Has Privatisation Failed?

Privatisation has failed. That is what current headlines are screaming following the news that Thames Water, a private utility company responsible for supplying and treating water in Greater London and the Thames Valley, is on the brink of collapse. Analysts have determined that Thames Water’s debts total 80% of the value of the company (£14 billion), despite the firm having been privatised without any debt. This is a stark example of the potential for private companies to be desperately mismanaged, yet it does not amount to a justification for re-nationalisation.

Thatcher’s privatisation of the UK’s water industry has been met with both support and criticism since the plan was announced in the 1980s. At that time, the water industry invested less than one-third of the amount it had invested in upgrading and maintaining systems 10 years prior. When new EU legislation increasing the rigour of water quality standards was introduced, the water sector could not afford to comply, and this led to the UK being prosecuted at the European Court of Justice. Privatisation was seen as the solution. While the benefits of competition and efficiency do come into play, the most potent reason to advocate for the privatisation of water companies is the competition for capital that a public industry faces.

The UK government announces its budget annually, setting out expenditures for the NHS, education, national defence, and other sectors. Funding the water industry would be included in this budget were it to be nationalised. However, to secure this funding, there is an opportunity cost: funding would be taken away from other areas of investment, decreasing overall consumer surplus. Despite its criticisms, the privatisation of water infrastructure has worked in cities in Spain, the Philippines, and Senegal, to name but a few. Notably, the UK’s water quality has drastically improved since before privatisation. The concentration of ammonia in UK freshwater sources has fallen 85% since 1990 alongside the increasing richness of invertebrate communities. These positive trends are overshadowed by recent declines in the rate and extent of improvements to UK water quality. What, then, is the cause of the UK water industries’ woes?

Each private water company holds a regional monopoly, meaning there is little competition despite privatisation. Consumers cannot switch providers and new firms are unable to enter the market, which reduces the incentive for water companies to invest. Public distrust is also hindering the ability of the industry to operate effectively: numerous scandals including sewage discharge and excessive manager bonuses taint the UK water industry. Another factor is the public perception of the UK being a “wet” country (wasn’t it raining just this morning?) preventing people from being willing to cut their water consumption levels. However, arguably, the biggest problem is regulatory capture. The water industry is small: a few companies and their regulators. A limited talent pool means workers move regularly between these groups meaning decisions are made in line with the interests of water companies, not in line with the interests of consumers.

These issues, while pertinent, pale in comparison to the extent of corporate mismanagement. Thames Water is in such a precarious position because its importance as a provider of a necessary good has been overlooked by its management. Interestingly, this highlights that it is not the failure of Thatcher’s privatisation as a concept, but the failure of it in practice. Luckily, there are solutions which do not require expensive re-nationalisation processes.

Integrating principles of Water Stewardship into market practices in the UK water industry can mitigate the environmental implications of poor investment in maintaining water infrastructure. Potentially, mandating Water Stewardship status for UK water firms could incentivise better preservation of water sources and would require investment to mitigate leakages. Furthermore, an initial increase in investment in repairing water pipes will lead to a positive multiplier effect as other firms are able to compete to innovate better solutions for the UK water industry.

While many proponents of privatisation are also advocates of deregulation, it is indisputable that high levels of regulatory capture have been detrimental to the development of efficient practices in the water industry. Bodies such as the Environment Agency and OFWAT must encourage communication between the state and private water firms to ensure that they are fulfilling the mandate of their role to the benefit of consumers. Dialogue with local communities can also work to repair trust and means firms can benefit from shared knowledge.

A fundamental, and perhaps justified, criticism of the state of the privatised UK water industry is the prevalence of international ownership. Thames Water, for example, is owned by Canadian Pension plans (22%), an Abu Dhabi-based Sovereign Wealth Fund (10%), China Investment Corporation (9%), and other foreign stakeholders. When companies supplying goods required by all UK consumers are not beneficiaries of the goods they are providing, the quality and efficiency are likely to fall. A water industry owned by British firms is argued to increase consumer welfare because of the increased desire on the part of the firm’s shareholders to deliver an effective service because the owners will be directly benefiting from the service they provide.

Some may still argue that nationalisation is the best course of action. In the current political and economic climate, this is unlikely to be a prudent decision. Instead of holding water companies to account, nationalisation promotes behaviour that worsens consumer welfare because it signals to other private companies that they can rack up billions in debt and then be bailed out by the government. To prevent other private firms from following the dangerous path that Thames Water is carving out, we must seek innovative ways to combine privatisation with the community in order to provide necessary services to UK consumers.

Erin McGurk is a guest author with Discover Economics. She is a Sixth Form student from Altrincham, studying economics.