A Normative Analysis of Local Public Utilities: Investments in Water Networks
39 Pages Posted: 20 May 2015
Date Written: April 30, 2015
We analyze rehabilitation investments in a regulated water industry with perfectly inelastic demand. We compare alternative organizational solutions for local provision (municipalization, corporatization and privatization), though subject to a common regulatory mechanism. We can then assess the effects of incentive regulation in public firms and find that even benevolent politicians always stick to the price-cap, in order to save on distortionary taxation. However, incentives to invest result to be excessive only in private firms, as the cost of capital is accounted differently by public and private undertakings.
We also provide a theory of mixed firms, based on strategic interaction between politicians and managers, which contributes to endogenously explain partial privatization and minority participation by private stockholders. In this last case incentives to invest appear to be driven just by governance and ownership reasons.
Keywords: Price-cap regulation, mixed firms, partial privatization, water networks, inelastic demand, natural monopoly
JEL Classification: H42, L32, Q95
Suggested Citation: Suggested Citation