 and 0.5 percent of GDP. Fay most high-income countries tend to charge water tar- et al. (2017) have found that the WSS sector has tradi- iffs close to the level required to cover operating tionally received a small share of Latin America and expenditures and asset depreciation, as well as main- the Caribbean’s investments in infrastructure, hov- tain infrastructure. On the other hand, water tariffs far ering between a quarter and a third of a percent of from cost recovery are most often found in low- and GDP in the period 2000–12. Data from Foster and middle-income countries. Utilities in Sub-Saharan Briceño-Garmendia (2010) suggest that Africa spends Africa, for example, usually operate at a loss and end around 0.5 percent of GDP, while Andres, Biller, and up lowering their capital expenditures to continue Dappe (2013) estimate that South Asia spent an aver- operating, which ultimately leads to a decline in ser- age of 0.41 percent of its GDP in the period 2000–11. vice quality. A more recent, and global, estimation of subsidies in Subsidies of networked water far exceed those for the WSS sector can be inferred from Fay et al. (2019), sewered sanitation globally, accounting for 64 percent who estimate infrastructure investments in low- of the total subsidy amount. Overall, advanced econo- and middle-income countries. Their report does not mies allocate a higher percentage of subsidies toward directly disaggregate CAPEX by sector. However, evi- sewered sanitation than do nonadvanced economies dence from BOOST allows the authors to investigate (44 percent). Sub-Saharan Africa and East Asia and the evolution of public infrastructure spending by Pacific allocate the lowest proportion (6 percent sector over the period 2009–16. During this time, and 11 percent, respectively). These differences are infrastructure spending in the WSS sector began at largely due to the higher rates of access to networked about 0.3 percent of global GDP, climbing to a peak of water than to sewered sanitation globally, and the var- about 0.6 percent in 2012, before falling back to ied rates of access to sewered sanitation across regions. ­ verage expenditure for this period 0.3 percent. The a While our estimates of subsidies for OPEX are rela- percent of global GDP. was around 0.4 ­ tively straightforward—they predominantly represent When combined with our estimates for OPEX, the use explicit expenditures required to sustain service of the limited direct CAPEX data available results in Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 29 total networked water and sewered sanitation subsi- tariffs—they will need to be covered by future gener- dies in low- and middle-income countries in the range ations to maintain existing WSS services over time. of 0.75–0.95 percent of GDP. While these estimates Since our model allocates such expenditure in equal are below our estimate of 1.59–1.95 percent of GDP installments across the design life of the asset, its for low- and middle-income countries, such discrep- estimates are significantly higher by reflecting these ancy is not unexpected given key differences intergenerational subsidies. between the two approaches followed. Second, while our model accounts for the full costs of First, the use of direct expenditure significantly required major repairs and replacement of existing infra- underestimates the CAPEX subsidies provided to the structure, it does not account for expenditures towards sector for existing infrastructure due to the deferral of infrastructure expansion. In a steady-state situation maintenance—a phenomenon especially common in whereby infrastructure expansion is limited, both esti- low- and middle-income countries. It has been mates should be reasonably similar since actual direct well-documented that low- and middle-income CAPEX would be exclusively and comprehensively countries in particular struggle with revenue collec- covering the maintenance and replacement of existing tion and limited fiscal capacity, and are thus prone to infrastructure. These key differences between the two significant deferrals of maintenance, as well as major models are depicted in figure 2.3. repairs and replacement of existing infrastructure. Finally, it is worth mentioning that these estimates Yet, even if these expenditures are not currently are global, and therefore represent regional and being made—either through taxes, transfers, or global  average levels of subsidies in the WSS sector. FIGURE 2.3. Estimating the Magnitude of Subsidies: Two Approaches Actual subsidy of key cost Full model Hybrid direct expenditure/ components approach model approach Infrastructure expansion CAPEX from direct expenditure extrapolation CAPEX Infrastructure CAPEX from replacement model OPEX OPEX and OPEX and ine ciencies ine ciencies from model from model Ine ciencies Source: Authors’ compilation. Note: CAPEX = capital expenditure; OPEX = operating expenditure. The full model approach estimates CAPEX, OPEX, and inefficiencies using our model, which complements utility-specific data with estimates of the long-term incremental costs of efficient model utilities. The hybrid direct expenditure/ model approach, meanwhile, substitutes direct expenditure data in the place of the CAPEX model estimates, while maintaining the model’s estimates for OPEX and inefficiencies. 30 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation Estimates at the country level may differ signifi- is important to ensure that these resources are well cantly from these ranges due to the many contextual targeted to poor households. The 2030 Agenda for factors that vary across countries. The estimation of Sustainable Development recognizes the importance subsidies at the country level would therefore of effective targeting in ensuring that no one will be require additional data and a refined methodology. left behind as a country’s socioeconomic develop- ment advances. This development includes, impor- Impact on the Broader Economy tantly, access to WSS services (WWAP 2019). The large magnitude of subsidies imposes a fiscal bur- Before discussing the distributional performance of den on the government budget that can adversely consumption subsidies and subsidies of initial costs impact the broader economy. These budgetary trans- and connection charges, it is important to note that fers practically become recurrent expenses that the poor targeting is not always related to inadequate government has little control over, thus reducing its subsidy design; the targeting of subsidies is also prone ­ available fiscal space to address other spending prior- to political interference. In most countries, both eco- ities. Moreover, the recurrent expenses, if large, may nomic and political efficiency considerations influ- affect the government’s ability to adopt fiscal stabili- ence decisions regarding subsidies. Government zation measures during times of economic slowdown. expenditure on infrastructure is not allocated only As access to subsidized services increase, so does the based upon need, but sometimes to advance politi- eroding the gov- magnitude of the transfers, further ­ cal agendas by favoring particular groups. In other ernment’s fiscal stability and debt sustainability. words, subsidies may not be well targeted from the standpoint of benefiting the poor, yet they are well 2.3  Most Subsidies Are Poorly Targeted targeted from the perspective of politicians. A recent Given that a primary objective of WSS subsidies is to analysis by the World Bank’s BOOST initiative pro- advance equitable access to affordable WSS services, it vides evidence from Albania on the prevalence of FIGURE 2.4. Politically Motivated Allocation of Capital Grants for Infrastructure in Albania 7,000 6,000 5,749 Per capita allocations, lekë 5,000 4,238 4,169 3,832 4,092 4,000 3,311 3,393 3,144 3,002 2,983 3,000 2,358 2,353 2,000 1,000 0 2010 2011 2012 2013 2014 2015 Politically-a liated local governments Politically-opposed local governments Source: World Bank’s BOOST initiative. Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 31 such favoritism in the financing of local infrastruc- have low connection rates. More recently, the World ture, including for WSS services. As shown in Bank Group (2017b) found that Tunisian households figure  2.4, local governments where the mayor is ­ in the bottom quintile of the distribution receive politically affiliated with the national government 11 percent of water subsidies, while those in the top get significantly higher capital grant allocations on a quintile receive 27 percent. per capita basis. This correlation persists even when Building on the methods of Komives et al. (2005) and controlling for socioeconomic variables, such as Angel-Urdinola and Wodon (2011), we provide new evi- regional poverty rates. dence on the targeting performance of piped-water consumption subsidies in 10 countries: Ethiopia, Mali, Distributional Performance of Consumption Niger, Nigeria, Uganda, El Salvador, Jamaica, Panama, Subsidies Bangladesh, and Vietnam.13 The analysis utilizes Since the 2000s, a growing number of studies have household survey data and utility providers’ admin- found that water consumption subsidies for the poor 12 istrative data as well as new estimates of coun- in low- and middle-income countries are usually badly try-specific cost-reflective tariffs.14 Most of these targeted due to many interrelated factors: (i) poor countries have IBT structures. Only Nigeria and households tend to reside in areas where there is no Uganda have fixed rates: the average unit prices access to water networks; (ii) poor households are not charged are on average lower than the cost of pro- connected to a network, even when residing in areas ducing and distributing piped water, resulting in with access; and (iii) correlation between piped water substantial subsidies. use and income is low (Fuente and Bartram 2018), In the 10 countries we analyzed, an average of meaning that subsidies delivered through the lower percent of subsidies reach the wealthiest quintile 56  ­ blocks of IBTs are poorly targeted (see box  2.1). Key of a country’s population, while a mere 6 percent reach examples of this literature—such as Komives et al. the poorest quintile. As shown in figure 2.5, in all (2005), Angel-Urdinola and Wodon (2011), and 10 countries analyzed, subsidies are regressive, with Fuente et al. (2016)—have shown that quantity-based, the amount of resources allocated to water con- targeted subsidies in Cape Verde, Nicaragua, Sri sumption subsidies increasing over the expenditure Lanka, and the cities of Bangalore (India), Kathmandu distribution. To identify this, we first classify all (Nepal), and Nairobi (Kenya) are regressive, with a households within each country into deciles, accord- smaller share of benefits ing to their places in the countrywide wealth distri- An average of accruing to the poor than bution. We then calculate the percentage of money the general population. spent on subsidies accruing to all households in a percent of subsidies 56 ­ These studies indicate given decile. Richer households in the top five deciles reach the wealthiest that ineffective targeting usually capture the lion’s share (although as box 2.5 is mostly associated with describes, those resources that do accrue to the poor quintile of a country’s poor neighborhoods’ low represent a substantial part of their consumption population, while a rates of access to water expenditure). In addition, we present the share networks; also, even in of total expenditure in the economy accruing to mere 6 percent reach neighborhoods with such each expenditure decile, to show if the subsidy the poorest quintile. access, poor households has a redistributive effect by reducing inequality 32 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation FIGURE 2.5. The Percentage of (a) Water and Sanitation Subsidies and (b) Total Economic Expenditure that Accrue to Population Segments, Organized by Wealth Distribution (Decile), in 10 Countries a. Ethiopia b. Mali 60 60 40 40 Percent Percent 20 20 0 0 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 Decile share in total amount of subsidies Decile share in total amount of subsidies Decile share in total expenditure Decile share in total expenditure c. Niger d. Nigeria 80 40 60 30 Percent Percent 40 20 20 10 0 0 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 Decile share in total amount of subsidies Decile share in total amount of subsidies Decile share in total expenditure Decile share in total expenditure e. Uganda f. El Salvador 80 30 60 20 Percent Percent 40 10 20 0 0 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 Decile share in total amount of subsidies Decile share in total amount of subsidies Decile share in total expenditure Decile share in total income figure continues next page Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 33 FIGURE 2.5. continued g. Jamaica h. Panama 40 40 30 30 Percent Percent 20 20 10 10 0 0 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 Decile share in total amount of subsidies Decile share in total amount of subsidies Decile share in total expenditure Decile share in total income i. Bangladesh j. Vietnam 30 25 20 20 15 Percent Percent 10 10 5 0 0 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 Decile share in total amount of subsidies Decile share in total amount of subsidies Decile share in total expenditure Decile share in total expenditure Source: Authors’ own compilation based on household surveys, administrative data, and cost-reflective tariff data. Note: All figures are calculated using sample weights. Total expenditure is total household expenditure in all categories. The distribution of expenditure (all countries except El Salvador and Panama) or income (El Salvador and Panama) refers to the countrywide distribution of expenditure per capita, that is, households are ranked according to their expenditure per capita. (i.e., if the share of subsidy is less concentrated in the networked services even though the poorest com- top deciles than the expenditure distribution). munities are typically in areas not serviced by net- Although subsidies across all 10 countries are regres- works. Second, even where poor households could sive, we find that in half of the cases, they do, in fact, connect to a network, many do not do so because reduce inequality15 (El Salvador, Jamaica, Nigeria, they cannot afford the connection and/or consump- Panama, and Vietnam). tion charges.16 The result is that many rich house- An analysis of how well consumption subsidies holds are included in the subsidy pool, while even target their intended beneficiaries in 10 countries sug- ­ more poor households are excluded (see table 2.3). gests that poor performance does not arise primarily This issue is particularly pronounced in the five from the subsidy design, but from two factors related African countries analyzed, where errors of inclu- to access. First, most WSS subsidies focus on sion and exclusion fall between 90 and 100 percent, 34 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation BOX 2.5. Materiality of Subsidies for the Poor: Networked Water Services in Ten Countries It should be emphasized that subsidies are in fact quite important to the poor since they represent a substantial part of the poor’s consumption expenditure. In order to better understand the impact that subsidies have on poor households that receive them, we constructed a measure of materiality as part of our analysis of the targeting performance of networked water subsidies in the 10 countries analyzed. The materiality of a subsidy is defined as the value of the subsidy for a given recipient household as a share of that household’s total expenditure. According to this analysis, materiality varies significantly across the 10 analyzed countries: from a high of 100 percent in Mali to a low of 5 percent in Uganda. In Ethiopia and Panama, subsidies constitute about 60 percent and 50 percent, respectively, of the consumption expenditure of the poorest decile. These results imply that, in many countries, subsidies are critical to ensuring consumption of networked water among those poor households that have access to the service. Yet only a small proportion of the poorest households have access to networked water services in these countries, due primarily to factors related to access. Therefore, with improved targeting, subsidies have great potential both to advance poor households’ access to networked water services (and, we might extrapolate, to sewered sanitation services) and to reduce poverty. Source: Authors’ compilation. TABLE 2.3. Water Consumption Subsidies: Errors of with the exception of Nigeria’s 74 percent error of Inclusion and Exclusion in 10 Countries inclusion. It should be noted, however, that subsidy Error of Error of design improvements could also be beneficial, as inclusion (%) exclusion (%) subsidy design factors (i.e., the subsidy’s type or Ethiopia 96.0 97.6 structure) on their own tend toward a neutral target- Mali 97.8 99.2 ing performance. (See box 2.1 near the beginning of Niger 99.7 99.9 this chapter for more on how both access- and Nigeria 74.4 89.6 design-related factors explain the inefficacy of IBTs Uganda 98.3 99.6 across different contexts.) El Salvador 82.0 78.3 Jamaica 77.6 53.1 Distributional Performance of Subsidies of Initial Costs and Connection Charges Panama 71.1 38.6 Bangladesh 87.7 95.5 Where households have limited access to service, subsi- Vietnam 66.5 50.3 dizing the initial costs of gaining access generally bene- Source: Authors’ own calculations using country-specific household fit the poor. This is because, in many cases, a lack of surveys, administrative data, and estimated cost-reflective tariffs. access to WSS services is a good proxy for poverty.17 Note: Poor households are defined as belonging to the first four deciles of the expenditure (or income) distribution in each country. Error of Therefore, even without targeting a specific customer inclusion is measured by the percentage of all beneficiary households that are rich; error of exclusion is measured by the percentage of poor group, subsidies of initial costs and connection households that do not get a subsidy. All figures are calculated using charges often prove progressive since, by definition, sample weights. Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 35 TABLE 2.4. An Overview of Connection Subsidies Targeted subsidies Untargeted subsidies Explicit targeting Implicit targeting Self-selection Administrative selection Mechanism No connection fee* Flat connection fee for Reduced connection fee for “Social connections” Subsidized interest rate unmetered connections, households that provide their for financing connections subsidizing high-volume own labor/materials or opt for consumers a lower service level Beneficiaries All new customers New connections that cost Households that provide their Households classified as more than the average to own labor or opt for a given poor or within designated connect due to technical service level geographic areas complications Source: Simplified version of Komives et al. (2005). Note: *That a connection charge is missing or discounted does not necessarily imply that a subsidy is in place, since a utility can recover connection costs by billing customers a recurring fixed charge. they are available only to unconnected or unserved benefit the land or facility owner. In the case of rented households. Table 2.4 categorizes several examples residences, if a connection subsidy is provided, the of connection subsidies and lists their beneficiaries. main beneficiary will be the homeowner, through It is important to note, however, that in the case of the consequent increase in property value (and, networked water and sewered sanitation services, a possibly, monthly rent charges). ­ given household’s ability to gain access is predicated Thus, when assessing the effectiveness of access sub- on location. Thus, related infrastructure must be sidies in reaching the poor, it is necessary to not only available within poor neighborhoods for connection know the number of people without access but also the subsidies of networked/sewered services to effec- reasons why. As pointed out by Komives et al. (2005), tively reach the poor. underlying factors will vary from place to place, with Meanwhile, not all households eligible to receive a implications for the effectiveness of subsidies. connection subsidy will ultimately decide to connect. 2.4  Most Subsidies Are Not Transparent Apart from the connection charge, when deciding whether or not to connect, households will consider Given the challenges of estimating the full costs of WSS the quality and reliability of water or sanitation service provision (as discussed above), the actual magni- ­ services, the recurrent tariffs or fees that they will tude of subsidies in the sector is rarely known to govern- have to pay, and the cost and quality of possible ments, regulators, or citizens. Without even an estimate alternatives. They will also consider the costs of nec- of this magnitude, policy makers are unable to make essary in-house upgrades required to fully enjoy the informed decisions on subsidy design and allocation. benefits of the networked/sewered service. These ­ And since a utility possesses more information about upgrades are particularly relevant in the case of its cost structure and level of efficiency than any sanitation services, and may cost more than the ­ ­ ­ ifficult to over- regulator, the lack of transparency is d connection charge itself. ­ come. This so-called informational asymmetry gives Another issue to consider is that access subsidies the utility a bargaining advantage that can lead to do  not always benefit the consumer, but may instead inadequate services, inflated costs, or both. 36 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation Evidence suggests that citizens are often unaware of ministry and utility com- Citizens are often or do not understand how expensive and inefficient panies (public or private) unaware of or do not current subsidies may be. Consequently, it is often dif- has been a focus of water ficult to gain public support for reform efforts that sector reforms (Le Blanc understand how would result in increased tariffs both because the 2008). The reason why expensive and public may perceive current tariffs to be cost-­ collusive arrangements reflective (and thus water production to be relatively persist can be explained inefficient current inexpensive) and because of a lack of awareness of by (i) administrative sim- subsidies may be. the adverse implications of the current subsidy plicity, as subsidies given (Gallaher, Alam, and Rouchdy 2017). to suppliers are “one-off,” Such information asymmetry and lack of transpar- the use of these funds are fungible and generally ency in cost structures, coupled with difficulty in undocumented, and the benefits are supposed to ­ monitoring maintenance needs and service provider trickle down to consumers; and (ii) corruption among performance, may render service providers unaccount- government officials and suppliers, spurred by a lack able for the use of scarce public resources as they fail of transparency. to benefit customers through improved service quality The influence over policy decisions possessed by pro- and/or reduced costs. A particularly opaque method fessionals in the field, a power known as professional of subsidization is general financial support to the dominance, jeopardizes the effective governance of service provider (through transfers to cover opera- subsidies. Given the technical and specialized nature tional expenditures, direct funding of capital assets, of their work, WSS engineers have credentials and a tax exemptions, subsidized prices for inputs, loan set of technical skills that give them a degree of guarantees, and so on). The government entity pro- autonomy, power, and dominance in the market. viding the subsidy hopes that the service provider These enable them to influence key features of ser- will pass it on to consumers in the form of improved vice delivery, including investment priorities, the services at lower costs. But since the service provider organization of supply, and standards of service, all is responsible for allocating the subsidy, much of the of which directly affect the size and type of subsidies financial support may end up being captured by the in the sector (McLoughlin and Batley 2012). provider’s management and employees instead of Professional dominance can also directly promote going toward the maintenance required to sustain or information asymmetry, leading to reduced upward improve the level of service. The customers, mean- accountability to government or regulators, and while, may scarcely benefit from the subsidy, reduced downward accountability to citizens. Water whether in the form of improved service quality or sector professionals and providers might even have reduced costs, and may even see service quality an incentive to “exclude competitors, manipulate deteriorate as maintenance is neglected. prices, or oppose reform,” which promotes ineffec- A related problem is so-called regulatory capture, tive subsidies to the detriment of more pro-poor and which occurs when the regulator colludes with utilities affordable services (Mason, Harris, and Batley 2013). at the expense of taxpayers. 18 Where institutional There is some indication that such rent-seeking capacity is limited and corruption common, securing behavior is more prevalent where private providers the regulator’s independence from both the water grow large and establish monopoly power.19 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 37 It is challenging to administer subsidies in contexts service providers. Though it can be argued that these where several levels of government oversee the WSS are not necessarily a direct impact of subsidization, sector, as is common in most countries. Shared over- subsidies can intensify prevailing distortions and sight, coupled with asymmetric access to informa- affect incentive structures, thus exacerbating ineffi- tion between the subnational and central levels of ciencies in service provision. government, can lead to several difficulties. Local Contributing to a Misuse of Public Resources needs are difficult for central authorities to observe Subsidies, even when structured to reward perfor- and estimate, and this may result in suboptimal lev- mance, can generate perverse incentives for service els of investment.20 Also, administrative complexity providers if not properly designed. For example, can provide cover for rent-seeking. For example, providing subsidies to utilities conditional on the ­ central authorities may deliberately foster opacity in number of connections serviced is a common out- intergovernmental allocations and the timing of put-based-aid approach (Rodriguez et al. 2014). transfers, in some cases influenced by patronage pol- A flat amount (subsidy) is provided in exchange for a itics at the local level. tangible outcome (e.g., a household’s first connec- Governments can exploit subsidies to advance their tion to piped water), in the hope this will promote political agendas, by manipulating cost allocations and access to piped water. However, if the government showing preference for certain demographic groups or does not additionally guarantee a profit for each cus- geographic areas. Section 2.3, for example, presents tomer connected, such an arrangement will, in prac- evidence on how Albanian politicians show prefer- tice, create an incentive to supply water primarily to ence for politically affiliated local governments in high-consumption areas with lower connection capital grant allocations. In other settings, subsidies costs; meanwhile, smaller, peri-urban, and rural con- targeting primarily middle- and high-income house- sumers will likely remain underserviced.21 At the holds might appeal to politicians if these groups are same time, utilities may use this distortion to cap- more likely to vote in elections and/or influence ture part of the subsidy pie. political outcomes. Contributing to the Deterioration of Service 2.5  Most Subsidies Are Distortionary Providers’ Performance Poorly designed subsidies lead to significant distor- Poorly designed subsidies contribute to inefficiency, tions that can contribute to the misuse of public and may even threaten service sustainability. Utilities resources, the deterioration of service providers’ per- may find themselves trapped in a vicious circle formance, and the overexploitation of natural whereby low tariffs lead to revenue losses and resources. As a departure required maintenance is postponed, leading to Poorly designed from an efficient, per- mounting losses. This in turn harms their creditwor- fectly competitive market thiness, inhibiting utilities from accessing commer- subsidies contribute to (Lipsey and Lancaster cial finance (Goksu et al. 2017). inefficiency, and may 1956), subsidies tend to As has been discussed, water and sanitation tariffs affect the consumption have historically been set well below cost-recovery lev- even threaten service and production decisions els in most low- and middle-income countries, often sustainability. of both consumers and with the goal of ensuring that the poor can afford them. 38 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation Such tariffs are made possible by the WSS sector’s utility particularly vulnerable to economic and very large sunk costs, long-lived fixed assets with political shocks, which can lead to the deterioration few alternative uses, and large economies of density of service and even the eventual collapse of the util- and scale that lead to a very high ratio of fixed to ity (see box 2.6). variable costs. WSS utilities can operate for long As visualized in the accountability framework for ­ periods of time without recovering all of their fixed service delivery developed in the World Development costs, although these costs will need to be covered Report 2004, the main channels of accountability are eventually to facilitate necessary repairs and replace- relationships between three sets of actors: policy ment. The maintenance needs of underground piped makers and politicians, service providers, and citizens networks in particular are difficult to observe and (see figure 2.6). The most efficient way for citizens monitor, often leading to underinvestment in their to hold service providers accountable is through maintenance. Inadequate maintenance shortens the ­ client power, known as the “short route” of account- life span of assets, reduces service quality and cover- ability, whereby service providers must meet the age, and contributes to financial losses. demands of the consumer—quality service at an Faced with the severe social costs stemming from affordable price—to maintain viability. Meanwhile, the interruption of a crucial service, public authorities the “long route” of accountability—which relies on generally opt to heavily subsidize service providers. the state as an intermediary—is important in meet- But this may weaken fiscal discipline, as poorly ing priorities not reflected in the purchasing power designed subsidies often have perverse incentives of consumers (World Bank Group 2003). Yet, when that encourage cost padding, condone inefficiency, heavily subsidized, a utility’s cost-benefit calcula- and undermine service quality. Importantly, such tion changes; while under free market conditions, dependence on a government subsidy renders the the revenue to be gained from undertaking any BOX 2.6. Subsidies and Resiliency to Economic and Political Shocks: The Case of South Sudan South Sudan has been unable to provide its urban population with a reliable water supply due to an overdependence on subsidies whose funding rests on the fluctuations of a commodity market. Since the 2005 signing of the Comprehensive Peace Agreement that paved the way for the establishment of the independent Republic of South Sudan in 2011, the state’s incentive to invest in and develop urban water supply has fluctuated. Factors include the availability of oil revenues to subsidize supply, the inexperi- ence of the nascent government in undertaking reform, and general security challenges that have often disrupted government revenue flows. As a result of its dependence on inconsistent government subsidies, public water supply is at best unre- liable, but most often nonexistent for urban residents. Private sector water providers have mushroomed to meet demand in urban areas, with water bottlers, jerry can vendors, and water truck haulers serving customers with both treated and untreated water supply, often at very high prices. The expensive, informal, and unregulated private water supply is a daily reminder for most urban residents that the new government is unable to provide the most basic services. Source: de Waal et al. 2017. Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 39 FIGURE 2.6. Routes of Accountability in Service Provision The state Politicians Policy makers te of accountabi g rou lity Lon Co mp ac ce t Voi Citizens/clients S h or t ro ut e Providers Coalitions/inclusion Management Client power Nonpoor Poor Frontline Organizations Services Source: World Bank Group 2003. service improvements and extensions to uncon- encourage efficient production or consumption. By nected customers may exceed the costs of such affecting prices, subsidies indirectly distort economic efforts, under subsidized conditions, this potential agents’ choices. On the supply side, subsidies may revenue may now be offset by the potential loss of discourage utilities from increasing their efficiency the subsidy. As a result, client power effectively by reducing water losses. On the demand side, subsi- breaks down, with only the long route of account- dized prices may discourage consumers from seeking ability remaining. This route is not only more cum- efficient providers or encourage overconsump- more ­ bersome, but depends upon the state acting in the tion in a context where true prices would encourage best interests of its citizens. conservation. Therefore, when subsidies are not responsibly managed, they can have large-scale neg- Contributing to the Overexploitation of ative impacts on the environment and prevent effi- Natural Resources cient resource use and allocation. Subsidized tariffs do not reflect the true cost of a ser- Pricing strategies that do not cover the full cost of vice and therefore cannot provide signals that might service incentivize overconsumption. Flat rates 40 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation provide the starkest example of this, since payment Notes is not conditional on the amount of water consumed. 1. The economic subsidy of a utility is calculated as the difference Usually these flat rates do not generate enough reve- between revenue and the economic cost of service. The economic cost of service encompasses all the economic resources deployed for nue to cover the cost of providing piped water and service provision, including the cost of not only O&M but also all cap- result in substantial amounts of subsidies, which are ital (depreciation plus return on capital), as well as costs imposed by operational inefficiencies. The methodology used to estimate the not targeted to the poor. So why do inadequate pric- economic cost of service provision for each utility in the IBNET data- ing strategies persist? One reason is that they are base is discussed in detail in appendix B. easy to understand and implement, which are cru- 2. See Komives et al. (2005), chapter 2, and the references therein. cial factors where administrative capacity is limited. 3. This is a controversial issue since the mere existence of a subsidy Moreover, flat rates are preferred by large consumers may create perverse incentives for the utility to relax its productive efficiency, hence augmenting the need for the subsidy. Subsidies to of water, which are likely to have influence in politi- the supplier (i.e., those given directly to the utility like payment for cal spheres. To counteract overconsumption, quanti- labor, power, or chemicals) disincentivize production efficiency gains. Furthermore, the monopolistic nature of networked service, ty-targeted subsidies such as increasing block tariffs in combination with poor regulation, allows utilities to pass the (IBTs) are options, given that a higher tariff can be set costs of their inefficiency on to users (and, eventually, the government). above a certain volume to create a disincentive to consume more than a given quantity. However, for   4. Different service types typically entail different costs. The same util- ity may choose to provide services of varying quality levels to appeal an IBT to achieve the objective of reducing water to users with differing consumption needs or abilities to pay. use, customers must respond to marginal, not aver-  5. See background paper 2 (listed in appendix A) for an analysis age, prices. But because tariffs in most low- and and quantification of the impact of inefficiencies on costs and subsidies. middle-income countries are so low, households ­ are  more likely to respond to average prices   6. The Chilean method aims to maximize both allocative efficiency (by setting tariffs equal to marginal costs) as well as productive effi- (the total bill) than marginal ones. Also, many IBT 22 ciency (by producing efficient quantities at the lowest cost possible, tariff structures are complex and hard to understand, without passing on additional inefficiencies to the customers through pricing) and also allows each utility to generate enough rev- which is likely to strengthen the focus on average enue to cover the costs incurred in providing the service. The cus- costs (Nauges and Whittington 2017). tomer bases of the various Chilean water and sanitation utilities range widely in size, from a few thousand to even over a million, The ramifications of such inefficient production and reflecting the heterogeneity present within the sector globally. The overconsumption can be profound—water insecurity resulting data capture the nuances of various cost structures, improving the accuracy of the Chilean model utilities when com- resulting from the overexploitation of water resources pared with other countries that have undertaken similar approaches. has contributed to some of the most tragic humanitar-  7. In this context, greenfield capital investment refers to the capital ian crises over the past decade, including the civil war investment required to construct all facilities necessary to provide a in Syria, local conflict and collective violence in Yemen, given level of WSS services to a utility’s customer base, independent of any preexisting infrastructure or site-related constraints. instability in northern Mali, and ethnic conflict in Kenya (Sadoff, Borgomeo, and de Waal 2017). Even high-­   8. It is important to note that our use of Chilean data as a basis for esti- mation does come with a few limitations. An assumption made in capacity environments are not immune; Cape Town, our methodology is that Chile’s geographical conditions are faced by South Africa, recently requested the World Bank’s all utilities. In our model, we assign an asset per customer value based on data from 15 Chilean firms, while in reality a utility’s invest- advisory support after years of environmentally ment plan is strongly influenced by the geographical conditions of unsustainable WSS policies and unprecedented the area it serves. For example, greater investment in certain assets may be required to operate in a particular environment. More specif- drought left the city on the brink of running out of ically, different countries have access to different water sources that water (World Bank Group 2018a). facilitate (or complicate) extraction, leading to lower (or higher) Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 41 expenditures on assets. In addition, access to technology plays a subsidy benefits received by the poor (SP  /SH), divided by the propor- role, for example, newer and better machinery can greatly reduce a tion of poor households in the total population (P/H). The indicator utility’s operational expenditures. Also, Chile is among the world’s can be split into factors related to water network access and subsidy most open economies, with low to nonexistent import taxes, while design. Factor values below 1 indicate that the factor contributes to commercial barriers in other countries drive up the cost of imported reduced target performance, and vice versa. assets, resulting in higher capital expenditures. Quality standards 17. This assumes that the service is not new and that wealthier house- also vary between countries: high-income countries usually have holds have, by and large, already connected to the service. higher standards than low-income countries. As a consequence, the latter often require more investment to improve service quality, 18. The problems associated with asymmetric access to information which is reflected in higher tariffs. between utility companies and regulators have received a lot of attention in the economic literature, notably by Joskow (2005) and 9. Although utilities in many countries treat fecal sludge collected from Laffont and Tirole (1993). on-site sanitation options, these costs are excluded from our estima- tion due to data constraints. 19. For example, in Honduras, according to evidence discussed by Savedoff and Spiller (1999: 49), “In SANAA [Servicio Autónomo 10. See more details about the methodology in appendix B. Nacional de Acueductos y Alcantarillados], the workforce captures a 11. A collaborative effort of the United Nations and World Health large proportion of system rents through a union that has estab- Organization, the Joint Monitoring Programme is tracking interna- lished very high staffing levels in Tegucigalpa . . . the union has tional progress toward the Sustainable Development Goals. acquired such strength and predominance in the company that the nomination of technical, administrative, and manual staff requires 12. It is important to note that consumption subsidies include all subsi- union approval, as do decisions related to operations and control.” In dies that reduce the recurring cost of service to users, that is, subsi- practice, however, levels of expertise and autonomy from piped-wa- dies earmarked to reduce tariffs directly, as well as those that reduce ter providers vary substantially across contexts. In many countries, the cost of service provision, and thus reduce tariffs indirectly. providers have been commercialized and/or privatized to increase These include general budgetary support to service providers, sup- autonomy, but there is often no clear way to guarantee that techno- port toward capital investments, reduced costs of inputs or  taxes, crats and managers are insulated from political elites. Moreover, the and so on. Access subsidies, conversely, reduce a user’s one-time deeply intertwined relationship between the state and utilities, access cost to a level below the cost of extending service to that user. especially when service providers are dependent on public financ- 13. The restriction of the study to 10 countries, chosen based on geo- ing, can give leverage to government actors, further compromising graphical diversity and also the availability of data, is due to time service providers’ autonomy (Mason, Harris, and Batley 2013). and resource constraints, and the scope might be expanded in the 20. For more on the general governance of intergovernmental transfers, future. See more details about the methodology in background see Broadway and Shah (2007). paper 7 (listed in appendix A). 21. This was found to be the case in Côte d’Ivoire, where the private 14. The value of the subsidy to each connected household was calcu- water system operator was reimbursed a flat fee for each social con- lated using imputed water consumption volumes from self-reported nection. This led to inefficiencies and poor subsidy coverage, as household water expenditure data, and multiplying this quantity by informal settlements and particularly poor areas were underser- the difference between the cost-recovery tariff and the average unit viced (Lauria and Hopkins 2004). price of water paid by that household. The cost-recovery tariff was calculated using the methodology presented in section 2.2 for esti- 22. For instance, Ito (2013) finds that consumers in Southern California mating the magnitude of subsidies. adjust their water consumption in accordance with changes in average price, rather than marginal or expected marginal price. This ­ 15. A subsidy reduces inequality if it is less regressive than the distribu- suboptimizing behavior makes nonlinear pricing unsuccessful in tion of expenditure or income. achieving its policy goal of conservation and further impacts its Our analysis follows the methodology from Komives et al. (2005), 16. effect on welfare. Ito (2014) finds similar results for electricity which defines the targeting performance indicator (Ω) as the share of pricing. 42 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation CHAPTER 3 Designing Effective and Efficient Subsidies Although current water supply and sanitation (WSS) subsidies tend to be perva- sive, expensive, nontransparent, distortionary, and poorly targeted, such poor outcomes are not a given. Well-designed subsidies are indeed an important and necessary policy instrument for decision makers, who can use them to effec- tively and efficiently attain their objectives and avoid the adverse impacts of the past. Improving the efficacy and efficiency of subsidies requires careful consideration of five key questions: 1. What is the context? 2. What are the policy objectives that the subsidy seeks to achieve? 3. What are the target service(s) and/or population(s)? 4. How will the subsidy be funded? 5. What subsidy design will be most effective and efficient? In this chapter, we provide guidance to policy makers on how each of these questions may be best approached. Since socioeconomic factors, WSS service ­ delivery modalities, levels of institutional capacity, and fiscal space vary sub- stantially from context to context, we do not seek to provide explicit recom- mendations on what should be subsidized and how. Instead, we discuss the myriad factors and policy options that should be considered along the way, therefore providing a roadmap for policy makers to follow in assessing their particular context and determining the most effective and efficient subsidy design. 3.1 Understanding the Context The first step in designing effective and efficient subsidies is to understand the policy context within which the subsidy will be implemented. It is important for policy makers to develop a thorough understanding of the current structure of the sector and the efficacy of existing subsidies in achieving their underlying Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 45 goals. Subsequently, a political economy lens should from the perspective of both the government and be used to assess the sector’s institutional and finan- taxpayers. By identifying the ultimate beneficiaries cial structure, the reasons behind an unsatisfactory of the subsidy and how they compare with those status quo (where applicable), and opportunities to outlined in the original objectives, the subsidy’s tar- improve and propel subsidy reform. Finally, policy geting efficiency and the extent of any required makers should investigate the affordability barriers reform can be assessed. to WSS service provision. By developing a thorough Policy makers should subsequently assess the trans- understanding of which households are unable to parency of the subsidy, focusing particularly on public afford access and/or consumption costs, they can perceptions and opportunities for rent-seeking. As dis- better identify the service(s) and/or population(s) cussed in section 2.4, a lack of transparency allows that subsidies will need to target. some service providers to misuse scarce public resources, failing to benefit customers through Understanding Existing Subsidy Performance improved service quality and/or reduced costs. Policy makers should seek to understand how effective Understanding a subsidy’s current degree of trans- and efficient existing subsidies are at attaining their parency will shed light on opportunities for underlying goals prior to deciding how they should be improvement. reformed. As discussed in chapter 2, most existing Finally, any distortionary impacts that reduce the subsidies are expensive, poorly targeted, not trans- efficacy and efficiency of WSS service provision should parent, and distortionary. Policy makers should be considered. As discussed in section 2.5, poorly invest in a thorough analysis of how existing subsi- designed subsidies lead to significant distortions dies perform in relation to each of these characteris- that can contribute to the misuse of public resources, tics. In particular, they need to understand the the deterioration of service providers’ performance, magnitude of public resources being expended, the and the overexploitation of natural resources. Such ultimate beneficiaries of these resources, the pub- adverse impacts can be mitigated by gaining an lic’s perception of the subsidy and any opportunities appreciation of the scale of the problem and recon- for misappropriation, and the adverse impacts on sidering a subsidy’s design accordingly. sector performance and resource allocation. Using this information, policy makers can then improve Understanding the Political Economy subsidy design to avoid current pitfalls. Upon investigating the factors related to the technical An assessment of existing subsidy performance design of existing subsidies that affect performance, begins with an estimation of the magnitude of public policy makers require a comprehensive understanding expenditure and the ultimate beneficiaries of that of the political economy factors that also impact sub- expenditure. This magnitude represents the public sidy performance and, importantly, can either propel or resources that, even in the absence of increased hinder subsidy reform. Thus far, this report has high- budgetary allocations from the government, are at lighted many such factors, including: distributional play in the reform process. Accounting for implicit, concerns about who benefits and how this might in addition to explicit, government transfers can sway their political support; citizens’ expectations clarify that the magnitude of subsidy is greater than and (sometimes inaccurate) perceptions regarding previously understood, raising the priority of reform who benefits from subsidies; whether or not users 46 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation are expected to pay for the full cost of services; and poor performance. These might hinge on insti- asymmetries of information between central and tutional factors—such as a lack of organizational local governments, as well as between these govern- or fiscal autonomy—that affect the incentive ments and service providers. structures of the service provider or other stake- Efforts to reform subsidies have had widely varied holders. The political economy reasons for the results across countries, with successes often predi- persistence of ineffective policy are particularly cated on reformers’ ability to understand and strategi- important to consider when analyzing subsidies cally overcome political barriers. The required analysis that target the poor. Increasing block tariff con- will generally consist of three steps: sumption subsidies in many countries, for example, have proven to primarily benefit the 1. Assessing the current setup.  An assessment of rich, and remain in place due, in part, to the dis- (i) the WSS sector’s institutional structure and proportionate political influence of the rich. (ii) how subsidies are currently organized allows Understanding a dynamic like this sheds light for a better understanding of the prospects for on the political forces and coalitions that will reform. This process begins with a thorough need to be either fostered or overcome to move cataloging of existing subsidies, including their past an unsatisfactory, yet stable, status quo. objective, type, scale, beneficiaries, and the 3. Identifying opportunities to improve and propel scale of distortions that they cause. An analysis subsidy reform. Building upon an understanding of when, how, and why subsidies developed, of the current political economy of the WSS sec- and what their original objectives were (whether tor, attention can now be turned to the future: formally stated or hidden), can highlight valu- identifying opportunities for reform and develop- able characteristics of the political and adminis- ing strategies to overcome institutional and trative decision-making process, including how policy-related bottlenecks. Important lessons ­ interest groups are organized, their relative about what works can be gleaned from the influence over policy, and their priorities. Also, experiences—both successful and not—of various ­ the areas and services favored by subsidies—for countries presenting contextual similarities.1 example, water vs. sanitation, networked vs. Policy makers should use their understanding of nonnetworked water, sewered vs. on-site sani- the local political economy to develop a plan to tation, and rural vs. urban areas—might reflect both (i) mobilize political coalitions to support the implicit government biases that may need to be intended reform (see section 4.2 of chapter 4 for reconsidered. more detail); and (ii) sequence the elements of a 2. Understanding reasons behind an unsatisfactory subsidy reform package2 so as to improve the like- status quo (where applicable).   If a particular lihood of its success. subsidy was initially conceived to be short term, its reasons for persisting should be inves- tigated. Where a subsidy is failing to achieve its Understanding Affordability intended objectives, a political economy analy- An up-front understanding of affordability barriers to sis can determine the key institutional and WSS service provision is imperative to the subsidy ­ p olicy-related bottlenecks that explain its design process. The number of households facing Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 47 affordability barriers to WSS service accessibility, impose an “unreasonable” burden on the consumer. their relative socioeconomic characteristics and Affordability will therefore vary across households, geographic locations, and the gap between what and depends upon the selection of the bundle of each household can reasonably be expected to pay WSS services determined by the policy maker to be and the total cost of service, in addition to any desirable. Different baskets of WSS services may be ­ liquidity barriers, are all crucial to answering the assigned to different users and in different contexts, four subsequent key questions. Affordability deter- reflecting that: (i) service providers may offer users mines: (i) whether a subsidy is required to advance various levels of service; and (ii) policy makers’ equitable access to affordable WSS services; (ii) the targets for service provision are shaped by context-­ ­ service and/or population that should be targeted; specific factors such as cultural preferences or (iii) the magnitude of the subsidy required, which in resource constraints. The higher the standard of ser- turn constrains the available funding options; and vice a basket represents, the fewer the number of (iv) the subsidy design options that would be most households who will find it affordable. effective and efficient. Despite the importance of affordability, there is no In brief, affordability entails that a bundle of WSS consensus on how to measure it, though various services with multiple attributes such as quantity, options have been proposed by policy makers. Box 3.1 quality, and timing is available at a price that does not describes the most common method for measuring BOX 3.1. An Improved Approach to Measuring WSS Affordability The most common method for measuring affordability is to compare a household’s spending on water and sanitation to its total expenditure (Smets 2012). This ratio is then compared with a defined value, or threshold. If the ratio exceeds the threshold, then it signals that water supply and sanitation (WSS) costs are unaffordable. There are several drawbacks to this approach, however, including its reliance on possibly inaccurate expenditure estimates, and its inability to capture the entire spectrum of costs for WSS services. Also, as it focuses on measuring what a household can “fairly” be expected to spend on WSS services, it may not capture what the household is actually willing and able to pay. An improved approach based upon the poverty line, the accepted methodology for measuring poverty, can overcome many of these drawbacks to better assess the affordability of WSS services. Poverty is commonly measured by comparing household income to a set poverty threshold or minimum income needed to cover basic needs. Households whose income falls below the threshold, or line, are consid- ered poor or unable to afford the goods and services necessary to meet their basic needs. Note that this approach considers the following elements: (i) basic needs, defined as a basket of goods and services; (ii) the costsa of this basket of goods and services; and (iii) the total income distribution within the relevant population. Note also that this approach does not consider families’ actual expenditure on the items included in the defined basket, or their willingness to pay for them. box continues next page 48 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation BOX 3.1. continued Under an improved model, a predefined level of water supply, sanitation, and hygiene (WASH) service is unaffordable to a household if the cost of purchasing that level of service is more than a fixed shareb of the total consumption expenditure. This approach provides additional information directly relevant to policy makers; it can disaggregate households on the basis of: (i) whether they currently have access to the pre- defined level of service; (ii) whether they can afford the recurring costs of using the service; and (iii) whether those who currently lack service could afford the initial fixed costs of connecting to/accessing the service. Moreover, the method provides insight into the difference between households facing fully cost-reflective prices (i.e., before subsidies) and households facing subsidized prices. This can contribute to improving the targeting and transparency of government resources designed to facilitate access to WASH services. This approach also facilitates a scenario analysis, determined by whether a household currently uses the minimum basket of WSS services, and whether it is able to pay for these services. We visualize these sce- narios as four quadrants (figure B3.1.1): households who currently use the minimum basket of services but cannot afford to pay for it (Quadrant 1),c households without access to the minimum basket of services and who cannot afford to pay (Quadrant 2), households without access but who could pay (Quadrant 3), and households who currently use the minimum basket of services and can pay for it (Quadrant 4). FIGURE B3.1.1. The Access and Affordability of Service: Four Scenarios With access to service Quadrant # 1 Quadrant # 4 Without access to service Quadrant # 2 Quadrant # 3 Unaffordable Affordable Source: Andres et al., forthcoming. Note: This figure considers a hypothetical “basket” of services that would meet a household’s basic needs. The word “access” is used to denote both access to services and their continuous use. In other words, affordability takes both access and consumption charges into account. Source: Andres et al., forthcoming. a. The approach allows for flexibility in how costs are estimated. Such costs can include the total initial and recurrent costs (i.e., before any subsidies are applied) or only the tariffs and fees that households actually pay (i.e., the postsubsidy price). b. The commonly used threshold of 5 percent can be adopted, or policy makers can define their own threshold based upon the local context. c. Note that households in quadrant 1 are currently paying for the minimum basket of services despite being classified, according to the chosen affordable threshold, as unable to afford the costs. Since these households are currently paying for and using the services, households without access to the service are likely a higher policy priority. Nevertheless, policy makers may choose to provide subsidies to these households to bolster their disposable income available for other purposes. Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 49 affordability and proposes an improved approach, Defining Policy Objectives 3.2  which facilitates a more comprehensive analysis of The specific policy objectives that a prospective sub- affordability by disaggregating households on the sidy seeks to attain largely dictate its design. As dis- basis of: (i) whether they currently have access to the cussed in chapter 1, the most common policy predefined level of service; (ii) whether they can objectives that WSS subsidies seek to attain are: afford the recurring costs of using the service; and (iii) whether those who currently lack service could • Advancing equitable access to affordable WSS afford the initial fixed costs of connecting to/access- services ing the service. • Harnessing positive externalities associated with A comprehensive analysis of affordability, such as WSS services through the method proposed in box 3.1, provides the policy maker with important insights into which popu- The first policy objective specifically targets the lations require support, and whether one-time access provision of WSS services to the poor and marginal- costs or recurrent consumption charges pose the ized, while the second objective aims to promote spe- greatest challenge to affordability. The policy maker cific services or behaviors in geographic areas that can then use these insights to inform key policy deci- have an outsized impact on broader society, namely sions later in the subsidy design process: (i) whether through environmental impacts and/or public health. or not a subsidy is required to advance equitable Before moving forward, it is important to note that access to affordable WSS services; and, if a subsidy is in most cases, a subsidy’s target population or ser- decided on, its (ii) target service(s) and/or popula- vice will differ depending upon which objective tion(s), and (iii) most effective and efficient design. is selected. Therefore, multiple objectives will From a policy point of view, households without generally require targeting different populations or ­ access and unable to pay for the prospective service services. are of the most interest,3 since they are the ones most A single policy instrument—no matter how inge- likely to benefit from targeted subsidies aimed at niously designed—is unlikely to meet all policy objec- increasing access to services. Furthermore, the tives simultaneously. As an example, a subsidized development of two separate affordability models— price may make access to water more affordable but one including access costs at the same time may condone waste and even com- in addition to consump- promise the sustainability of service provision. A single policy tion charges and one Different objectives call for the use of different without—can identify instruments. For instance, prices can be raised to instrument—no matter promote cost recovery and signal scarcity, but equity which households within how ingeniously this quadrant require considerations may call for any price increases to be merely a subsidy for ini- accompanied by compensation or transfer mecha- designed—is unlikely to nisms (World Bank Group 2018c). tial access costs, and meet all policy which households would There are many ways in which subsidies can advance additionally require a equitable access to affordable WSS services, all of objectives which seek to either reduce the cost of service to end recurrent subsidy of con- simultaneously. sumption charges. users (i.e., ensure a minimum level of consumption) 50 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation or  expand service areas to unserved populations Identifying the Target Service(s) and/or 3.3  (i.e., expand access). Costs of service can be reduced Population(s) through either supply- or demand-side subsidies. Upon selecting a policy objective, policy makers must For example, any reductions in the costs of infra- determine which service(s) and/or population(s) will structure construction/rehabilitation or operations be targeted. As with policies in general, there is no and maintenance may, ideally, be passed down to one-size-fits-all solution to the problems of inade- users in the form of lower prices. Similarly, any quate access to or con- investments that improve the operational efficiency sumption of WSS services: There is no one-size- of a service provider should reduce costs to users. the most suitable policy fits-all solution to the Demand-side subsidies can also be used to directly will depend on the spe- reduce user tariffs. Meanwhile, the population that cific goals to be attained, problems of inadequate can access WSS services can be expanded through the context in which it is access to or the subsidization of new infrastructure and services, to be implemented, and such as new pipelines into previously unserved consumption of WSS the resource constraints neighborhoods, new community-level water points of the government and services. and water schemes, fecal sludge management facili- stakeholders. ties, or supply chains. The choice of approach has In this section, we discuss the trade-offs inherent in implications related to targeting, transparency, and subsidizing different services, populations, or costs in distortionary effects, as discussed in further detail in the WSS sector and how these choices affect the effi- the next section. cient attainment of the chosen objective. Although Meanwhile, the pursuit of positive externalities subsidies with a policy objective to advance equita- will lead to the prioritization of populations and ser- ble access to affordable WSS services will, by defini- vices that have increased potential to positively tion, seek to benefit the poor and marginalized, the impact the environment and/or improve public decision to target, for example, a particular service health. Oftentimes, effective and efficient subsidies (e.g., networked or nonnetworked) or geographic for this purpose require the consideration of area (e.g., rural or urban) will establish the eligibility ­factors— such as population density, environmental of particular segments of the population, even before ­ vacuation— sensitivity, and drainage and effluent e any selection of a targeting mechanism. Even though that would not be considered under the goal of these trade-offs are neatly categorized to aid the pro- equitable access. For example, the environmental cess of analysis, it should be noted that there is con- and health implications of poor WSS services in siderable overlap among them, and their relevance densely populated urban areas will generally will depend on the specificities of the case at hand. exceed those in more rural areas. Also, despite the primordial importance of potable water at the indi- Water vs. Sanitation vidual level, improved sanitation services may Although access to both water and sanitation is consid- present greater positive externalities at the com- ered a human right4 and is the focus of one of the munity level (Lauria, Hopkins, and Debomy 2005). Sustainable Development Goals (SDGs),5 the general These issues are discussed further in the next scarcity of public resources often prevents govern- section. ments from fully addressing the factors that make Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 51 TABLE 3.1. Pros and Cons of Subsidies for Water vs. Sanitation Water subsidies Sanitation subsidies Pros Cons Pros Cons • Address a primary need • May encourage • Have large economic returns • May require subsidies for • Have immediate impact on overconsumption thanks to their positive behavioral change programs households’ health and well- effects on public health and (and not just infrastructure) being the fact that existing access to be fully effective levels are typically low • Less attractive to politicians • Have large potential impact since the benefits to on demand, since households human health are delayed, are usually less willing to pay diffused, and more difficult for sanitation than for water to trace back to subsidies • Can improve water resource (although well-being may quality by encouraging be immediately impacted households to safely evacuate through gains in convenience and treat human waste and dignity) Source: Authors’ compilation. these services unaffordable to some citizens. return on efforts to attain universal access to Therefore, policy makers will need to make difficult improved sanitation is $5.50 per U.S. dollar invested, decisions regarding which service to prioritize when while this figure is $2 for water. allocating their budget. As noted in table 3.1, several Meanwhile, the benefits to be derived from sanita- arguments can be made in favor of either water or tion, mostly related to health, are generally more dif- sanitation. fused, more delayed, and less obviously attributable Although water subsidies address a primary need, to the uptake of services than are the benefits derived appropriate sanitation systems may provide a better from consuming water,6 although well-being may nev- economic return due to their substantial positive ertheless be immediately improved through gains in externalities. For one, the quality of water sources convenience and dignity, particularly for women (WHO can be undermined by contamination from poor 2018). As a consequence, people are more aware of sanitation systems, rendering sanitation systems the benefits of water services, a large share of which essential to sustaining the benefits gained from are private benefits (e.g., the improved odor and improved access to water. Additionally, there is evi- taste of higher-quality water, the health benefits of dence that the positive externalities (i.e., associated clean water, the time saved by a water connection benefits to society) of a private water connection are on premises, etc.). Thus, households are in general lower than those of a private sanitation facility. more willing to pay for water rather than for sanita- Inadequate sanitation systems have hazardous tion services, leaving an important role for sanita- effects on the entire population because of the many tion subsidies. Related to this, although behavior diseases related to the improper disposal of waste- change might also be needed to enjoy the benefits of water and human feces (Lauria, Hopkins, and improved water (e.g., some communities prefer the Debomy 2005). The World Health Organization taste of untreated water to treated water, or even (WHO 2012a) estimates that the global economic surface water to groundwater [Kulinkina et al. 2017]), 52 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation habits pose a particular obstacle to improved sanita- populations (Ravallion, Chen, and Sangraula 2010). tion. For example, in India it has been found that Most rural communities are poor, a majority (80 per- many people see open defecation as a healthy and cent) of the poorest households are found in rural socially acceptable practice, and insist that storing areas (Castaneda et al. 2016), and rates of access to feces close to home will render the home impure WSS services are lowest in rural areas (WWAP 2019). (Gupta et al. 2017). The Joint Monitoring Programme estimates that only The extent to which sanitation is a priority will 55 percent of rural households use safely managed depend on the characteristics of the population in drinking water services, compared with over 85 per- question, particularly the percentage of the population cent of urban ones. A gap can also be observed in with access to safely managed water supply, and the access to safely managed sanitation: 34.6 percent in population density. Sanitation may be a particularly rural areas versus 43.2 percent in urban areas.7 These high priority for public resources where access to factors imply that subsidizing rural services is the water has already been sufficiently addressed or most effective means of both targeting scarce where the problem of insufficient access to sanita- resources toward the poor and increasing their levels tion is exacerbated by poor drainage, flooding, or of access to services. Yet the majority of current con- related problems. In densely populated areas, the sumption subsidies focus on urban piped networks substantial public health implications of poor sanita- (as noted in chapter 2, section 2.3). tion provide an additional argument in favor of prior- Similarly, most donor funding for WSS services goes itizing sanitation over water. to urban areas (WHO 2017). A WHO report on South While many of the above arguments point to a strong Asian countries found that 77 percent of such funds case for subsidizing sanitation over water, global targeted the extension of services in urban areas expenditure on sanitation is approximately half that (WHO 2012b). The 2017 GLAAS report estimates that, for water (WHO 2017: 30), and in some low-income in a sample of 13 countries, nonhousehold expendi- countries the difference is even greater (in Nigeria, for tures on WSS services in urban areas were three example, 96 percent of WSS expenditures went to times what they were in rural areas (WHO 2017). To water in 2014 [World Bank Group 2017c]). This in part better understand the rationale behind this bias and explains the lagging levels of sanitation coverage. whether it should be revisited, we explore the pros The fact that returns to sanitation investments take and cons of subsidizing either rural or urban services longer to materialize and are less visible to house- in table 3.2. holds could explain why politicians may prioritize While basic water services can be provided through water over sanitation. Yet, as has been discussed less-expensive solutions in both rural and urban com- here, access to both is of vital significance, pointing munities, delivering SDG-compliant water services is to a need to better balance public expenditure more challenging in rural communities than in urban between the two. ones. Networked services—which, in urban areas, are generally the most cost-effective means to achieve Urban vs. Rural Areas the SDG target of a safely managed water supply on Even with rapid urbanization, rural populations still household premises—may not be financially feasible constitute the majority of the world’s poor and are amid the low population density of rural areas since more homogenous in terms of income than are urban economies of scale cannot be exploited. Therefore, Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 53 TABLE 3.2. Pros and Cons of Rural vs. Urban Subsidies Urban subsidies Rural subsidies Pros Cons Pros Cons • Greater consumer • Where poor households • Geographic targeting may be • The need for community heterogeneity permits the use are distributed throughout easy since there is a strong involvement to be sustainable of cross-subsidies (between a service area, geographic correlation between location (especially where services are different categories of service), targeting can be difficult (and and household income/ managed at the community thus tapping consumers as a errors of inclusion likely) resources in rural areas level) adds complexity funding source • If targeted, usually requires a • May benefit the poorest • More likely to require • May require less subsidization costly administrative system households, the majority of subsidies for behavioral for similar technologies • The reform of inefficient which generally reside in rural change programs, beyond due to economies of scale subsidy schemes favoring areas infrastructure subsidies, to (if networked services are urban households may be • May be used to support increase demand for services provided by a few large more difficult than those campaigns raising awareness • The presence of multiple providers) favoring rural households, of hygienic practices, which providers across a large area • May cost relatively little to since urban households often may be the most effective may increase the cost of design and implement (or have more political power in rural, homogeneously designing and implementing reform), since both users and poor areas and may have subsidies providers (and, in some cases, the potential to mobilize institutional stakeholders) are household resources concentrated in a small space • May generate large benefits to public health and the environment amid higher population density Source: Authors’ compilation. policy makers need to consider whether scarce pub- population density is often the greatest, involves lic funds are best allocated toward (i) providing SDG- significant administrative and technical challenges compliant services or (ii) much cheaper services that that may preclude the provision of SDG-compliant have the potential to benefit more households, yet household connections, requiring instead alterna- merely comply with the now-outdated Millennium tive  technologies such as public taps and public Development Goals (and may include water points toilets. and water schemes with public taps that impose a significant burden of collection, in terms of both Networked/Sewered vs. Nonnetworked/ time and distance, on users). On-Site Services On the other hand, improvements in WSS ser- Despite the fact that nonnetworked and on-site ser- vices in urban areas have a larger impact on public vices are an integral part of a sound WSS strategy in health (Hathi et al. 2017). This is simply because most countries, most subsidies are for networked the negative spillover effects (or externalities) water and sewered sanitation services. According to of inadequate water and sanitation are amplified the 2017 GLAAS report, assistance in setting up where populations are large and dense. It should “basic systems”8 (a category mostly made up of be noted, however, that extending service to infor- water or on-site sanitation) involved only a quarter mal urban settlements (such as slums), where of official development assistance disbursements 54 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation TABLE 3.3. Pros and Cons of Subsidies for Networked/Sewered vs. Nonnetworked/On-Site Services Subsidies of networked/sewered services Subsidies of nonnetworked/on-site services Pros Cons Pros Cons • Facilitate exploitation of • Only benefit households • Usually target rural areas • More likely to require economies of scale in densely that are connected or can where most of the poor live subsidies for behavioral populated areas potentially connect to the (better targeting) change programs (and • Mostly support on premises service, which tends to • Less expensive technologies not only infrastructure) to services (required for SDG exclude the poorest entail more beneficiaries per increase demand for services compliance) • More expensive technologies dollar spent • May require training of users entail less beneficiaries per or community members to dollar spent conduct periodic maintenance • May promote a lower level of service Source: Authors’ compilation. for water and sanitation in 2015—that is about $1.9 For sanitation, most on-site solutions can be SDG billion of a total $7.4 billion spent that year in the compliant. In low-income countries, networked/ sector (WHO 2017). Meanwhile, most subsidies for sewered WSS coverage rates are relatively low networked services end up, in practice, benefiting overall, and typically concentrated in certain geo- the richest (and most powerful) households and graphic areas. In such circumstances, connection producers, while discouraging efficient and sustain- subsidies in areas already covered by a network, able service provision and consumption.9 To inform or capital expenditure subsidies for network allocative decisions, it is important to investigate expansion in key unserved areas, could reach the the pros and cons associated with the subsidization poor who would not benefit from consumption of either networked/sewered or nonnetworked/ subsidies. on-site services (table 3.3). However, it is not possible or economically efficient Subsidies of networked/sewered services will only to expand networks or facilitate additional connec- benefit households that: (i) already have access tions in most rural neighborhoods, and even certain to services (consumption subsidies), or (ii) live urban or peri-urban neighborhoods. In many rural within the service area, are eligible to connect, and areas, networked water and sewered sanitation ser- thus would gain access through the subsidy itself vices are cost prohibitive amid low population den- (­connection subsidies). Networked and sewered sities. Here, looking beyond networked solutions services entail technology that tends to be more may reveal a viable alternative. Meanwhile, their expensive than their nonnetworked and on-site lack of feasibility in urban or peri-urban neighbor- counterparts, although their per capita costs can hoods may be due to physical or administrative be greatly reduced in densely populated areas by constraints (such as within urban slums) or because exploiting economies of scale. Also, networked the targeted households are unable to afford con- water supply services are typically more reliable sumption tariffs. In such neighborhoods, alterna- than many nonnetworked solutions and, unlike tive service providers may offer an acceptable the majority of common nonnetworked solutions, short-term solution to the problem of water and allow for a service quality that is SDG compliant. sanitation provision. Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 55 Where the poor are concentrated in areas without Access vs. Consumption access to networked services, subsidies for nonnet- According to the 2017 GLAAS report, most countries worked water or on-site sanitation hold promise to report the use of some sort of consumption subsidy. By increase their access rates. If the goal is to ensure that contrast, only 5 of the 43 countries analyzed had set the maximum number of poor people possible up an access subsidy (WHO 2017). While consump- receive a minimum level of service, nonnetworked tion subsidies aim to ensure that water service tariffs and on-site options may be preferable to networks, are affordable for the poor, access subsidies aim to since they are lower cost in general (unless large, increase the number of households with access to geographically concentrated, and well-off popula- those services. Besides this difference in the driving tions allow networks benefit from economies of policy goal, both access and consumption subsidies scale). have various pros and cons, elaborated in table 3.4. In certain situations where networked and sewered High connection charges (in the case of networked services are in place, it may be worthwhile to subsidize water and sewered sanitation) or initial costs (in the consumption, since piped water and sewerage systems case of nonnetworked water and on-site sanitation) usually require a minimum level of use to operate effi- often prove a financial barrier to poor households that ciently. In the case of piped water supply, for exam- might otherwise gain access to water and sanitation ple, to operate below this threshold is usually more services. Connection subsidies are most warranted in expensive and may adversely affect water quality,10 countries or regions where rates of access to WSS implying that in some cases it is more cost-effective ­ services (whether networked/sewered or not) are for a utility to actually lose water (by generating low, and where connection costs present the greatest more than is consumed or paid for) than operate at a barrier to access. suboptimal level. Similarly, underutilized sewer net- Consumption subsidies, on the other hand, are directed works are prone to clogging and may therefore to households that are already connected to a network, require more frequent maintenance. and if properly targeted, are not able to afford a specific TABLE 3.4. Pros and Cons of Access vs. Consumption Subsidies Access subsidies Consumption subsidies Pros Cons Pros Cons • Benefit households that • Complementary policy • Encourage a minimum • Often poorly targeted due to lack currently lack access to the measures (to increase amount of water of correlation between poverty and service (which are typically demand for services) may be consumption by improving proxy variables used for targeting the poorest households) needed to ensure continued service affordability like water consumption and • Low administrative costs use/sustainability geographic location (both inclusion and exclusion errors are common) • Bring more users into the system and achieve greater • Administratively costly if targeted economies of scale • May encourage overconsumption • Can become entrenched/difficult to remove once introduced Source: Authors’ compilation. 56 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation level of water consumption deemed critical to human advantage of networked services often requires health. To target such subsidies to the poor typically upgrades or the installation of new equipment or involves high administrative costs (to what degree facilities (e.g., bathrooms, drains, plumbing, fixtures depends on the targeting method), while untargeted such as toilets) either within the dwelling itself or on subsidies, though less expensive, will usually entail the surrounding property. Many policy makers over- high inclusion errors (i.e., they will benefit wealthier look the significance of household-level facilities, as households as much if not more than poor ones). subsidies continue to be overwhelmingly channeled However, if the poorest lack access to the service being toward utility-level infrastructure such as pumping, subsidized, consumption subsidies will entail large pipe networks, and treatment facilities. Table 3.5 exclusion errors independent of targeting. lists the pros and cons of focusing subsidies on (i) All in all, most of the consumption subsidies found in large-scale, shared infrastructure or (ii) personal, low- and middle-income countries do not ensure that household-level facilities. poor households can access safely managed and Constructing a needed facility on household premises ­ sustainable WSS services at an affordable price. represents a one-time, usually high, initial cost. After Where  access rates among the poor are low, and this, periodic maintenance (e.g., the emptying of pit resources are scarce, effectively targeted access sub- latrines) also costs something. For the many poor sidies may be prioritized. Conversely, where access 11 households with severe resource and credit con- is widespread but services remain unaffordable to straints, such costs pose insurmountable barriers. In many, well-targeted consumption subsidies might the case of networked water and sewered sanitation be considered. services, governments may consider subsidizing households’ personal investments in household Infrastructure On or Off Household Premises facilities, complementing the subsidization of For many poor populations, insufficient infrastructure off-premise (i.e., utility-level) infrastructure. on household premises represents an important bar- The initial costs of household-level facilities, which rier to accessing WSS services. For example, taking are often higher than service connection fees, TABLE 3.5. Pros and Cons of Subsidizing Infrastructure on Household Premises vs. Off Premises On premises Off premises Pros Cons Pros Cons • Increase number of • Less likely to attract political • More politically feasible • May require a minimum connections to networked/ buy-in than subsidies for • Increase number of threshold of uptake for sewered services (given their more visible, large-scale connections to networked/ efficient operation availability) by reducing overall infrastructure sewered services by • May require complementary access costs for the poor • Effectiveness may depend expanding service area subsidies of household- • Counter the effects of the on other complementary level facilities in order potentially high per capita costs investments in networked/ to benefit the poor and of a household-level facility’s sewered infrastructure or avoid underutilization of initial construction/installation fecal sludge management infrastructure • Can improve facility design and construction standards Source: Authors’ compilation. Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 57 regularly prevent subsidies of large-scale infrastruc- to relocate to cheaper housing without access to ture from reaching the poor—their intended benefi- improved WSS services. Additionally, poor house- ciaries. Subsidies of investments in household holds are the least likely to own land, and may have facilities may be delivered in various ways. For exam- no legal claim to the land where they reside, which ple, governments may provide hardware subsidies in may make them ineligible for any on-plot service cash or in kind, by providing the required construc- investments. Section 4.1 of this report discusses tion materials at a reduced cost. They may also facili- several policy options that may help to alleviate tate the provision of microfinance, either by serving these concerns. as a broker within the sector or by subsidizing conces- sional rates.12 Supply vs. Demand The bias against subsidizing household facilities in Schemes focusing on the subsidization of either the favor of utility-level infrastructure may reflect politi- demand or supply of water and sanitation have the cians’ belief that household capital expenditures are a same end goals: that is, increasing users’ access and/or personal responsibility. Also, such facilities, being pri- consumption. Their difference lies in how these goals vate, are less visible than large infrastructure, and so are pursued. As previously described, demand-side are less likely to attract political interest. Another subsidies involve a direct transfer from the fund pro- challenge is that subsidies of household facilities are vider to the subsidized user, while supply-side subsi- more challenging to implement since they involve dies channel funds through the service provider or various materials (different types of toilets, etc.), sup- another third party, which, in theory, passes the pliers, and contractors, while infrastructure invest- funds on to the consumer in the form of lower prices. ments center on one large provider—usually a utility. The main advantages and disadvantages of a focus Policy makers’ bias against subsidizing household on supply or demand are outlined in table 3.6. facilities is particularly notable in the case of on-site Schemes focused on subsidizing the supply side usu- sanitation services. Subsidies for these services can be ally involve utilities providing networked water or sew- substantiated based on the significant adverse ered sanitation; often they benefit from direct transfers impacts that inadequate household-level sanitation or a reduction in the costs of operational inputs or has on community-level health and the environment. materials. The goal is that the subsidies will be passed Many governments and international donors over the on to consumers in the form of lower tariffs. In effect, past two decades have focused exclusively on efforts these subsidies are untargeted, meaning that all con- to raise communities’ awareness and mobilize their sumers are recipients of the subsidized lower price, own participation and resources in the provision of including even high-income households that could on-site sanitation solutions. But these efforts might normally afford the service and are willing to pay for be more fruitful if complemented by subsidies of it. Since the poorest populations often lack access to household facilities, as discussed in box 3.2. the networked/sewered services being subsidized, A problem with subsidies for household-level facil- they are in effect excluded from the benefits. ities is that such facilities may benefit landlords Other supply-side subsidy schemes entail invest- instead of tenants, through increased property val- ments in expanding infrastructure or strengthening ues. Any resulting increase in rent could force poor supply chains. These are commonly found in countries tenants, the intended beneficiaries of the subsidies, with low coverage rates. Where they seek to benefit 58 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation BOX 3.2. Community-Led Total Sanitation Community-led total sanitation (CLTS) is a participatory approach to combating open defecation, with the objective of helping communities eradicate the practice of open defecation by changing social norms regarding sanitation. Implemented most often in rural communities, CLTS aims to (i) highlight the poor sanitation practices present in a community; (ii) raise awareness of the role of open defecation in facilitating the fecal-oral route of disease transmission; and (iii) communicate that so long as a small number of people in the community continue to defecate in the open, all community members are at risk. After being educated regarding the negative externalities of open defecation, community members are expected to come up with a coordinated, community-wide solution to increase the ownership and sustainable usage of latrines, including the use of their own resources for latrine construction—a process intended to foster genuine demand for on-site sanitation and a greater sense of ownership (Kar and Chambers 2008). Since its inception, CLTS has been implemented in more than 50 countries all over the globe (Institute of Development Studies n.d.) and is now the main approach used to address inadequate rural sanitation in many low-income countries. Although CLTS is certainly an important methodology, it is not a panacea. Quantitative evidence sug- gests that the resulting reductions in open defecation are not always large enough to significantly reduce the existing sanitation access gap. Moreover, the “open defecation free” status achieved by beneficiary communities has not proven sustainable in many cases. Additional policy measures—including target- ed subsidies for poor households and support of viable sanitation entrepreneurs to deliver necessary products and services across the sanitation service chain—are generally required to convert the demand for sanitation generated through CLTS into improved sanitation facilities. For example, trials in India and Bangladesh suggest that the benefits of CLTS could be enhanced by complementing it with subsidies for latrine construction that target vulnerable populations (Dickinson et al. 2015; Guiteras, Levinsohn, and Mobarak 2015; Patil et al. 2014; Pattanayak et al. 2009). While low demand for private sanitation unrelated to financial constraints should be recognized as a key factor in explaining the current sanita- ­ tion gap in some contexts, financial barriers to service access are often equally or more significant, and CLTS on its own can do little to increase the uptake of services. Finally, it is important to consider not only the benefits of CLTS but also its costs, as part of a comprehensive cost-benefit analysis. In particu- lar, attention should be drawn to the hidden costs of CLTS implementation, which according to the few available estimates, are comparable to those of subsidy-driven approaches (USAID 2018a). Source: Background paper 13 (listed in appendix A). nonnetworked water or on-site sanitation services, development within the sanitation service chain these subsidies are usually directed at supply chains, found that continuous external funding and support providers of inputs, and microfinance institutions. over a period of four to six years was generally Supply-side subsidy schemes are particularly import- required to achieve scale and profitability (USAID ant for on-site sanitation, which requires access to a 2018b). An advantage of supply-side subsidy schemes range of products and services across the sanitation is that they often involve some sort of technology or service chain.13 A recent desk review of enterprise knowledge transfer to local manufacturers or service Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 59 TABLE 3.6. Pros and Cons of Supply vs. Demand Subsidies Supply subsidies Demand subsidies Pros Cons Pros Cons • Easier to administer than • Usually involve a large budget • Allow proper targeting of • May imply high administrative demand subsidies • May reduce service quality and intended beneficiaries (poor costs • May involve technology efficiency if receipt of funds is not and marginalized, thus • Require good data for good or knowledge transfer to conditional on performance minimizing inclusion and targeting results local producers exclusion errors; budget is • Do not allow for proper targeting of • May require significant efforts spent more efficiently) intended beneficiaries to change consumer behaviors • May require close monitoring of (if existing demand is low) many providers • Require up-front efforts to gather information on user preferences for service types/features Source: Authors’ compilation. providers, thus increasing local capacity, and, most required to ensure households’ uptake or sufficient sustainability (see, likely, productivity and self-­ use of available WSS services. for example, GRDR and GRET 2016). In general, ­supply-side subsidies for nonnetworked services may Capital vs. Operating Expenses effectively target the poor, particularly when they The decision to allocate funds to subsidize service pro- focus on rural areas or urban neighborhoods with viders’ capital or operational expenditures depends on homogenously poor populations. policy goals and the cost structure of the services being Focusing on the demand side, or consumer, allows for supported. Networked water or sewered sanitation the more accurate targeting of subsidies, increasing services have high fixed costs. This in turn makes their impact on the intended beneficiaries. Various efficient pricing using marginal costs difficult: such mechanisms can be employed to identify those pricing would not allow for full cost recovery, since households that actually need assistance, as elabo- the marginal costs are lower than the average costs. rated in section 3.5. Effective targeting reduces the Capital expenditure (CAPEX) therefore tends to be funding required to assist the poor as well as the subsidized in both low- and high-income countries distortions caused by subsidization. Yet it requires ­ alike. The operating expenditure (OPEX) of poorly some degree of administrative capacity to effectively performing utilities is most often subsidized in deliver the transfers to their intended recipients (and low-income countries. Many nonnetworked water thus minimize inclusion and exclusion errors). In services, as well as on-site sanitation services, entail some cases, particularly in low-income countries, large, one-time expenditures that preclude the pos- demand-side subsidies may complement or support sibility of financing CAPEX through user tariffs. programs that promote behavioral change, for exam- Although CAPEX subsidies for community-level ple, by raising rural communities’ awareness of the nonnetworked services are commonplace, govern- importance of household-level water treatment, or ments have tried to avoid subsidizing OPEX costs the health risks of open defecation. Across the board, associated with these services. Table 3.7 lists several in urban and rural areas, changes in behavior may be pros and cons of CAPEX and OPEX subsidies. 60 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation TABLE 3.7. Pros and Cons of Subsidies for Capital vs. Operating Expenditures CAPEX subsidies OPEX subsidies Pros Cons Pros Cons • Allow for increased service • May distort optimal input • Easy for governments to • Encourage inefficiency coverage combination implement (in the case of • May distort optimal input combination • Time bound (they are usually • May result in networked services) • May foster overconsumption of water one-time payments for intergenerational transfers • May be essential in some • Directed only at existing users (thus specific investments, unlike whereby future generations areas to ensure service excluding the poorest households OPEX subsidies, which tend must pay tariffs beyond the sustainability and protect that often are without access) to continue in perpetuity) economic cost of the assets initial capital investment used • More opaque (than CAPEX subsidies) and difficult to change or repeal Source: Authors’ compilation. Note: CAPEX = capital expenditure; OPEX = operating expenditure. CAPEX subsidies may be needed if providers struggle play in sustaining poor rural communities’ access to to collect sufficient revenue to recover their CAPEX services. expenditures, or if network expansion is required to In general terms, whether providers are large utilities extend access to poor communities that are not per- or small-scale providers (e.g., water boards, water user ceived as profitable by providers. CAPEX subsidies for organizations), they should aim to at least cover their both networked and nonnetworked services are seen OPEX with user tariffs to guarantee the sustainability in not only low-income countries but also in high-in- and continuity of services in the short term. However, come economies such as the United States, albeit ­ argeted OPEX where the poor cannot afford service, t generally more limited and better targeted. However, subsidies that translate into lower user tariffs are mer- subsidizing CAPEX for users that are already con- ited. Such subsidy schemes usually entail direct bud- nected (e.g., to support a new wastewater treatment get transfers to providers or, occasionally, lower rates plant where all households already have access to for their operational inputs (such as electricity) or tax safely managed, sewered sanitation) might entail exemptions to lower their fiscal burden. Yet while high errors of inclusion and exclusion. these OPEX subsidies support utilities to keep provid- In many rural areas, CAPEX subsidies are provided to ing water and sanitation services to all households, install water points or develop infrastructure for small they reduce providers’ incentives to improve their water schemes.14 Subsequently, community users are performance, and often lead to diminishing service often expected to pay for 100 percent of the OPEX quality.15 Thus, OPEX subsidies should be viewed as through user fees, and ensure that repairs are cov- temporary instruments that are necessary only where ered by that revenue. However, this model may be the customer base is unable to afford cost-reflective unsustainable where communities cannot afford to tariffs, and as the service provider works toward cover OPEX. The problem is widespread—for exam- developing better management practices that will ple, available data suggest that approximately one in sustain an efficient level of service. four hand pumps in Sub-Saharan Africa are nonfunc- OPEX subsidies may be considered where expand- tional at any given point in time (Foster et al. 2019). ing access to sanitation services is a priority. This suggests that OPEX subsidies may have a role to Depending on the context, they may be appropriate Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 61 to support the provision of on-site sanitation or the possibility of funding current subsidies through “downstream” portions of the supply chain for sew- intergenerational subsidies, meaning that future ered services. For example, OPEX subsidies could generations will be required to pay tariffs beyond the be used to incentivize the frequent emptying of economic cost of the assets used to provide them the pits/tanks, or the safe treatment and disposal of service. Although this practice may potentially be wastewater. Such efforts would advance the justified under the assumption that future genera- health-related and environmental benefits of proper tions would benefit from improvements in income sanitation. through economic growth, such projections of eco- nomic growth are subject to significant uncertainty. 3.4 Selecting the Funding Source We would therefore caution policy makers against the use of such unfunded subsidies. WSS services are funded by a mixture of revenues from Each type of funding source (government, other the so-called three Ts: tariffs, taxes, and transfers users, or third parties) carries its own risks. (OECD 2009). Ideally, services are funded through Governments may fail to deliver the promised full cost-reflective tariffs. However, such tariffs are resources. This risk is borne by the customer in the often unaffordable for many households in develop- case of demand-side subsidies, or by the utility in ing countries. An affordability analysis, as described the case of supplier-side subsidies. Also, in many above in section 3.1, can be used to determine the cases, subsidies are part of the national budget and need for subsidization of access and/or consumption therefore must be approved on an annual basis, costs. Such subsidization is generally funded through implying a continuity risk for the funding of long- taxes, but in some cases, may also be funded through lived sunk assets. When the subsidy is financed by transfers from international donors or from private underpricing an input generated by other sectors, charities. this risk is also present, since the subsidy depends As discussed in chapter 1, WSS subsidies can be on a government policy that can be changed or funded by either taxpayers (through government) or reversed. In the case of cross-subsidies, cost recov- philanthropic funds, or through cross-subsidization by ery requires an estimation of user charges across charging other present and/or future users more than the customer base to ensure a proper balance the cost of service (which can include users of an unre- between subsidy recipients and cross-subsidizers. lated service subsidizing users of WSS services). The The difficulty in conducting this estimation intro- choice of funding will largely be driven by the gov- duces the risk that the subsidy amount may exceed ernment’s fiscal space, opportunities for philan- the revenue collected from the cross-subsidizers, thropic funding or concessional financing, and the thus entailing a deficit. potential for cross-subsidization across users. For the latter to be a viable option, a sufficiently large proportion of the service’s customer base must be 3.5 Designing the Subsidy able to afford tariffs exceeding the full cost-reflective After selecting the policy objective, the target ser- price. In some cases, however, governments may vice(s) and/or population(s), and the means of fund- facilitate cross-subsidization by users of unrelated ing, we can now turn our attention to the design of services, such as energy, telecommunications, or the subsidy itself. As policy makers proceed in solid waste collection services. We should also note designing subsidies, it is important to keep in 62 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation mind the characteristics of well-designed subsi- As described in section 3.3 of Subsidies should be dies: they should be well-targeted, transparent, this chapter, access subsidies well-targeted, and nondistortionary. are warranted in contexts where In this section, our goal is not to present a compre- connection rates are low, where transparent, and hensive catalogue of subsidy design options. Instead, the poor in particular lack WSS nondistortionary. we highlight three key strategies that have proven, household connections, and when well-designed and implemented, to improve where sufficient infrastructure the efficacy and efficiency of subsidies: (i) using exists to service their neighborhoods. In such circum- alternative approaches to improve targeting, (ii) stances, a lack of connection serves as a proxy making subsidies conditional on performance, and for poverty, and its use as an eligibility criterion for (iii) decoupling subsidies from service charges. subsidization reduces errors of exclusion and inclu- sion. However, the connected poor, whatever their Improving Targeting numbers may be, often require additional support As discussed in chapter 2 (section 2.3), common meth- beyond one-time connection subsidies. In these ods of targeting WSS subsidies have generally been cases, well-targeted consumption subsidies are also ineffective at directing scarce public resources toward required. their intended beneficiaries—the poor. Increasing Administrative selection involves categorizing and block tariffs, one of the most common targeting tools, identifying potential recipients, in an attempt to effec- have proven particularly ineffective on account of tively deliver subsidies to those households that need two main problems (see box 2.1, chapter 2). First, the them most. Means-tested subsidies, which aim to poor often lack access to services to begin with, so benefit particular categories of consumer groups, are they do not benefit from the lower, subsidized rates. among the most successful at minimizing both errors Second, there is no direct correlation between piped of inclusion and exclusion. These aim to identify water use and income (Fuente and Bartram 2018). In households’ ability to afford water through the use of other words, a low-income household may consume income or expenditure data. Because of the substan- a large volume of water, especially if it shares a single tial amount of data required and the related high point of service connection with several other house- administrative costs, means-tested subsidies may holds, as is common among the poor. appear cost prohibitive for many low-income coun- There are three main approaches that may be used to tries. However, these administrative costs can be sig- better target WSS subsidies to the poor, the appropri- nificantly reduced through the use of innovative ate mix of which will depend on local conditions: technology or by sharing such costs with other gov- ernment programs that seek to target benefits to the 1. Subsidize poor households’ connection/access to poor. For example, a national socioeconomic survey WSS services. in Chile has been used to inform policy in several 2. Better identify poor households requiring sectors (Serra 2000). consumption subsidies through administrative Where the administrative capacity or funds to imple- selection. ment means-tested subsidies are unavailable, a readily 3. Provide a range of types of WSS services that are observable factor strongly correlated with poverty better suited to reach everyone. (e.g., location) may be used as a basis for targeting. Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 63 Where the poor are concentrated in particular neigh- connections, low-pressure systems, and electronic borhoods, governments and service providers can limiters in the relatively high-capacity setting flow-­ direct subsidies using geographic targeting by imple- of Durban, South Africa (Brocklehurst 2001; Heymans menting reduced tariffs in certain neighborhoods. et al. 2016). Since the choice to opt for a lower service This type of targeting method is usually cheaper level is likely to be correlated with poverty, subsidies than means-tested schemes, although inclusion and can then be targeted to these customers, further exclusion errors are unavoidable since completely reducing their tariffs. homogeneous neighborhoods (in terms of monetary Finally, we must call attention to new and innovative income) are extremely rare. approaches to targeting that are made possible by con- Another way to target low-income consumers is to tinued improvements in technology. For example, the provide different types of WSS services at different use of remote sensing and street view data, coupled price points. The most common service-level with machine learning algorithms, is currently being ­ targeting involves the installation of public water piloted by the World Bank to develop a poverty map taps. These taps are usually built in low-income of the city of Luanda, Angola, that could then be neighborhoods without high rates of networked used to target subsidies to the poor (World Bank water consumption, whether because of a lack of Group 2019). necessary infrastructure, or because the average household income does not allow for a household Making Subsidies Conditional on Performance connection (or a basic level of water consumption via As discussed in chapter 2 (section 2.5), the characteris- a household connection). While setting up public 16 tics of networked water and sewered sanitation ser- taps usually allows households in the vicinity to vices make service providers susceptible to a vicious ­ consume basic levels of water, the risk of contamina- circle whereby low prices lead to losses, postponement tion rises as water is transported from the tap. of required maintenance investment, and hence even Additionally, households are required to invest a higher costs down the road, leading to yet more losses. significant amount of time in fetching water, and ­ In order to stave off the severe social costs of service may also incur additional expenses for house- interruptions, public authorities tend to heavily sub- hold-level water storage and treatment. Community- sidize service providers, which weakens fiscal disci- level toilet blocks, constructed to provide the poor or pline due to perverse incentives that encourage the particularly densely populated neighborhoods with padding of costs, condone inefficiency, and disre- a short-term sanitation solution, offer another com- gard service quality. One alternative is to divert pub- mon example of a differentiated service type. lic resources to demand-side subsidies, which avoid Where networked water or sewered services are this vicious cycle by maintaining the service provid- provided at the household level, technologies can be ­ er’s accountability to its customers, since revenue employed to reduce the collection depends on the provision of high-quality Inefficiencies stemming cost of provision faced by service that customers are willing to pay for. from supply-side the service provider, thus However, inefficiencies stemming from supply-side allowing for reduced tar- subsidies are not inevitable—instead, it is possible to subsidies are not iffs. An example is the avoid such inefficiencies by conditioning subsidies on inevitable. use of restricted-diameter well-crafted performance targets that are tangible, 64 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation transparent, verifiable, and under the service provid- providing it with a market-​ Cash transfers er’s control. Performance- and results-based con- driven revenue stream suffi- avoid distortionary tracts can be used in both public-public or cient to fund its operations private contracts to improve performance by public-​ and maintenance activities. impacts on service linking subsidies not to individual expenditures, but The service provider remains providers. rather to the timely and quality delivery of verifiable accountable to meeting the outputs or results (Mumssen et al. 2018). needs of the customer, since it Key performance indicators, developed by the gov- cannot depend upon direct transfers from the gov- ernment or regulator, may include standards for ser- ernment to make up any funding gaps. Its only way vice continuity and water pressure; nonrevenue water to capture the subsidy is by servicing the cash trans- reduction; service connections, meter installation, or fer recipients at a desirable level of quality. Since service repair schedules; the volume of waste treated cash transfers are generally blind to the service pro- or reused; or the resolution of consumer complaints. vider, households can opt for alternative means of For example, a World Bank-financed project in a supply if the utility is either not servicing the area or part of Ho Chi Minh City, Vietnam used a perfor- is providing a substandard level of service. Therefore, mance-based contract approach to greatly reduce networked utilities have the incentive to extend ser- nonrevenue water (Chen 2018). Output-based aid 17 vice out to poor neighborhoods, which, in receiving instruments supporting the construction of facilities the cash transfers, can now afford the service. to expand access, such as water connections for the By decoupling subsidies from the service itself, the poor, have proven particularly successful in many targeting of WSS subsidies is improved in contexts countries—including Colombia, Kenya, Morocco, the where a significant proportion of poor households lack Philippines, and Uganda—on account of their trans- access. As discussed in chapter 2 (section 2.5), the parency. Performance contracts are most effective poor targeting performance of most WSS subsidies in when they include simple agreements, clear respon- place today arise mostly from factors related to sibilities, realistic targets, reporting requirements, access. In order to benefit from subsidies delivered and monitoring and auditing arrangements (World through the service provider, a household must be Bank Group 2018e). consuming that service. Through the use of cash transfers, poor households that either live outside of Decoupling Subsidies from Service Charges the provider’s service area or are unable to connect The decoupling of subsidies from WSS access and con- can now benefit from the subsidy. sumption charges through the provision of cash trans- However, providing subsidies through cash transfers fers, whether conditional or unconditional, has the does not guarantee that households will use those potential to improve the efficiency, transparency, and ­ subsidies for the intended purpose, unless they are targeting of WSS subsidies. By avoiding the use of the provided through vouchers or made conditional on the service provider as an intermediary, cash transfers payment of WSS bills. Vouchers may stipulate that avoid the distortionary impacts on service providers they be used only toward paying for piped water and previously discussed in chapter 2 (section 2.5). This sewered sanitation, or for alternatives like water is because the service provider can collect the ATMs, prepaid service, water tankers, and so on. cost-reflective tariff directly from each customer, They may also leave the household free to choose its Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 65 service provider, as long as the vouchers are used   5. SDG 6: “Ensure availability and sustainable management of water and sanitation for all.” toward WSS services. Yet despite the apparent bene-   6. For example, as shown by Cronin et al. (2017), a certain threshold of fit of ensuring that cash transfers are used toward sanitation usage (e.g., 60 percent) may be required in a community improving WSS services for their recipients, an eco- in order to see health benefits. Coverage levels below this threshold may not result in substantial gains. Thus, a household is unlikely to nomic argument can be made against the use of such reap the benefits of ending open defecation unless the majority of conditions, as they restrict the choice of the con- its neighbors do so as well, whereas a household whose members sumer, thus reducing gains to welfare.18 are still defecating in the open will reap the benefits if most of their neighbors give up the practice. This is consistent with findings that There are several examples of decoupling subsidies suggest strong positive externalities of toilet coverage and strong from WSS tariffs and charges. One of the most well- negative externalities of open defecation (see, for instance, Gertler et al. 2015). known multisector cash transfer programs is Brazil’s   7. Data refer to 2015 values and were extracted from https://washdata​ Bolsa Familia program, introduced in 2003, that uses .org/data. a social registry to target conditional cash transfers   8. Rural water supply is often facilitated through “basic systems,” to eligible households (ECLAC 2016). A decade prior, which include hand pumps, spring collectors, gravity feeding in the early 1990s, Chile sought to improve the tar- systems, rainwater harvesting, storage tanks, and small distribu- ­ tion systems that usually involve shared connections. Urban geting of subsidies through a means-tested subsidy ­ systems employ water pumps and neighborhood networks, scheme after new regulatory frameworks compelled including those with shared connections. Basic sanitation sys- tems include on-site disposal systems and latrines. In some cases, utilities to charge cost-reflective tariffs. Although household- or community-level investment in such systems this was not a cash transfer per se, Chile effectively may be promoted. decoupled the subsidy from the tariff by billing a   9. As seen in background paper 3 (listed in appendix A), current con- sumption subsidies for networked services tend to be regressive. portion of the user’s charge directly to the municipal government (Contreras, Gomez-Lobo, and Palma 10. According to the American Water Works Association (AWWA 2015), water quality may decrease when low consumption reduces the 2018). More recently, the Iranian government has speed of water in a system to below 1 meter per second (m/s) on introduced compensatory cash transfers in its efforts average per day (1 m/s is required by the standard ANSI/AWWA ­ C651-14). Slow-moving water reacts with piping material to become to raise energy and water tariffs to cost-recovery lev- discolored, turbid, and smelly. Customers’ poor perception of such els over the past decade (see box 4.1, chapter 4). water can lead them to reduce their consumption, and may discour- age potential customers from connecting, reducing revenue from water sales. With regard to wastewater networks, a minimum flow Notes rate of 1.2–1.5 m/s is generally required to prevent the clogging of gravity-fed networks and/or ensure the proper functioning of pumps 1. Stalled reforms are particularly informative. In these cases, a politi- in pressurized networks. cal coalition may have successfully supported reform legislation but later proved insufficient to see it implemented. These situations 11. See, for example, background paper 3 (listed in appendix A) and bring to light specific modifications to the reform process that might Komives et al. (2005). enable a better outcome. 12. For further details on these and other mechanisms, please refer to 2. A subsidy reform package includes phases in the rollout of the sub- background papers 4 and 8 (listed in appendix A). sidy reform itself, as well as additional elements such as comple- mentary sector or legal reforms, policies to temporarily compensate 13. The sanitation service chain includes all products and services users for loss of benefits, communication strategies, and so on. required for the processes of containment, emptying, conveyance, treatment, and disposal/reuse. See background paper 11 (listed in 3. See background paper 12 (listed in appendix A) for an application of appendix A) for an overview of potential subsidy structures. this model in Nigeria. 14. See background paper 8 (listed in appendix A). 4. As recognized by the UN General Assembly and the Human Rights Council in Resolution 64/292 in 2010, and then again by the General 15. CAPEX subsidies can be loosely associated with connection subsi- Assembly in Resolution 70/169 in 2015. dies and OPEX subsidies with consumption subsidies, although 66 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation for networked/sewered services, it is difficult to determine 17. With more than 8,000 connections replaced and leaks fixed in over whether general transfers from the government to utilities are 600 kilometers of pipe, leakage was reduced by almost half. The earmarked for CAPEX or OPEX unless specific clauses or regula- water saved could serve 500,000 people—half of the population in tions exist. the performance-based contract area (Chen 2018). 16. Even if the tariff charged by the utility at public water taps is less 18. Microeconomic theory states that conditional cash transfers make than that charged for household connections, the tariff paid by the people better off than a subsidy for specific goods or services, even end user may, in fact, be higher if the taps are run by private groups if both are worth the same money. This is called “the lump sum or individuals that charge a significant mark-up. In Kampala, principle”; specifically, “an income tax or subsidy leaves the indi- Uganda, the utility has taken efforts to reduce or eliminate such vidual free to decide how to allocate whatever final income he or mark-ups by either further reducing the tariffs charged to the opera- she has [while] taxes or subsidies on specific goods both change a tor, or cutting out the middleman through the use of electronic person’s purchasing power and distort his or her choices” tokens (Heymans et al. 2016). (Nicholson and Snyder 2008). Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 67 CHAPTER 4 Designing an Effective and Efficient Subsidy Reform Package Subsidies do not function in isolation: any well-designed subsidy requires a num- ber of additional elements to facilitate its acceptance and improve its efficacy in both advancing equitable access to affordable water supply and sanitation (WSS) externalities. Alongside subsidy design, four services and harnessing positive ­ elements—namely, complementary policy mechanisms, a strategy to foster a supportive political coalition, a communications strategy, and an exit strategy (when applicable)—are critical to consider when creating a subsidy reform ­package. 4.1 Mechanisms to Complement Subsidies Poor households are hard to reach using traditional WSS delivery mechanisms factors. Expanding service networks is itself difficult in some due to a range of ­ geographic terrains, or amid the chaos of unplanned and congested ­ settlements. Poor households often consume relatively small quantities of dispersed. These and other fac- water, and those in rural areas may be widely ­ tors discourage service providers from investing in poor households’ access to services. networked WSS ­ This section aims to discuss various complementary policy mechanisms that may be used to complement subsidies, with the aim of improving WSS services’ population. Table 4.1 access and affordability for the poorest segments of the ­ provides a nonexhaustive list of types of subsidies and some complementary policy mechanisms that can be used to reduce the amount of a subsidy that ­ oor. They are split into two may be required to improve WSS services for the p categories, based on their goal of either (i) improving access or (ii) ensuring a minimum level of consumption, although both categories are linked and can separately. be difficult to analyze ­ Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 69 TABLE 4.1. Subsidies and Complementary Policy Mechanisms for Improving Access and Consumption Priority Types of subsidies Complementary mechanisms Access • For providers’ capital investment • Community-based resource management, and small-scale • For consumers’ initial costs and connection providers (demand-responsive approach) charges • Expansion of service access linked to employment programs • Community empowerment programs • Alternative technologies • Home-based systems • Microfinance • Removing legal and administrative barriers for the poor Consumption • Cross-subsidies • Mechanical public standpipes and water-vending machines • Social tariffs • Payment and billing technologies • Increasing block tariffs • Smart metering and prepaid water systems • Volume-differentiated tariffs • Improved management and operations • Administrative selection • Targeted vouchers and cash transfers Source: Authors’ ­compilation. Mechanisms that Prioritize Access including Argentina, seeks to reduce the capital The first two complementary policy mechanisms we expenditures required to expand access—while consider seek to increase access to WSS services by simultaneously addressing unemployment and reducing the costs associated with service p ­ rovision. social exclusion—by providing training and jobs in The first of these is a demand-responsive approach the construction of required ­ infrastructure.2 pioneered by water boards in rural Paraguayan com- In areas where traditional piped-water and sewerage munities that aims to reduce management costs systems are not feasible, innovative or alternative through community e ­ ngagement. Nonprofit associa- technologies can be used to simultaneously expand tions of users take full responsibility for the manage- communities. For example, access and empower ­ ment of their WSS systems, including monthly billing Sulabh, an Indian social service organization, has to cover their operations and maintenance expenses, coupled public toilets with biogas digesters (and and have proven successful in expanding house- effluent treatment systems) that fully recycle human holds’ access to more sustainable and better-quality waste, improving the potential for financial sustain- services (OVE 2016).1 Emerging evidence suggests ability while simultaneously reducing communities’ that such alternative mechanisms, involving small- reliance on waste s ­ cavengers. The technology is sim- scale systems, are indeed more effective than tradi- ple enough to be implemented by locally trained tional supply-driven models in reaching rural and members of the community, and all materials are peri-urban areas, and hence a large proportion of the locally sourced (Sulabh International 2016, 2018 1001 poor (OVE 2016; Andres et  ­ al. 2017). The second n.d.). Where households lack access to Fontaines ­ mechanism, implemented in several countries, water supply on premises, inexpensive point-of-use 70 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation water treatment, such as chlorination and filtration, land titles, therefore, is Informal settlements are effective interim solutions to expand access to often a necessary prereq- and a lack of land titles potable water by reducing the risk of water-borne ill- uisite to extending access nesses stemming from contamination either at the to networked WSS services represent significant source or during transport from source to home in such ­ communities. barriers to expanding al. 2015). (Clasen et ­ Meeks (2018) investigated Finally, microfinance loans can assist the poor in the effect of a land-titling poor households’ access overcoming their lack of credit and resources to cover program in Peru and found to networked WSS the large up-front connection charges associated with small but statistically sig- access to networked/sewered services, as well as the nificant increases in access ­services. large up-front initial costs associated with nonnet- to water supply, mostly worked/on-site services ( ­Water.org 2018). A number driven by increased investments in infrastructure by of WSS microfinance programs around the world the government or water utility, as opposed to by indi- have demonstrated that many poor households vidual households (Meeks 2018: 345–57). are not only willing to take loans to finance their Service providers themselves face significant tech- WSS assets but also consistently repay these loans nical and administrative challenges when expanding ­ (Water.org. 2018). A well-known example is that of service into unplanned peri-urban communities; the Bangladesh’s Grameen Bank, which has successfully lack of property demarcations makes the installation reached rural populations with affordable loans for of pipelines difficult, while the lack of an official water and sanitation, specifically targeting women address system hinders payment collection (Meeks (Khandker, Khalily, and Khan 1995). Another exam- 2018: 345–57). The terrain and the absence of public ple is in Vietnam, where many women’s unions have rights of way pose significant engineering chal- helped households to invest in their own toilets construction.3 A lack lenges to traditional network ­ through a revolving fund initially capitalized by mul- of compliance with building codes, zoning ordi- tilateral funds (Trémolet, Kolsky, and Perez 2010). nances, and other standards further complicates installation and increases the risk that service Removing Legal and Administrative Barriers to term. investments will not be viable in the long ­ Access for the Poor In both informal and formal settlements, ensuring Informal settlements and a lack of land titles represent that current tenants benefit from improvements in significant barriers to expanding poor households’ access to WSS services, as opposed to relatively well- access to networked WSS s ­ ervices. In many countries, challenging. Tenants, often off landlords, proves ­ WSS service connections are seen as a means for among the poorest and most vulnerable (Eales and inhabitants of a particular property to stake a legal Schaub-Jones 2005), are often underappreciated by claim to its o ­ wnership. Governments, fearful of this regulators or policy makers due to inaccurate tenant implication, may hesitate to provide such c ­ onnections. estimates stemming from difficulty ensuring accu- Moreover, since voting rights can be conferred on the racy in censuses and surveys and even intentional basis of land ownership, inhabitants without land underreporting by ­ landlords. Also, when access to titles lack sufficient bargaining power to demand improved WSS services is expanded, landlords may change from their political ­ representatives. Providing use this as an opportunity to increase ­rents. For some Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 71 tenants, this represents an untenable financial bur- countries is the provision of water supply through den that forces them to move to more distant and/or coin- or card-operated public standpipes or ­ ousing. New WSS services thus do not inadequate h machines. Both options, which tend water-vending ­ reach their intended beneficiaries (WSUP 2013). to be used overwhelmingly by the poor, typically Thus, due to a combination of political, technical, offer water at a cheaper price than the tariffs charged and administrative hurdles, tenants and households for household connections, while avoiding the man- without secure land titles may be effectively agement costs that would be entailed by hiring atten- excluded from a network, even where they might be dants to manage service provision (WUP 2003). able to afford (possibly subsidized) ­ services. Meanwhile, the connected poor face significant Aside from addressing the issue of land tenure financial constraints to paying their water bills, includ- directly, Water and Sanitation for the Urban Poor income. Many ing unpredictable and often seasonal ­ (WSUP 2013) proposes several policies to improve would benefit from shorter, frequent billing cycles tenants’ access to WSS ­ services. These include the al. 2005) and flexible payment systems (Komives et ­ provision of conditional subsidies for the construc- (that utilize mobile phones, for example, or payment tion of private or shared sanitation facilities, the al. 2011). Also kiosks in nearby towns) (Hope et  ­ revision and enforcement of rental housing bylaws, important, smart metering and prepaid water tech- and the use of service models appropriate to areas nologies allow consumers to be more aware of their rates. In Naivasha, Kenya, for with high tenancy ­ real-time water usage and charges and adjust their example, subsidies of shared sanitation facilities consumption accordingly (Heymans, Eales, and prioritize live-in landlords, who have a greater stake Franceys 2014). in investing in services than do absentee landlords, Improved Management and Operations and landlords are required to ensure that their ten- The overstaffing and water production losses of net- ants have full access to the subsidized f ­ acilities. In worked water and sewered sanitation services cost Nairobi, Kenya, landlords in some informal settle- low- and middle-income countries, excluding China and ments were required to give up a percentage of their year.4 Our esti- India, over $37 billion in subsidies each ­ land for the subsidized construction of improved mation of global subsidies for networked water and infrastructure. In Antananarivo, Madagascar, WSS ­ sewered sanitation allows us to quantify the percent- new rental housing bylaws require landlords to pro- age of subsidies directly attributable to inefficiencies vide sanitation facilities to their t ­enants. Finally, in staffing and water production losses, as well as the shared services that are provided on a pay-per-use additional capital expenditure (CAPEX) required for basis allow users to access the service without prior the excess production needed to cover these losses, investment and regardless of their tenure status as well as overconsumption resulting from subsi- (WSUP 2013). pricing. According to our estimates, approxi- dized ­ Mechanisms that Prioritize Consumption mately 7.8 percent of operating expenditure (OPEX) Several measures that may be used to complement subsidies and 13.8 percent of CAPEX subsidies in consumption subsidies help service providers more low- and middle-income countries, excluding China poor. Among the effectively target subsidies to the ­ and India, can be directly attributed to these most common such measures in low-income inefficiencies. Because of data constraints, this ­ 72 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation estimate does not even include the costs associated planning, the use of simple, robust, and low-cost with other management efficiencies, including low technology, optimized project design and manage- ­ aintenance. billing and collection rates, and subpar m 5 ment, efficient procurement, effective capital main- In fact, a World Bank study (Goksu et ­al. 2017) found tenance, incentive-based approaches toward capital that, without even attempting any tariff reforms, expenditure efficiency, and end-use demand man- operational efficiency gains alone would bring agement can result in capital savings in the order of percent of the 690 utilities included in the study to 65 ­ 25 percent or more, allowing existing investment to financial viability, defined here as the recovery of deliver a 33 percent increase in benefits (Kingdom ­ osts. These efficiency gains 120 percent of operating c et ­al. 2018). involve four measures to cut costs and bolster reve- Beyond direct cost savings, efforts to improve opera- nue (figure 4.1). tional efficiency complement tariff reform in other sig- With that said, improvements in capital expenditure nificant ­ways. When operations are more efficient, efficiency may be as important to financial viability as service providers are better able to set realistic tariffs efficiency. In developed improvements in operational ­ that reflect service quality while being more countries where utilities account for the full cost of affordable. Customers are willing to pay more for ­ service delivery, debt servicing required to repay better service, especially if they have been footing loans for capital costs amount to nearly half of total ­ ast. Moreover, the bill for inefficient delivery in the p ­costs. A number of strategies, including strategic 6 by strengthening the link between service quality FIGURE  4.1.  Efficiency Improvements that Help Utilities Reach Financial Viability A 10% increase in revenue would 90 then increase this to 77% of utilities. 80 With operational efficiency gains 65% of utilities 77 Percentage of utilities deemed viable con cover operational costs and some debt service. 70 65 60 Only 15% of utilities in 50 developing countries cover 41 40 O&M costs and generate cash 29 30 surpluses 20 15 10 0 Currently viable Step 1: Step 2: Step 3: Step 4: Collection rate Non-labor With reduction Increase revenue increased to cost reduced of current level of by 10% 100% by 15% non-revenue water to 25% al. 2017.  Sources: World Bank calculations based on IBNET data; Goksu et ­ countries. IBNET = International Benchmarking Network for Water and Sanitation Note: Estimates from data on 605 utilities in low- and middle-income ­ maintenance. Utilities; O&M = operation and ­ Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 73 and revenue, providers are encouraged to be more where between 2005 and 2014 a water utility more customer oriented: the better they understand their than tripled its connections (14,000 of new connec- customer base, the better able they will be to make tions involved the urban poor), reduced nonreve- appropriate ­improvements. nue water to 17 percent, and lowered energy costs Therefore, as noted in the World Bank’s Utility by 23 percent (Goksu et ­ al. 2017). Turnaround Framework, any sector turnaround should begin with making service providers’ current opera- Facilitating Access to Commercial Financing tions and capital investments more efficient (Soppe, Although commercial financing is a separate issue from Janson, and Piantini 2018). the funding required for subsidies, it represents a sig- Any sector turnaround Greater efficiency, in turn, nificant opportunity for service providers to rehabili- can encourage govern- tate or expand their infrastructure to meet the needs should begin with ments to allocate addi- users. Commercial financing of current and future ­ making service tional resources to the allows service providers to effectively distribute the providers’ current sector, if necessary, while costs of such infrastructure across current and future encouraging private sec- generations, ideally in a manner whereby each gen- operations and capital tor investment through an eration of users pay the economic costs of the assets investments more improved risk-reward bal- for. that they are responsible ­ ance (as discussed later in The higher targets and new baseline of SDG 6 require efficient. this ­section). investment estimated at $1.7 trillion in water and sani- Experience shows that such reforms can be quickly tation between 2015 and 2030 (Hutton and Varughese implemented from a technical perspective but they 2016)—a significant challenge for many low- and mid- first require a government champion to assert direct ­ector’s poor dle-income countries, given the WSS s leadership in championing reforms and a catalyst that public funds, and cost-recovery record, dependence on ­ change. Catalysts vary by context creates space for ­ low and uncertain fiscal transfers (World  Bank Group but most commonly involve a crisis, such as chronic 2017­a). Additionally, the WSS sector in many low-­ water shortages or severe financial distress, or a income nations suffers from underfunding as political decision that pushes service providers governments ­ struggle with competing public reform. This kind of political decision might toward ­ expenditure priorities and a fast-growing urban ­ involve (i) a political threat to streamline the service population. To bridge the gap between current levels ­ provider, thus threatening the livelihood of the ser- of WSS service and the SDG 6 targets, existing fund- vice provider’s staff, (ii) a loss of subsidies, or (iii) a ing from governments and development partners change in sector governance frameworks that pro- supplemented. In addition to more will have to be ­ vide incentives for reducing costs and increasing public expenditure in the sector, another potential revenues (Soppe, Janson, and Piantini 2018). For way forward is to leverage private resources through example, governments likely need to authorize subsidies. the strategic deployment of available ­ ­ service providers to collect bills and give them Leveraging private resources in the WSS sector can the autonomy to restrict service to nonpaying be very challenging, since private sector investors ­ customers. Such reforms in the early 2000s greatly must meet their obligations to shareholders and gen- improved the performance of service providers erate acceptable returns, compatible with the risks across Vietnam, including in the city of Da Nang, ­accepted. Funding needs are characterized by large 74 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation initial public outlays, relatively long design periods the time frame of cost recovery, since capital costs (which, in turn, postpone the point at which revenue charges. are ultimately collected through service ­ starts to flow), and modest returns, given that water Thus, such contributions help reduce the service is often considered a basic need and social service charges paid by individual consumers, the avail- rather than a pure economic g ­ ood. As a result of ability charges paid in a public-private partnership these challenges, the sector largely depends on loan. (PPP), or loan repayments required in a private ­ poorly designed subsidies, which may give rise to a • Concessionary loans reduce the interest rate pay- host of problems, including financial and technical able on the project cost and thus the overall inefficiencies, such as inadequate management and amount to be repaid, generally through the collec- overstaffing. These in turn impact creditworthiness ­ tion of service charges. ­ and ultimately inhibit private sector i nvestment. • Operational contributions cover the running costs However, it is possible for development partners and of operating and maintaining the utility, which in governments to use their own limited resources, par- charges. Operational con- turn subsidizes service ­ ticularly through the judicious use of grants and con- tributions (sometimes called viability subsidies) cessionary funds, to improve both the operational are the most common way to subsidize utilities to and financial performance of service providers and make them creditworthy, although they tend not sector. leverage more investment from the private ­ to attract a lot of private capital, primarily because Private investors are driven by a “risk-reward bal- nature. of their irregular and unreliable ­ ance,” irrespective of the sector they fund or invest i ­n. In other words, the higher the risk, the higher the • Grants to improve capacity are temporary subsidies required expected return, until a point at which the that reduce the cost of running the utility and help investor determines that the risk is too great and is achieve more efficient and effective service provi- no longer willing to ­ invest. To encourage private sec- way. It is important sion in a financially sustainable ­ tor investments, the risk-reward balance must be to note that access to commercial financing requires acceptable to both investors and ­ recipients. When it that service providers receive a reliable flow of isn’t, the public sector can influence the private sec- resources, primarily through user ­tariffs. Such grants tor’s willingness to invest by either increasing the can help improve capacity to achieve this by imple- reward or decreasing the ­ risk. menting uniform billing systems, implementing Blended finance, defined by the Organisation for metering systems, standardizing approaches to GPS Economic Co-operation and Development as “the stra- on. (global positioning system) mapping, and so ­ tegic use of development finance for the mobilization • Financial guarantees against default with fees set of additional finance toward sustainable development below market rates do not fully reflect the risk in developing countries,” specifically seeks to improve involved. The difference between the market-based ­ the risk-reward balance by either de-risking projects or cost of the guarantee and the actual cost charged enhancing returns (OECD 2018). Subsidies can serve subsidy. would constitute a quantifiable ­ several different roles in such blended finance trans- • Nonenforcement of standards: Should the set examples. actions, including the following ­ standards of a public-private partnership project, ­ • Capital contributions/grants effectively reduce the whether a concession or a delegated management initial capital costs of a p ­ roject. This in turn reduces contract, deliberately not be enforced, it will Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 75 represent a cost savings to the private operator TABLE 4.2. Characterizing Subsidy Policy Benefits: Basic Framework subsidy. and thus an indirect ­ Generalized Generalized • Tax concessions are an additional hidden means of benefits are large benefits are small ­ubsidy. They have two forms: the providing a s Interest group Case 1 Case 2 government may either (i) waive existing taxes, benefits are large such as value-added taxes; or (ii) provide tax Interest group Case 3 Case 4 investors. incentives or waivers to ­ benefits are small Source: Adapted from Inchauste, Victor, and Schiffer (2018: 11). • Waiving dividends or returns on equity: In most cases where a utility is established as a company or a separate state-owned enterprise, it is capital- as the rich who may disproportionately access net- ized by the public sector without any expectation worked services, or service providers or government of a dividend or return on capital, effectively con- ­ ystem). actors profiting from inefficiencies in the s stituting a subsidy. (These dimensions are consistent with the life-cycle diagram presented in box 2.2 in chapter 2.) Ultimately, the goal is to understand how interest Building Political Coalitions to Support 4.2  groups might support or oppose government efforts Reform ­ eform.8 This will depend on the level toward subsidy r A strategy to both foster supportive political coalitions of organization and political power of the groups con- and mitigate the impact of opponents is an essential cerned, as well as the ability of reformers to choose element of any r ­ eform.7 Broad and diffused interests political allies and to weaken or even win over the tend not to be well organized, whereas concentrated political influence of groups that could potentially interest groups can mobilize more readily and effec- block a proposed reform’s ­ implementation. tively to advance their narrower c ­ auses. This basic A subsidy reform may seek to shift this equilibrium, logic is behind a simple political economy frame- but of the four cases outlined in table 4.2, none is pref- work that categorizes the political equilibrium of a contexts. For example, a well-targeted erable in all ­ country’s subsidy policy (table 4.2) along two axes: subsidy that seeks to exclusively benefit the poor (i) the size of benefits accruing to all households or should strive toward case 2, while a reform program individuals in the population (generalized benefits); seeking to gradually remove subsidies in order to and (ii) the size of benefits accruing to only particu- attain cost-recovery tariffs should strive toward case lar segments, or interest 4. Note that only those situations where costs accrue groups, within that largely to the government (taxpayers) while benefits A strategy to both foster population. It is import- ­ accrue to interest groups and the general populace supportive political ant to note that an inter- cases. In reality, the are considered in these four ­ est group can be any costs borne by citizens and interest groups would coalitions and mitigate group with a stake in the need to be considered in any comprehensive politi- the impact of opponents system; that is, either analysis. cal economy ­ intended beneficiaries To design feasible reforms and implementation is an essential element (such as the poor) or unin- plans, it is crucial to figure out the current political reform. of any ­ tended beneficiaries (such equilibrium in a country and to develop a strategy for 76 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation how to shift the status ­quo. For example, when gener- Reforms are successful alized benefits and benefits accruing to interest only where an informed Reforms are successful groups are both large (case 1), the following may and supportive public improve the feasibility of reform: understands the rationale only where an informed for ­reform. • The government communicates a strong, simple, and supportive public Communication is a nec- and credible narrative, outlining the risks of the essary investment that understands the status quo and breaking complex economic pro- should be planned and cesses down to a simple relatable ­ logic. reform. rationale for ­ implemented by profes- • Citizens develop a better understanding of how sionals before, during, and after a reform’s the existing system is harmful to their interests— ­implementation. By assessing risks and opportunities by, for example, effectively redistributing public early, informing the public in accessible and engag- it. funds to the wealthy—and mobilize to counter ­ ­ elping people understand the bene- ing ways, and h • The government credibly commits to citizens and fits of subsidy reform and how these link to their interest groups that policy reforms will leave them own lives, policy makers can encourage public same. This may require either better off or the ­ goodwill. understanding—and, ultimately, ­ offering them medium-term benefits to offset the A well-planned communications strategy must also subsidies. loss of ­ be flexible to accommodate shifting political, social, • Interest groups that would oppose reform find it process. and cultural factors relevant to the reform ­ difficult to mobilize, or the government finds a Planners should take the following steps: aims. way to satisfy their core ­ • Clearly define the strategy’s primary goal, charac- ­e.g., • The costs of providing benefits rise sharply ( terize the political and socioeconomic context in because of a fiscal crisis or impending water secu- which it will be developed, and understand what rity ­crisis). makes the reform urgent as well as the possible • The costs of subsidies are not sustainable, coupled implementation. obstacles to its ­ quality. with declining service ­ • Map the relevant stakeholders by category and • External pressure from donors or lenders changes deepen understanding of their views, feelings, equilibrium. the political ­ perceptions, motivations, beliefs, and practices by A detailed description of each type of case, as well conducting opinion research, focus groups, as possible strategies for reform in each context, is on. in-depth interviews, and so ­ C. provided in appendix ­ • After internalizing how the target audiences think, feel, and may react, create compelling messages 4.3 Communications Strategies for Reform that harness the power of emotion and storytell- International experience has shown that a well-planned ing, define credible messengers, and select appro- and professionally executed communications strategy, communication. priate channels of ­ based on empirical research, is critical to the success of • Implement a “monitoring-evaluation-learning” reforms. Public reactions to subsidy WSS subsidy ­ process to gauge the impact of the campaign and ­ ynamic. reform programs are highly contextual and d required. adjust the strategy if and as ­ Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 77 BOX 4.1. A Successful Communications Strategy: The Case of Iran In March 2010, the Iranian parliament ratified the Targeted Subsidies Reform Act, establishing a gradual increase of energy and water prices to attain full cost recovery, along with the gradual elimination of a variety of agriculture and transportation service subsidies, within a five-year period (2010–15). In parallel, the govern- ­ ransfers. ment replaced the subsidies with compensatory nationwide cash t The Government of Iran implemented a communications campaign before the subsidy reform to help build support. The authorities emphasized the social inequity resulting from cheap energy (Guillaume, Zytek, public ­ and Reza Farzin 2011: 17). The communications campaign increased consumers’ awareness of the poten- tial price increases and demonstrated how the reform would support poor and vulnerable households not system. The campaign clearly communicated that subsidies would not be benefiting from the current subsidy ­ eliminated completely, but instead redirected to specifically benefit poor h ­ ouseholds. The government used a series of messages to communicate how the reform would: (i) improve standards of living, (ii) distribute national wealth fairly and equally, (iii) minimize income disparities, and (iv) increase efficiency and prevent wasteful consumption, among other ­ benefits. The reform was preceded by an extensive public relations campaign to educate the population on the growing ­ eform. The government appointed costs of low energy and water prices and on the benefits expected from the r ­ eform. Through a special spokesman to coordinate the envisaged public relations campaign in support of the r a broad range of educational programs, news media (newspapers, websites, radio, and television), and public ­ rices. Political, business, and social seminars it was explained how energy waste resulted from low energy p leaders, as well as academics, were mobilized to speak in favor of the reform and enumerate its benefits (Guillaume, Zytek, and Reza Farzin 2011: 17). To make the process transparent, utilities exposed Iranian house- holds to the new prices well before they were implemented, sending them bills that foreshadowed the true ­ ates. unit cost and the full amount due after reform, in addition to the current subsidized r Overall, the public relations campaign proved successful, owing largely to the following elements: (i) strong political will to reform subsidies; (ii) a unified and coherent message; (iii) well-organized pre-reform prepa- rations to attract public support; (iv) excellent communication of the impacts of subsidies, energy price increases, and expected benefits; and (v) efficient messengers using the right c ­ hannels. Despite the initial suc- cess, the subsidy reform program was later derailed due to the progressive imposition of economic sanctions and successive economic shocks, which reduced the real value of cash transfers and pressured the govern- ment to reintroduce some subsidies (Salehi-Isfahani 2014). Nevertheless, Iran’s reform efforts demonstrate the importance of an effective subsidy reform package that complements pricing reform with complementary policy measures and a comprehensive communications strategy that cultivates a supportive political coalition. report. Source: “Iran (Removal of Consumption Subsidies),” a case study prepared for this ­ With these elements in place, a communications 4.4 When to Design a Subsidy Exit Strategy strategy for subsidy reform will set the foundation An exit strategy is an important component of a sub- success. The communications strategy used for ­ sidy reform package when the relevant subsidy is during Iran’s subsidy reform process, initiated in term. When proposing a new intended to be short ­ 2010, illustrates this in action (box 4.1). 78 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation subsidy, policy makers should consider whether the A reform likely to adversely impact the poor or an conditions demanding the subsidy are permanent or otherwise politically salient group might be designed future. Are all subsidy likely to dissipate in the near ­ in such a way that subsidies are removed gradually, in beneficiaries likely to be able to afford the full cost of time. As has been discussed, social phases, over ­ service at some point in the future, and thus the sub- safety nets may be used to ease households’ burden sidy can be removed, or will some degree of support ­ liminated. Some as benefits are rolled back and/or e need to continue, with potential modifications to the of the reform’s phases might include additional ele- subsidy amount and targeting? If the conditions are ments such as complementary sector or legal temporary in nature, policy makers should develop a reforms, policies to temporarily compensate users credible commitment mechanism that helps govern- for the loss of benefits, and communication strate- right. ment exit when the time is ­ ­ thers. The choice and timing of these gies, among o Where particular user groups enjoy entrenched ben- informed. elements should be politically ­ efits, social safety nets or time-bound cash transfers may be required when subsidies are either removed or Notes ­reformed. The Iranian government, for example,  1. Successful community management of WSS services, however, requires significant levels of external support, which may include made use of additional revenue gained from the linkages with professional area mechanics, supervision, and funding removal of large, regressive energy and water subsi- for recurrent costs (Chowns 2015). dies to simultaneously introduce universal monthly   2. See ­http://www.aysa.com.ar/index.php?id_seccion=569. cash transfers to households9 and financial assis-   3. A range of design standards available for nonconventional sewerage businesses. Given these groups’ tance to private ­ contexts. For a discussion of them, see, may be appropriate in these ­ al. (2014). for example, Ily et ­ long-standing dependence on subsidized water and ­ ndertaken.   4. Refer to section 2.2 for a description of the methodology u energy tariffs, providing such compensation proved Low- and middle-income countries are defined by the International necessary in the short to medium term to gain their economies. Monetary Fund as nonadvanced ­ al. 2014). support for reform (Demirkol et ­   5. Note that our estimates of overall subsidies do include inefficiencies To remove or modify entrenched subsidies, policy in billing and collections; however, we are unable to differentiate between subsidies associated with such inefficiencies and those makers would do well to (i) mobilize political coalitions tariffs. associated with non-cost-recovery ­ to support the intended reform, and (ii) sequence the   6. Capital costs amount to an average of 49 percent of total costs for elements of the reform package to mitigate potential al. 2018). water utilities in the United Kingdom (Kingdom et ­ ­resistance. Citizens’ perceptions and expectations   7. This section is based on Inchauste, Victor, and Schiffer (2018: 11). will shape their reaction to reform: Do they believe organized.  8. Note that not all interest groups will be politically ­ Moreover, within governments themselves, officials may hold con- the status quo is economically inefficient? Do they policy. flicting positions regarding subsidy ­ believe they are benefiting from the subsidy (even if   9. Note that, despite being universal, these cash transfers proved to be they are not)? Do they expect free water? Therefore, more progressive than the subsidies, through which low-income a communications strategy to discuss the evidence little. The government has since sought to households benefited ­ transfers. gradually exclude wealthier households from the ­ and develop a shared understanding of the need for 10. Voters do not always understand the economic rationale behind change will be critical to mobilizing a political coali- (e.g., through a cash trans- change—even if they are going to benefit ­ contexts.10 tion in many ­ removal). fer alongside subsidy ­ Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 79 CHAPTER 5 Key Takeaways In this report, we explore the question of how scarce public resources can be used most effectively to achieve universal delivery of water supply and sanitation (WSS) services. We begin by analyzing existing subsidies in the sector before provid- ing guidance to policy makers on how subsidies can be better designed and implemented to improve their efficacy and efficiency in attaining their objectives. This report puts forward three key messages, as discussed below. Message 1: Current WSS subsidies fail to achieve their objectives due to poor design; they tend to be pervasive, expensive, poorly targeted, nontransparent, and distortionary. In chapter 2, we discuss each of these characteristics in detail: • Subsidies are pervasive across countries, irrespective of region or income level. Subsidies are particularly prevalent among networked and sewered WSS services, as illustrated by the IBNET database. Only 14 percent of the 1,549 listed utilities generate enough revenue to cover the total economic costs of service provision, while only 35 percent are able to cover, at a minimum, the ­ operation and maintenance costs of service provision. • The cost of subsidies associated with the operations, maintenance, and replacement of existing WSS infrastructure in much of the world (excluding, notably, China and India) is an estimated $289–$353 billion per year, or percent of these countries’ combined gross domestic product.1 This 0.46–0.56 ­ figure rises, shockingly, up to 1.59–1.95 percent if only low- and middle-­ income economies are considered, an amount largely due to the capital subsidies captured in our estimation. It is important to note that our esti- mation does not include either capital expenditure for infrastructure expansion—which tends to be fully subsidized—or environmental costs. ­ agnitude of networked water and sanitation Therefore, the actual global m subsidies is much greater than our estimation. • Most existing subsidies are poorly targeted to the poor. In the 10 countries we analyzed, an average of 56 percent of networked water supply subsidies reach the wealthiest quintile of the population, while a mere 6 percent reach the poorest quintile.2 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 81 • Many common approaches to subsidizing the increasing block tariffs have generally been WSS sector lack transparency ; this allows some employed to target subsidies to poor households service providers to misuse scarce public since the latter are thought to use less water than resources, failing to benefit customers through do wealthier households. Yet there is growing evi- improved service quality and/or reduced dence that such pricing is ineffective, as piped costs. water consumption is not correlated with poverty • Poorly designed subsidies contribute to inefficiency, (Fuente and Bartram 2018). As an alternative, there and may even threaten the sustainability of service. is an increasing array of targeting options made In addition, subsidized tariffs do not reflect the possible through technological innovations. true cost of a service and therefore cannot provide Additionally, the inefficiencies arising from sup- signals that might encourage efficient production ply-side subsidies are not inevitable—subsidies or consumption. can be made conditional on performance. Despite the pessimism surrounding the possibility of lever- Message 2: The current poor performance of WSS sub- aging commercial financing in the WSS sector, the sidies can be avoided; new knowledge and technolo- strategic use of subsidies can improve investors’ gies are making it increasingly possible for subsidies to perceived risk-reward balance, in turn attracting cost less and help more. private resources. Finally, designing subsidies to • Some amount of subsidy will always be needed, yet advance equitable access to affordable WSS ser- they should be well designed, transparent, and vices can be facilitated through the use of a rede- ­targeted. Given that most of the remaining fined metric of service affordability, proposed in unserved are poor, subsidies will be essential for this report, that more accurately estimates service achieving the global goal of equitable access to costs, better assesses households’ financial con- safely managed WSS services for all. There is no straints, and provides information specific to a one-size-fits-all solution to the problems of inade- government’s particular sectoral goals. quate access to WSS services; all options have both Message 3: To successfully reform subsidies, a subsidy strengths and weaknesses. The most suitable pol- reform package, in addition to improved subsidy icy will depend on the specific goals to be attained, design, is required. An effective subsidy reform pack- the resource constraints of the government and age includes complementary policy measures, the stakeholders, and the context in which it is to be building of a supportive political coalition, a commu- implemented (i.e., the specific demographic, envi- nications strategy, and an exit strategy (where ronmental, institutional, and cultural characteris- applicable). tics, as well as on baseline levels of access to WSS services across population groups). However, the • Various complementary policy mechanisms may be scarcity of public resources and the inevitable used to complement subsidies, with the aim of presence of trade-offs demand that subsidies be improving WSS services’ access and affordability for well designed, transparent, and targeted. the poorest segments of the population. A number • New knowledge and technologies are providing of mechanisms can be used to reduce the amount policy makers with an increasing array of tools ­ of subsidy required or to support service providers to improve subsidy performance. For example, in more effectively targeting subsidies to the poor 82 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation and in overcoming financial, legal, or administra- achievement will require substantial financial tive barriers to access. resources. Given the scarcity of public resources • To design feasible reforms and implementation globally, it is more important than ever to ensure plans, it is crucial to develop a strategy to both fos- that those public resources already allocated to ter supportive political coalitions and mitigate the the sector are used efficiently. Well-designed impact of opponents. Policy makers must under- subsidies effectively achieve the goals of expand- stand the interplay between various sector stake- ing access to affordable, sustainable, and quality holders and tailor policies that mobilize a political WSS services, while maximizing the targeting of coalition in favor of reform or, at the least, tacitly the poor, promoting transparency, and minimiz- supportive of it. ing distortion. As the financial sustainability of service providers improves, these public • A well-planned, consistent, and flexible communica- resources can be leveraged to attract complemen- tions strategy will help galvanize such public sup- tary private resources to the sector. By moving port. By assessing risks and opportunities early, beyond the design flaws of the past, subsidies are informing the public in accessible and engaging a viable means of ensuring access to sustainable ways, and helping people understand the benefits and safely managed water supply and sanitation of subsidy reform and how these link to their own services for all. lives, policy makers can encourage public under- standing—and, ultimately, goodwill. • Finally, policy makers should consider whether the Notes conditions giving rise to subsidies are persistent or 1. China and India were notably excluded due to insufficient data and likely to dissipate in the near future. If the condi- the fact that their singularity makes estimates based on extrapolation tions are temporary, policy makers should plan impossible. ahead for the phased reduction or removal of 2. Building on the methods of Komives et al. (2005) and Angel- Urdinola and Wodon (2011), we provide new estimates of the per- subsidies. formance of piped-water consumption subsidies in terms of pro-poor targeting across 10 countries: Ethiopia, Mali, Niger, The SDGs for water supply and sanitation set Nigeria, Uganda, El Salvador, Jamaica, Panama, Bangladesh, and out a transformational vision for the future whose Vietnam. Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 83 References Please refer to appendix A for a list of background papers and case studies prepared as part of the present study. 1001 Fontaines. n.d. “The Approach.” https://www.1001fontaines.com/en/approach. Alsan, M., and C. Goldin. 2019. “Watersheds in Child Mortality: The Role of Effective Water and Sewerage Infrastructure, 1880–1920.” Journal of Political Economy 127 (2): 586–38. Andres, L., D. Biller, and M. H. Dappe. 2013. Reducing Poverty by Closing South Asia’s Infrastructure Gap (English). Washington, DC: World Bank Group. http://documents.worldbank.org/curated/en​ /881321468170977482/Reducing-poverty-by-closing-South-Asias-infrastructure-gap. Andres, L., S. Deb, M. Gambrill, E. Giannone, G. Joseph, P. Kannath, M. Kumar, P. K. Kurian, R. Many, and A. Muwonge. 2017. “Sustainability of Demand Responsive Approaches to Rural Water Supply: The Case of Kerala.” Policy Research Working Paper 8025, World Bank, Washington, DC. Andres, L., C. Chase, Y. Chen, R. Damania, G. Joseph, R. Namara, J. Russ, and E. D. Zaveri. 2018. “Water and Human Capital: Impacts across the Lifecycle.” World Bank, Washington, DC. Andres, L., C. Brocklehurst, J. Grabinsky, G. Joseph, and M. Thibert. Forthcoming. “Measuring the Affordability of Water Supply, Sanitation, and Hygiene Services: New Framework and Evidence.” Angel-Urdinola, D., and Q. Wodon. 2011. “Does Increasing Access to Infrastructure Services Improve the Targeting Performance of Water Subsidies?” Journal of International Development 24 (1): 88–101. http:// microdata.worldbank.org/index.php/citations/2168. AWWA (American Water Works Association). 2015. “Disinfecting Water Mains.” AWWA Standard, ANSI/AWWA C651-14, AWWA, New York. https://www.mwa.co.th/download/prd01/reference/AWWA_std/Disinfecting​ _Water_Mains.pdf. Banerjee, S., V. Foster, Y. Ying, H. Skilling, and Q. Wodon. 2010. “Cost Recovery, Equity and Efficiency in Water Tariffs: Evidence from African Utilities.” Policy Research Working Paper 5384, World Bank, Washington, DC. Barde, J. A., and P. Lehmann. 2014. “Distributional Effects of Water Tariff Reforms—An Empirical Study for Lima, Peru.” Water Resources and Economics 6: 30–57. Beato, P. 2000. “Cross Subsidies in Public Services: Some Issues.” Technical Papers Series, Sustainable Development Department, Inter-American Development Bank (IDB). Boistard, P. 1993. “Influence of the Price of Public Water Utilities on Domestic Water Consumption.” Revue des sciences de l’eau (Journal of Water Science) 6 (3): 335–52.  Broadway, R., and A. Shah. 2007. Intergovernmental Fiscal Transfers: Principles and Practice. Washington, DC: World Bank. Brocklehurst, C. 2001. Durban Metro Water: Private Sector Partnerships to Serve the Poor. Nairobi, Kenya: Water and Sanitation Program. Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 85 Carver, P. H., and J. J. Boland. 1980. “Short-and Long-Run Effects of Group, Washington, DC. https://hubs.worldbank.org/docs/ImageBank​ Price on Municipal Water Use.” Water Resources Research 16 (4): 609–16. /Pages/DocProfile.aspx?nodeid=30803488. Castaneda, A., D. Doan, D. Newhouse, M. C. Nguyen, H. Uematsu, and Fay, M., L. A. Andres, C. J. E. Fox, U. G. Narloch, S. Straub, and M. A. J. P. Azevedo. 2016. “Who Are the Poor in the Developing World?” Policy Slawson. 2017. Rethinking Infrastructure in Latin America and the Research Working Paper 7844, World Bank, Washington, DC. https:// Caribbean: Spending Better to Achieve More (English). Directions in openknowledge.worldbank.org/handle/10986/25161. Development. Washington, DC: World Bank Group. http://documents. worldbank.org ​ /c urated/en/3489715005 44504305/Rethinking- Chowns, E. 2015. “Is Community Management an Efficient and Effective infrastructure-in-Latin​-America-and-the-Caribbean-spending-better- Model of Public Service Delivery? Lessons from the Rural Water Supply to-achieve-more. Sector in Malawi.” Public Administration and Development 35 (4): 263–76. doi: 10.1002/pad.1737. Fonseca, C., and L. Pories. 2017. “Financing WASH: How to Increase Funds for the Sector while Reducing Inequities.” Position paper Chen, G. 2018. “Plugging the Leaks to Help Close the Water Financing for  the Sanitation and Water for All Finance Ministers Meeting, and Access Gaps.” Everything About Water E-Magazine (February 2018): April  19. https://sswm.info/sites/default/files/reference_attach- 16–17. ments​/ Fonseca%3B%20Pories%20%282017%29%20Financing%20 WASH.pdf. Clasen, T. F., K. T. Alexander, D. Sinclair, S. Boisson, R. Peletz, H. H. Chang, F. Majorin, and S. Cairncross. 2015. “Interventions to Improve Water Foster, T., S. Furey, B. Banks, and J. Willetts. 2019. “Functionality of Quality for Preventing Diarrhoea.” Cochrane Database of Systematic Handpump Water Supplies: A Review of Data from Sub-Saharan Africa Reviews 10: 1–201. and the Asia-Pacific Region.” International Journal of Water Resources Development. DOI: 10.1080/07900627.2018.1543117. Contreras, D., A. Gomez-Lobo, and I. Palma. 2018. “Revisiting the Distributional Impacts of Water Subsidy Policy in Chile: A Historical Foster, V., and C. Briceno-Garmendia. 2010. Africa’s Infrastructure: Analysis from 1998–2015.” Water Policy 20 (6): 1208–26. https://doi​ A Time for Transformation: A Time for Transformation. Africa Development .org/10.2166/wp.2018.073. Forum. Washington, DC: World Bank. https://openknowledge.worldbank​ .org/handle/10986/2692. Cronin, A. A., M. E. Gnilo, M. Odagiri, and S. Wijesekera. 2017. “Equity Implications for Sanitation from Recent Health and Nutrition Evidence.” Foster, V., A. Gómez-Lobos, and J. Halpern. 2000. “Designing Direct International Journal for Equity in Health 16 (1): 211. Subsidies for the Poor: A Water and Sanitation Case Study.” Viewpoint, Demirkol, O., R. Blotevogel, R. Zytek, P. Zimand, and Y. Liu. 2014. “Targeted Note no. 211, World Bank, Washington, DC. https://openknowledge​ Subsidy Reform in Iran.” IMF Selected Issues Paper on Islamic Republic of .worldbank.org/handle/10986/11428. Iran, International Monetary Fund, Washington, DC, March 18. Fuente, D., and J. Bartram. 2018. “Pro-Poor Governance in Water and de Waal, D., M. Duret, A. Gaju, M. Hirn, S. Huston, N. Jain, D. Mirindi, N. Sanitation Service Delivery: Evidence from Global Analysis and Mudege, D. Niyungeko, C. Richey C. Ochieng, C. Print, M. Sitali, and H. Assessment of Sanitation and Drinking Water Surveys.” Perspectives in Skilling. 2017. Water Supply: The Transition from Emergency to Public Health 138 (5): 261–69. https://doi.org/10.1177/1757913918788109. Development Support. Nairobi, Kenya: World Bank. Fuente, D., J. Gakii Gatua, M. Ikiara, J. Kabubo-Mariara, M. Mwaura, and Dickinson, K., S. Patil, S. Pattanayak, C. Poulos, and J.-H. Yang. 2015. D. Whittington. 2016. “Water and Sanitation Service Delivery, Pricing, and “Nature’s Call: Impacts of Sanitation Choices in Orissa, India.” Economic the Poor: An Empirical Estimate of Subsidy Incidence in Nairobi, Kenya.” Development and Cultural Change 64 (1): 1–29. /2015WR018375. Water Resources Research 52 (6): 4845–62. doi:10.1002​ Eales, K., and D. Schaub-Jones. 2005. “Sanitation Partnerships: Gallaher, M., T. Alam, and N. Rouchdy. 2017. “The Impact of Electricity Landlord or Tenant? The Importance of Rental Relationships to Poor and Water Subsidies in the United Arab Emirates.” RTI Policy Brief no. Community Sanitation in 3 African Countries.” BPD Sanitation Series, PB-0012-1705, RTI Press, Research Triangle Park, NC. Building Partnerships for Development in Water and Sanitation, Gamper-Rabindran, S., S. Khan, and C. Timmins. 2010. “The Impact of London. https://nl.ircwash.org/sites/default/files/Schaub-Jones-Eales​ Piped Water Provision on Infant Mortality in Brazil: A Quantile Panel -2008-Sanitation.pdf. Data Approach.” Journal of Development Economics 92 (2): 188–200. ECLAC (Economic Commission of Latin America and the Caribbean). Gertler, P., M. Shah, M. L. Alzua, L. Cameron, S. Martinez, and S. Patil. 2016. “Registro Unico de Programas Sociales del Gobierno Federal de 2015. “How Does Health Promotion Work? Evidence from the Dirty Brasil.” https://dds.cepal.org/eventos/presentaciones/2016/0418/Panel​ Business of Eliminating Open Defecation.” NBER Working Paper 20997, -II.1.Brasil-FRibeiro.pdf. National Bureau of Economic Research, Cambridge, MA. Faulhaber, G. R. 1975. “Cross-Subsidization: Pricing in Public Enterprises.” Goksu, A., S. Trémolet, J. Kolker, and B. Kingdom. 2017. Easing the The American Economic Review 65 (5): 966–77. Transition to Commercial Finance for Sustainable Water and Sanitation. Fay, M., H. Hyoung, M. Mastruzzi, S. Han, and M. Cho. 2019. “Hitting the Washington, DC: World Bank Group. http://documents.worldbank.org​ Trillion Mark: A Look at How Much Countries Are Spending on /curated/en/182521503466225465/pdf/119048-WP-REPLACEMENT​ Infrastructure.” Policy Research Working Paper WPS 8730, World Bank -PUBLIC.pdf. 86 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation Grafton, R. Q., M. B. Ward, H. To, and T. Kompas. 2011. “Determinants of Ily, J.-M., C. Le Jallé, J. Gabert, and G. D. Desille. 2014. Non-Conventional Residential Water Consumption: Evidence and Analysis from a Sewerage Services: When to Choose This Option, How to Implement This 10-Country Household Survey.” Water Resources Research 47 (8). Solution. Paris: Programme Solidarité-Eau. GRDR and GRET. 2016. Améliorer l’Accès À l’Eau et À l’Assainissement en Inchauste, G., D. G. Victor, and E. Schiffer. 2018. Good Practice Note 9: Mauritanie. Pour Une Plus Grande Implication Des Communes Dans Les Assessing the Political Economy of Energy Subsidies to Support Policy Reform Services D’eau Et D’assainissement. Paris, France: GRDR and GRET. Operations. Energy Subsidy Reform Assessment Framework (ESRAF). https://www.gret.org/wp-content/uploads/Guide-Aicha_Peagg_Vf2.pdf. Washington, DC: World Bank Group. http://documents.worldbank.org​ /curated/en/976071531112775611/pdf/ESRAF-note-9-Assessing-the-Political​ Guillaume, D., R. Zytek, and M. Reza Farzin. 2011. “Iran: The Chronicles -Economy-of-Energy-Subsidies-to-Support-Policy-Reform-Operations.pdf. of the Subsidy Reform.” IMF Working Paper WP/11/167, International Monetary Fund, Washington, DC. Institute of Development Studies. n.d. “Countries.” Community-Led Total Sanitation. Accessed June 10, 2019. http://www.communityledtotalsanitation​ Guiteras, R., J. Levinsohn, and A. M. Mobarak. 2015. “Encouraging .org/where. Sanitation Investment in the Developing World: A Cluster-Randomized Trial.” Science 348 (6237): 903–06. Ito, K. 2013. How Do Consumers Respond to Nonlinear Pricing? Evidence from Household Water Demand. University of Chicago. http://home​ Gupta, A., D. Spears, D. Coffey, N. Srivastav, P. Hathi, and S. Vyas. 2017. .uchicago.edu/ito/pdf/Ito_Water_Irvine.pdf. “Understanding Open Defecation in Rural India: Untouchability, Pollution, and Latrine Pits.” RICE, January 7. https://riceinstitute.org​ ———. 2014. “Do Consumers Respond to Marginal or Average Price? /research/culture-and-the-health-transition-understanding-sanitation​ Evidence from Nonlinear Electricity Pricing.” American Economic Review -behavior-in-rural-north-india/. 104 (2): 537–63. GWI (Global Water Intelligence). 2004. “Tariffs: Half Way There.” Joskow, P. 2005. “Regulation of Natural Monopolies.” MIT-CEEPR GWI, Oxford, United Kingdom. Working Paper 05-008 WP, Center for Energy and Environmental Policy Research, Massachusetts Institute of Technology, Cambridge, MA, April. Hanke, S. H., and L. D. Mare. 1982. “Residential Water Demand: A Pooled, Time Series, Cross Section Study of Malmö, Sweden.” JAWRA Kar, K., and R. Chambers. 2008. Handbook on Community-Led Total (Journal of the American Water Resources Association) 18 (4): 621–26. Sanitation. Brighton, UK: Institute of Development Studies. Hansen, L. G. 1996. “Water and Energy Price Impacts on Residential Katzman, M. T. 1977. “Income and Price Elasticities of Demand for Water Water Demand in Copenhagen.” Land Economics 72 (1): 66–79. in Developing Countries.” JAWRA (Journal of the American Water Resources Association) 13 (1): 47–55. Harberger, A. 1971. “Three Basic Postulates for Applied Welfare Economics: An Interpretive Essay.” Journal of Economic Literature 9 (3): 785–97. Khandker, S., B. Khalily, and Z. Khan. 1995. Grameen Bank: Performance Hathi, P., S. Haque, L. Pant, D. Coffey, and D. Spears. 2017. “Place and and Sustainability. Washington, DC: World Bank. Child Health: The Interaction of Population Density and Sanitation in Kingdom, B., D. Lloyd-Owen, S. Trémolet, S. Kayaga, and J. Ikeda. 2018. Developing Countries.” Demography 54 (1): 337–60. https://doi.org​ “Better Use of Capital to Deliver Sustainable Water Supply and Sanitation /10.1007/s13524-016-0538-y. Services: Practical Examples and Suggested Next Steps.” World Bank, Heymans, C., K. Eales, and R. Franceys. 2014. The Limits and Possibilities Washington, DC. of Prepaid Water in Urban Africa: Lessons from the Field. Washington, DC: Kochhar, M. K., M. C. A. Pattillo, M. Y. Sun, M. N. Suphaphiphat, World Bank. https://www.wsp.org/sites/wsp.org/files/publications/WSP​ A. Swiston, M. R. Tchaidze, B. J. Clements, S. Fabrizio, V. Flamini, -Prepaid-Water-Africa.pdf. L. Redifer, and M. H. Finger. 2015.  “Is the Glass Half Empty or Half Heymans, C., R. Eberhard, D. Ehrhardt, and S. Riley. 2016. Providing Full? Issues in Managing Water Challenges and Policy Instruments.” Water to Poor People in African Cities : Lessons from Utility Reforms IMF Staff Discussion Note SDN/15/11, International Monetary Fund, (English). Water and Sanitation Program Report, Water and Sanitation Washington, DC. Program (WSP). Washington, DC : World Bank Group. http://documents. Komives, K., V. Foster, J. Halpern, Q. Wodon, and R. Abdullah. 2005. worldbank.org/curated/en/316751472482999236/Providing-water-to​ Water, Electricity, and the Poor: Who Benefits from Utility Subsidies? -poor-people-in-African-cities-lessons-from-utility-reforms. (English). Directions in Development. Washington, DC: World Bank. Hope, R. A., T. Foster, A. Krolikowski, and I. Cohen. 2011. “Mobile Water http://documents.worldbank.org/curated/en/606521468136796984​ Payment Innovations in Urban Africa.” School of Geography and the / Wa t e r - e l e c t r i c i t y- a n d - t h e - p o o r -w h o - b e n e f i t s - f r o m - u t i l i t y​ Environment and Skoll Centre for Social Entrepreneurship at Saïd -subsidies. Business School, Oxford University, UK. Kulinkina, A. V., J. D. Plummer, K. Chui, K. C. Kosinski, T. Adomako- Hutton, G., and M. Varughese. 2016. “The Costs of Meeting the 2030 Adjei, A. I. Egorov, and E. N. Naumova. 2017. “Physicochemical Sustainable Development Goal Targets on Drinking Water, Sanitation, Parameters Affecting the Perception of Borehole Water Quality in and Hygiene.” Water and Sanitation Program Technical Paper 103171, Ghana.” International Journal of Hygiene and Environmental Health 220 World Bank, Washington, DC. (6): 990–97. doi:10.1016/j.ijheh.2017.05.008. Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 87 Laffont, J.-J., and J. Tirole. 1993. A Theory of Incentives in Regulation and OECD (Organisation for Economic Co-operation and Development). Procurement. Cambridge, MA: MIT Press. 2009. Managing Water for All:  An OECD Perspective on Pricing and Financing—Key Messages for Policy Makers. Paris: OECD Publishing. Lauria, D., and O. Hopkins. 2004. Pro-Poor Subsidies for Water https://doi.org/10.1787/9789264060548-en. Connections: Cases from West Africa. Consultant’s Report. Chapel Hill: University of North Carolina. ———. 2018. Making Blended Finance Work for the Sustainable Development Goals. Paris: OECD Publishing. Lauria, D. T., O. S. Hopkins, and S. Debomy. 2005. Pro-Poor Subsidies for Water Connections in West Africa: A Preliminary Study. Washington, DC: OVE (Office of Evaluation and Oversight). 2016. “Fortalecimento de las World Bank. http://documents.worldbank.org/curated/en/50215146831955​ Juntas de Saneamiento. Organicemos Nuestra junta de Saneamiento.” 7784/A-preliminary-study. http://www.senasa.gov.py/application/files/3714/6066/9525/Manual-1​ -Organicemos-nuestra-Junta-de-Saneamiento1.pdf. Le Blanc, D. 2008. “A Framework for Analyzing Tariffs and Subsidies in Water Provision to Urban Households in Developing Countries.” DESA Patil, S., B. Arnold, A. Salvatore, B. Briceño, S. Ganguly, J. Colford, and Working Paper 63, United Nations Department of Economic and Social P. Gertler. 2014. “The Effect of India’s Total Sanitation Campaign on Affairs, New York. Defecation Behaviors and Child Health in Rural Madhya Pradesh: A Cluster Randomized Controlled Trial.” PLOS Medicine 11 (8): e1001709. Lipsey, R. G., and K. Lancaster. 1956. “The General Theory of Second https://doi.org/10.1371/journal.pmed. Best.” Review of Economic Studies 24 (1): 11–32. doi:10.2307/2296233. Pattanayak, S., J.-C.Yang, K. Dickinson, C. Poulos, S. Patil, R. Mallick, JSTOR 2296233. J. Blitstein, and P. Praharaj. 2009. “Shame or Subsidy Revisited: Social Mason, N., D. Harris, and R. Batley. 2013. The Technical Is Political: Mobilization for Sanitation in Orissa, India.” Bulletin of the World Health Understanding the Political Implications of Sector Characteristics for Organization 87 (8): 580–87. the Delivery of Drinking Water Services. London: Overseas Prüss-Üstün A., R. Bos, F. Gore, and J. Bartram. 2008. Safer Water, Better Development Institute. https://www.odi.org/sites/odi.org.uk/files/odi​ Health: Costs, Benefits and Sustainability of Interventions to Protect and -assets/publications-opinion-files/8640.pdf. Promote Health. Geneva: World Health Organization. McCarthy, Shawn. 2019. “Federal Budget 2019: Ottawa Pledges Prüss-Ustün, A., J. Bartram, T. Clasen, J. M. Colford Jr., O. Cumming, $4.7-Billion in Funds to Address Indigenous Issues.” The Globe and V. Curtis, S. Bonjour, A. D. Dangour, J. De France, L. Fewtrell, and Mail, March 19. https://www.theglobeandmail.com/politics/article​ M. C. Freeman. 2014. “Burden of Disease from Inadequate Water, -grits-pledge-47-billion-in-funds-to-address-indigenous-issues/. Sanitation and Hygiene in Low-and Middle-Income Settings: McLoughlin, C., and R. Batley. 2012. “The Effects of Sector Characteristics A Retrospective Analysis of Data from 145 Countries.” Tropical on Accountability Relationships in Service Delivery.” Working Paper 350, Medicine & International Health 19 (8): 894–905. Overseas Development Institute, London. Ravallion, M., S. Chen, and P. Sangraula. 2010. “New Evidence on the Urbanization of Global Poverty.” Policy Research Working Paper WPS Meeks, R. 2018. “Property Rights and Water Access: Evidence from Land 4199, Development Research Group, World Bank, Washington, DC. Titling in Rural Peru.” World Development 102 (C): 345–57. Rivera, Jr., V. 2014. Tap Secrets: The Manila Water Story. Mandaluyong Mumssen, Y., G. Saltiel, and B. Kingdom. 2018. “Aligning Institutions City, Philippines: Asian Development Bank and Manila Water Company. and Incentives for Sustainable Water Supply and Sanitation Services. https://www.adb.org/publications/tap-secrets-manila-water​-story. Report of the Water Supply and Sanitation Global Solutions Group.” World Bank, Washington, DC. http://documents.worldbank.org​ Rodriguez, D. J., M. A. Suardi, M. Ham, L. M. Mimmi, and A. J. Goksu. 2014. /curated/en/271871525756383450/pdf/126016-WP-P159124-PUBLIC-7-5​ “Applying Results-Based Financing in Water Investments.” Water papers, -2018-12-14-46-W.pdf. Water Partnership Program (WPP), World Bank Group, Washington, DC. Nagpal, T., A. Malik, M. Eldridge, Y. Kim, and C. Hauenstein. 2018. Sadoff, C. W., E. Borgomeo, and D. de Waal. 2017. Turbulent Waters Mobilizing Additional Funds for Pro-Poor Water Services: An Exploration Pursuing Water Security in Fragile Contexts. Water Global Practice. of Potential Models to Finance Safe Water Access in Support of Sustainable Washington, DC: World Bank Group. http://documents.worldbank.org​ Development Goal 6.1. Washington, DC: Urban Institute. /curated/en/885171489432062054/pdf/113504-WP-P15770-PUBLIC-3-14​ -8am-W16005-eBook.pdf. Nauges, C., and D. Whittington. 2017. “Evaluating the Performance of Alternative Municipal Tariff Designs: Quantifying the Tradeoffs between Salehi-Isfahani, D. 2014. “Iran’s Subsidy Reform: From Promise to Equity, Economic Efficiency, and Cost Recovery.” World Development 91: Disappointment.” Policy Perspective No. 13, Economic Research Forum 125–43. (ERF), Dokki, Egypt. http://erf.org.eg/wp-content/uploads/2015/12/PP13​ _2014.pdf. Nicholson, W., and C. M. Snyder. 2008. Microeconomic Theory: Basic Savedoff, W. D., and P. T. Spiller. 1999. Spilled Water: Institutional Principles and Extensions. United States: Thomson/South-Western. Commitment in the Provision of Water Services. Washington, DC: Inter- https://books.google.com/books/about/Microeconomic_theory.html​ American Development Bank (IDB). ?id=6-jfAAAAMAAJ. 88 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation Serra, P. 2000. “Subsidies in Chilean Public Utilities.” Policy Research WHO (World Health Organization). 2012a. Global Costs and Benefits of Working Paper WPS 2445, World Bank, Washington, DC. http://​ Drinking-Water Supply and Sanitation Interventions to Reach the MDG documents.worldbank.org/curated/en/850051468768861504/pdf​ Target and Universal Coverage. Geneva: WHO. /multi-page.pdf. ———. 2012b. UN-Water Global Analysis and Assessment of Sanitation and Smets, H. 2012. “Quantifying the Affordability Standard.” In The Human Drinking-Water (GLAAS) 2012 report: The Challenge of Extending and Right to Water: Theory, Practice and Prospects, edited by Malcolm Sustaining Service. Geneva: WHO. http://www.who.int/iris/handle​ Langford, 225–75. Cambridge: Cambridge University Press. /10665/44849. Soppe, G. N. A., N. M. Janson, and S. Piantini. 2018. “Water Utility ———. 2017. UN-Water Global Analysis and Assessment of Sanitation and Turnaround Framework: A Guide for Improving Performance.” Drinking-Water (GLAAS) 2017 report: Financing Universal Water, World Bank, Washington, DC. http://documents.worldbank.org​/curated/ Sanitation and Hygiene under the Sustainable Development Goals. en/5159315 42315166330/Water-Utility-Turnaround-Framework​ Geneva: WHO. License: CC BY-NC-SA 3.0 IGO. -A-Guide-for-Improving-Performance. ———. 2018. Guidelines on Sanitation and Health. Geneva: WHO. Stites, E., K. Howe, and D. Akabwai. 2017. Five Years On: Livelihood WHO and UNICEF (United Nations Children’s Fund). 2017. Progress on Advances, Innovations, and Continuing Challenges in Karamoja Uganda. Drinking Water, Sanitation and Hygiene. Geneva: WHO and UNICEF. Somerville, MA: Feinstein International Center, Tufts University. Wolf, J., P. R. Hunter, M. C. Freeman, O. Cumming, T. Clasen, Sulabh International Social Service Organisation. 2016. “Water that J.  Bartram, J. P. Higgins, R. Johnston, K. Medlicott, S. Boisson, and Heals.” News release, February 21. http://www.sulabhinternational.org​ A. Prüss-Ustün. 2018. “Impact of Drinking Water, Sanitation and /water-that-heals/. Handwashing with Soap on Childhood Diarrhoeal Disease: Updated ———. 2018. “Bihar To Make Contaminated Water Potable.” News release, Meta-Analysis and Meta-Regression.” Tropical Medicine & International July 16. http://www.sulabhinternational.org/bihar-to-make-contaminated​ Health 23 (5): 508–25. -water-potable/. World Bank Group. 2002. Willingness to Charge and Willingness to Pay: Trémolet, S., P. Kolsky, and E. Perez. 2010. “Financing On-Site Sanitation The World Bank-Assisted China Rural Water Supply and Sanitation for the Poor: A Six Country Comparative Review and Analysis.” Technical Program. Washington, DC: World Bank. Paper, Water and Sanitation Program, January 2010. ———. 2003. World Development Report 2004 : Making Services Work for Tynan, N., and B. Kingdom. 2005. “Optimal Size for Utilities-Returns to Poor People. Washington, DC: World Bank. https://openknowledge​ Scale in Water: Evidence from Benchmarking.” Viewpoint, Note no. 283, .worldbank.org/handle/10986/5986. World Bank, Washington, DC. ———. 2017a. A Thirst for Change: The World Bank Group’s Support for USAID (United States Agency for International Development). 2018a. Water Supply and Sanitation, with Focus on the Poor. Independent An Examination of CLTS’s Contributions toward Universal Sanitation. Evaluation Group. Washington, DC: World Bank Group. Washington, DC: USAID Water, Sanitation, and Hygiene Partnerships ———. 2017b. Reducing Inequalities in Water Supply, Sanitation, and and Learning for Sustainability (WASHPaLS). Hygiene in the Era of the Sustainable Development Goals: Synthesis Report ———. 2018b. Scaling Market Based Sanitation: Desk Review on Market- of the WASH Poverty Diagnostic Initiative. Washington, DC: World Bank. Based Rural Sanitation Development Programs. Washington, DC: USAID https://openknowledge.worldbank.org/handle/10986/27831. Water, Sanitation, and Hygiene Partnerships and Learning for Sustainability (WASHPaLS). ­———. 2017c. A Wake Up Call: Nigeria Water Supply, Sanitation, and Hygiene Poverty Diagnostic. WASH Poverty Diagnostic. Washington, DC: World Van Bueren, M., and D. H. MacDonald. 2004. “Addressing Water-Related Bank. https://openknowledge.worldbank.org/handle/10986/27703. Externalities: Issues for Consideration.” Paper presented at Water Policy Workshop convened by the Australian Agricultural and Resource ———. 2018a. Water’s Edge: Rising to the Challenge of a Changing World. Economics Society, Melbourne, February 10. Global Water Security & Sanitation Partnership Annual Report 2018. Washington, DC: World Bank. http://documents.worldbank.org/curated​ Walker, I., F. Ordonez, P. Serrano, and J. Halpern. 2000. “Pricing, Subsidies, /­en/501621542313008673/pdf/132114-AR-PUBLIC-nov-26-5am-GWSPAR​ and the Poor: Demand for Improved Water Services in Central America.” Web.pdf. Policy Research Working Paper 2468, World Bank, Washington, DC. ———. 2018b. When Water Becomes a Hazard: A Diagnostic Report on The Water.org. 2018. Programmatic Impact Update: Second Quarter Report. State of Water Supply, Sanitation and Poverty in Pakistan and Its Impact January 2018–March 2018, World Water Development Report, Chapter 4. on Child Stunting: Pakistan. Washington, DC: World Bank Group. http:// documents.worldbank.org/curated/en/649341541535842288/pdf​ Whittington, D., C. Nauges, D. Fuente, and X. Wu. 2015. “A Diagnostic /131860-WP-P150794-PakistanWASHPovertyDiagnostic.pdf. Tool for Estimating the Incidence of Subsidies Delivered by Water Utilities in Low- and Medium-Income Countries, with Illustrative ———. 2018c. Getting the Price Right: A Review of Water Tariffs. Washington, Simulations.” Utilities Policy 34: 70–81. DC: World Bank. (Unpublished manuscript). Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 89 ———. 2018e. “Regulation of Water Supply and Sanitation in Bank Client Delivery.” Topic brief TB#006, USAID, Washington, DC. https://www​ Countries: A Fresh Look.” Discussion Paper of the Water Supply and .wsup.com/content/uploads/2017/08/ TB006-ENGLISH-Tenure​ Sanitation Global Solutions Group, Water Global Practice, World Bank, -Tenancy.pdf. Washington, DC. https://openknowledge.worldbank.org/bitstream​ WUP (Water Utility Partnership for Capacity Building) Africa. 2003. /handle/10986/30869/132262-WP-P159124-PUBLIC-20-11-2018-13-50-14​ Better Water and Sanitation for the Urban Poor: Good Practice from Sub- -W.pdf?sequence=1&isAllowed=y. Saharan Africa. Kenya: European Communities and Water Utility ———. 2019. “Angola Water, Sanitation, and Hygiene (WASH) Sector Partnership, World Bank. Diagnostic.” Project concept note P169877. Water Global Practice, World WWAP (UNESCO World Water Assessment Programme). 2019. The Bank, Washington, DC. United Nations World Water Development Report 2019: Leaving No One WSUP (Water and Sanitation for the Urban Poor). 2013. “Dealing with Behind. Paris: United Nations Educational, Scientific and Cultural Land Tenure and Tenancy Challenges in Water and Sanitation Services Organization (UNESCO). 90 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation Doing More with Less: Smarter Subsidies for Water Supply and Sanitation APPENDIX A Related Background Papers and Case Studies Unpublished Background Papers Prepared for the Present Study “Description of Subsidies.” Background Paper 1, World Bank, Washington, DC. “Estimating the Magnitude of Subsidies.” Background Paper 2, World Bank, Washington, DC. “Identification of Capital Expenditures and Subsidies in the Water and Sanitation Sector Using BOOST Data.” Background Paper 3, World Bank, Washington, DC. “Costs Estimation in the Water and Sanitation Sector.” Background Paper 4, World Bank, Washington, DC. “Quasi-Fiscal Deficits in WSS: The Effect of Hidden Costs on Performance.” Background Paper 5, World Bank, Washington, DC. “On the Use and Misuse of Prices and Subsidies in the Water Sector.” Background Paper 6, World Bank, Washington, DC. “The Distributional Performance of Piped Water Consumption Subsidies.” Background Paper 7, World Bank, Washington, DC. “Access Subsidies.” Background Paper 8, World Bank, Washington, DC. “Targeted Consumption Subsidies Reconsidered.” Background Paper 9, World Bank, Washington, DC. “CAPEX Reconsidered.” Background Paper 10, World Bank, Washington, DC. “Subsidies of Non-Networked WASH Services.” Background Paper 11, World Bank, Washington, DC. Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 93 “Affordability of WASH: Issues, Approaches and Unpublished Case Studies on Subsidy Measurement (with Data Analysis from Nigeria).” Reform Prepared for the Present Study Background Paper 12, World Bank, Washington, DC. “Argentina (Means-Tested Targeting).” World Bank, “Community-Led Total Sanitation: A Global Washington, DC. Evaluation.” Background Paper 13, World Bank, “Chile (Means-Tested Targeting).” World Bank, Washington, DC. Washington, DC. “Deciding the Best Use of Scarce Public Funds.” “Colombia (Geographical And Means-Tested Target- Background Paper 14, World Bank, Washington, DC. ing).” World Bank, Washington, DC. “The Impact of Subsidies on Leveraging Private “Iran (Removal of Consumption Subsidies).” World Financing in the Water Supply and Sanitation Sector.” Bank, Washington, DC. Background Paper 15, World Bank, Washington, DC. “Kenya (OBA and Water ATMs).” World Bank, Wash- “Alternative Mechanisms for Reaching the Poor.” ington, DC. Background Paper 16, World Bank, Washington, DC. “Mexico (Implicit Subsidy Schemes—The ‘Aprove- “Output-Based Aid in the Water Sector: An Overview.” chamiento’ System).” World Bank, Washington, DC. Background Paper 17, World Bank, Washington, DC. “Mexico (Incidence of Subsidies to Residential Pub- “The Political Economy of Water and Sanitation lic Services).” World Bank, Washington, DC. Subsidies.” Background Paper 18, World Bank, Washington, DC. “Mexico (Means-Tested CCTs).” World Bank, Washington, DC. “Communications Strategy.” Background Paper 19, World Bank, Washington, DC. “Peru (Means-Tested and Geographic Targeting).” World Bank, Washington, DC. “WSS Subsidization in Countries Affected by Fragility, Conflict and Violence.” Background Paper “Uganda (Public Stand Pipes).” World Bank, 20, World Bank, Washington, DC. Washington, DC. 94 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation APPENDIX B Methodology for Estimating the Magnitude of Networked Water and Sanitation Subsidies To estimate subsidy levels at the international level, we used utility-specific data from the World Bank’s International Benchmarking Network for Water and Sanitation Utilities (IBNET) complemented with estimates of the long- term incremental costs of efficient model utilities, as determined by the Chilean regulator, with the aim of computing an efficient water supply and sanitation tariff for each utility covered by IBNET.1 This method is indeed appropriate for our purposes, as it not only aims to maximize both allocative efficiency as well as productive efficiency but also allows each utility to generate enough reve- nue to cover the costs incurred in providing service. Regarding allocative effi- ciency, the approach attempts to recreate competitive market results: efficient quantities are produced by charging tariffs equal to the marginal costs a utility faces. Moreover, productive efficiency is achieved (or is at the very least aimed at) by producing efficient quantities at the lowest cost possible, considering feasible parameters. It is assumed that any additional inefficiencies a utility might have are not passed on to consumers through pricing, effectively encouraging utilities to be as efficient as possible. In Chile, assets are estimated using a greenfield sce- nario at the start of every five-year period. To this end, the regulator models each utility based upon its size, network characteristics, services provided, and the subactivities conducted for each service (e.g., production, treatment, and distribution), taking into account any necessary expansion stemming from demand growth. Efficient, optimized asset values for each service provided (water and/or sanitation) are obtained from calculating the net present value of future investments in the j subactivities related to that service: K l = ∑ i, j Investmentsij,l (1 + r )i Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 97 Where: table B.1. The values are weighted averages of the  K: Efficient optimized asset base val- unit asset base for each category, disaggregated by service l ues for each ­ service.   Investmentsij:  Investments in the j subactivities The appropriate unit cost is then applied to the (production, treatment, distribution) IBNET customer field to obtain an optimized asset in period i value for each service (water and/or sanitation) pro-  r: Opportunity cost of capital vided by each utility represented in the IBNET database:3 Information on the efficient asset base for each util- ity was obtained from its latest available tariff review. KINI s,l, m (USD) = Unit Kl,m * Customers IBNET s,l We converted this value to U.S. dollars and applied an inflation factor, to express all values in 2017 U.S. Where: dollars. To estimate the capital investment for other  KINI s,l,m: Estimated asset base for each utilities we need to identify a common driver. service l, of size m for s utilities In general, the main determinant of the total capital in the IBNET database devoted to providing each service is the size of the cus-   Unit K : Unit asset base for each service l,m tomer base. So, estimating capital expenditure (CAPEX) l, of size m per capita per service may be used as the basis of com- Customers in each service l, for   Customers IBNET :  s,l puting total capital costs for other utilities. s utilities in the IBNET database Chile’s mechanism for determining tariffs is Our next step is to estimate the cost of capital for based on a greenfield project with a 35-year2 time each country represented in the IBNET database. To horizon. Therefore, the asset base computed is a do this, we first calculate a pretax weighted average function of demand growth over 35 years. Chile’s cost of capital (WACC). This cost of capital reflects regulator estimates the annuity of investments the opportunity cost of a water or sanitation utility and associated customers over that time period, without considering country-specific risks. But ­ ndicator allowing us to construct a unit capital cost i almost all regulators in emerging economies add a that will properly account for demand growth. country-specific risk premium to account for Formally:  Unit   K l    USD  Annuity   Investments = ( l ) TABLE B.1. Average Unit Asset Base of 15 Chilean   Customers  ( Annuity   Customersl ) Utilities, Categorized by Size of Customer Base Unit asset base ($/customer) Where: Category Customers Sanitation Water Total  Investmentsl: Investments in each service l (*)  Customersl: Customers in each service l Large 200,000+ 3,717 4,794 8,512   Unit K :  l Unit capital costs in dollars for each Medium 100,000–200,000 5,342 4,602 9,944 service l Small 0–100,000 6,411 4,662 11,073 Source: Authors’ elaboration of SISS information. According to the size of their customer base, it is pos- Note: (*) Though the difference is not statistically significant, large utilities display a slightly higher value for sanitation assets per sible to categorize the 15 Chilean model utilities into customer, probably because of differences in how each utility reports three groups (large, medium, and small), as shown in its assets. 98 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation differences in risks among countries.4 In line with costs,  a “rule of thumb,” based on a percentage of this practice, we then estimate the cost of capital for total assets, is used to estimate annual O&M costs each country represented in the IBNET database by when no detailed information is available. The refer- adding a country-specific risk premium to the cost of ence values generally used lie between 2.5 percent debt and the cost of equity. and 3 percent of invested assets. For the purposes of Once we have an estimate of the cost of capital and this study, the upper limit of 3 percent was assumed the asset base for each service provided by each util- as a reference value. When this methodology is ity, we can compute both depreciation and capital applied to all utilities represented in the IBNET data- remuneration by calculating an annuity: base, O&M costs represent an average 24.7 percent of total efficient costs, which is similar to the average D s + real r s pretax ∗ K INI s 28 percent figure from our sample. K INI s We compute a real pretax WACC, so the tax cost is =   1    n reflected in the discount rate and not in the cash 1 − (   1 + real   r s pretax   )   real r s pretax flow. Using the total assets for water and sanitation    separately for each utility and the cost of capital (cor- Where: responding to the country in which the utility is  KINI s: Estimated asset base for each util- located), we can estimate the water and sanitation ity s in the IBNET database annuities covering the depreciation and return on  Ds: Estimated depreciation for each capital. To determine efficient O&M we use a fixed utility s in the IBNET database proportion of the value of total assets. For this exer- Pretax cost of capital in real terms   real r s pretax:  cise we assume O&M costs to be 3 percent of total for utility s assets per year for both water and sanitation ser-  n: 35-year life span of a greenfield vices. From the efficient revenue requirements, we can estimate an efficient average tariff, individually The use of an annuity instead of separate values for for both water and sanitation, by dividing the total depreciation and return on capital serves two pur- revenue requirement by total sales (as reported in poses. First, it simplifies the calculations. Second, IBNET), formally: the use of a constant annuity implies adopting an RR increasing pattern of depreciation. Given that we TEfficient = Demand evaluate capital over a 35-year period, an increasing Where: depreciation rate provides the correct allocative sig-  TEfficient: Efficient tariff nal, since the system is bound to have excess capac-  RR: Revenue requirement ity at the beginning of the period.  Demand: Sales by utility s as reported by IBNET To estimate operation and maintenance (O&M) costs, we have analyzed different alternatives includ- The tariffs computed up to this point are intended ing reported values from IBNET in 2017 U.S. dollars. to recuperate the capital and O&M costs of an We computed an efficient tariff using estimated O&M efficient model utility. But this assumption of ­ costs. In general, during tariff revision processes, ­ efficiency is unrealistic: most utilities present and in particular when estimating long-run marginal inefficiencies. The inefficiencies we consider are ­ Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 99 interwoven with operational expenditures. Most s ∆CAPEX losses have to do with overstaffing and water production losses, as well as with capital expenditures, since = (ToL − TeL) ∗ ( K s s, Prod, m ∗ Customers IBNET s,Water ) extra assets are required to increase production to (1 − ToL ) s make up for the water losses incurred. The objec- Where: tive of this step is to compute a tariff that reflects  ECs: Reported electricity costs for utility s the effective level of efficiency of each utility in  CCs: Reported chemical costs for utility s terms of two variables: losses and labor costs. We  ToLs: Reported total losses for utility s call this a full tariff, since it allows a return compat-  TeL: Efficient total losses from the Chilean ible with a utility’s opportunity cost of capital (i.e., sector to be economically sustainable) with costs includ-  K Estimated asset base for water produc- :  s,Prod,m ing a certain level of inefficiency. tion services of size m for utility s in the IBNET database a. Losses: We assume that a minimum nonrevenue   Customers IBNETs,Water: Reported water custom- water loss of 15 percent is to be expected regard- ers of utility s in the less of how efficient a utility is. We label the differ- IBNET database ence between this and a utility’s actual, total losses as “inefficient losses.” A higher level of losses Finally, in denoting the total sales of utility s as implies higher costs. In terms of O&M, higher Demand, we can compute a tariff differential as: losses are linked to the use of more energy and ∆Closses chemical products. On the capital side, higher Tlosses = Demand losses imply greater investment to cover the addi- tional production needed to serve customers. To b. Labor costs: The model assumes by definition an account for this cost differential, we estimate the efficient level of employees per customer. The effi- incremental cost associated with the difference cient ratio of employees per customer5 we adopt is between the 15 percent assumed in the model util- based on our sample of Chilean model utilities, ity estimate and the level reported in IBNET with using a weighted average for each size category, as the following formula: shown in table B.2. In general, most water and san- itation providers, particularly in low- and mid- s s s dle-income countries, have staff numbers that are ∆Closses = ∆O& Mlosses + ∆CAPEXlosses substantially higher than the values we estimate Where: s as efficient.   ∆Closses : Total cost differential associated with higher losses for utility s s   ∆O& Mlosses O&M :  cost differential associated TABLE B.2. Efficient Ratio of Employees to Customers with higher losses for utility s Category Customers Employees/1,000 customers s   ∆CAPEXlosses CAPEX differential associated with :  Large 200,000+ 2.4 higher losses for utility s Medium 100,000–200,000 4.4 ( )( ) Small 0–100,000 5.2 s ∆O& Mlosses = EC s + CC s ∗ ToLs − TeL Source: Authors’ elaboration of SISS information. 100 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation Overstaffing implies higher costs in terms of O&M. calculate the full tariff for each utility in IBNET, add- To account for this cost differential, we estimate ing these two elements to the efficient tariff com- the incremental cost associated with the differ- puted. Formally: ence between (i) the number of employees per 1,000 customers assumed in the model and (ii) the TFull = TEfficient + Tlosses + TEmployees level reported in the IBNET sample, using the fol- Where: lowing formula:  TFull: Full tariff s ∆Cemployees = Labor Costs s −  TEfficient: Efficient tariff  Labor Costs s  Tlosses: Tariff differential due to excessive losses  ∗ optimal staff ratio ∗  Staff s  TEmployees: Tariff differential due to overstaffing ( MAX Customers IBNET s,Water , While the tariff differential due to excessive water Customers IBNET s,Wastewater )  1000  losses is exclusively allocated to the water tariff, the tariff differential due to overstaffing is distributed Where: across water and wastewater services proportionally s   ∆Cemployees : Total cost differential based on the respective asset bases. One of the main associated with over- problems with subsidies is that they create allocative staffing in utility s distortion. Since the price users pay is below the eco-   Labor costs :  s Reported labor costs of nomic cost of providing the service, consumption is utility s higher than what is socially optimal. Following   Staff :  s Reported number of Harberger (1971), a subsidy can be decomposed into loyees in utility s emp­ two effects: a transfer given and an allocative distor-   Optimal staff ratio: Efficient ratio of employ- tion. On the one hand, the subsidy implies a mone- ees per 1,000 customers tary transfer to consumers. As they face lower prices   Customers IBNET s,Water:  Reported number of water for water and sanitation services they are left with a service consumers of util- larger disposable income. On the other hand, lower ity s in IBNET database prices incentivize a higher level of consumption of the subsidized service or product, so consumers   Customers IBNET s,Wastewater:  Reported number of increase their consumption above the optimal level. wastewater service This creates a distortion in the allocation of resources consumers of utility s in the economy—a distortion that can be measured. in IBNET database The degree of allocative distortion created by the Based on this formula we estimate the cost and tariff subsidy is a direct function of two elements: the rel- differential associated with inefficient levels of ative size of the subsidy and the price elasticity of employment for each utility in IBNET: demand. Clearly, the larger the subsidy, the greater ∆Cemployees the increase in consumption. Price elasticity mea- TEmployees = Demand sures the proportional change in the quantity Once we have computed the cost differential asso- demanded of a good, given a 1 percent change in its ciated with water losses and staffing levels, we price. The greater the elasticity, the greater the Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 101 distortion associated with a subsidy. If the price elas- prices for water and sanitation service—the adjust- ticity is zero, there is no distortion, since the quan- ments are larger. Again, this means that the estimate tity demanded is the same across all prices. Using is a lower bound for the efficiency gains expected in this analytical framework, we can estimate the size the medium and long term as a result of a better-de- of the deadweight loss associated with tariff subsi- signed subsidy scheme. It is important to note that dies in the water supply and sanitation sector. For the elasticity concept refers to marginal changes in the purpose of this exercise we use some interna- prices and quantities. Applying nonmarginal changes tional comparators and choose a price elasticity in prices—as done in some countries to simulate a in the lower range. This will give us a lower bound shift from an inefficient tariff to one reflecting full for the allocative inefficiency associated with the cost-recovery—results in values that need to be con- existing tariff subsidies. Table B.3 shows the range sidered very carefully, with several caveats in mind. of price elasticities estimated by different authors in The allocative inefficiencies associated with water different countries. and sanitation subsidies for each utility are equivalent The estimates in table B.3 were obtained through to the difference between the quantity of water that a variety of methodologies studying both short- and would be consumed under efficient O&M and actual long-term elasticities among residential and com- water use. To estimate consumption under efficient mercial consumers. The results vary within a small O&M, we use the average tariff revenue for each utili- range in the short term, between 0.11 and 0.17, but ty’s service and compare it with the efficient cost tariff the difference reaches 0.33 in the long term. Based for that service. Assuming a linear demand and a price on these available comparators we assume a price elasticity of 0.10, we estimate the impact on consump- elasticity of 0.10. This means that a 10 percent tion levels. Formally: increase in price will produce a 1 percent decrease Demand Efficient Consumption = in the quantities consumed. This reflects the short- T  Efficient − AvgR  1+ ∗ ∈ term range of elasticities adopted by Boistard (1993).    AvgR  In the long run—as the economy adapts to higher Where:  TEfficient: Efficient tariff TABLE B.3. Estimated Price Elasticities in Water and Sanitation, by Study and Estimate  AvgR: Average revenue   ¨: Elasticity Price-elasticity Author(s) Year Sample location  Demand: Total sales estimation Carver and Boland 1980 Washington, DC 0.1 or less Boistard 1993 France 0.11–0.33 Extrapolating Subsidy Costs within Hanke and Mare 1982 Sweden 0.15 Countries Katzman 1977 Malaysia 0.1–0.2 IBNET contains data for utilities in 91 countries,6 but Hansen 1996 Denmark 0.1 or less not all utilities providing either water or sanitation Grafton et al. 2011 10 OECD countries 0.429 services in each country are included in the database. Source: Authors’ compilation. We can measure the degree of coverage for water and Note: OECD = Organisation for Economic Co-operation and Development. The range adopted by Boistard (1993) is based on a survey of various sanitation services individually in each country by studies of residential elasticity. Hansen (1996) estimates a water demand comparing the population served by utilities listed in function for domestic households on pooled time series data to calculate both energy cross-price and water-price elasticities. the IBNET database with the total population served 102 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation in the country overall. This last value is estimated middle income, and low income—based upon the ­ using total coverage data from the World Health World Bank’s country classifications by income for Organization/United Nations Children’s Fund and fiscal year 2019. Next, for water and sanitation sepa- population data from the World Bank. In the first of rately, we calculated an average subsidy per person these databases, coverage rates are differentiated by served, using IBNET data, as available, for countries type of facility (piped and nonpiped facilities for in the four groups (see appendix C). Then, for coun- water; and sewered, latrine, and septic tank facilities tries not in the IBNET database, we multiplied this for sanitation). The total population served in each 7 per person subsidy by the total population served by country for each service was therefore computed by the respective service (estimated by multiplying the multiplying the coverage rate for piped water and country’s coverage rate8 and its total population). sewered coverage, respectively, by population data Due to a lack of data, China and India were both from the World Bank. By dividing the total population excluded from our estimates. served in a country by the population served in IBNET, we compute an extrapolation factor for each service. Sensitivity Analysis Assuming that the average tariff charged by utilities The main drivers for these estimates are the unit cost not included in IBNET is equal to that of the utilities in in the asset base calculations. The results presented IBNET—and that the average efficiency of both groups in the report assume a +/–10 percent variation in the is also similar—we estimate total subsidies at the unit asset base estimates. country level by multiplying the total subsidies of the service for utilities in IBNET by the extrapolation fac- Notes tor for that service. The total estimated subsidy level 1. See more details about the methodology in background paper 2 for the water and sanitation sector in each country is (listed in appendix A). 2. See Chilean law 70 from 1988. then the sum of the water and sanitation service sub- 3. In case of missing sanitation data in the IBNET database, if only one sidies in that country. A few countries represented in of a utility’s number of sewerage connections or volume of wastewa- the IBNET database were estimated to have a negative ter processed was missing, the analogous data from the utility’s water coverage were used in its place (sewerage customers = water custom- subsidy (estimated full tariffs were greater than the ers or wastewater treated = water sold). Utilities without any sanita- observed average tariffs). Most of these were high-­ tion data were classified as water-only providers. income countries, where efficiency may exceed the 4. Country-specific risk premiums can be found at Damodaran: http:// www.damodaran.com. level assumed in the model. Where this was the case, 5. A generally accepted benchmark for staff efficiency is 5 employees for subsidies were assumed to be 0. Using data on gross every 1,000 customers, although we refrain from using this, since it domestic product for the year 2015 from the World does not reflect economies of scale and thus may result in the illusion that large companies have efficient staffing levels. Bank, we calculate subsidies as a percentage of gross 6. China and India were not extrapolated due to low proportional repre- domestic product. sentation in IBNET and a general lack of data availability. 7. Water and/or sanitation coverage data for six countries (Bahrain, Fiji, Indonesia, Kosovo, Kuwait, and Solomon Islands) were incomplete, Extrapolating Subsidy Costs for Countries and were thus supplemented by additional data and estimates. with Data Gaps 8. Water and/or sanitation coverage data from the World Health First, we separated out China and India, while the Organization/United Nations Children’s Fund for three countries (Austria, Isle of Man, and Micronesia), in addition to the six previ- remaining countries were grouped into four clus- ously cited with partial IBNET data, were incomplete, and were thus ters—high income, upper middle income, lower supplemented by additional data and estimates. Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 103 APPENDIX C Building Political Coalitions to Support Reform Building upon section 4.2, this appendix provides additional guidance to policy makers regarding the conditions and strategies that can be harnessed and employed to promote subsidy reform. A subsidy reform may seek to shift the equilibrium represented in table C.1 (identical to table 4.2 in chapter 4), but of the four equilibria outlined there, none is preferable in all contexts. For example, a well-targeted subsidy that seeks to exclusively benefit the poor should strive toward case 2, while a reform program seeking to gradually remove subsidies in order to attain cost-recovery tariffs should strive toward case 4. Note that only those situations where costs accrue largely to the govern- ment (taxpayers) while benefits accrue to interest groups and the general pop- ulace are considered in these four cases. In reality, the costs borne by citizens and interest groups would need to be considered in any comprehensive politi- cal economy analysis. To design feasible reforms and implementation plans, it is crucial to figure out the current political equilibrium in a country and to develop a strategy for how to shift the status quo. A detailed description of each type of case, as well as possi- ble strategies for reform in each context are provided below. Case 1: Generalized Benefits Are Large, as Are Benefits to Interest Groups An example of case 1 is when all consumption is substantially subsidized, and access to networked services is universal. Large users benefit exponentially, but average citizens also see a significant contribution to their household bud- gets. Large benefits typically lead to fiscal unsustainability. This is because all citizens benefit without much concern about the costs, especially when these are deferred to the future or hidden in complex institutional arrangements. A large portion of benefits may go to special interest groups with significant political power or to wealthier segments of society. Governments tolerate this situation when they gain electoral and other benefits from the subsidy and are not forced to deal with its costs. (Box 4.1 in chapter 4 describes a successful reform strategy used by Iran to remove a case 1 subsidy.) Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 105 Characterizing Subsidy Policy Benefits: TABLE C .1. • The costs of providing benefits rise sharply Basic Framework (e.g.,  because of a fiscal crisis or impending Generalized Generalized water security crisis). benefits are large benefits are small • The costs of subsidies are not sustainable, coupled Interest group Case 1 Case 2 with declining service quality. benefits are large Interest group Case 3 Case 4 • External pressure from donors or lenders changes benefits are small the political equilibrium. Source: Adapted from Inchauste, Victor, and Schiffer (2018: 11). By contrast, reform is less likely under the following Found in: Countries with near-universal access and conditions: increasing block tariffs, where most consumption • Interest groups are effective in developing com- falls within subsidized blocks (especially common in pelling narratives against the reform to galvanize East Asia and Pacific, Latin America, and Middle East citizen protests. and North Africa). • Powerful government officials are making large illegal financial gains and stand to lose from Successful reforms of case 1 subsidy: Argentina reform. (to  case 2), Chile (to case 2), Peru (to case 2), Iran (removed/replaced with cash transfers). • Governments promise to replace subsidies with cash transfers to average citizens, but fail to adopt In case 1, the likelihood of subsidy reform increases credible plans, such that citizens do not believe when some or all of the following conditions are the promised transfers will materialize. present: • The government communicates a strong, simple, and credible narrative, outlining the risks of the Case 2: Generalized Benefits Are Small, and Benefits to Interest Groups Are Large status quo, breaking complex economic processes down to a simple relatable logic. Case 2 may involve several circumstances. Supply- side subsidies may not benefit citizens noticeably, if • Citizens develop a better understanding of how at all, if service providers pocket the additional reve- the existing system is harmful to their interests— nue without passing any value on to the consumers. by, for example, effectively redistributing public Or the intended beneficiaries may not benefit from funds mainly to the wealthy—and mobilize to the subsidies either because of chronic service inter- counter it. ruption or because of a lack of access to the subsi- • The government credibly commits to citizens and dized service (which disproportionately benefits the interest groups that policy reforms will leave them rich). It is important to note, however, that case 2 either better off or the same. This may require may also involve a subsidy that is well targeted to its offering them medium-term benefits to offset the intended beneficiaries, most likely the poor. loss of subsidies. Therefore, case 2 is an ideal outcome of a subsidy • Interest groups that would oppose reform find it that seeks to make WSS services affordable to the difficult to mobilize, or the government finds a poor. However, case 2 may equivalently involve a way to satisfy their core aims. poorly targeted subsidy that significantly benefits 106 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation unintended and/or nonpoor beneficiaries. As a gen- • External pressure from donors or lenders changes eral rule, subsidies of this type persist because they the political equilibrium. benefit a powerful but small fraction of the popula- By contrast, reform is less likely under the following tion, or their costs are not large enough to have sub- conditions: stantial, broad-based impacts on the functioning of • The total cost of the subsidy is small, such that the the economy and the public budget. political and financial cost of reform may out- weigh its benefits. Found in: Countries with targeted subsidies benefit- ing particular interest groups, whether the poor • Interest groups develop strong narratives that con- (such as in Argentina and Chile through means test- vince the general public that they will lose from ing, or Kenya and Uganda through service differenti- the reform. ation and connection subsidies) or special interest Case 3: Generalized Benefits Are Large, and groups (such as Albania through political favoritism); Benefits to Interest Groups Are Small also, countries with subsidized networked services Case 3 generally involves subsidies that are intended and low access for the poor (common throughout to benefit most households, such as low residential Sub-Saharan Africa). tariffs. As with case 1, providing large benefits to In case 2, the likelihood of subsidy reform increases citizens likely implies a lack of fiscal sustainability. ­ when some or all of the following conditions are Yet unlike case 1, there are no interest groups that present: reap significantly greater benefits than the average • Governments credibly provide special interest household. In these settings, citizens may be well groups with alternative benefits to replace those organized enough to demand subsidies from politi- lost via reform. If the poor are indeed benefiting cians, who then perceive subsidies as a means to gain from a subsidy, the government may want to intro- broad-based political support. duce direct cash transfers. Found in: Countries with near-universal access and • Citizens or dispersed interests who would gain subsidized common infrastructure expenditure or from larger government revenue develop a better subsidized fixed costs. understanding of the price they pay for current subsidies, and the possible benefits of reform. In case 3, the likelihood of subsidy reform increases They then mobilize in their own collective inter- when some or all of the following conditions are ests. To promote this, a government might facili- present: tate citizens’ participation in the reform design • Broad public support is no longer pivotal to elec- process, and raise awareness of positive social toral success. outcomes. • The government can credibly communicate, offer, • The administration changes, and benefiting interest and administer alternative systems, such as direct group(s) lose their influence over key politicians. cash transfers, to target the poor. • The costs of providing benefits rise sharply (e.g., • The costs of providing benefits rise sharply (e.g., because of a fiscal crisis or impending water secu- because of a fiscal crisis or impending water secu- rity crisis). rity crisis). Doing More with Less: Smarter Subsidies for Water Supply and Sanitation 107 • Politicians shift their mindset regarding the need significant political opposition from any interest for free or low-cost water. group is unlikely. Although per-household or per-business subsidies may be small, the total cost of • External pressure from donors or lenders changes the subsidy could still be large, therefore increasing the political equilibrium. government incentives to undertake reform and By contrast, reform is less likely under the following reallocate scarce public resources to a more produc- conditions: tive purpose. Conversely, if the cost of the subsidy • Governments fear mass mobilization and public is  small, the fiscal pressure on the government to protest in response to subsidy reform. reform the subsidy may also be small, thus reducing the likelihood that the government would champion • Governments continue to perceive the existing reform. It should be noted that a case 4 equilibrium, subsidy as crucial to their political survival. by definition, implies that a subsidy is ineffective at attaining its goals, since even the intended beneficia- Case 4: Benefits to Both the General Populace and to Interest Groups Are Small ries are not significantly impacted. In case 4, no interest group, organized or general, Found in: Countries with subsidies that provide insig- benefits exceptionally. Because the benefits to all nificant benefits to all users, but that may still repre- groups are negligible, the need to overcome sent a significant fiscal burden. 108 Doing More with Less: Smarter Subsidies for Water Supply and Sanitation W19045