The Theory of Water and Utility Pricing - Global Drinking Water Management and Conservation - page 76

Mirrlees ( 1971a , b ). A key idea in the demarcation of private or public production is
that the optimal choice between public and private be determined by “ absolute

ef ciency advantage, ” (Huizinga and Nielsen 2001 ). However, as Huizinga and

Nielsen is paper is concerned with the privatization decision, they do not investigate

the characteristics of absolute ef

'

ciency advantage; in their paper, the line of
demarcation between public and private production depends on a param-

eter, within a framework of optimal taxation. Therefore it would be interesting to
develop the necessary conditions for absolute ef

“ waste ”

ciency advantage, conditions that
would be consistent with Huizinga and Nielsen, and with the theory of optimal
taxation. Dore et al. ( 2004 ). examined the question of whether the ”

production should be carried out in a public enterprise or whether it should be
carried out by the private sector. Accordingly, the Ramsey-inspired theory suggests
that the decision should be based on which form of enterprise has absolute effi-

“ public utility

-

ciency advantage. The section below draws on Dore et al. ( 2004 ).

5.4 Absolute Ef ciency Advantage

First, an enterprise that had absolute ef ciency advantage would be free of failures of

both market and public types, and hence there would be no negative externalities.
Under competitive conditions, absolute ef

ciency advantage would yield a higher
consumer surplus. (Otherwise it would contradict the de ciency). The

assumption of perfect competition means that the technology used would be the
“

nition of ef

technology, assuring the optimal quality of the product. Further-
more, under perfect competition, there are no externalities, by assumption. That is,
the lower cost and/or quality are not obtained at the expense of some other social
cost, such as the degradation of the environment or the shifting of social costs to a
future generation. These considerations suggest the following necessary conditions
for absolute ef

state of the art ”

ciency
advantage if: (a) its product is superior in terms of quality, (b) it can supply the good
at a lower unit price, and (c) the production does not entail any negative externalities.
If these three conditions were met, then the consumer surplus would be the highest
possible. The consumer surplus cannot be higher unless the waste of resources is at a
minimum. Indeed these necessary conditions would also be necessary and suf

ciency advantage: an enterprise would have absolute ef

cient
under conditions of perfect competition. (Of course at the social optimum, charac-
terized by competitive general equilibrium, waste would be zero, and all potential
gains exhausted, with all resources allocated to their highest marginal values.)
However, in a second-best (Ramsey) world, it would be safer to state the same
three conditions as necessary conditions, not suf cient conditions. In a second-best

world, there are distortionary taxes paid by the private sector, monopolistic com-
petition and market power, unionized labor, etc. Both product quality and unit cost
would also depend on the technology used, and the quality of management may
vary. To repeat, economic theory recognizes that taxation has distorting effects, and
of course private enterprise would be subject to taxation. Thus when a product is