Should Water Be Privatized?

There's an investment gap in the public water sector. A study by the American Water Works Association determined that more than $1 trillion in forecasted investment will be needed until 2035 to maintain, replace, and improve the United States's aging water infrastructure. The study also expects water bills will go up, in some cases tripling from their current prices, while national-level water infrastructure replacement costs will rise to $30 billion annually by 2040, up from $13 billion per year in 2010.

The AWA's figures are a startling contrast to the amount that municipalities currently invest in water projects, which rose to $19 billion between 2000 and 2012. Further, in 2014, the Government Accountability Office reports that 40 out of 50 state managers expect to see water shortages over the next 10 years, while a decade-long U.S. Geological Survey study concluded that one-fifth of California's ground water contained such natural contaminants as uranium and arsenic.

Given the water crisis in Flint, Michigan, and California's drought, analysts wonder whether following in England's footsteps and privatizing water providers is one way to address America's water problems. In England, investment spending increased dramatically from £9.3 billion to £17 billion in the first six years after privatization (the World Bank Group). However, this rise in investments also led to 28% increases in utility prices, soaring profits for private providers and growing public mistrust. To help determine whether going private is a viable solution for the U.S., we will examine some empirical studies on the private vs. public debate, focusing on cost savings, efficiency and access/quality from findings around the world.

(See also: Economics Basics: Monopolies, Oligopolies and Perfect Competition and Water: The Ultimate Commodity.)

A meta-study (a study of existing studies from 1965 to 2008) by the University of Barcelona found no empirical evidence of cost savings from privatization over time. The study found that barriers to entry within the private water sector led to lower competitive pressures and higher customer prices, that incentives to reduce costs may come with the risk of lowered service quality, and that high sunk costs might prevent competitive discipline amongst providers.

Bear in mind that due to the wide variety of studies conducted across different time periods, each having different variables and sample sizes, the meta-study can't be used to conclusively determine whether or not cost savings can be attained through privatization. For example, referring to a different study, the authors reported that "given the different results obtained in the U.S. empirical works already reviewed, [the study] analyzed reasons that could explain these differences. They found models with more restrictions and more omitted variables were more prone to find larger differences between private and public production."

That said, the authors concluded that incentives to cut costs or generate efficiency were nonexistent due to longer contract terms. Even when a contract was up for renewal, the incumbent is in an advantageous position, given the specificity of the assets. As the authors noted, using data from Public Works Financing, "of all privatization contract renewals of water/wastewater in the U.S. between 1998 and 2001, 75% were renewed by renegotiation (without competition), 16% were renewed by competition (10% retained by the incumbent and 6% won by another company) and 8% were deprivatized (returned to public production) (Moore, 2004). The popular literature typically confuses privatization and competition, but you can have privatization without competition and that is the case in water privatization."

Below is a table with the study's findings. Ex. 1: Characteristics of relevant works on privatization and costs in water distribution (Bel, Warner: Does privatization of solid waste and water services reduce costs? A review of empirical studies)

Also central to the public vs. private debate is the question of efficiency. Free market capitalists are quick to bring up Adam Smith’s concept of the “Invisible Hand”: the market’s inherent characteristic to discover an efficient price and quantity for trading between willing buyers and sellers. If the free marketers are correct, greater efficiency should be realized via privately-owned means of water provision. However, a study done by the World Bank found very little differentiation between the efficiency profiles of private and public water suppliers in Asia. Further studies on the subject in Malaysia and Brazil have provided noticeably similar results. Common in all of these studies is that the potential power of the "invisible hand" is stifled by the lack of competitive forces, stemming from the high costs of entry. 

Finally, there are the differences in the levels of quality and water access between public and private providers---especially in regards to lower-income members of society. Evidence from Puerto Rico has shown that water quality didn't improve after privatization, while Argentina’s massive privatization campaign resulted in an 8% decrease in child mortality rates, with the effect most pronounced in the country's poorest areas. Colombia also experienced benefits from privatization, posting improvements in water quality and access in urban municipalities, as well as positive effects on health in both rural and urban areas.

However, as predicted by privatization critics, many benefits to urban populations came with negative impacts on costs and access for the rural poor. As mentioned earlier, privatization in England is still a controversial topic after 27 years. Currently water quality is high and access to it plentiful, but critics contend that English water providers generate excessive profits through the manipulation of economic regulation, that they borrow too much and/or don't return enough money into regulated business, and that providers still experience little to no competition from new entrants.

Water privatization is a hot-button topic, with proponents arguing that privatization will result in lower prices and greater efficiencies. Opponents argue that privatization could mean higher costs (mostly borne by the poor) and rent seeking characteristic of a system that prioritizes profits over social utility. Evidence for and against privatization centers on costs, efficiency and quality/access, and continues to be mixed.

While there are a multitude of studies analyzing successes and failures of privatization programs around the world, even more studies are required to determine what variables impacted the results (i.e., the why behind the what) and to see if certain results can be replicated in the United States. One prominent obstacle to a free-market-based water provision system is the lack of competition arising among service providers due to the barriers to entry inherent within the public utility sector. Further research should be conducted, and each country studied on a case-by-case basis. Until then, sweeping arguments made on both sides, based on emotions and anecdotes, simply don't hold much water.