Thatcher and Water Utility Privatization: Part I

As I was on the road last week I’m very late by Internet standards to the topic of Thatcher’s death. As Prime Minister, one of her major initiatives was water utility privatization. Her legacy on this matter remains controversial to this day.

I’m not going to make a definitive statement on whether her initiatives were on the whole good or bad. I am skeptical that such a statement is possible and would advise against fully trusting anyone who believes it is. Privatization is always a politically controversial issue particularly when it involves such fundamental public needs as water. And is likely to rise in salience again with the start of negotiations of a U.S.-E.U. Free Trade Agreement later this year. Furthermore there is a lot of confusion around this topic, and many times ideology is mixed up with economic science, predictably muddling political discourse. Because of this muddling, I’ll focus this post on the economic theory surrounding privatization by parsing the economic scientific arguments from a free market ideology. In a second post, I’ll take a brief look at Thatcher’s specific policies as a case study of privatization.

The basic theoretical argument for free markets is fairly simple. People look after their economic self interest. In doing this some people will supply goods and services that others demand and sell these goods and services at a profit. Those demanding the goods and services will look for the best price they can find, and so where there are multiple suppliers there will competition on price as the suppliers try to maximize their profits by undercutting others on price to sell more units. At the end of the day, some price is found by which supply roughly equals demand and just about all the goods and services are sold to willing buyers. This last bit is the empirical bit, and one should remember that when all kinds of fantastical claims are being made for and against markets.

This simple picture of markets quickly disappears when we talk about the water sector as we have what is termed a “natural monopoly.” It is too costly to build multiple water supply and sewer networks so consumers are going to be stuck dealing with one supplier. This gives the supplier substantial power over the consumers, and the supplier can abuse this power like any monopolist and charge consumers  “monopoly rents” (which basically means it charges them through the nose).

As we cannot very well ask people to go without water, in many cases we have it managed publicly to tame any kind of profit motive. But what if we believe that our public utility is being run inefficiently? For example, it is not using up to date asset management practices (which is very common in the U.S.). Or one sees that public rate setting boards are artificially depressing rates for political reasons and thus preventing it from making capital investments? Well one may seek to privatize it.

But even if one does privatize it, because of the natural monopoly problem, there needs to be some regulatory control of rates. And thus we’re still stuck with one of the problems that a public utility struggles with: how to set appropriate rates. And we have a new one: even if the private utility is incentivized to minimize costs, it has to make a profit. So the public is going to lose some of those efficiency gains to shareholders.

The “public versus private” debate in the water sector is not a world for panaceas. The choices are hard and imperfect, and often unsatisfactory as we’ve already strayed quite far from the economic ideal. In fact, I think it is a mistake to frame the debate as “public versus private,” terms which are politically loaded, in part due to Ms. Thatcher. The terms “organization versus market” (Simon 1996) are good for sidestepping this ideological mess. Because anyone who has had a problem with the DMV or a cable company can tell you, human organizations are going to lead to frustrations whether they are run for the public interest or for a profit motive. If we really want to improve our organizations we have to look at where markets are good at disciplining them, and where we have to look for other means.

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