Welcome back, our topic for this session is municipal water pricing and tariff design. This is the first of five videos. This first video provides a short introduction to this topic. The second video discusses the objectives of water tariff design and what we're trying to accomplish. The third video examines different tariff designs. In the fourth video, we'll describe current practices in tariff design in low and middle income countries. The fifth video examines problems with increasing block tariffs, the most prevalent tariff design used in low and middle income countries. Let's start by defining what a water tariff is. A water tariff is a set of prices, charges and taxes that are used to calculate customers' water bills. If the water utility's accounting system is computerized, the tariff is actually the computer code that is used to generate these water bills. The computer code might or might not perfectly match a water utility's official tariff structure. These rules for determining customers' water bills have several functions. First, the tariff determines the level and pattern of a utility's revenue stream. Second, because the tariff establishes the magnitude and timing of the utility's revenue, it determines a utility's ability to attract capital and obtain financing in the capital markets. Third, the tariff creates incentives for the utility to produce water services efficiently, and for customers to use water efficiently. Fourth, because costumers' water use responds to prices, the tariff affects the need for new water production and wastewater treatment capacity. These functions of a tariff do not seem, at first glance, to have a lot of emotional content. But, in reality, water pricing and tariff design is a hugely controversial topic. Why is this? As we saw when we introduced the concept of ancient instincts about water, some people feel strongly that water services should be provided free or at least heavily subsidized. But others feel that water prices should signal the scarcity of the water resource and reflect the costs of delivering water services. So, there is, thus, a huge range of opinion about the appropriate price to be charged, from zero to the full long run marginal costs of services. Moreover, our ancient instincts about water prices put a huge premium on the perception of fairness. But there are additional reasons besides ancient instincts as to why water pricing and tariff design are so controversial. Next, we will examine these additional reasons for controversy. The first reason is that currently piped water and sanitation services are heavily subsidized in low and middle income countries. Most households are thus use to pay low prices for water services and they do not want the status quo to change. This figure shows a frequency distribution of the average price households paid for water in cities in the global water intelligence database. As you can see, the average price paid in the bottom 50% of the cities is less than 40 US cents per cubic meter. Households pay more than 80 US cents per cubic meter in only 10% of the cities. Households in most cities pay only the operation and maintenance costs of water services, or in many cases, less. In only a few cities do average prices cover a significant portion of the capital cost of providing water and wastewater services. The second reason is, that households have no idea what it actually costs to provide services to them. This is partly a result of these low average water prices. Because households do not know what their cost of services are, and because subsidies are so wide spread, tariff increases are almost always perceived as unfair and unjustified. And thus are controversial. But the problem is even worse. Many water professionals, themselves, do not know the cost of piped water services either. I teach an executive training program for water utility professionals on water pricing and tariff design. I often ask participants, the average marginal cost of piped water services and their utility. And they have no idea. I then ask them, how can this be? How can they be in a business and not know the cost to produce their product? Many participants claim that this is not part of their responsibilities. Sometimes I show participants this table. It compares the average tariff in different cities, the cost of the government of providing these water and sewage services, and the percentage of the cost of services subsidized by the government. Most people are surprised by the high levels of subsidy presented here. A fourth reason that tariffs are controversial, is that there is no market test to drive bad tariffs out of the market. If a private business tried to sell a product using a pricing scheme that customers didn't like, it wouldn't sell its product. It would be forced to change the way it priced its product or go out of business. But this doesn't happen with the tariff structures used by water utilities. Poor tariff structures can have a long life. Finally, there's a fifth reason why water tariffs are controversial. There are good theoretical why tariffs should be low. And there are good theoretical and practical reasons why tariffs should be higher. We will discuss these in more detail in the next video on the objectives of a water tariff. My own view is, that from an economic and financial perspective, in most places in developing countries, prices for piped water and sanitation services should be significantly higher. There are five main reasons why I feel this way. First, the financial cost of services are high. Second, the opportunity costs of raw water are increasing. Third, the environmental cost of wastewater discharge are increasing. Fourth, water utilities need additional financial resources to adapt to climate change. And fifth, higher tariffs are needed to provide increased incentives for innovation in this sector. But if water tariffs needed to be higher this raises two key questions. First, how can tariffs be designed to keep water and sanitation services affordable to poor households, and at the same time provide the correct economic signal to water users about the relative value of water and to raise sufficient revenue to put the water utility on a sound financial basis? Second, how can political leaders and policy makers be convinced of the necessity of raising prices for water services as part of a sector reform agenda? We're going to address the first question in subsequent videos. Let me briefly say a few things about the second question. Policy makers generally have several reactions to any proposals to raise water tariffs. This slide list four common ones. The first is the political campaign promises have already been made. Politicians often promise not to raise prices, or even to lower prices, to get elected themselves. They cannot then easily renege on their promises. The second is that there are other agendas at work than economists' notions of using scarce resources wisely, and the financial sustainability of the water utility. As we saw in our part one of this MOOC, when we examine the status quo conditions in the water sector, rent seeking is common. And powerful stakeholders may be benefiting from the status quo. Not everyone wants water and sanitation services to improve. And policy makers know this. A third reaction is, why me? I'll be leaving office soon. I will leave this unpleasant task to others. Fourth, a relayed reaction is that the proposal may make good sense but is not worth the political problems. It's just too big a headache to tackle. Policy makers do understand ancient instincts about water. For water sector reformers, I think there are four responses to this reactions from policy makers. The first is, you can't stay here. In other words, try to get the policy maker, understand the dynamic baseline. She may want to just maintain the status quo, but this is not possible. The goal is to shift the policy maker's reference point to focus on the fact that baseline conditions are deteriorating. The second response is, that you get what you pay for. Offer households a deal. Improve services in exchange for higher prices. A third response is, yes, but look what else you get. The policy maker can sweeten the deal with non water benefits. And the fourth response for reformers is, to wait and be ready. Conditions may change and a window of opportunity may open up when tariff reform becomes possible. Be ready to act with concrete tariff proposals when the opportunity arises. But, importantly, reformers should not be under any illusions that changing tariffs will be easy. Public education about the water utilities operations and the local water resources situation, will usually be an essential component of any reform strategy, and this takes time. In the next video, we will discuss the objectives of water tariffs in more detail. [BLANK-AUDIO]
