Incentives matter: politicians file

Usually the reasons for public ownership are placed into one of three categories: market failure, regulation problems or transaction cost reasons. An interesting case study of waterworks in the US is offered in the Troesken and Geddes paper Municipalizing American Waterworks, 1897-1915. This paper provides support a transaction cost interpretation of municipal acquisition of private waterworks. The incentive facing the local governments and the private companies are an important factor in the government take over.

The basic Troesken and Geddes story is that municipalities were unable to credibly precommit to not expropriating value from private water companies once (sunk) investments were made. This gave the private firms an incentive to reduce investment in water provision. This rational under investment was then used by local governments a pretext for municipalizing the private water companies.

Troesken and Geddes explain that their evidence supports the idea that because local governments held the assets of the private firms hostage, they could use their police powers to undermine the value of the private waterworks and thus acquire these firms at reduced rates. The water companies anticipated such opportunistic behaviour and rationally devised strategies to reduce its effects. For example, firms would demand contractual provisions limiting the power of local governments and reducing investments in idiosyncratic assets. Water companies would, for example, reduce the number of water mains they installed if they faced a high probability of future public takeover. Such underinvestment was then used by local authorities as justification for a takeover. Troesken and Geddes summarise the situation as

When Progressive Era reformers advocated municipalization of urban water systems, they often pointed to places like New Orleans and Duluth, where there was clear evidence that private water companies were providing inadequate service. While reformers were certainly justified in claiming that water companies in such places were failing to deliver adequate service, they did not appreciate the ultimate cause of that failure: the threat of municipalization itself, which was often accompanied by a host of opportunistic strategies. The fact that the threat of future municipalization discouraged private water companies from extending their distribution systems suggests failure stems not from private provision per se, but from a more fundamental contracting problem.