Why did water utilities in the U.S. become mostly publicly owned?

Michael Giberson

Among U.S. water utilities, some are publicly owned and some are privately owned. Same thing for gas utilities and electric utilities. But unlike in the gas and electric power industries, the water business has become predominantly organized by publicly-owned utilities. Scott Masten explores why it was that public utility ownership became dominant among water utilities in an article, “Public Utility Ownership in 19th-Century America: The ‘Aberrant’ Case of Water,”  appearing in the October 2011 issue of the Journal of Law, Economics, and Organization.

I would have guessed that the large up-front costs with low salvage value (termed “relationship-specific assets”) created a large potential for post-investment opportunism (i.e., like the “competition over infra-marginal rents” story that John Neufeld says help explain the rise of state electric power regulation). After all, seems like there are few better examples of sunk costs than the networks of underground pipes that make up a municipal water supply system.

Masten discusses the idea that relationship-specific asset related problems favored municipalization, but finds no evidence in his data to suggest that water utilities will larger investments were more likely to be publicly owned. And yet his favored explanation is related: he finds strong support for the idea that frictions between city governments and private water utilities was a key contributor to municipalization. Friction was often over city-demanded expansions that were resisted by private water utilities, mostly because contracts negotiated between cities and private utilities didn’t provide efficient incentives for expansions and occasionally cities reneged on promised subsidy arrangements to induce expansion. This is, as Masten explains at pp. 621-625, is a fight over infra-marginal rents, so I’m not sure why Masten favors a “relational friction” story over a “relationship-specific assets” story. In any case public ownership, by integrating city and water utility, eliminates the costly conflict that would otherwise undermine the efficiency of private operations.

While his data and analysis mostly revolve around the late 19th century, he notes the issue is of more than historical interest. From the conclusion (notes omitted):

The World Bank has recently been actively studying privatization of waterworks as a way of addressing severe water problems in developing countries.The dominance of public ownership of water and sanitation services in the United States should, at a minimum, give policymakers pause: If, despite an institutional environment conducive to private ownership, American water and sanitation systems are overwhelmingly publicly owned and operated, is it reasonable to expect privatization to yield long-term gains in developing countries where the environment for private enterprise may be much less hospitable? Understanding the determinants of variations in waterworks ownership both over time and between communities may help inform whether privatization of water systems in developing countries makes sense .

Public ownership does eliminate costly fighting between city and private utility over infra-marginal rents, but it doesn’t eliminate the rents and so likely won’t eliminate the competition to capture them. Masten’s suggestion for further research are useful, but also needed are complementary studies of the efficiency of publicly owned water utilities in countries “where the environment for private enterprise may be much less hospitable.” The question in terms of generalized economic growth seems to be under which system are more of the rents yielded to consumers.

Masten’s abstract:

Unlike other public utilities, most water in the United States is supplied by publicly owned and operated waterworks. The predominance of the public sector in the supply of water was not always the case, however; private firms dominated US water supply throughout most of the 19th century. This article analyzes the puzzle of why water and sanitation systems were the only major utilities to become predominantly public by, first, reexamining historical accounts of the problems of contracting for water services in light of modern theories of economic organization and, then, evaluating hypotheses derived from those accounts using data on 373 waterworks serving US municipalities with populations over 10,000 in 1890. Among other results, municipal ownership is found to be related to the distribution of population and commerce within a city in ways that suggest that frictions between cities and private companies over system extensions and improvements played a significant role in the shift to municipal ownership.

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