The Theory of Water and Utility Pricing - Global Drinking Water Management and Conservation - page 77

produced in the private sector, the absolute ef ciency advantage should remain even

after taxation, since all agents are taxed. Hence, for goods with some characteristics
of a public good (such as drinking water), there may be a presumption that the
distortionary effects of taxation can be avoided if the good is produced in the public
sector, assuming of course that there is no public failure. On the other hand, if the
product is produced in the private sector, then the absolute ef ciency advantage

must be demonstrated.
The demonstration must focus on the necessary conditions. The third of the three
necessary conditions (no negative externalities) would in general be hard to dem-
onstrate conclusively, but some evidence may nevertheless be available. In the
privatization of drinking water production, two countries are often cited: the UK
and France. Dore et al. ( 2004 ) reexamined the evidence of the consequences of
privatization in terms of absolute ef

ciency advantage in both countries. They used
the necessary conditions for absolute ef ciency advantage stated above. They

showed that in water production, absolute ef ciency advantage requires that we

consider product quality, unit price, and whether there is evidence of negative
externalities. The theory indicates that each of the three necessary conditions must
be met in order to demonstrate absolute ef

ciency advantage. Dore et al. ( 2004 )
next investigated the impacts of privatization.
In the UK, privatization resulted in signi cant environmental improvements. The

massive investments by the 10 regional water firms improved the quality of drinking
water and the country

s waterways and increased the number of beaches at which it
was safe to swim. Compliance with European standards also improved from
76 percent in 1989 to almost 92 percent in 2000. These improvements, however,
were not without cost as water bills also increased substantially. The question arises
as to what increases would have happened if the utilities had not been privatized. A
de

'

nitive answer is virtually impossible. We do know that the price increases
exceeded the rate of in ation, but once again, we do not know what the increase

would have been under a publicly owned system. We can, however, compare the
privatized utilities in the UK with publicly owned utilities elsewhere. For example,
the average rate of return for the English companies was approximately 3 times that
of publicly owned Swedish companies. Over the period, the total pre-tax pro

ts for
the 10 UK water companies increased on average by 142 percent (Dore et al. 2004 ).
Comparing these pro t margins with those in Sweden, Spain, Hungary, and France

indicates much higher pro t rates in

the UK were extremely high by international standards. It is therefore not surprising
that the regulatory bodies eventually found the increases to be unwarranted and
ordered rebates, and the abnormal pro

ts for the English firms. Suf ce to say, the pro

ts were taxed away. We may conclude that
although the environment improved, in the case of the UK the record does not show
that the private sector had any decisive absolute ef ciency advantage.

Unlike the UK privatization, the water and sewage systems in France are pub-
licly owned but in large part privately operated by a variety of contracts. As in the
UK, the main policy objective was compliance with the new European Union
standards. To achieve this objective, a polluter-pay strategy was adopted, albeit
with inherent problems. The tax was not related to the amount of ef

uent