Developing Wastewater Services in Emerging Market Economies: The Cases of China and Ukraine John Bachmann, PADCO

http://www.padco.aecom.com john.bachmann@padco.aecom.com Delivering affordable, dependable and sustainable wastewater services is a challenge for local governments worldwide. But it is an especially tall order in emerging market economies, in which the old service norms, institutional forms and pricing policies often constrain the development of autonomous and competent wastewater service providers that can develop their systems to meet users’ needs and collect sufficient revenues to cover their costs. China and Ukraine are two countries that are wrestling with the problems of developing sustainable wastewater collection and disposal services while their economies transition toward the market. This paper examines the performance of local governments and their Wastewater Service Providers (WASPs) in selected towns in both countries and seeks to identify the factors that contribute toward improving service quality and achieving financial sustainability.1 The goal of the analysis is to draw conclusions that may be applicable to WASPs in other emerging market economies. The paper will examine in turn three aspects of wastewater service delivery — institutional arrangements, service pricing and stakeholder participation — in each of the two countries. For each aspect, the paper will briefly define the Chinese and Ukrainian contexts and identify the main problems faced by WASPs and local governments (LGs). A final section will attempt to draw conclusions about the types of interventions that could be successful in promoting improved service delivery in the future.

Institutional Arrangements for Wastewater Service Delivery
In both China and Ukraine, wastewater service delivery is a devolved function for which local governments are responsible. Ukraine’s law “On Local Government” of 1996 makes LGs responsible for the provision of a number of “communal services,” including piped wastewater collection and disposal. Most LGs execute this official mandate through “vodokanals,” which are legally independent organizations that are nominally owned by the local community (residents of the town or city) but in practice operate under the direction of the local government. (A minority of vodokanals or their fixed assets are leased to private companies.) Vodokanals are generally responsible for water supply and piped wastewater collection and disposal. Chinese towns are also responsible for the delivery of local wastewater services. In small cities and towns, services are usually provided by a municipal department, often operating independently from the water company, a municipally owned utility. In large cities, wastewater collection and disposal services are generally carried out by municipal departments or LG-owned water/wastewater companies. The broad outlines of the institutional arrangements in both countries are favorable to responsive, sustainable wastewater service delivery to the extent that local governments can design and implement their own programs. However, the specific roles and responsibilities of
1

The material in this paper is drawn from two technical assistance projects implemented by Planning and Development Collaborative International, Inc. (PADCO): the ADB-financed “Town-Based Urbanization Strategy Study” (TA 4335-PRC) implemented China in 2004-2005, and the USAID-financed “Ukraine Tariff Reform and Communal Services Enterprise Restructuring Project” implemented in 2000-2005.

the WASPs are insufficiently defined, and there are few incentives for WASP managers and staff to improve institutional performance and/or service quality. In the Chinese case, the operational environment for wastewater delivery is first and foremost undermined by the political imperatives of local government leaders. In recent years, the Government of the People’s Republic of China (PRC) has put heavy emphasis on economic growth. Local government leaders — both in the Party and the town or city government — are evaluated based on the amount of new investment they leverage and the increase in local economic output. Prospects for promotion within the party and to larger urban settlements will depend first and foremost on economic growth. The degree of environmental sustainability of local growth is not an evaluation criterion. These political priorities do not incentivize improvements in urban environmental infrastructure generally or in wastewater service delivery in particular. On the contrary, many officials are driven to undertake any investment project that will boost growth, regardless of its impact on the environment. Another constraint in Chinese towns is the dependence on decision-makers at higher levels of government in order to improve wastewater services. Large capital investment projects and tariff increases require approval of higher-level governments, such as a county, countylevel city or prefecture-level city. Finally, the performance of many Chinese WASPs is undermined by their separation from water service providers. It is much more effective to bill customers for wastewater and water supply services at the same time (through the same bill), given that willingness-to-pay for water supply is always higher than willingness-to-pay for wastewater collection. The fact that water suppliers are able to disconnect their customers in case of non-payment also contributes to higher payment collection rates, which benefit wastewater service providers also when billing is combined. Unlike their Chinese counterparts, Ukrainian local have the authority to set tariffs for wastewater services delivered by vodokanals (communal service enterprises) without higher-level approvals. The vodokanals calculate the tariffs and make a proposal to the LG, which approves the tariff by action of its executive committee. While the autonomy afforded by this arrangement is an asset, it also subjects the pricing of wastewater services to the vagaries of local government politics in an emerging democracy. Many Ukrainian mayors feel that raising the prices of communal services will lower their chances of being reelected. The old notions of water as a public good that the State should provide for free run deep in Ukrainian society, especially among older people and pensioners, which make up a large portion of the total population. It takes a progressive local government leader to decide that raising tariffs is either (i) the right thing to do for sustainable service delivery, despite its unpopularity, or (ii) can be fashioned into a political asset by emphasizing improvements to service coverage or quality.

Economic growth continues to trump environmental protection in Chinese towns. In both Ukraine and China there is a general lack of clarity about the roles and responsibilities of WASPs vis-à-vis municipal owners and end users (customers). There are few written agreements between local governments and wastewater service providers specifying the responsibilities of the wastewater service provider with respect to service levels, capital investment financing, and service pricing (tariffs). The obligations of the local government — in effect, the LG’s contribution to improving wastewater services — are also underarticulated: there is no specific commitment by the municipality to provide financing for improvements, build public support for increasing payment collection, or approve necessary tariff increases. At the same time, there are no contractual agreements between WASPs and end users. In this operational environment, the wastewater service provider lacks clear targets to work toward and clear commitments from the city and customers to assist in achieving institutional and sector objectives.

Pricing of Wastewater Collection and Disposal Services
At its best, the pricing of urban services such as wastewater collection and disposal is a complex, interdisciplinary and flexible exercise through which interested parties set prices to achieve a set of often conflicting objectives. On the one hand, user charges should be affordable to customers. On the other hand, tariffs should be set to ensure the level of revenue needed to keep providing decent services in the future. Where fixed assets require rehabilitation or coverage must be expanded, tariff revenues may have to cover capital investment costs too. In a successful service development planning and tariff setting process, the different parties work together to find common goals and then formulate interventions to achieve them. Such a “holistic” view of the tariff setting process is not yet widespread in Ukraine. In the 1990s, most municipalities, despite being responsible for service pricing, distanced themselves from this process in order to limit perceived political damage. Cities would posit themselves as the arbiter of the tariff setting process, a role that assumes conflicting views among vodokanals and customers. Generally siding with the customers in order to strengthen their position for future elections, municipal governments would generally reject tariff increases proposed by vodokanals, thereby locking the WASPs into a downward spiral of aging assets, rising energy costs and financial shortfalls. Wastewater service pricing in China is also influenced by the notion of water supply (and by association, wastewater) as a public good to which all citizens are entitled. Local government leaders are wary of raising water and wastewater tariffs, which are consequently below the level required for recovery of operation and maintenance (O&M) costs in most towns.

In cities in China and Ukraine, extensive capital investment is needed to ensure adequate future service delivery. In China, it is necessary to expand coverage of piped wastewater collection services in response to rapid urban development and to build appropriate wastewater treatment facilities. Ukrainian municipalities need to rebuild pumping stations and treatment plants to reduce energy consumption and lower energy costs; moreover, much of the aging piped network needs replacement. Under the principle that the customer should bear as much of the cost of service provision as possible, WASPs in both countries should calculate new tariffs that cover O&M costs and whatever share of investment costs the end user can bear. This calculation requires knowledge of household income and expenditures. Ability-to-pay analysis was carried out under the USAID-financed Tariff Reform and Communal Services Enterprise Restructuring Project in two Ukrainian cities (Lutsk and Khmelnytsky) to evaluate the impact of alternative hypothetical tariff scenarios on household finances. The analysis concluded that there was additional disposable income, and that it would be possible to raise water and wastewater tariffs without surpassing the normative “15% limit” set by the local governments: combined housing and communal services costs should not exceed 15% of the income of a household at the 25th income percentile. On the basis of this analysis and extensive stakeholder consultation, the City of Lutsk decided to increase its water and wastewater tariffs by 32 percent in June 2002. In combination with increased payment collection, the higher tariffs provided enough revenue to cover O&M costs and finance a modest $500,000 short-term capital investment plan. Following on the Lutsk experience, three-quarters of the 29 communal service enterprises that graduated from the Tariff Reform Project over the period 2002–2005 achieved cost recovery through a combination of tariff increases, higher payment collection rates and operational cost reduction (27 enterprises were loss-making at entry into project).

% Payment Collection, Residential Customers

95 85 75 65 55 45 35 2000 2001 2002
Khmelnytsky Vodokanal Khmelnytsky Heat Lutsk Vodokanal Lutsk Heat

Municipal public works departments and wastewater companies in China also desperately need to raise tariffs in order to generate financing for the construction of wastewater treatment plants. But there is no standard methodology for calculating tariffs that include a component for O&M and another component for capital investment. And ability-to-pay

analysis is not used to systematically evaluate the capacity of customers to pay more. Perhaps most critically, there is no established public forum in which packages of service improvements and pricing options could be discussed and agreed with customers and other stakeholders in Chinese cities in towns.

Stakeholder Participation in Wastewater Service Delivery
The Government of the PRC is currently pursuing a goal of creating a “harmonious society” in which the benefits of growth are equitably distributed among different population groups. Equitable distribution of the benefits of urban development requires dialogue among the various concerned parties: local governments, real estate developers, holders of use rights to land, buyers of newly created real estate products, and users of wastewater and other municipally provided services. In China today, however, customers do not have a voice in the provision of urban services. Decisions about service levels and coverage in many cities are taken primarily based on engineering requirements and the availability of capital investment subsidies from higher-level governments. There is no systematic consultation of different population groups, and end user preferences and priorities are not incorporated into the service planning and pricing process. The investment requirements of Chinese towns and cities in the area of wastewater treatment are staggering. If the current trend in environmental degradation of surface and ground water supplies is to be halted, thousands of urban settlements across the country will need to build wastewater treatment facilities. Under current conditions — an unfunded mandate to provide services coupled with insufficient authority to increase tariffs — it would seem difficult for Chinese WASPs to respond to the challenge. Any successful approach to improving service levels will have to be multi-pronged, but one important aspect is likely to be improving relations with stakeholders: the users of wastewater collection and disposal services. In the respect, the recent experience of Ukrainian cities may prove instructive. In the 1990s Ukraine adopted a representative democratic form of government in which executive and legislative officials are elected at the local government level. This system requires some degree of responsiveness to the priorities of the public on behalf of local mayors and council deputies. But as described in the service pricing section above, elected officials have in many cases acted as arbiters rather than leaders in the area of urban services provision. This is now changing. Town halls in such cities as Komsomolsk, Chernigiv, Kalush and Lutsk have forged partnerships with their communal service enterprises (including vodokanals) and the local stakeholders. Where such partnerships have been forged, the parties have been able to agree on and implement substantial improvements in service delivery and sustainability. The process in most towns has followed this general outline:
1. Build customer awareness. Conduct public outreach and carry out media campaigns to educate the public about the need to rehabilitate or expand wastewater systems, to increase revenues in order to pay for improvements, and to pay for services in order to ensure the financial viability of vodokanals. 2. Gather information on customer preferences and priorities. Conduct focus groups and/or customer surveys to find out what customers see as the major problems, what types of service improvements are most important to them, and whether they are willing to pay more in user charges in order to receive better services. 3. Formulate proposals that respond to customers’ stated priorities. In the process of service planning and capital investment programming, include the projects and operational changes that will improve coverage, improve wastewater treatment, protect local rivers and streams, etc. Formalize these proposals into strategic action plans.

4. Garner public support for the strategic plans. Publicize the plans by distributing summary versions of them, posting them in public places for review, and holding public hearings on the plans.

Public hearings in Ukraine are used to build stakeholder support for wastewater services reform. Participants in focus groups and public hearings can be presented with different technical/pricing options that have different sets of capital improvements associated with them. Each option or scenario is presented as a package; for example, achieving 24 hour a day water supply (from scheduled delivery) will necessitate a 20% tariff increase, while 24/7 water and higher water pressure above the second story will entail a 30% increase. Participants should be able to evaluate the costs and benefits of each package themselves, and contribute their opinion to the decision-making process.

Conclusions
This brief review of the wastewater sector in Chinese and Ukrainian towns indicates that there is great scope for refining and improving institutional arrangements, pricing policies and stakeholder participation. The following concrete recommendations are set out for consideration by policy-makers and practitioners in emerging market economies.
• Reinforce the legal and regulatory basis of WASPs so that they can establish technical service targets, plan capital investments and set prices in collaboration with local governments and stakeholders; Develop and implement service agreements in which the rights and responsibilities of local governments and WASPs are clarified. Local government commitments to achieving service delivery targets must be spelled out clearly; Get the incentives right for improved performance of WASPs and LGs. Link improvements in wastewater services and environmental protection to the career advancement among civil servants and elected officials. Unite the entities responsible for water supply and wastewater collection into a single organization responsible for both services. This will improve service planning and facilitate tariff payment collection; Use ability-to-pay analysis to determine how much local households can afford to pay for improved wastewater services; Use customer outreach techniques such as focus groups and customer surveys to determine end user preferences and priorities with respect to wastewater service levels and coverage. Develop a tariff calculation methodology that includes a capital investment component.

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Develop and evaluate alternative capital investment and tariff scenarios with input from stakeholders; Build consensus for a preferred option or scenario through information dissemination and public hearings. Implement the strategic plan.

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