Does Increasing Access to Infrastructure Services Improve the Targeting Performance of Water Subsidies? December 2007 Diego F. Angel-Urdinola and Quentin Wodon* Abstract There is ample evidence that utility subsidies imbedded in inverted block and other tariff structures are not well targeted to the poor, simply because the poor tend to have much lower access rates to water and electricity networks than richer households. This paper provides an analysis of the changes over time in the targeting performance of water consumption subsidies in Nicaragua. Because access rates to piped water increased substantially between 2001 and 2005, the targeting performance of consumption subsidies improved, despite the fact that the tariff structure remained essentially the same over time. It is shown that the observed changes in access rates had a much higher impact for improving the targeting performance of consumption subsidies than changes in the tariff structure could have had if they had been implemented. The results suggest that one of the best ways to improve the targeting of consumption subsidies may be to increase access rates, so that the poor have a better chance of receiving the subsidies. JEL codes: Key Words: Targeting, Subsidies, Utility Tariffs, Water, Nicaragua. Corresponding author: Diego Angel-Urdinola World Bank 1818 H Street Washington, DC 20433 e-mail:
[email protected]
*
The authors are with the World Bank. This work was prepared as a contribution to the Poverty Assessment for Nicaragua. Results from the paper were presented in Managua in March 2007. Comments from Simon Abinden and Florencia Castro-Leal are gratefully acknowledged. The views expressed here are those of the authors and need not reflect those of the World Bank, its Executive Directors or the countries they represent.
1 Electronic copy available at: http://ssrn.com/abstract=1133125
1.
Introduction Given budget constraints faced by governments, good targeting performance of
public subsidies is important for poverty reduction. Several studies have been devoted to assessing the targeting performance of a wide range of programs in developing and transition economies (e.g., Grosh, 1994; Subbarao et al., 1997; Braithwaite et al., 2000; Coady et al., 2004). In the case of utilities such as water and electricity, while subsidies are very widespread, it is not clear that they are well targeted (Estache et al., 2002; Wodon et al., 2003; Komives et al., 2005, 2007; Angel-Urdinola et al., 2006, AngelUrdinola and Wodon, 2007)1. This is problematic given that in developing and transition economies, utility subsidies are often more costly than other transfer programs (Alderman 2002). In this paper, we extend the framework first proposed in Angel-Urdinola and Wodon (2007) in order to look at the targeting performance of water subsidies in Nicaragua, and at the impact of changes in access rates to water networks on this targeting performance. Nicaragua is a good case study for this work because water subsidies have become an important fiscal issue due to tight budget constraints faced by the sector. After a reform in 1998, the formal water and sanitation sector now comprises of two major state institutions: the national urban water utility ENACAL (Empresa Nacional de Acueducto y Alcantarillado), which operates water and sanitation systems in urban areas2; and the water regulator INAA (Instituto Nicaragüense de Acueductos y Alcantarillado), which is responsible among others for surveillance of service quality and tariff adjustments. Tariffs cannot be freely set by ENACAL in accordance to its production and distribution costs, because they are administered centrally by INAA. According to World Bank (2007), water services in Nicaragua have deteriorated significantly since 2000, particularly in the capital city of Managua where poor neighborhoods are increasingly confronted with extended water shortages. Many factors have led to this situation, including poor management, low labor productivity, low 1
There are exceptions to this when subsidies are allocated according to proxy-means testing as in the case of Colombia and Chile (e.g., Gomez-Lobo and Contreras, 2003). Yet when compared to other targeted subsidies, utility subsidies typically are less well targeted than these other subsidies (Wodon and Yitzhaki, 2002). On tariff design, see among others Whittington (1992) and Boland and Whittington (2000). 2 In Matagalpa and Jinotega water and sanitation services are provided by AMAT and EMAJIN, two local state-run service providers.
2 Electronic copy available at: http://ssrn.com/abstract=1133125
metering rates, leakages or technical inefficiencies, and high rates of water theft. But one should not underestimate the impact on the sector of the low water tariffs that are far below production cost levels due to a tariff freeze since 2001. Although ENACAL has submitted various petitions to INAA to adjust and increase its tariff structure, none of these petitions since 2001 have been approved; in part because tariffs are a much politicized matter. This has put ENACAL at the verge of bankruptcy. The company’s net income has steadily decreased in real terms since 2001; while production costs have increased dramatically, largely due to substantial raises in energy costs. In 2005, ENACAL’s looses exceeded $CO 235 million (about US$12 million). Liquidity constraints have had a negative influence on ENACAL’s ordinary maintenance operations. Furthermore deficient service quality has decreased its clients’ willingness to pay for their water bills, which has further lowering revenues. The tariff freeze was initially meant not to hurt the poor, yet the poor suffer most from the company’s incapacity to provide a minimum service level and extend the network3. Nicaragua’s situation is a classic example of a country in which the utility subsidies imbedded in an inverted block tariff structures which does not permit cost recovery are not well targeted to the poor, simply because the poor tend to have much lower access rates to the water network than richer households. In such a context, it would be better to increase tariffs, and use the additional revenues to increase access for the poor, than to continue the status quo of subsidies benefiting mainly the better off. In fact, increasing access to the water networks is probably one of the best ways to improve the targeting performance of consumption subsidies. But for the utility to have incentives to increase access there must first be some level of cost recovery that does not lead to higher losses each time access is increased. In addition, it must also be feasible and affordable for households to connect to the network, and for this, as noted by Kayaga and Franceys (2007), it is necessary that connection charges not be too high. This paper analyses changes over time in targeting performance of water consumption subsidies in Nicaragua, in order to test empirically the argument that better access is essential to better targeting of consumption subsidies. Our findings suggest that
3
This is not to say that in some cases, tariff increases related for example to liberalization may not ending up hurting the poor significantly. For a case study on this in Argentina, see Haselip et al. (2005).
3
because access rates to piped water increased substantially between 2001 and 2005, the targeting performance of consumption subsidies indeed improved, despite the fact that the tariff structure remained essentially the same over time. It is also shown that the observed changes in access rates had a much higher impact for improving the targeting performance of consumption subsidies than changes in the tariff structure could have had if they had been implemented.
The results thus confirm that one of the best ways to
improve the targeting of consumption subsidies may be to increase access rates, so that the poor have a better chance of receiving the subsidies. In section 2 we describe our framework, which is applied to water subsidies in Nicaragua in Section 3.
2.
Framework This section extends previous work by Angel-Urdinola and Wodon (2007). The
objective is to provide a simple measure of the distributional incidence of subsidies together with a decomposition explaining changes in this incidence over time (the same decomposition could be used to analyze differences in targeting performance between groups). We will consider water subsidies in the text just to fix ideas, although the framework can be applied to any subsidy. Define by SP and SH the total monetary amounts of subsidies granted to the poor and to the population as a whole respectively. Our benefit targeting performance indicator γ is the share of the subsidy benefits received by the poor, which is simply SP/SH. Denote by H the population size and by P the number of the poor. The value of γ is: γ =
SP ∑P q ( p − C) , = iH=1 i i SH ∑ i =1 q i ( p i − C )
(1)
where qi is the quantity of water consumed by household i and p i − C is the unit subsidy for household i (i.e., the difference between average unit price for water used and paid by the household and the unit cost of water per cubic meter C assumed constant across households.) In what follows, we provide a multiplicative decomposition of the value of γ as a product of six terms. We first consider factors affecting whether a household benefits or not from the subsidy, without taking into account the value of the subsidy. In order to benefit from the water subsidy, three conditions have to be met. First, the household
4
must live in an area where network water is provided. Access at the neighborhood or village level is denoted by AP and AH for the poor and the population as a whole, typically with AP
