Time to Revisit Water Privatization?

public_good

CNN Money recently reported seven publicly traded water utilities that have seen new highs and an average year to date performance of at least 7%. The anticipation that the recent water pollution crisis in Flint, Michigan would initiate several states and municipalities to involve private water utilities for managing their water supply may have motivated the investors to long these stocks. Several of these publicly traded companies are part of the National Association of Water Companies, a consortium of private water companies that provide a broad range of water services. Private water companies serve almost one-quarter of the countries population.

Shika Dalmia of Reason magazine has a comprehensive coverage of the water crisis and the mishaps of the governance at various levels. It started with choosing the less expensive Karegnondi Water Authority (KWA) over the Detroit Water and Sewage Department (DWSD) for a new contract and re-opening the Flint water treatment plant in the interim. Cash-strapped cities like Flint can benefit from privatizing their water utilities as private enterprises would make investments needed to meet the stringent water quality standards. Their long term infrastructure investments would perhaps compensate for the past under-investment in the water infrastructure. Flint particularly has a receding population base with at least a billion dollars in unfunded liabilities.

Perhaps, the first modern privatization of waterworks dates back to 1989 when England and Wales, under the leadership of Margaret Thatcher, sold ten public water utilities. Caroline Van den Berg from the World Bank, in her article in viewpoint in 1997, reported that these reforms delivered a volume of new investments in water supply systems, full compliance with the drinking water standards and have lead to a higher quality of river water along with more transparent water pricing system.

Privatizing water comes with resistance. The two primary arguments against privatization are the public good and the natural monopoly ideas. Public good by definition has to be non-excludable and non-rival in consumption. Non-excludable for water as good is the fact that the entity providing it cannot exclude the access of water to people who do not pay for it. Nonrival in consumption of water is the fact that one person’s use does not reduce somebody else’s.

Recently, DWSD and Baltimore Water Department (both public water utilities) shut off water for customers with delinquent accounts. Clearly, water as a commodity in not non-excludable in the eyes of public water utilities, especially when they are up against decreasing revenues. Water is also rival in consumption. If I use X gallons of water for my lawn, those gallons of water are not available for my neighbor. One could argue that water supply is unlimited, making it practically non-rivalrous, and hence, the marginal utility of water is zero. Try winning that argument with a farmer in Central Valley, California or resident in San Fransisco. Hence, on both accounts, water as a public good fails.

Monopoly-Man

The nature of water industry, some argue, necessitates a natural monopoly since it requires massive fixed costs and economies of scale in the production of the good. Hence, in the long run, two or more companies that started off operating as competitors, would eventually have to yield to either one that could expand and achieve lower unit costs with increasing output. The inconvenience caused by having to deal with many water and sewer lines underground further supports this argument. It is reasonable for anyone to, therefore, think that there will be one company that will capture the entire market and start exploiting the consumers with higher prices.

Assuming that the monopolistic company has in fact raised the water rates, a rational customer, in the absence of any competing companies (for the time being) will respond to this rate increase through under consumption and rationing –thereby decreasing the revenue for the monopolistic utility. Residents of California, in 1976, have demonstrated a rationing of 40% to 50%, thus drastically reducing the revenues of their respective water districts. ┬áThe customer will prioritize his needs and budget the super expensive water supplied by the monopolistic company for essential needs. The client would respond to price increases in the same way as he would to water supply shortages — “conservation.”

He will consider purchasing bottled water if it is cheaper that the current water rate. The price signal is already out, and a different company can provide water trucks to the community at a more competitive rate. Recall that the customer is only stuck with this company as there is no one else who can come into the market, lay the pipes and start providing water. Bottled/truck water is rather mobile for any new company to come into the market. If the rates are exorbitant, to the point that the customer cannot afford any water, he is then compelled to create his own by rainwater harvesting and traditional water purification techniques. Remember, at that price level, his time value of developing water resource for survival is still much cheaper than the water rate he was offered. Price gouging so-called natural monopolies can seldom sustain. Economist Thomas DiLorenzo, in his article on “the myths of natural monopoly” has a comprehensive treatment of this concept, starting with the origins of the term “natural monopoly” in economics.

In the last two years, Flint switched three utilities (all three public) for providing water. DWSD whose contract expired on 2014, the new KWA, which was supposed to provide water from Lake Huron in two years time and the interim water supplier from the Flint River. Suffice to say that this is proof enough to bring in private utilities who would compete for market by providing lower rates and better services. The Department of Environmental Quality of Michigan and the Environmental Protection Agency, responsible for ensuring quality checks, might, in fact, be more vigilant on the private companies than their public counterparts. The private companies are also liable to class action lawsuits in the event of such incidents. The municipality, on the other hand, may claim sovereign immunity.

Steve Hanke and Stephen Walters, in 1987, presented the ideas of how a privatized water system can work. They proposed a franchise bidding system where the company wins based on the water rates and services it offers. They also provided examples of private waterworks from France. In the United States, economist Charles Howe, in his national academy of press’s open book in 2002, presented a comprehensive assessment of issues and experiences from privatization of water services.

It is time to revisit these issues and reflect on private water provision in the US.

2 Comments

  1. Hey Naresh –
    I super liked reading your article on the Flint Water Crisis- its amazing that it took nearly 2 years to draw federal attention to this crisis. Weather the water supply be controlled by the public services or privatize it – what concerns me most is that the simple act and thought of clean drinking water is every humans’ basic and minimal rights –
    thanks for writing such a neat yet though provoking article – look forward to many more!!

  2. Idea of privatizing a natural resource such as water can be scary to most people. What scares me personally is the concept of working for “profit”. Private companies are in business to make money. How will one ensure equitable distribution of water? If a said company can make good money by supplying water to places that cater to the rich, then what incentive do they have to be fair to the poor? Policy making would become even more difficult once private companies/investors come into play. Look at the education system in India. Private entities stepped in to support the crumbling public school system. It eventually led to creating an advantage to the rich. What’s topping that from happening with water? Issues like Flint Water Crisis are a result of corrupt and negligent politicians. It could have happened even if a private entity was in charge . Just my two cents.

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