Socialists Are All Wet:

Why Privatizing Water Utilities Is Good for Public Health and the Environment

Elizabeth Brubaker, Executive Director, Environment Probe

Presentation to Fraser Institute Student Seminar on Public Policy Issues

November 13, 2004

(Please click here for the PowerPoint slides that accompanied this talk.)

[Slide #1] I'm going to start this morning's session with a few quotes from Canada's most vocal critics of water utility privatization. That honour is shared by two organizations - the Council of Canadians and the Canadian Union of Public Employees, or CUPE. Both have been fighting privatization tooth and nail for years.

[Slide #2] Water privatization is, in the Council of Canadian's words, a disaster.

And why is that? What's the problem with privatization? Well, part of it has to do with the nature of water itself. [Slide #3] The water we drink is simply too precious to trust to corporate hands. It's too essential. Water is not a commodity. No person has the right to profit from it.

The other part of the problem has to do with the nature of business. You just can't trust corporations to act in the public interest. [Slide #4] The role of business is not to provide quality water: No, the role of business is to make a profit. Shareholders' objectives, and the needs of people and nature, are fundamentally at odds.

Given the perils inherent in private water treatment, the Council of Canadians and CUPE put their faith in public suppliers. [Slide #5] Water must remain not only under public control - through regulation - but also under public management. The private sector simply can't match the quality, accountability and affordability of public water systems.

You get the picture. Public water good. Private water bad. Even hybrids, such as public-private partnerships, or P3s, as they're known, are bad. We'll leave the last word on this to Paul Moist, the national president of CUPE. [Slide #6] P3s, he says, are risky propositions, combining higher costs, reduced accountability, and poorer service.

Can you see the joke coming? This guy isn't just Moist. He's all wet!

Let me start my rebuttal by taking a look at some of those vaunted public systems.

Walkerton was a public system. Publicly owned, publicly financed, and publicly operated.

The manager of that most public system was incompetent and dishonest. He lied about where water samples came from. He lied about levels of chlorine in the system. He lied about the safety of the water in his system.

The result? Seven people dead. More than 2,300 people sick. More than 64 million dollars in hard costs and another 91 million in less tangible costs, such as lives lost.

And what about the accountability that public utilities are supposedly famous for? The Walkerton manager still hasn't paid a penny in fines or served a day in jail. Last month, he arranged a plea bargain so that two of the criminal charges against him would be dropped. Where's the accountability in that?

If you think that Walkerton was a tragic exception to the rule, think again. Walkerton was just one of hundreds of lousy public systems in this province. Let's take a look at a few figures. [Slide #7]

246: That's the number of boil water advisories that Ontario issued in the six months following the Walkerton tragedy. Most of those advisories were issued when inspectors found fecal bacteria in the water.

357: That's the number of plants that failed inspections in the six months after the Walkerton tragedy. Some weren't training their operators. Some weren't doing enough sampling. Some hadn't mastered disinfection. Whatever the reason, more than half of our publicly owned, publicly financed, and publicly operated plants were failing to do the job right.

Of course, after Walkerton, the province cracked down on water utilities. It toughened the rules, and it conducted more inspections. But the utilities were very slow to respond. And so the numbers got even worse.

In 2002/2003, 407 plants failed inspections. That's an astonishing figure. More than two years after the Walkerton tragedy, 407 plants - that's 61 percent of our plants - were out of compliance with provincial laws and regulations.

The Council of Canadians tells us that "the water we drink is simply too precious to trust to corporate hands." Well I don't know about you, but these figures make me think that the water we drink is simply too precious to trust to public water utilities! They have done a terrible, terrible job.

And what about our public sewage utilities? Are they doing any better? No ...

101 sewage treatment plants violated provincial laws or guidelines in 2001. 79 were on the list in 2002. We don't have the figures for 2003 yet.

[Slide #8] This is how the Environmental Commissioner of Ontario summed up the problem last year: "The effluents of Ontario STPs [sewage treatment plants] are putting very serious pressure on the environmental quality of Ontario waterways."

Sadly, these problems are typical of systems all across Canada. Many hundreds of communities provide unsafe drinking water. And hundreds more provide inadequate sewage treatment.

Environment Canada recently called sewage pollution "one of the largest threats to the quality of Canadian waters." The Boston Globe called it "Canada's ugliest environmental secret." It reported that our sewage pollution is "on a scale unseen outside the Third World."

The Council of Canadians tells us that privatization has been "nothing short of disastrous." Well, I've got news for them: It's our public systems that are disastrous. They're dangerous. They threaten the environment and human health. And they're an international embarrassment.

That's the context in which we should be discussing privatization. We've got some very serious problems that need to be solved. The status quo - public financing, public ownership, and public operation - is not working. The question is: Can the private sector help? If so, how? And perhaps more interesting, why?

My research into privatization in Europe and the United States has convinced me that some form of privatization - long-term contracts, perhaps, or concessions - is key to solving Canada's water and sewage problems. Yes, some of our problems could certainly be solved without privatization. And no, privatization alone is no panacea.

But privatization, combined with good public regulation, does have unique and inherent advantages over public provision. I want to talk about four of these. [Slide #9] First, the private sector can provide desperately needed capital. Second, the private sector brings with it a great deal of expertise. Third, the private sector has incentives to operate systems efficiently. And fourth, the private sector is more accountable than the public sector.

Let's start with the issue of capital investment. Our water and wastewater systems are in desperate need of investment. Estimates vary, but they're all in the billions - some, as high as 90 billion over 20 years. [Slide #10]

That's a lot of money. And the public sector has always been reluctant to cough it up. That's not going to change. If we're going to see the kind of investment we need, some of it is going to have to come from the private sector.

We're not alone in this. The need for investment has driven privatizations all around the world. It was a huge factor in England and Wales. (They sold off their water systems in 1989.) The British water companies have put an enormous amount of cash into their systems. By the end of next year, they will have invested 50 billion pounds - that's about 112 billion Canadian dollars. As one official from the Department of the Environment said, "You just couldn't contemplate that kind of expenditure in the absence of privatization."

Closer to home, we have an example in Moncton. In the 1990s, Moncton was desperate for a water filtration plant. But it couldn't afford the upfront investment. And it couldn't get provincial or federal funding. So it turned to the private sector. It held a competitive bidding process, USF Canada won, and the firm financed, designed, built, and now operates a state-of-the-art plant.

So that's one reason for municipalities to consider privatizing: The private sector is a potential source of capital that can be invested in our crumbling infrastructure. [Slide #11] I also want to point out that it's a good source of capital. Even if public money were available - and there's no sign that it is - there are still several reasons to go for the private money.

One has to do with opportunity costs. There are many competing demands for our public funds. And those funds are limited. What we spend on water infrastructure we can't spend on health care or education. Why spend public money on water when the private sector is willing and able to foot the bill? Why not free up public money for other uses?

Another reason for using private rather than public money is that doing so transfers financial risks to the private sector.

Another reason to go with private capital is that it's likely to be used more efficiently than public capital. In a competitive environment, private firms have incentives to keep capital costs down. That's how they win contracts. In Moncton, USF Canada built the water plant for at least 25 percent less than the city was planning to spend.

Those, then, are four reasons to go with private capital: To meet investment needs. To free up funds for other uses. To offload risk. And to increase capital efficiency.

And what about the operations side of things? Why go with a private operator? The answer is simple: Good private operators have both the tools and the incentives required to get the job done. [Slide #12]

Let's look at the tools first. One argument for privatizing operations is that doing so will inject expertise into our systems. The large international water companies have far greater expertise than any municipality. A couple of them have been in the business for more than a century. They've served hundreds of millions of customers around the globe. They have thousands of specialized employees - employees whose expertise can be harnessed to solve local problems. They invest small fortunes - hundreds of millions a year - in research and development.

It was this kind of experience and expertise that persuaded Indianapolis to privatize the operation of its sewage system. The director of that city's public works department said, "It's just a different league. These guys have resources our guys could only dream of."

Now, expertise can certainly be important. But in many towns, operations are actually quite straightforward. The managers of those systems don't need a century of experience behind them. What they do need is incentives to do their job well.

Municipalities that privatize can build such incentives right into their contracts. They can structure contracts to reward good performance and to penalize bad performance. Milwaukee does this. Its sewage contract includes bonuses if the private operator keeps pollutants below certain limits. And it includes penalties if the operator exceeds limits. This gives the operator a real incentive to perform well.

Competition for contracts also creates incentives to operate efficiently. Privatization's critics often scorn efficiency. [Slide #13] The way private companies stay in business is through cutting costs, they complain. But cutting costs is a good thing, as long as standards aren't cut along the way. If the quality of service is regulated, efficiencies won't come at the expense of good performance. Instead, they're achieved through innovation, through the elimination of waste and duplication, and through economies of scale. All of these factors allow a company to do more with less. That can mean two things. It can mean that money formerly spent on operations can be dedicated instead to capital improvements. Or the savings can translate into lower costs for consumers.

In the US, the cost savings from privatization have been enormous. [Slide #14] In Houston, contracting out water plant operations brought savings of 43 percent. In Seattle, the contract to design, build, and operate a water filtration plant was priced at 40 percent below the city's benchmark. In Indianapolis, privatizing sewage treatment reduced costs by 42 percent. Milwaukee expects to save about 30 percent.

Cost savings of that magnitude would make a tremendous difference to water systems here in Ontario. One firm has estimated that it could save Toronto between 95 and 110 million dollars every year if it managed our water and wastewater systems. Money that's currently being used for operations would be freed up for capital improvements. That's a persuasive argument for privatization.

To this point, I've argued that the private sector can provide needed capital, and that it has the expertise and the incentives to operate our systems effectively and efficiently. I want to turn now to the other major advantage of privatization: and that's accountability. A private owner or operator is inherently more accountable than a public owner or operator. It's more accountable to provincial regulators, to the public, to municipal governments, and to the market.

I want to spend some time on this - in part because I think it's the most compelling reason to privatize, and in part because it seems to be the hardest for many people to grasp.

Privatization's critics have embraced what I call the myth of public-sector accountability. They maintain that public utilities are inherently accountable ... and that private utilities are inherently un-accountable. [Slide #15] As private water companies grow, they warn, "accountability will vanish, and the world will lose control of its source of life."

Well, public-sector accountability may sound good in theory ... but it sure doesn't work in practice. Remember those figures on the screen? Those hundreds of non-compliant plants? The owners and operators of those plants have almost never been held accountable. They have almost never been prosecuted for breaking the law.

Our governments' consistent failure to enforce the law exposes an inherent flaw in the system. [Slide #16] Our governments are in conflicts of interest. They simply cannot properly regulate systems that they also finance and, in some cases, operate. These different roles inevitably conflict with one another. The result? Regulatory paralysis.

Here in Ontario, the government is paralysed by two conflicts: a financial conflict and an operating conflict. The financial conflict works like this: The province pays the lion's share of upgrades to water and sewage systems. It understands that if it enforces the law - if it, in effect, demands upgrades - it will end up footing the bill. This threat of financial responsibility makes it think twice - or three, or four times - before enforcing the law.

The government's also in an operational conflict. The province operates hundreds of water and sewage plants. It does so through the Ontario Clean Water Agency, or OCWA. Unfortunately, OCWA hasn't done a very good job. Over the years, dozens of its water and sewage plants have violated provincial rules. Obviously, it would have been very awkward for the government to prosecute OCWA for these violations. After all, it would have been prosecuting itself. Governments don't like to prosecute themselves.

The only way to resolve this conflict is to get the provincial government - and its so-called children, the municipalities - out of the business of operating and financing water systems. In short, privatize. Privatization will enable the province and municipalities to focus on their core responsibilities: overseeing and regulating the systems.

This is a point I cannot stress enough. People often associate privatization with deregulation, or a loss of control. [Slide #17] But the privatization of water utilities does not in any way imply deregulation. On the contrary, it goes hand-in-hand with a new focus on regulation. [Slide #18]

Norm Sterling, the former environment minister, confirmed this at the Walkerton Inquiry. He said that privatization would mean better enforcement of regulations. He said that it's easier for the government to regulate the private sector. He said that there's no potential conflict of interest and less reluctance to prosecute.

Ontario's limited experience with privatization confirms this. In Hamilton, enforcement got much tougher during its ten-year experiment with privatization.

The same thing has happened in other jurisdictions, most notably in England and Wales. Before privatization, the government understood that it was in a conflict. In its words, it was both the poacher and the gamekeeper. Privatization changed that. It separated the operator from the regulator. One regulator identified this separation as the most significant gain of privatization.

Since privatization, the system of water regulation in the UK has become one of the toughest in the world. The results have been very impressive.

Now, we shouldn't fool ourselves into thinking that privatization will solve all regulatory problems. We know that governments tolerate private pollution as well as public pollution. That's why it's important to have another level of accountability: accountability to the public.

One aspect of accountability to the public is legal liability. Legal liability is different for those who work in private and public systems. One major difference is that governments are often immune from tort liability for the consequences of policy and budget decisions. This doesn't have any parallel in the private sector. A private water company can't defend itself by arguing that it had a policy not to repair pipes ... or that it had decided not to budget for repairs that year.

The consequences of liability are also different for public and private suppliers. They tend to be more serious in the private sector. The individuals who are responsible are more likely to lose their jobs. The companies are more likely to lose their profits. Because private decision makers will bear the costs of their decisions, liability has a great deterrent value.

Another form of accountability comes through the contract mechanism. Enforceable contracts with specific performance criteria provide municipalities with powerful tools to compel compliance. Contracts can guarantee water quality, or maintenance levels, or capital expenditures. And, as I mentioned, they can include financial penalties for non-compliance.

In a privatized system, the market itself provides yet another form of accountability. Critics see the market as a force for evil rather than good. [Slide #19] They fear that "when the primary interest is shareholder returns and market share, water for people and for nature will be left out of the picture."

But I ask them: How will a company increase its shareholder returns or its market share if it performs poorly? When a company performs poorly, stock prices fall. Investors are punishing the company - they're holding it accountable. There was an example of this on the front pages of the newspapers last month. [Slide #20] A pharmaceutical company had to pull an unsafe drug off the market. The company's stock fell almost 27% in one day. That took billions off the company's stock-market value.

Market accountability works on a larger scale as well. Clients and potential clients will refuse to work with irresponsible companies. As the president of Azurix once said to me, "If you are negligent, you are history." A former official with the environment ministry said the same thing at the Walkerton Inquiry. Private firms, he said, would "be put out of business" if they provided unsafe water. The punishment of being put out of business rarely threatens municipal or provincial service providers. And that makes them less accountable.

Those, then, are what I think are the four best reasons to privatize. Privatization will provide capital investment, expertise, efficiency, and more complete accountability.

For these reasons, we're seeing a huge amount of privatization around the world. [Slide #21] England is now completely private. Private water firms serve almost 80 percent of the French and 50 percent of the Spanish. In the US, there are about 30,000 privately owned water or sewage systems. Another 2,400 communities in the US have contracted out operations. Seattle, Indianapolis, Milwaukee, Houston, Phoenix - privatization is almost commonplace south of the border.

It's time for us to join the flow. Given the state of our systems, we can't afford not to.