The Value of Free Water: Analyzing South Africas Free Basic Water Policy

This paper analyzes the Free Basic Water Policy in South Africa, where households receive a free water allowance of 6 kiloliters per month. I structurally estimate residential water demand under a complex non-linear pricing structure and provide optimal price schedules derived from a social planners problem. I use a unique dataset of monthly metered billing data for 60,000 households for 2002-2008 from a particularly disadvantaged suburb of Pretoria. The dataset contains rich price variation allowing the identi\u85cation of structural parameters and a counter-factual analysis without zero prices. I \u85nd that without government subsidy the mean monthly consumption would decrease from 12.6 to 5.6 kiloliters, which is below the clean water consump-tion recommended by the WHO. However, it is possible to reallocate the current government subsidy to form an optimal tari ¤ without a free allowance which would increase welfare while leaving the revenue of the water provider unchanged. This optimal tari ¤ would also reduce the number of households consuming below the WHO recommended level. The intuition behind this result is that under the current policy, households attempt to stay within the free allowance in order to avoid paying high marginal prices. I would like to thank Patrick Bajari, Tom Holmes, Amil Petrin, Chris Timmins, Gergely Ujhelyi, and seminar participants at the University of Minnesota for comments and suggestions. I am grateful for the assistance and cooperation of Fazel Sheri¤, Director of Water and Sanitation at the City of Tshwane, and Pieter Avenant, Financial Director of Odi Water, without whom this project would not have been possible. All views expressed in this paper are the authors and were not endorsed by the City of Tshwane or Odi Water. 1 Water is life, sanitation is dignity