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C7.4 Subsidies and incentives

Characteristics

Subsidies can be used to protect vulnerable and poor groups in society but great care is necessary to ensure that they do not simply benefit the better off.

However, subsidies often encourage excessive consumption of water, either when its use is directly subsidised or where the prices of goods and services that consume water are subsidised, or affect its use. Examples include:

• Industrial plants that are heavy water users, operating in a protected, subsidised regime, lack any incentive to conserve water or use it efficiently;
• Low prices in the power/energy sector encourage excessive use of water;
• Subsidised prices for "thirsty" farm crops, causing heavy use of irrigation water.

Setting the right price signals (‘getting prices to tell the truth’) means that existing distortions in the workings of the market should be removed. For instance, farm prices should become more market-based or industrial firms should operate in a less protected environment or the prices of energy should be liberalised.

Taxes and/or subsidies need to be applied in a selective way to reflect environmental considerations ("green" taxes and subsidies) or other specific policy aims. For example, polluting farm chemicals should be taxed while water-efficient appliances could be subsidised. Subsidies can be used to encourage changes in behaviour (as for instance, to encourage the introduction of drip irrigation, see C3).

Pricing of water alone (C7.1) will not have its desired effect if it is frustrated by policies elsewhere that pull in the opposite direction. This lesson has been clearly learned from attempts to reduce water use in agriculture and to reduce the waste of water and pollution in highly protected industries.

All major policy areas affecting water use should be "joined up" (see also A3 – financing structures and A1, water policies). The market signals faced by water users (whether individual households, institutions, firms or farmers) should be consistent and persuasive.

Lessons learned

• The introduction of new subsidies should be very carefully considered, since they tend to be difficult to remove and can become a fiscal burden. However, they can be useful to encourage the uptake of unfamiliar technology (e.g. recycling and water-efficient irrigation methods) or stimulate pilot schemes that might lead to a wider acceptance of desirable practices.
• Subsidies (such as low-interest loans) might also be a way of tackling stubborn market failures (e.g. the habit of needing excessively short pay-back periods for recycling or water-efficient appliances).
• Subsidies can also be used in combination with a tax/charge regime to make the regime more acceptable, since people and firms paying the tax can see that the revenues are being applied for the same purpose.
• Policy reforms aimed at the removal of economic distortions can have double the benefit ("win-win" policies) of economic and environmental gains.
• But there is also a risk that general economic reforms that do not address distortions specific to the water sector may aggravate the latter's problems. For instance, trade liberalisation may increase pressure on a natural resource like water, unless accompanied by a concurrent water reform programme. (See policy formulation A1).
• Subsidies may help those who already water services, but not benefit those without access to water.

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