6
Broader Implications of Water Services Privatization

Changes initiated by water services privatization may have wideranging effects, as the process of providing water supply and wastewater treatment services affects parties beyond the supplier and the consumer. Water’s fluid nature may lead to significant indirect, beneficial (and at times detrimental) impacts on the local economy, the environment, and other “third parties.” Customers and voters in water districts often view these indirect impacts as part of the set of services provided by the utility, and there may be apprehension regarding the protection of these indirect benefits under privatization arrangements. This apprehension may be a significant cause of the cautious approach to water privatization observed in the statistics listed in Chapter 1.

Because there are few economies of scale to be gained from the water delivery infrastructure, privatized systems can only offer advantages by generating cost savings in three components of water supply: labor efficiency, centralization of financial and operating services, and improvements in the management and yield of the basic water supply and nondistribution system assets. Water services privatization may thus effect changes in local employment and supply acquisition, as well as changes in the land and recreational assets related to the basic water supply. This chapter examines some broader and longer-term implications of water services privatization: community values, environmental protection and long-term water supply, and regional economic development.



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Privatization of Water Services in the United States: An Assessment of Issues and Experience 6 Broader Implications of Water Services Privatization Changes initiated by water services privatization may have wideranging effects, as the process of providing water supply and wastewater treatment services affects parties beyond the supplier and the consumer. Water’s fluid nature may lead to significant indirect, beneficial (and at times detrimental) impacts on the local economy, the environment, and other “third parties.” Customers and voters in water districts often view these indirect impacts as part of the set of services provided by the utility, and there may be apprehension regarding the protection of these indirect benefits under privatization arrangements. This apprehension may be a significant cause of the cautious approach to water privatization observed in the statistics listed in Chapter 1. Because there are few economies of scale to be gained from the water delivery infrastructure, privatized systems can only offer advantages by generating cost savings in three components of water supply: labor efficiency, centralization of financial and operating services, and improvements in the management and yield of the basic water supply and nondistribution system assets. Water services privatization may thus effect changes in local employment and supply acquisition, as well as changes in the land and recreational assets related to the basic water supply. This chapter examines some broader and longer-term implications of water services privatization: community values, environmental protection and long-term water supply, and regional economic development.

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Privatization of Water Services in the United States: An Assessment of Issues and Experience PRIVATIZATION AND COMMUNITY VALUES Concerns that communities typically cite with regard to privatization include the following (Limbach, 1993): fear over the loss of employment and pensions for the municipal utility work force; possible loss of grant money or tax-exempt financing for capital improvements; higher water rates because private firms charge full costs and must pay taxes and earn a profit; surrender of control over ratemaking and other financial issues to state public utility commissions; loss of control of daily operations and of service standards, as well as planning for long-term growth and economic development. These points are often regarded as deterrents to privatization, although they may be better characterized as issues of interest to affected stakeholders, which include governments, employees and labor unions, citizen-taxpayers, customer-ratepayers, and local groups representing business, consumer, and environmental interests. Privatization is often advocated in terms of lowering costs and promoting cost efficiency. Albeit important, cost efficiency, defined here as a minimized cost for a given level of service, is but one of several criteria for evaluating the provision of public services. In many public water agencies, some degree of cost efficiency in water service delivery is sacrificed in the interest of achieving other community goals such as equity, provision of recreational opportunities, and provision of water that exceeds quality standards. Maintaining the local public works department may provide a mechanism to preserve local jobs and, in some jurisdictions, serve as a means of preserving opportunities for political patronage. A related economic issue is whether equipment and supplies are purchased locally. Large utility companies often use out-of-town or out-of-state call centers and procurement to reduce costs. To counter these concerns, water services privatization agreements are often structured to preserve jobs and benefits by streamlining the labor force only through attrition and retirement. Improvements in working conditions, safety, and upward mobility have been cited in Indianapolis and elsewhere. The prospect of water services privatization raises a number of issues related to service quality. As described in Chapter 3, surveys have indicated that consumers have a substantial willingness to pay for safe and reliable water. Customers expect their water provider to meet (or exceed)

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Privatization of Water Services in the United States: An Assessment of Issues and Experience standards for public health and environmental stewardship. Both publicly and privately owned water utilities (or utility operators) must comply with applicable standards. Most communities want to ensure that safety and reliability are not compromised by water services privatization. Even with privatization, customers will hold public officials accountable for the safety and reliability of water services delivery. Privatization may raise concerns about the terms of service and the need for consumer protections, particularly for residential customers. As rates rise, provision of lifeline rates and provision of other mechanisms to ensure basic affordable water service are likely to emerge as important regulatory issues. Some communities offer bill-payment assistance and protection against disconnection. Extending water service to unserved areas or areas where the quality of service is currently unacceptable may be a community goal. However, the method by which the additional costs of such extensions are spread among the existing customers may be politically contentious. Providing a forum for consumers to resolve complaints is important for all utility operations, whether private or public. State public utility commissions provide this function for regulated investor-owned utilities. Privatization arrangements may or may not provide this function at a local or regional level. Maintaining Local Capabilities Privatization of governmental functions creates the need for expanded capability in contract oversight, monitoring, and enforcement. As water delivery functions are shifted to the private sector, the contracting government needs to assure that its internal administrative capacity can engage in and support the privatization process, monitor performance, and enforce provisions of the contract. Communities often lack the necessary expertise and financial resources to conduct sound evaluations of public-private financing options (Compton, 1992). The process of preparing and overseeing an initial bid can be daunting. Local governments should recognize the inherent tensions in the “principal-agent” relationship between city and private contractor (see Kettl, 1993). No matter how well a privatization arrangement is crafted, the interests of the principal (the city) seldom match those of the agent (the private contractor). Ensuring sustainable performance requires a long-term commitment to the oversight process. Information on enforcement and dispute resolution methods can be obtained from larger agencies or public sources such as the Environmental Protection Agency (EPA, 1997). Water services privatization raises issues of lost capability and expertise. If a municipality chooses to terminate a contract and reinitiate service, it may have to rebuild in-house capability in terms of personnel,

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Privatization of Water Services in the United States: An Assessment of Issues and Experience equipment, and expertise. Furthermore, a city that privatizes its water services may lose ancillary services, such as snow removal or emergency management. The loss of capacity may increase costs in other service areas. Fortunately, there are numerous sources of information that provide advice on contracting for municipal services. In some areas of the United States, there are other private water service providers that a municipality could contract to take over a terminated service contract. When the roles of the private sector in water utility operations are expanded, local government must understand that its role in the utility’s operations changes dramatically. A key change is shifting from personnel management to contract management. When operations are directly managed by a public utility, the utility’s emphases are on personnel management and longer-term planning. When a contractor provides the operations, however, local government’s major focus becomes contract management. The talents and skills needed for these roles are significantly different than those in traditional water utility operations. Water services privatization can blur responsibilities and obscure ultimate accountability in such areas as environmental compliance and permitting. Another example of privatization’s implications for public goods is found in water delivery capacity for fire-fighting demands. The water main and local storage capacities needed for this purpose frequently determine the level of infrastructure investment. Fire-fighting services represent a public good that benefits all structures in the area. As a result, water for fire fighting is specified in the contract with the private operator. Political Considerations Strategies for improving water utility performance must be implemented within a local political environment shaped by the values and interests of the community and elected officials. In some localities, decisions about water utility ownership have been brought before voters in the form of nonbinding referendums. More often, political leadership plays a significant role in supporting privatization, as in the case of former Indianapolis Mayor Stephen Goldsmith. Goldsmith built a national reputation for promoting privatization of city services, and stated he could “run the city with four contract managers” (Fantauzzo, as cited in Scalar, 2000). The chief lesson, however, is that privatization usually needs a local champion in order to find a place on the political agenda. Political conflict can be a deterrent to privatization. Local politicians may fear losing control of the agency and the loss of jobs. Long-standing relationships between local officials and suppliers are also a factor, as is the strength of labor unions. In some instances where companies have

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Privatization of Water Services in the United States: An Assessment of Issues and Experience succeeded in persuading municipalities to privatize operations or assets, companies have been required to avoid layoffs and reduce jobs only through attrition (Byrne, 1996). And, as noted in earlier chapters, responsibility for the provision of water will always rest with the public agency. Whether a public or private operation provides water services, failure to fulfill the expectations of the community is likely to result in a public outcry. IMPLICATIONS FOR ENVIRONMENTAL AND WATER SUPPLY PROTECTION Concerns about control over public land and watershed issues are frequently debated in discussions regarding water services privatization. Opponents of privatization believe that basic water supplies and related land resources are most properly owned and managed by the public sector and usually fear that resources will be improperly managed or squandered under private ownership. Others contend that responsible resource management is irreconcilable with profit seeking. It should be noted that the privatization of water services is not necessarily linked with ownership of watershed areas and raw water resources. That is, water services may be privatized in a watershed in which lands and raw water supplies are still publicly owned. Watershed management typically provides public benefits such as recreational access, aesthetic aspects, ecosystem preservation, and downstream water quality. Water quality and quantity can be degraded if watershed managers, public or private, are provided with improper incentives. Because providing these watershed-related benefits does not add to a water utility’s profits, long-term watershed conservation may be deemphasized or neglected. In addition, the length of most management contracts is generally less than the time in which ecosystem impacts can be distinguished from natural fluctuations of the system. Private acquisition of watersheds is sometimes motivated by the development potential of those lands, which often have become desirable for residential use. A prominent example of land-use conflicts between private water companies and local residents was in Old Tappan, New Jersey (Hanley, 1999). The dispute, which came to a head in 1999, centered on wooded land adjoining the Lake Tappan reservoir that the private owner, United Water, wanted to sell for high-value residential use. Local townspeople wanted the wooded area preserved and used as a regional park. The case is complex, but it illustrates the potential conflicts facing private resource ownership in situations where the value of the resource is changing (see Box 6-1).

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Privatization of Water Services in the United States: An Assessment of Issues and Experience BOX 6-1 The Connecticut Water Companies Case In 1975, the U.S. Environmental Protection Agency was about to publish its drinking water regulations under the 1974 Safe Drinking Water Act; the earlier 1962 standards, issued by the U.S. Public Health Service, applied only to communities providing water for interstate carriers, which did cover most large cities. The projected turbidity maximum contaminant level was to be reduced from 5 turbidity units to 1 turbidity unit. Many long-standing private water companies in Connecticut that were within commuting distance of New York City owned reservoirs and watershed lands that served their service areas. These watersheds were well protected and there was little development. Before new regulations required filtration, water from these reservoirs was treated only by chlorination. With these new regulations, the companies decided to sell their watershed lands, citing two justifications: the funds would help pay for the filtration, and the filtration would mitigate the damage done to the water quality by the developments. The watershed lands over the years had grown greatly in financial value, with increasing number of people employed in New York City seeking housing in western Connecticut. The land sales would redound to the financial advantage of the companies’ shareholders. However, there were rising concerns over the proliferation of trace synthetic organic chemicals and over whether the introduction of conventional filtration would assure mitigation. An engineer of the Connecticut State Department of Health succeeded in getting the state legislature to declare a two-year moratorium on sales of watershed lands while a Council on Water Company Lands was created to evaluate the issue. The council, after a period of study and public hearings, recommended that sales of the land to private parties for development should not be permitted, and legislation to that effect was adopted. Sales of land to the state for parks were not precluded. The water companies sued the state (Bridgeport Hydraulic Company et al., appellants, v. Council on Water Company Lands of Connecticut et al. Defendants), alleging that the law was unconstitutional. The Federal District Court for Connecticut in 1977 upheld the state, primarily based on its right to exercise police powers, which include the protection of the public health (Citation: 453 F. Supp. 942, D. Ct.1978). The U.S. Supreme Court affirmed the District Court (Citation: 439 U.S. 999, 99 S.Ct. 606, 58L. Ed 2d 674, 1978). Few, if any, states have followed suit. Public resource managers, however, are not inherently more sensitive to environmental values than are private water system operators. For example, in 1998 a group of 16 national and California environmental organizations wrote to the California Department of Water Resources (DWR), arguing that that agency should use economic criteria and more cost-effective methods in planning water supplies and wastewater treat-

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Privatization of Water Services in the United States: An Assessment of Issues and Experience ment for California. Among the points made was the DWR’s failure to incorporate economic criteria in the long-term Water Plan (Bulletin 160), which led to incorrect estimates of future demands and incorrect estimates of water available for environmental purposes. The use of lands and streams for water services may involve trade-offs against ecosystem quality and recreation. For example, a city’s main drinking water supply may consist of a reservoir surrounded by a wooded alpine area. Maintaining high-quality water in that reservoir may require the city to limit or ban recreational activities (e.g., hiking, biking, off-road vehicles) from that watershed. Conversely, a city seeking to expand its water supply may be unable to impinge upon valuable riparian and recreational resources. An example occurred in Colorado in the late 1980s, when the city of Denver planned to build the Two Forks Dam on the South Platte River southwest of Denver. The city was ultimately denied a permit by the U.S. Environmental Protection Agency to construct the reservoir because of the uniqueness of the South Platte Valley’s ecosystems and the excellent trout fishing on that section of the South Platte. Another public good issue is the protection of cultural values. Access to water supplies is often an important dimension of local values in both large and small communities. The concept that the community’s natural resource base is a shared asset often imparts commonality and cohesiveness. Access to hunting on watershed lands or fishing on reservoirs may be important to local residents. The sale of these assets to outside interests may deny access and cultural linkage to the natural resource. As an example of community coherence, California farmers stated in response to a survey that they would consider transferring water to other users within the same sector and watershed, but that they would regard transfers to other sectors and watersheds with suspicion (Berk and Whelan, 1994). Out-of-basin transfers of water rights may adversely affect regional water supplies and water quality of the exporting region (Howe et al., 1990). PRIVATIZATION AND REGIONAL ECONOMIC GROWTH The reliability of a region’s water supply is widely perceived to have significant impacts on regional economic development. The city of San Diego, for example, spent large amounts of money and political effort during the late 1990s trying to develop an independent source of water supply. San Diego currently relies on the Metropolitan Water District (MWD) for a majority of its supplies, and MWD provides the sole source of imported water. Because the system of water priority allocation is based on when a city joined the MWD, among the cities in the district, San Diego has the lowest priority for water in times of shortage. In 1991, when San Diego was suffering from a drought and was threatened with severe wa-

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Privatization of Water Services in the United States: An Assessment of Issues and Experience ter supply reductions, the city attempted to purchase additional water supplies from entities outside the region. Those supplies, however, had to be transported through MWD’s distribution system—for which they would be charged high “wheeling” charges by MWD. This dependence on another water agency and the resultant uncertainty of supplies are seen as disincentives to new economic activity. In the arid U.S. West and Southwest, constraints on water supplies and wastewater treatment services have sometimes been used to restrict urban and suburban development. Concern has been expressed that privatization of water development and delivery may then open the door to unfettered development. However, municipal utilities sometimes have a legal obligation to serve areas outside municipal boundaries. Regulations that require demonstration of the existence of a long-term water supply are usually permissible under local government police powers. Regardless, even with high connection fees, water costs constitute only a small percentage of residential or commercial development costs and are thus unlikely to change many development decisions. The limited ability to use water supplies as a growth control measure is reflected in efforts by the city of Santa Barbara, California. In the 1960s, in an effort to explicitly restrict urban growth, the city declined the offer to connect to the California State Water Project. However, despite the absence of new water supplies in Santa Barbara County, residential development continued rapidly. The tightening of the water supplies in Santa Barbara County came at the expense of their drought contingency supply margin. In California’s most recent major drought, Santa Barbara resorted to water rationing, experienced severe fires, and even purchased an expensive desalination plant to augment supplies. The desalination plant has subsequently been dismantled and sold, partly because the high cost of water from the plant led to extensive and effective water use efficiency and conservation programs. Economics of Water Marketing in the Western United States In the arid parts of the western United States, urban areas are continually faced with acquiring reliable additions to water supply to accommodate expanding populations. Water marketing arrangements of various types have evolved to facilitate the transfer of water from older, less productive uses (usually agriculture) to urban use. For example, the “Cal-Fed” agreement in California between several state and federal agencies will use a market-based “environmental water account” (EWA) to supply water for environmental purposes. The EWA will enable urban regions to acquire water for environmental and recreational purposes from willing sellers. Most sales are likely to be from the agricultural sector to the urban

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Privatization of Water Services in the United States: An Assessment of Issues and Experience BOX 6-2 The Impact on Regional Employment of Trading Water Supplies A case study of the 1991 California Emergency Drought Water Bank showed that the sale of water between regions and users in California in 1991 had a positive net effect on employment. Jobs were lost in the water exporting regions, but the gain in jobs in the importing regions outweighed the losses. The table below shows the estimated impacts on employment by sector. The agricultural industry had a net reduction in jobs because of sales to the water bank. However, the state of California as a whole benefited from 3,741 additional jobs from the transfers. These broad measures show that, in terms of both income and jobs, the water bank generated substantial net gains to the state and most regions. Most transfers occurred without any independent environmental review. Subsequent studies of third-party economic and environmental effects found the costs to be relatively small compared to the water banks social benefits. In contrast to the temporary transfers under the California Water Bank, permanent transfer of water rights outside a region can lead to substantial negative impacts on the local economy. Howe et al. (1990) demonstrated significant regional losses of income and employment in farming and linked activities. Alternatives to permanent sales of agricultural water exist. “Drought lease-outs” or options can modulate the negative impacts. Under these arrangements, the water remains in farming in most years, thus maintaining agricultural operations and providing a source of secondary income for associated businesses. Since the farmer is still active and a resident in the region, the stream of option payments will add to regional income. Also, the negotiation of water sales options allows enough time to negotiate third party compensation where appropriate. Statewide Employment Impacts of the 1991 Water Bank Sector Jobs Lost Jobs Gained Net Change in Jobs Exporting Agricultural Regions 3,130 1,490 −1,640 Importing Agricultural Regions 0 1,150 1,150 Importing Urban Regions 0 4,240 4,240 Net Statewide Change 3,130 6,880 3,750 sector. Cal-Fed has the goal of reducing the transaction costs of water transfers by providing an internet-based information clearinghouse for water trades. Water markets have long been used in transferring water from agricultural uses to municipalities (see NRC, 1992). Water markets could be considered a form of privatization, but they have existed for 100 years, independent of urban water utilities. Naturally, urban utilities (public or private) avail themselves of the services of water markets in the acquisi-

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Privatization of Water Services in the United States: An Assessment of Issues and Experience tion of new supplies or drought-year lease-outs, but a full treatment of such markets is outside the purview of this report. Water markets raise several issues, including negative impacts on “third parties” and the environment. Water quality can be negatively affected in the exporting area if it is not protected by state laws governing transfers in the exporting area. “Secondary impacts” in the form of reduced tax bases and reduced employment can be serious for the exporting area (see Howe, 2000). On the other hand, the net employment effects of water transfers are often positive in the longer term, as higher-value uses of water replace lower-value uses. The experience with the California Water Bank of 1991 shows that even short-term, temporary transfers can result in an employment gain (see Box 6-2). Interregional transfers of water by private sales can impose costs on other local users, particularly if groundwater is involved. In a 1995 California case, small farmers who relied on groundwater in Butte County were severely impacted when nearby large farms sold their groundwater pumping rights to municipal areas. This case spawned a county-level water transfer code that restricts the ability of individual parties to transfer water in the county. SUMMARY Privatization of water services often results in a range of effects felt beyond the supplier and the consumer. These include employment, considerations of local control and oversight capabilities, and environmental and economic impacts. The appropriate balance of public and private ownership and operation for a municipality is a function of values that go beyond the cost, reliability, and quality of water. Communities must decide the degree to which private contractor objectives and likely performance are compatible with a range of community values such as environmental preservation, cultural impacts of water, recreational and aesthetic values, and preservation of local employment. The prospects of water services privatization tend to increase awareness of water’s importance to a community’s economy, culture, and environmental resources. It is not clear if either public or private utility operators will be more sensitive to the broad implications of privatization; there is anecdotal information that supports both views. The community and water service provider will be better served to the extent that these broader considerations of water management are made transparent and are publicly discussed.