A puzzle: Sanitation is one of the most productive investments a government can make. There is now rigorous empirical evidence that improved sanitation systems reduce the incidence of diarrhea  among children. Diarrhea, in turn, harms children’s nutritional status  (by affecting their ability to retain nutrients). And inadequate nutrition (stunting, etc.) affects children’s cognitive skills , lifetime health and earnings. In short, the benefits of sanitation investment are huge. Cost-benefit analyses  show rates of return of 17-55 percent, or benefit/cost ratios between 2 and 8.
But if the benefits are so high (relative to costs), why aren’t we seeing massive investments in sanitation? Why are there 470 million people in East Asia, 600 million in Africa and a billion people in South Asia lacking access to sanitation? Why are there more cellphones than toilets  in Africa?
This is a puzzle because nobody cares more about children than their parents. Why aren’t they investing in toilets, so their children will be sick less often, be better nourished, learn more in school and become more productive adults? One answer is that they don’t know about all these benefits from sanitation. But the evidence has been around for decades. Also, we should never underestimate poor people’s knowledge. We used to say the same thing about education—poor people don’t send their kids to school because they don’t know the benefits—until we found out that illiterate parents know more about the benefits of education than literate ones .
Another response is that poor people don’t have the money. But they are making decisions every day on how to spend their money—on food, clothing, etc. The returns to sanitation expenditures are higher than some items that they’re already spending on.
Even if households don’t invest enough, why doesn’t the government step in? 17 to 55 percent rates of return are better than many, if not all, public projects.
Here is the resolution of the puzzle: This evidence is not what is relevant for government investment decisions. Finance ministers are constantly besieged by advocates for one activity or another who say, “My sector has all these effects on growth and poverty reduction, so you should spend more on my sector.” This argument is wrong.
Why? Because governments have limited resources. Any expenditure by government on sanitation will come at the expense of something else (or higher taxes)—such as roads or education or health.
So how should governments decide what to spend on? They should spend on those things that the private sector will not spend on, or will not spend enough on. The classic example is an externality—where the benefits or costs occur to people other than the person undertaking the action (such as when an upstream firm pollutes downstream villages). Society is better off if government steps in and taxes the externality provider.
Sanitation, or its converse, open defecation, is a negative externality. People who defecate in the open not only harm their own children, but other people’s children. Their incentive to invest in sanitation is less than the costs. In Maharashtra, India, a village-level sanitation program showed that children from households that didn’t adopt latrines were statistically better off  (taller, etc.). In rural India, the reduction in diarrhea incidence from others’ adopting sanitation is about half  of the effect of your own household’s adopting it.
This is the strongest case for public spending on sanitation. Furthermore, ignoring the externality argument has serious consequences. Governments typically overspend on private goods, such as high-end medical care, at the expense of goods with externalities, such as sanitation. Rich people and medical unions have political power to lobby for spending on curative health care; others lobby for fuel subsidies (another private good). Poor people’s voice for sanitation goes unheard. This was also the case in today’s rich countries—in the 19th century. William Henry Harrison, the tenth president of the U.S., died  of enteritis, contracted from fetid marshes near the White House. Unfortunately, today, many of our cities in Africa and South Asia look like Dickensenian England—or worse.
Another consequence of ignoring the externality is that implementation of sanitation projects can fail. India’s sanitation program, where they gave out free toilets to households, wasn’t working. The reason was that people were using the toilets for other purposes, such as grain storage . Meanwhile, Bangladesh had a very successful program, run by an NGO, financed by government. The difference was that in Bangladesh, they were giving the toilets to the community, and asking them to allocate to individual households. They recognized that by giving toilets to people, you weren’t solving the problem of the externality. But giving it to the community enabled the community to monitor whether people were using the toilets. The community as a whole had an interest in everybody using the toilets (rather than open defecation). The good news is that Maharashtra now has a successful total sanitation program. So much so that you now see signs saying, “We will not give our daughters in marriage to someone from a village that doesn’t practice total sanitation.”
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