Assessing the impact of full cost recovery of water services on European households

Abstract

We assess the impact of implementing the full cost recovery (FCR) principle for water services on European households. This assessment includes three dimensions. First, we measure how household water consumption reacts to the price change induced by implementing the FCR principle. Second, we provide a measure of the resulting household welfare losses. Third, we evaluate how household water affordability is impacted. This assessment which relies on a household water demand function approach has been conducted for 9 European countries (Austria, Bulgaria, Czech Republic, Estonia, France, Greece, Italy, Portugal and Spain). For most of these countries, we show that implementing the FCR principle does not lead to substantial water affordability issues. Bulgaria (and to a lesser extend Estonia and France) is one exception since poor households (i.e. households belonging to the first income decile) have to devote more than 3% of their income for paying their water and wastewater bill under a FCR regime. The fact that water affordability may become an issue under FCR for some countries gives some ground for public authorities to develop specific policies targeted to poor households.

Introduction

Full-cost recovery (FCR) of water services, in particular through use of efficient water prices, is considered as a cornerstone of any sustainable water management policy [1]. However it is well recognized, both in the academic literature and in most of national legislations, that implementing efficient water prices may raise social and redistributive concerns which have to be addressed by public authorities. In Europe for instance, Article 9 of the Water Framework Directive indicates that Member States may have regards to the social, environmental and economic effects of the recovery of costs.

Some previous works have then specifically focused on the tradeoff between efficiency (i.e. maximization of the social welfare) and equity of water pricing. Hajispyrou et al. [2] have analyzed the welfare effects of block price systems for residential water use in Cyprus. They find that the heterogenous regional block price systems induce strong price distortions that cannot be justified based on an efficiency argument. Garcia and Reynaud [3] have questioned the efficiency of water prices in France. They show that the pricing scheme used in France has a detrimental impact on water affordability for small water users, that is, in fact for low-income households. García-Valiñas [4] has investigated the distributional impacts of water pricing in Spain. This paper considers Ramsey prices, that is prices to be used by a monopoly wishing to maximize the total welfare under the condition of non-negative profit. In spite of being frequently used, García-Valiñas [4] shows that Ramsey pricing goes against the equity principle. García-Valiñas [4] proposes then to use a pricing scheme derived from Feldstein's works where the Ramsey pricing rule is distorted in order to take into account some redistributive objectives of public authorities. Lastly, Ruijs [5] explores the distribution and welfare effects of changes in block price systems in the Metropolitan Region of São Paulo, Brazil. Ruijs [5] shows that there is a tradeoff between efficiency and redistribution. Compared to a flat price system, a pro-poor price system may result in a lower total welfare, but with a higher individual welfare for the poor.

None of the above papers addresses the effect of implementing the FCR principle on water prices. This will be the central issue of our cross-country analysis. More specifically, we propose here to assess the impact of implementing the FCR principle for water services on European households. We will first measure how household water consumption is expected to react to the price change induced by implementing the FCR principle. Second, we will provide a measure of the resulting welfare losses for households. Lastly, we propose to evaluate how water affordability for households is impacted. Measuring water affordability for targeting pro-poor policies has been recognized by several international organizations as an important objective for public authorities. For example, in the 2006 Human Development Report, Watkins [6] suggests that any pro-poor water access policy should include sustainable and equitable cost-recovery measures and that affordability is one of the keys to equity. From a methodological point of view, our assessment will rely on a household water demand function approach conducted on some selected European countries. This is the first time that such a cross-country analysis is undertaken.

The remaining of this paper is organized as follows. In Section 2, we review the literature having addressed the FCR principle for water services with a specific focus on Europe. Section 3 is devoted to presenting our methodological approach. In Section 4 we conduct a cross-country assessment of the FCR principle for water services for households and we conclude by deriving some policy implications.