Public water utilities in many countries are charging households a price that is just a fraction of what it costs to deliver water, let alone maintain or expand water infrastructure, according to David Lipton, first deputy managing director of the International Monetary Fund (IMF).

Although it is “abundantly clear” that worldwide, demand for water outpaces supply, an imbalance which is the clearest sign that water is underpriced many governments are reluctant to price water like other goods, Mr. Lipton said.

Commenting on a recent IMF study examining whether governments succeed in protecting their citizens by providing cheap water, he said:

“When you do not get prices right for water, you end up with misallocation of water today and misallocation tomorrow. Misallocation today can take the form of thirst, low agricultural productivity, or worse, poor sanitation, disease, and malnourishment. Misallocation tomorrow can take the form of inadequate investment in infrastructure and the technologies to meet future water needs and ensure water security.”

The IMF’s second-in-command cited India as an example of a country where underpricing of water and inputs is contributing to scarcity today and long-term problems that will be hard to solve.

“Water-related subsidies—through lower prices of diesel and free electricity for irrigation pumps—have led to widespread overuse of underground aquifers and increased salinity of soils, nearly undoing all the productivity gains from the green revolution of the 1960s”, he said.

Decades of mispricing had also played a role in California’s water shortages – in mid-2014 the state implemented an executive order mandating a 25 percent reduction in water use over the next 12 months compared with 2013 levels.

Rapid depletion of underground aquifers and a deterioration in water quality were evidence of numerous other examples around the world which show that mispriced water leads to what Mr. Lipton described as the “tragedy of the commons.” Individual users of a resource acting independently and rationally according to their own self-interest behave contrary to the common good of all users by depleting that resource.

Image: Source IMF

IMF figures flag up tip of the iceberg on underpricing

The IMF has calculated that in 2012, underpricing resulted in water subsidies totalling about $456 billion worldwide, or about 0.6 percent of global GDP, with subsidies amounting to as much as 5 percent of GDP in some countries.  Mr. Lipton warned that this is just the tip of the iceberg -  the estimates exclude agricultural uses of water, which constitute the bulk of water consumption in developing countries.  In some countries, water subsidies are even exceeding total spending on public investment .

Since the subsidy that one gets is proportional to the water one uses, and since the poor often have limited or no access to water, subsidies in developing countries end up benefiting mostly upper-income groups. In select low-income economies, the richest households get, on average, three dollars’ worth of subsidized water for every dollar’s worth provided to the poorest (see Chart 2).

Governments need to price water in a way that achieves full cost recovery

Mr. Lipton concludes that achieving greater efficiency in water consumption requires a holistic approach complemented by the reform of policies that drive—directly or indirectly—water use.

“Governments could put in place regulations that strengthen rights to water access and promote its efficient use, build strong and independent institutions in charge of water management, and conduct public awareness campaigns that help build support for these reforms”, he said.

“Water pricing reform should be an essential component of any drive to improve water management, helping to rationalize demand, improve its delivery, and unlock further supply. Governments need to price water in a way that achieves full cost recovery, including costs of maintenance and investment.”