Thatcher and Water Utility Privatization: Part II

Alright, I’m a little late getting this one up. Had to travel to Southern California and surf/sail/drink with friends and then up to Sonoma for some urgent wine and beer tasting. At this rate I’m going to be spoiled to do anything productive, ever. But I promised my loyal readers a post on privatization of the water sector in Thatcher’s England, so here it is…

To begin, no definitive summary of the impacts of these policies floated to the top of my literature searches. I didn’t look for much more than an hour but from what I saw on Google Scholar, Google, and the sources cited on Wikipedia the controversies of those years are still with us today. The literature was all a bit dated as well. So as any mealy mouthed journalist would, I grabbed an article for and against.

The “pro” article I used is a policy note on Water Privatization and Regulation in England and Wales by Caroline van den Berg the Lead Water Economist at the World Bank. The “against” a briefing on UK Water Privatization by Emanuele Lobina and David Hall, research fellows at the University of Greenwich.

The articles don’t disagree on the basic facts but rather which facts they emphasize in their interpretations. Even the pro-privatization van den Berg piece notes some problems, however, so the fervent supporters should take pause before using “privatization” as a buzzword that will fix all that ails the U.S. water sector.

Van den Berg lays out quite nicely the history of the U.K.’s privatization in which the 10 Regional Water Authorities (created by consolidation in the 70s) were sold off by the government. The government tried to overcome the natural monopoly problem I mentioned in my earlier post by creating an economic regulator, OFWAT, which sets price caps for five-year periods based on projected utility operating and capital costs, inflation, performance standards, efficiency, and service levels. OFWAT was given substantial discretion and independence so it would be immune to political interference.

Now, the government didn’t make any money on selling the Regional Water Authorities. In fact it lost £1.3 billion on the sale which was intended to be favorable to shareholders and included substantial forgiveness of debt acquired under public management.  This was seen as necessary as it was such a new policy and such large investments were necessary. Van den Berg sees the major investments from the private sector in the years following privatization as a major success for the policy. There were £17 billion in investments in water infrastructure in the six years following privatization as opposed to  £9.3 billion in the years before.

She notes that there were some problems with private sector incentives. Some large projects were gold plated to take advantage of the fact that rates were set on a “rate of return” basis, private utilities were unlikely to pay the high upfront costs of installing water meters as they were not highly concerned with water conservation, and utilities transferred costs from unregulated to regulated subsidiaries to game the system and get higher rates. The final, and most politically sensitive issue, is that rates went up substantially, 28% from 1989-1997, resulting in affordability problems and service cutoffs. At the same time water companies were hugely profitable. Van den Berg believes that this problem could have been fixed if the operator had lowered the price caps sufficiently to force the private utilities to lower their operating costs. She sees these problems as resolvable if the regulator has proper information and evaluation methods.

As the issue of substantially rising rates combined with high company profitability is a political flash point, Lobina and Hall devote substantial space to discussing it. They cite water and sewage fees as rising 36% and 42% respectively from 1988-1998 as pre-tax profits rose by 142% in the first eight years of privatization and directors’ pay rose 50-200% in the first seven years. Overall, profits by U.K. companies were 3 to 4 times as high as profits at water companies in France, Spain, Sweden, or Hungary. Lobina and Hall found that the companies in the U.K. gamed the system by projecting high operating and high costs to get the regulator to set higher rates then later finding “efficiencies” to avoid these costs and thus increase profits.

Despite these high profits, a Parliamentary committee found that there was serious underinvestment in underground infrastructure as sewers were unrealistically projected to last for 280 to 1000 years. The companies have also become increasingly indebted through a string of failed attempts to diversify beyond the regulated business. The public, disgusted with what they perceive to be greedy businesses has been less willing to do their part. A call by a public utility for reduced use due to drought in 1976 resulted in a 25% reduction of water used, a similar call by a private company in 1996 led to no reduction at all.

Overall, Britain’s sudden and full privatization of the water sector under Thatcher left room for improvement but informed people can still disagree on whether privatization was a mistake or whether further reforms were simply needed. Perhaps the most interesting fact is that U.K. companies had profits 3-4 times as high as those in other European countries, suggesting that we should look elsewhere for models of privatization. Indeed, German utilities have been able to maintain affordable user rates, high quality underground infrastructure, while the use of private utilities has gradually increased. In fact, I recently saw a paper suggesting that Britain was 30 years behind Germany in the water sector. Maybe we shouldn’t be looking to the U.K. for any lessons, public or private.

 

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