Wednesday, August 1, 2012

Is a Government-Enforced Private Monopoly Better Than Government Ownership

The back story:  Some cities are reversing privatization of water systems based on an example by Paris, among other cities.  Commenting on the story, Tyler Cowen observes:
For advanced water systems, there is no cost advantage to having a privatized system.  It is a regulated monopoly and over time it acquires skill in manipulating the political process, most of all its regulators.  Why expect lower costs and prices?  A wide variety of studies of this topic, including studies by “market-oriented” economists, find no cost advantage for the private sector in this setting. 
For very poor countries, very often water privatization would in principle be a good idea, since the public sector is not supplying much piped water at all.  Monopoly is better than carrying a bucket on your head, and you still can carry the bucket if you wish.  Yet privatization also won’t get very far in many of these cases.  One reason is that there is no way to make people — many of whom are non-registered and lacking in assets — pay their water bills, and not enough legal infrastructure to prevent them from cutting into the pipes or otherwise going rogue.  You shouldn’t “blame” privatization here, but still it may not be a useful option. 
Finally, there is a sweet spot in the middle, often for reforming or middle-income countries.  In those cases water privatization can mobilize private capital rapidly and expand water coverage.  It often brings higher quality water, higher quality connections, lower rates of unaccounted-for-water, and higher prices. 
Certainly private operation without private market signals and competitive threats is is a weak privatization model, particularly if (when?) the company develops all kinds of insider political clout to change rules in its favor.

I am constantly suspicious of privatization deals whose main benefit is a one-time cash hit for a struggling government entity (the equivalent, say, of Arizona's sale and lease-back of its capital building).  A better privatization model would be one that was structured to reduce operating costs rather than generate a one time budget fix.  I wonder if it would be possible to lease the operating rights to the water system, rather than sell it outright?  The private company would still get paid out of water revenues, but a contract end date and rebid process would help keep some competitive pressure on the company even if for the duration of the contract they were effectively a monopoly.  

In the public recreation privatization model, the government retains ownership of the assets and leases just the concession rights.  Private companies in return bid for those rights, and must rebid every 5-10 years.  These bids are not just for concession fees but for fees charged to the public, quality metrics of the operation, capital invested, etc.  Concession fees are used by the agency to pay for capital maintenance and upgrades that are not part of the concessionaire's responsibility.

Update:  Other municipalities are going the opposite direction, from an article by Len Gilroy a while back in the WSJ:
In April, the Chicago City Council overwhelmingly approved Mr. Emanuel's $7 billion program to "rebuild Chicago" by constructing two new runways at O'Hare Airport; replacing 900 miles of water pipes and 750 miles of the sewer system; creating special routes for rapid bus transit; modernizing schools, transit stations and city buildings; and building 12 new parks and 20 playgrounds.
To pay for these projects, Mr. Emanuel is turning in part to private firms including Citibank and Citi Infrastructure Investors, Macquarie Infrastructure and Real Assets Inc., J.P. Morgan Asset Management Infrastructure Investment Group, and union-held Ullico. These firms say they are ready to provide at least $1.7 billion to help build the "new Chicago." (Though the details are not yet set, the likely arrangement would have the private firms putting up capital and then recouping their investments through user fees over a set period of years or decades.)
"This model of private financing for public infrastructure is happening all over the world, but not here in America," said Mr. Emanuel, who served from 2009-10 as President Obama's chief of staff. "I can't get from here to there on the old model—it's broken."... 
Mr. Emanuel's new infrastructure plan is bolstered by the privatization success he's already experienced in Chicago. Last summer he launched a large-scale competitive bidding process in which two companies compete with each other—and head-to-head with city workers—to provide cheaper curbside recycling for Chicagoans.
The competition forced government workers to find better ways to do their jobs, and Chicago reported reducing costs by $2 million in the first six months alone. "The City's crews have worked to close the gap between the private haulers' $2.70 price per cart by reducing their costs by 35 percent from $4.77 to $3.28 per cart," the city government reported in April.
Also privatized by Mr. Emanuel: Chicago's water-bill call center, airport and library custodial services, and the city-worker benefits-management system. Hiring private companies that could manage these services at lower costs led the city to lay off over 600 employees, so the mayor came under predictable fire from government unions. "My duty as mayor is to protect our city's taxpayers and be their voice—not to protect the city's payroll," he responded.


  1. There is one model here where cost savings could be achived by privatization. Note: I am not suggesting that this either has been done or should be done, but it is at leat theorectially possible.

    In the US or at least in the part of it that I live in, water utilities wether fully government operated or operated by a private entity on contract exist mostly at the municipality level although there are a few county wide systems as well.

    It may be possible for several municipalities and or counties that are close together or spatially contigous to obtain cost savings through economies of scale by all privatizing to a single company.

  2. I agree - too many "privatization" schemes are nothing more than state-enforced monopolies for private parties, the type of thing Adam Smith decried in the Wealth of Nations.