An Examination of the Effect of Ownership on the Relative Efficiency of Public and

Private Water Utilities

Author(s): Arunava Bhattacharyya, Elliott Parker and Kambiz Raffiee
Source: Land Economics , May, 1994, Vol. 70, No. 2 (May, 1994), pp. 197-209
Published by: University of Wisconsin Press

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An Examination of the Effect of Ownership on the Relative
Efficiency of Public and Private Water Utilities

Arunava Bhattacharyya, Elliott Parker, and Kambiz Raff

ABSTRACT. The behavior of privately and pub- The existing studies in the literature o
licly owned water utilities is examined by the
esti- ownership/efficiency issue of privat
mating a generalized variable cost function and public water utilities do not suppo
containing the regular characteristics of thethetheoretical argument made by public
neoclassical cost function without requiring that
choice theorists that privately owned firm
cost minimization subject to market prices be
are more efficient than publicly owne
imposed as a maintained hypothesis. Assuming
firms.
that unobserved shadow prices reflect the regu- Feigenbaum and Teeples (1983) est
latory environment of the water industry, mate
tests a translog cost function which in
cludes three input prices (for labor, capita
for cost minimization are obtained by deriving
and energy) as well as a hedonic functi
shadow prices as functions of market prices.
The empirical results provide evidence thatto capture quality differences among wat
pub-
lic water utilities are more efficient than private
utilities. They find no statistical evidence
utilities on average, but are more widely dis-
reject the hypothesis that public and priva
persed between best and worst practice.water
(JEL utilities are equally efficient.
L33)
This lack of evidence for the hypothesi
that private water utilities are more efficien
than their public counterparts is consiste
I. INTRODUCTION with studies of electric utilities. Atkinson
and Halvorsen (1986) find no significant di
The debate over the relative efficiency of between publicly owned and regu
ference
public versus private enterprise has lated a longprivately owned electric utilitie
history in economic thought that goes back
Other empirical studies, in fact, support t
to the scholarly writings of John opposite
Stuart conclusion that publicly owne
Mill. The dominant positive model firms
of the
in this industry have lower costs than
effect of alternative ownership forms on that are privately owned.'
those
economic efficiency is the public choice,
Theorimportant contribution of the stud
property rights, model. Alchian (1965)
by and
Feigenbaum and Teeples (1983) is th
De Alessi (1974, 1980) emphasize the theim-
empirical analysis of the ownership/e
portance of nontransferability of ownership
ficiency is highly sensitive to specificatio
and attenuation of property rights inbias
public
resulting from: (a) misspecification
firms in support of efficiency differences
the functional form of the underlying co
between privately and publicly owned
structure, (b) exclusion of important inputs,
firms. The basic argument is that the non-
and (c) improper measurement of the var
transferability of property rights in public
enterprises eliminates the advantages from
ownership and inhibits the capitalization of
future market consequences into current
property rights of the firm. Since property
From the University of Nevada, Reno, the author
rights are transferable in the privately
are, respectively: assistant research professor, D
owned firm, capitalization of efficiency
partment of Agricultural Economics; assistant profe
sor,the
gains can be captured by the seller of Department of Economics; and associate profes
sor, Department of Economics.
rights. In other words, shareholders have
'These studies include Pescatrice and Trapan
the incentive to continuously seek improve-
(1980); Fire, Grosskopf, and Logan (1985); and Meye
ments in efficiency. (1975).

Land Economics * May 1994 * 70(2): 197-209

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 198 Land Economics May 1994

in the final
ables.2 Lambert, section. The data and variables
Dichev, and Ra
examine the efficiency/ownersh
construction are presented in the Appen-
dix. public water uti
for private and
linear programming to calculat
and technical efficiency,
II. A GENERALIZED RESTRICTED as m
production efficiency,COST FUNCTION MODEL
for each
utility in the sample of their s
Estimation
find no significant of a cost function implicit
differences in
ciency between the
requires two groups
the assumption that combinatio
prises. In addition, both
of input factors types
be at their o
cost-minimizi
are found to be values. This assumption
equally of static equili
efficient i
the least cost combinations of factors of rium may be violated, however, for tw
capital, energy, labor, and materials. reasons: (a) if some factors are fixed in t
Theoretical or empirical analysis of theshort run and cannot adjust instantaneous
impact of ownership on the cost structure to their optimal amounts, or (b) if costs a
of enterprises is an indirect test of the
minimized over shadow prices known
trade-off between two sources of ineffi- the manager but different from those ob
served by the economist. For our analys
ciency in private and public water utilities:
(a) inefficiency from regulation of privatewe use a generalized cost function in whi
utilities (Averch and Johnson 1962; Atkin- capital is restricted to a fixed quantity i
son and Halvorsen 1984; Raffiee and Wen- the short run (Samuelson 1953; Lau 1976
del 1988) and (b) inefficiency from attenua-
The cost-minimizing enterprise is unable
tion of property rights in public utilities. Inadjust fixed costs but minimizes variab
this paper, we present new empirical evi-costs. The optimization problem can b
dence on the efficiency/ownership hypoth- represented as:
esis by examining the cost behavior of 225
public and 32 private water utilities using Min VC = W'X subject to:
the data obtained from a 1992 survey of the 4(X, K, Z) = Q
water industry conducted by the American Rs(X, K, Z) = R, s = 1, 2,...,S, [1]
Water Works Association (AWWA). We
use a generalized variable cost function that where VC is observed variable cost; X E
exhibits the regular characteristics of the R+ , is a vector of variable inputs including
neoclassical cost function but does not re-
labor (L), energy (E), and materials (M); W
quire that cost minimization subject to mar-
ER + is a vector of observed input prices;
ket prices be imposed as a maintained hy-K is the amount of the fixed (capital) input;
pothesis.3 We assume that firms chooseQ is the level of output; and Z represents
variable factors of production subject to ownership characteristics. Output is deter-
output, a fixed capital stock, and unobserv-
able shadow prices that reflect the regula-
tory environment of the water industry.
2These methodological issues are applicable to a
Tests for cost minimization are obtained by number of studies in the literature. For example, the
deriving shadow prices as functions of mar- finding reported by Crain and Zardkoohi (1978) that
ket prices. The empirical results provide private water utilities have lower costs than publicly
evidence that the public water utilities are owned water utilities is inconclusive, since they are
using a log-linear cost function derived from a Cobb-
more efficient than private utilities on aver-
Douglas production function with only two inputs of
age, but are more widely dispersed between labor and capital. Also see Teeples, Feigenbaum, and
best and worst practice. Glyer (1986); Teeples and Glyer (1987); and McGuire
The outline of the paper is as follows.and Ohsfeldt (1986) for a review of the empirical and
methodological issues in testing the hypothesis of
In Section II a generalized restricted cost
efficiency/ownership in the water industry.
function for water utilities is presented. The 3This is also known as the nonminimum or shadow
estimation results are discussed in Section cost function approach (Atkinson and Halvorsen
III. Conclusion of the study is summarized
1984).

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 70(2) Bhattacharyya et al.: Water Utilities 199

shadow price func-

mined by a well-behaved production of the ith factor facing the
utility
tion (4), and there are S other deviates systematically from the fac-
unobserved
tor price observed
restrictions (R = Ro E Rs) which depend by the econometrician:
on input levels and ownership. The R = Ro
restrictions would include a rate-of-return Pi = kiW,. [5]
constraint in addition to other possible con-
straints such as market distortions, taxes, The shadow price ra
union bargaining power, etc. The first-order distortion of regul
conditions for this problem are: other restrictions. The minimum variable
cost function is therefore misspecified, both
on the left-hand and the right-hand sides, if
W + s aR S estimated directly. The observed (nonmini-
1 axi Pi mum) cost function, generalized to the case
W.. + [2] of ki $ 1, is derived following Atkinson and
s ORs Pj" Halvorsen (1986)4 from equations [3] and
[4] as:

The parameter k, is the Lagrange multiplier

for the sth constraint, and P E R + is a
vector of input shadow prices. The input
VC = X = VC
j=1 j=1 j J
levels which solve this optimization prob-
lem yield conditional input demands X*(P,
Q, K, Z). The minimum variable shadow
= VC*(I Sk- [6]
j=1
cost of producing an output Q of water in
our study is VC* = P'X*. Shadow variable The observed shares are similarly derived
cost is an unobserved function of the in terms of shadow shares:
shadow factor prices for variable inputs of
labor, energy, and materials (PL, PE, and WXc PXV k -1
Si = = -
PM), output, and capital. Let us define this
as:

j=1
I WX,
j=1
I PX*
n

S k7-I
VC* = >PiX*
i=l 1 n [7]
= Aof(PL, PE, PM, K, Q), [3]
j=1

where AO is a multiplicative shift factor, X*

Both equations [6] and [7] can actually be
= [L*, E*, M*], and n = 3. We can re-
cover the variable-cost shares which mini- estimated, once specified. We approximate
the shadow variable cost function by a
mize variable costs by an application of
translog form, which is a second-order Tay-
Shephard's Lemma in logarithmic form:
lor-series approximation to an arbitrary
functional form (Christensen, Jorgenson,
S* SPiX- O In VC* Vi = 1, 2, 3.
VC* a In Pi
[4] and Lau 1973).5 This function is:

The conditional factor demands (X*) are 4For the development of the Generalized Cost/
assumed to equal observed input levels Profit Function approach, see Lau and Yotopoulos
even though the shadow prices are unob-(1971); Yotopoulos and Lau (1973); Toda (1976, 1977);
servable. and Atkinson and Halvorsen (1980, 1984).
SThe translog and the Cobb-Douglas forms are the
In addition to assuming that capital in- two most common forms in this area of research.
puts deviate from their optimal amounts, The translog is a flexible functional form for which
we suppose, as per equation [2], that the the Cobb-Douglas is a testable hypothesis. In a Monte

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 200 Land Economics May 1994

In VC* = InA0 +prices in relative terms. The shadow price

Inf(Y)
N ratio for materials is set to unity:

lnf(Y) = a cIn Yj kL = eQ(L+?tLzZ+kLQIneQ)

kE = e(+E +EZZ +EQlnQ)

+ j- Z i3ln Yiln Yj kM = 1. [12]

i
The firm is "relati
terms of observed
Q'
ki = 1 V i; otherwis
S = [PL, PE , P, , Q], N = 5. [8] ficient. The firm is
shadow price effici
Symmetry (Oij = 3ji) is required by is important to not
Young's Theorem. Capital stock is ex- price inefficiency
pressed per unit of output in order to sim- since any scalar m
plify testing of returns to scale. Linear ho- price ratios is inc
mogeneity in factor prices requires 1 + N function's intercep
additional restrictions: Estimation of the observed variable cost
and share system of equations, as defined
aM = 1 - OL - OE above, is discussed further in the next sec-
Mj = - PLj - Ej Vj. [9] tion, along with the results of estimation.
The estimates are examined for the condi-
The constant term AO is assumed tions toof cost
de- minimization, the degree of
inefficiency,
pend on B, the number of distribution sys- the underlying parameters of
the production
tem breakdowns for the water utility per technology, and the signifi-
cance
unit of annual output, as well as Z, anof the effect of ownership on effi-
own-
ership dummy variable:6 ciency.
The marginal value of capital may be de-
fined as the marginal reduction in variable
InAo = YT + yB + ?TZ. costs [10]
resulting from additional investment,
so a positive marginal product of capital re-
The dummy variable Z = 1 if the utility is
quires that:
publicly owned, and Z = 0 if the utility is
privately owned. The coefficient estimate
Tz is an approximation of the percentage
aK
aC < 0. [13]
of average variable cost by which public
enterprises differ from private ones. The
shadow shares derived from the shadow Carlo analysis, Parker (1993a) fou
generalized cost function perfor
variable cost function (see equation [4])
other flexible functional forms.
are:
6Other variables that might aff
able cost of water are found to b
N include the source of water, wh

S* = a + 0,InY.+ [11]n
ground water, or other sources,
per unit of output, and average r
incorporation of Z into the tran
stead of A0 was tested, and no
Let us define the shadow price ratios (ki) as provement at any reasonable lev
positive exponential functions of ownership 7A specification which inclu
shadow price ratios, as suggest
and the log of output.7 Since the cost func- referee, was found to be statistic
tion is linearly homogeneous in factor 8See, for example, the discussi
prices, one of the k, variables cannot be son and Halvorsen (1992) and Eakin and Kniesner
identified, and we may only define shadow (1992).

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70(2) Bhattacharyya et al.: Water Utilities 201

Assuming that total shadow cost

costform (see next
equals section), this elasticity
the
is calculated
sum of capital expenditures and as: shadow
variable cost, we get:
N

C* = PKK + VC*. [14] S= 1 + Q + Z eiIn Y. [17]

Minimization of C* with respect to K im-

This statistic may be interpreted as the r
plies that:
of marginal shadow cost to average sha
a VC* VC*EK
variable cost; if it is less than unity
PK = kK WK = -K [15] utility is experiencing increasing retur
scale in the short run. In order to determ
whether the utility is producing at the
where ,K = (8 In VC*I/ In of K). From
output equa-
which minimizes average
tion [15] we derive the following formula
the first derivative of average variable
for calculating the shadow price ratio of
with respect to output is set to zero,
capital:
the level of Q which solves this equatio
N

&-K + 1 Ijn Yj
kK = _ - -1 [16]
Q* = e - . [18]
(WKK) WKK(nj)
j--1 1
The generalized r
The hypothesis that kK = 1 implies that cost function
able
must
capital is a variable cost, which can be satisfy mono
factor prices and
tested directly with a Hausman specifica-
factor
tion test (Schankerman and Nadiri 1986). prices. It is d
ditions
The hypothesis that the return to capital is for significa
less than unity, or even less than zero,but can- they can be
not be tested directly in this framework, buteach observatio
on
mates. This requir
the distribution of the calculated statistic kK
should give some indication. of variable cost w
To assess the underlying production nonnegative, (b) th
negative,
technology and the appropriateness of our and (c) th
specification, we perform a number ondof rou- derivatives w
price
tine tests on the estimated generalized cost be negative
function. Using joint restrictions on the pa-
rameters, we first test the underlying pro-
duction technology for homotheticity, ho-
E Q 0, -0'O Vi
mogeneity, and constant returns to scale.
The conventional wisdom is that water util-
( V2P*})is NSD. [19]
ities are natural monopolies which operate
under decreasing average costs (and in- The conditions for negative semidefinite-
creasing returns to scale), since the mini- ness are checked for each of the naturally
mum average cost for the technology sig- ordered principal minors. The formulae
nificantly exceeds a competitive share of for the necessary partial derivatives are
demand. An indicator of estimated returns straightforward, and are not shown here.
to scale is the elasticity of shadow variable Technological information regarding the
cost with respect to output. Since the vari- possibilities for factor substitutions may be
able cost function is estimated in average derived from the shadow cost function by

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 202 Land Economics
calculating the
as X2 Allen-Uzawa
with a degree of freedom equal to the
substitution (AUES):
number of explanatory variables other than
A(vc
)il = ) Vi = L,+E, -
M, l)
"U= 1 + VSji j. [20]
Perhaps a more useful statistic than the
VC VC
AUES is the short-run Allen partial elastic-
ity (APE) of factor demand, which can be
calculated as: where V^C
a In X
S a InP= *Si a. [21]
a olnPj
Parameter restrictions may be used to
test a number of hypotheses (shown in Ta-
ble 2). These include the hypotheses that:
(1) there is no difference in price efficiency
between public and private utilities, (2) util-
ities are relatively price efficient in variable
inputs, (3) variable cost shares are unaf-
fected by other factor levels or prices, and
(4) the underlying technology exhibits con-
stant returns to scale. The price efficiency
hypothesis (2) can be broken into: (a) pri-
vate utilities exhibit relative price effi-
ciency, (b) public utilities exhibit relative
price efficiency, and (c) scale has no effect
on price efficiency. The constant returns to
scale hypothesis (4) is also subdivided into
hypotheses for (a) homogeneity and (b) ho-
motheticity in the underlying technology.
A final test (hypothesis (5)) of the differ-
ences between private and public enter-
prises is a test for heteroscedasticity in
ownership, which should reflect the disper-
sion of inefficiency (Parker 1993b). In the
absence of information regarding the ex-
pected functional form of heteroscedastic-
ity, the Breusch-Pagan (1979) test is ap-
plied. The squared residual from the cost
function estimate, normalized by its own
mean, is regressed on a constant and one
of two additional explanatory variables, the
ownership dummy (Z) and output (Q). The
explained sum of squares from this regres-
sion, divided by two, is, under the null hy-
pothesis of homoscedasticity, distributed
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May 1994
elas
the constant.
A Farrell (1957) index of technical effi-
+ " )
ciency, normalized such that the maximum
observed efficiency is unity, is also calcu-
lated to measure the extent of technical in-
efficiency. The index used is:
is the fit
variable cost. The existence of distortions
from equation [2] prevents the utilities from
achieving the optimal neoclassical mini-
mum variable cost. The extent of short-run
price efficiency can be determined by an
index of the ratio of fitted shadow to fitted
observed variable costs:
VC*
r C- v [23]
V^C
This index is unity if kL = kE = 1, and
firms are relatively price efficient. Besides
technical and price efficiency, firms may
also exhibit inefficiencies in scale. A firm
without technical or price inefficiency
which produces a level of output that re-
sults in an average variable cost above the
minimum may be considered socially inef-
ficient even if the size of the market is the
only constraint on expansion. A third index
which captures the amount of scale effi-
ciency is calculated as the ratio of average
shadow variable cost at optimal output (Q*)
to that at actual output (Q):
s C*(Q*)Q*
SVC*(Q)/Q [24]
The aggregate efficiency index, -l, is equal
to the product of all three efficiency indi-
ces.
III. ESTIMATION AND RESULTS
The econometric model consists of the
translog generalized variable cost function
[6] and the share equations [7]. The ob-
70(2) Bhattacharyya et al.: Water Utilities 203

served variable cost function, by theexpressed

likelihood-ratio in(LR) test'0 with 5
logs, is converted into average cost form
percent significance, even though the pa-
by subtracting the log of output rametersfromare individually
it. Be- insignificant (see
cause the shares sum to unity, Table the
1). Thelast
relative price efficiency hy-
share
equation (for materials) is dropped.9 Theinputs is rejected
pothesis (2) for variable
final form of the cost function when incorporates
treated separately for (a) private and
in it equations [8], [9], [11], (b) and
public[12]
utilities.
withThis suggests that both
the price homogeneity restrictions private and public[9] im-water utilities in our
posed. The model is estimated sample are jointly
using theand it-independently sub-
erative nonlinear seemingly ject unrelated re-
to allocative distortions resulting from
gression technique, which the in unspecified
convergence R = Ro restrictions. The
approximates maximum hypothesis likelihood (ML)
that price efficiency is unaf-
estimation. In order to increase the likeli- fected by scale (2c) is also rejected.
hood of finding the global maximum, initial While the joint difference between pub-
parameter values are derived in steps, be- lic and private firms in technical and price
ginning with the results of a system of linearefficiency is statistically significant, esti-
equations and then adding estimation of
mates of the efficiency indices shown in Ta-
nonlinear components. The ML parameter ble 3 seem to indicate that the differences
are not particularly large. The mean com-
estimates and their asymptotic standard er-
rors are reported in Table 1. bined efficiency index of 20 percent for
We have checked the curvature propertypublic enterprises, which includes the ef-
(for concavity) of the shadow cost functionfect of technical, price, and scale effi-
using conditions [19] at every data point.ciency, is only slightly larger than the index
The percentage of concavity violations areof 19 percent for their private counterparts.
reported in the bottom part of Table 3. TheThe average technical efficiency for the
concavity condition (NSD) is satisfied forpublic and private utilities is 37 and 35 per-
almost all data points. Satisfaction of thecent, respectively, though there is a wider
concavity condition guarantees the optimi-dispersion of the estimated values for pub-
zation behavior on the part of the utility lic utilities. Performance of both groups
companies which is further reflected in theis much better regarding their price effi-
positive estimated values for all factor ciency-public water utilities are 85 per-
shadow shares (S*) and output elasticities cent price efficient and private firms are 81
(Fe) for all water utilities irrespective of
percent. Absolute scale efficiency (rls = 1)
ownership. Thus concavity, monotonicity,requires that firms produce at the estimated
and nonnegativity conditions are satisfiedminimum average cost, which may signifi-
at each data point. cantly exceed the size of their regulated
Total cost minimization also requires market. Regarding scale efficiency, private
negative values for EK for all observations,utilities outperform public ones, with 67
a condition which has not been achieved percent scale efficiency relative to 64 per-
for 99 percent of companies. This, along cent for publicly owned companies.
with the above set of conditions (concavity,In this study we have tried several re-
monotonicity, and nonnegativity), seems strictive
to specifications which were statisti-
indicate that while the water utility firms cally tested against the final form; some of
are minimizing their shadow variable cost, these are included in the hypotheses shown
they are not using their quasi-fixed input- in Table 2, and are tested using the LR test.
capital--optimally.
A number of key hypotheses are tested,
and the results are shown in Table 2. The 9The results are invariant to the particular share
equation dropped (Greene 1980).
central null hypothesis is that there is no
'oThe test statistic is -2(LR - Lu) - 2q., where
difference between public and private utili-
LR and Lu are the restricted and unrestricted values
ties with regard to price and technical effi-
of the log-likelihood function and q is the number of
ciency. The joint hypothesis (1) is rejected
restrictions.

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 204 Land Economics May 1994

TABLE 1
GENERALIZED RESTRICTED COST FUNCTION ESTIMATES

Parameter Standard Parameter Standard

Estimate Error t-Statistic Estimate Error t-Statistic

"Yo -0.5515 (0.1832) - 3.01** 3LL 0.0539 (0.0397) 1.36

YB 0.0002 (0.0001) 2.97** 3LE -0.0380 (0.0258) - 1.47
Tz -0.1164 (0.0735) -1.58 P3LK 0.0056 (0.0059) 0.95
aL 0.2313 (0.12%) 1.78* 3LQ -0.0065 (0.0123) -0.53
aE 0.2695 (0.0929) 2.90** PEE 0.0064 (0.0311) 0.20
aK 0.2322 (0.0575) 4.04** PEK -0.0062 (0.0121) -0.51
aQ -0.0547 (0.0609) -0.90 I3EQ - 0.0678 (0.0325) - 2.09**
PKQ 0.0463 (0.0240) 1.93*
tL -1.4806 (1.0144) -1.46 3KK 0.0565 (0.0250) 2.26**
tZ 0.2646 (0.2021) 1.31 ,QQ 0.0249 (0.0420) 0.59
tLQ -0.2534 (0.1803) - 1.41
tE 0.8546 (0.3566) 2.40** In Y 411.23
tEZ -0.0691 (0.1555) -0.44
tEQ -0.4332 (0.1336) - 3.24**
** Significant at 5 percent (two-tailed).
* Significant at 10 percent (two-tailed).

The first of these versions, hypothesis (2),mogeneity or homotheticity are imposed).

specifies that the distortion factors ki are In spite of the fact that many of these
parameters are individually insignificant,
not factor specific; i.e., the utilities are rel-
atively price efficient in variable inputs the LR test rejects these specifications in
and the estimating equations are linear.favor of the translog form. As noted in foot-
The second, hypothesis (3), specifies that note 5, the LR test cannot reject the hy-
shadow variable shares are not functions of pothesis that the translog form estimated
other factors, which is almost equivalent to should not be expanded.
imposing a Cobb-Douglas form without ho- Finally, the hypothesis (5) that private
motheticity. The third, hypothesis (4), im- and public utilities do not differ in the
poses constant returns to scale on the dispersion of the errors is tested. The
underlying technology (alternatively, ho- Breusch-Pagan X2 statistic for explanatory

TABLE 2
HYPOTHESIS TESTING

Degrees of
Hypothesis x2 Statistic Freedom
(1) 'TZ = tZ = EZ = 0 9.40** 3

(2)a)tLtL
= t==tLQ
tLQ =
= E4E
= =EZ =EQ = 0 16.01** 6
= EQ = 0 15.41** 4
b) tL + LZ = tLQ E + EZ = EQ = 0 14.69** 4
c) tLQ = EQ = 0 9.88** 2
(3) 3LL = LE= 3EE= LK= EK = 0 33.40** 5
(4) aQ = p3QQ = = Q LQ = EQ = 0 35.22** 5
a) PQQ = KQ = LQPL = PEQ = 0 15.84** 4
b) PKQ = PLQ = PEQ = 0 8.09** 3
(5) Breusch-Pagan Test:
a) With respect to Zt 5.53** 1
b) With respect to Q 1.01 1
** Significant at 5 percent (one-tailed).
tFor hypothesis (5a), the estimated coefficient f

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70(2) Bhattacharyya et al.: Water Utilities 205

TABLE 3
CALCULATED STATISTICS AND INDICES

Publicly Owned Privately Owned

Calculated Standard Calculated Standard
Statistic Mean Deviation Mean Deviation

Mean Estimated Values:

71 0.20 [0.11] 0.19 [0.07]
qrT 0.37 [0.14] 0.35 [0.09]
IP 0.85 [0.04] 0.81 [0.04]
'Is 0.64 [0.22] 0.67 [0.19]
kL 0.30 [0.07] 0.23 [0.05]
kE 2.34 [0.92] 2.49 [0.98]
kK -0.02 [2.11] -0.14 [0.06]
EQ 0.85 [0.07] 0.86 [0.06]
EK 0.16 [0.06] 0.18 [0.05]
COL -0.65 [0.56] -0.51 [0.21]
aCE 0.02 [0,31] -0.02 [0.24]
C.LM 0.76 [0.04] 0.75 [0.03]
rEE - 2.16 [0.86] - 2.07 [0.58]
CErEM 1.18 [0.03] 1.18 [0.01]
rMM -0.91 [0.23] -0.89 [0.22]
EL - 0.09 [0.08] - 0.06 [0.03]
ELE 0.01 [0.04] -0.00 [0.03]
eLM 0.10 [0.02] 0.09 [0.01]
EEL 0.02 [0.08] 0.00 [0.07]
EEE -0.65 [0.06] -0.65 [0.06]
EEM 0.39 [0.07] 0.39 [0.07]
eAL 0.42 [0.07] 0.42 [0.06]
eME 0.65 [0.09] 0.65 [0.08]
eMM -0.48 [0.07] -0.48 [0.07]
VC/VC* 1.15 [0.23] 1.23 [0.21]
SL/StL 3.04 [1.13] 3.61 [0.73]
SEISE 0.43 [0.28] 0.37 [0.20]
SM/S* 0.90 [0.35] 0.83 [0.24]
Violations of:
Concavity 0.4% 0.0%
S? > 0 0.o% 0.o%
eQ > 0 0.0% 0.0%
SK K 0 98.7% 100.0%
Note: These standard deviations reflect variations in calculated

water
variable Z is 5.53, which utilities,
rejects the mean
the hypoth-
two at
esis of homoscedasticity groups
the 5 are reported
percent
level of significance. Thecomparison
sign of thein regres-
Table 3. Th
ticities are
sion coefficient is significantly of appropriate
positive indi-
cating that public utilities
fairly
have
inelastic
the greater
input dem
residual dispersion. For values
theofexplanatory
the standard dev
variable Q, the statistic culated
is 1.01,own-price
and we failelasti
to reject the hypothesis. and APE)"I show more flu
The price responsiveness of the water
utilities is estimated using both Allen partial
price elasticities (APE)"The
and own-price
Allen-Uzawa
AUES meas
has a very high value for both
elasticity of substitutions (AUES). Since in
cannot be directly interpreted t
this paper we intend to mand
highlight
curve.the
APErelative
is a more dire
efficiency of publicly dient
and privately
of the demand curve. owned

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 206 Land Economics May 1994

responsiveness for
their greater publicly
underutilization of energy, rel- ow
ative to materials.
utility companies than The ratio
for kL/kEpriva
can be
used to evaluate
For public water the efficiency in labor-use
utilities, the
relative to energy.
of the cross price For both ownership cat-
responsivenes
egories, this ratio is less than unity, im-
all variable factors are substitutes for each
other by both measures. Labor and energyplying that labor was underutilized relative
are weak complements for private utilities,to energy, and this ratio is even smaller for
but the large standard deviations suggest private water utilities.
this degree is insignificant. For both owner- The effect of allocative distortion on the
ship types, the AUES indicates that the use of all three variable factors can be ap-
isoquant exhibits relatively less substitut- proximated by taking the ratio of the pre-
ability between labor and materials and dicted values of the input shares with and
relatively more substitutability between en-without distortions for each input. These
ergy and materials.2 The cross Allen-are reported in the middle part of Table 3.
Uzawa elasticity of substitution, of course, These show (in an absolute sense) an over-
is symmetric, i.e., cri = cri. Except for theutilization of labor and an underutilization
mean cross effect between energy and la- of both energy and material by both groups
bor, there is not much difference between of water utilities. Again, the magnitude of
privately and publicly owned utilities con-allocative distortions is higher for private
cerning the magnitude of elasticity of sub-water utilities, while the dispersion is
stitution. higher for their public counterparts.
The estimates of the variable cost elas-
ticity with respect to output, EQ, show that IV. CONCLUSION
both groups of utilities enjoy increasing re-
turns to scale of more or less the same mag- In this paper, we analyze the hypothesis
nitude. The positive value of the elasticity that public and private utilities are equal i
of intensity, EK (the elasticity of variable technical, price, and scale efficiency usin
cost with respect to the fixed factor), in- a generalized nonminimum (shadow) re
dicates that increases in capital inputs stricted (fixed capital) variable cost func-
increase, rather than decrease, variable tion. Both public and private water utilitie
shadow cost on the margin for both groups. are found to exhibit significant relativ
For private utilities, this supports the price inefficiency in addition to excessive
Averch-Johnson hypothesis of excessive capitalization. Contrary to the widely hel
capitalization. view of the public choice, or property
In our model, the shadow price was in- rights, model that private enterprises are
troduced in terms of the distortion factors more efficient than public enterprises, ou
or shadow price ratios, ki, so the behavior empirical findings provide the evidence th
of these variables with respect to their nu- private water utilities in the sample of th
meraire, kM, indicates the nature of distor- study are less efficient than public water
tions and the extent of the deviation from utilities both technically and in the use o
neoclassical cost optimization. Labor's variable inputs of labor, energy, and mate
shadow price ratio is found to be less than rials. Private water utilities are, however,
unity for both private and public water utili- much more consistent in their degree of in
ties, which from the perspective of neo- efficiency, as the residuals in the average
classical cost minimization indicates over- variable cost function exhibit significant
utilization of labor relative to materials byheteroscedasticity with respect to the typ
both publicly and privately owned water of ownership. Public water utilities show
utilities. The degree of such distortion is wider dispersion of technical inefficiency
slightly higher for private water utilities. from best to worst practice.
Energy, on the other hand, is underutilized
relative to materials by both groups of
firms. This distortion is relatively larger in 12Relative to a Cobb-Douglas form, which woul
magnitude for the private firms, indicating impose a unit cross-elasticity of substitution.

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 70(2) Bhattacharyya et al.: Water Utilities 207

Both public and private water

water industry utilities
conducted by the American W
appear to have a negative marginal
ter Works prod-
Association. In the original data bas
there were 438 water
uct of capital, a fact consistent with utilities
the in U.S. cities serv-
Averch-Johnson hypothesis, ing a population
and the over 25,000
rate ofpersons. Missing
data utilities
return of capital for private pared the original
is moregroup of 363 publicly
owned water utilities and 75 privately owned
negative. Consistent with the common wis-
water utilities down to 257 utilities in the fin
dom that water utilities are natural
sample: 225 public monop-
and 32 private water utilitie
olies, there are significant returns
Output to scale
(Q) is measured by the total quantity
in both categories of ownership. Private
of water (wholesale, retail, and other sales) d
water utilities are, on average, moreofscale
livered in millions gallons per year. Outpu
efficient, even thoughprice they(P) is average
total revenuesless
(wholesale, retail, an
output as a percentage of other
the sales of water) divided
estimated op- by output. Variab
timum. This is because cost (VC) is the
a small sum of observed
portion of total expend
public water utilities hastures
an on labor, energy,
output thatand ac-materials in $1,0
per year. Based
tually exceeds the output level which mini- on the assumption that there a
2,040 working hours in a year, observed labo
mizes the average variable cost function.
cost is calculated as WLXL = (labor price
Our empirical findings provide new evi-
dollars/hour) (total number of full-time equiv
dence for the hypothesis that alternative(2,040
lent employees/year) in- hours)/1,000. Ob
stitutional arrangements are important in as WEXE = (en
served energy cost is calculated
determining the outcome ergy of
priceconduct
in dollars/106and
BTU's) (total units o
performance of economic firms
energy in 109involved.
BTU's/year). Observed energ
Our results are consistent pricewith
(WE) is a growing
a weighted average of the observ
body of empirical evidence3 that denies the and fuel, wher
prices of natural gas, electricity,
theoretical argument that the public
weights are the percentage of expenditure
ownership
on natural gas,
of water (or electric) utilities reduces incen-electricity, and fuel by a wat
utility. Observed materials cost is calculated
tives to monitor managerial conduct and,
WMXM = (materials price in dollars/unit) (tot
consequently, promotes units
inefficient opera-
of materials in 1,000 units per year).
tion in these enterprises. In the case
Following Moroney ofandthe Trapani (1981), w
water industry, it appears that attenuation
assume that the total return to capital include
and nontransferability of ownership
profit, an assumption shares
consistent with rate of re
in public firms have not resulted in any
turn regulation.14 Theinfe-
capital stock, therefor
rior production process isforestimated
water to bedelivery
the residual of revenue less
variable cost
as compared to private firms, (including labor,
perhaps be- energy, and mat
rials),
cause private utilities are divided by themore
relatively opportunity cost of capit
burdened with the cost of This opportunity
regulation. cost includes
This an average depr
ciation rate of 3.5 percent plus the long-term in
evidence brings up a very important ques-
terest rate.
tion for public policy towards the promo-
Prior to estimation, the data is normalized
tion of efficiency in the such
water industry. Incost, output
that the means of variable
formulating the policy for rearrangement of
ownership in the water industry, it should
be emphasized that the argument of public
choice, or property rights, theorists that
13For example: Atkinson and Halvorsen (1984);
privatization of public enterprises will re-
Fare, Grosskopf, and Logan (1985); Feigenbaum and
sult in higher efficiency has
Teeplesnot
(1983);been
Lambert,unani-
Dichev, and Raffiee (1993);
mously supported by the existing
Pescatrice empirical
and Trapani (1980); and Teeples and Glyer
studies in the literature. (1987).
'4In a simple Cobb-Douglas production function,
this measure is tested against three alternative mea-
sures: debt, debt plus taxes, and the difference be-
tween revenue and variable cost less taxes. In an
APPENDIX
equation containing all four measures, with the null
hypothesis that the coefficients for other measures are
In this appendix, the data and variable con-
zero, for each measure in turn, the hypothesis is re-
struction used in this study are explained.
jectedThe
for the other alternatives at 5 percent signifi-
data were obtained from a 1992 survey cance,
of the but not for the chosen measure.

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 208 Land Economics May 1994

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