Structural and Political Determinants of Water Privatization

In the developed and developing world alike, seemingly small decisions over how to organize utilities can significantly impact the lives of average citizens. Whether a given utility is publicly or privately controlled may affect firm capabilities and objectives, which explains the not infrequent headlines and controversy surrounding decisions to privatize essential utilities. At the same time, privatization is often defended as a solution to public sector inefficiency or indebtedness. Nonetheless, little is known about what factors actually drive sector organization decisions. This paper develops a model of local government decisions over utilities ownership that depends on long-term regulatory and administrative costs, consumer sensitivity to product quality, and the political costs associated with acting contrary to the desires of interest groups and voters. In order to test the implications of the model in a way that controls for unobserved heterogeneity, this paper undertakes a firm-level analysis of one particular utility: water. Using a unique panel dataset covering all community water utilities in the United States over the period 1997-2003, we shed light on two questions: First, what factors account for the present-day distribution of ownership types in the U.S., where water utilities are almost evenly divided between public and private ownership? Second, what factors induce local authorities in control of publicly-owned systems to undertake privatization? As expected, local conditions that increase the costs of administrating and regulating private utilities make private ownership less likely. However, there is also strong evidence that utility ownership decisions are a function of the political interests of the median voter as well as organized labor, and that increased voter sensitivity to water service quality makes public ownership more likely.