Regulation and Efficiency Incentives: Evidence from the England and Wales Water and Sewerage Industry

Abstract

This paper evaluates the impact of the tightening in price cap by OFWAT and of other operational factors on the efficiency of water and sewerage companies in England and Wales using a mixture of data envelopment analysis and stochastic frontier analysis. Previous empirical results suggest that the regulatory system introduced at privatization was lax. The 1999 price review signaled a tightening in regulation which is shown to have led to a significant reduction in technical inefficiency. The new economic environment set by price-cap regulation acted to bring inputs closer to their cost-minimizing levels from both a technical and allocative perspective. IntroductionThe England and Wales water and sewerage industry was privatized in 1989 and thenceforth has been subject to a sequence of five-year price controls in the form of price caps. Price-cap regulation is set out to be a high-powered incentive scheme. However, previous empirical findings have shown that the cap introduced at privatization in 1989 had been lax (Saal and Parker, 2000), in the sense of allowing real price increases and the evidence that the first price review in 1994 produced efficiency gains is weak Parker, 2001 and. This may be explained by the double duty of the regulator to encourage a higher level of efficiency and provide the companies with the financial resources to support their investment programs. The 1999 price review signaled a change in the implementation of regulatory policy by imposing for the first time a real price reduction.

The welfare costs of non-marginal water pricing: evidence from the water only companies in England and Wales

“…This finding is consistent with past studies by Bottaso and Conti (2003), Erbetta and Cave (2007) and Maziotis et al (2009) where the authors suggested that the tightened 1999/00 price review had a positive impact on companies' productivity indicating that both the most productive and the less productive firms had strong incentives to improve their productivity in order to regain economic profitability. Another study by Bottasso and Conti (2009) Another paper by Garcia and Reynaud (2003) estimates the benefits of efficient water pricing in France and finds small efficiency gains -roughly 0.4% of initial surplus.…”

Dynamic efficiency in the English and Welsh water and sewerage industry

“…Stone and Webster (2004) and Bottasso and Conti (2009) state that the presence of overcapitalisation could result in a misspecified total cost function where the assumption is that firms can instantaneously vary the level of capital. Saal and Parker (2000) and Erbetta and Cave (2007) consider a total cost function through the use of parametric and non-parametric specifications respectively.…”

“…Data from the ASHE (Annual Survey of Hours and Earnings) could be considered but due to the lack of regional data, this would mean applying the same price index for all companies. Staff costs were obtained from the statutory accounts rather than the June Return (Erbetta and Cave, 2007) as those reported within the June Return only relate to direct labour. This is not a perfect measure as the statutory accounts relate to the group activities.…”

“…Following Stone and Webster (2004) capitalised staff costs were not excluded due to a lack of consistency in the company's reports. 18 Saal andParker (2000, 2001), Saal and Reid (2004), Stone and Webster (2004) and Erbetta and Cave (2007) The methodology for adjusting the capital stock follows that of Parker (2001), Saal andReid (2004), Stone and Webster (2004) and Erbetta and Cave (2007 Total costs are calculated as the sum of capital costs and operating expenditure net of third party services, exceptional items, doubtful debts, service charges and local authority rates 21 .…”

Price-cap regulation in the English and Welsh water industry: A proposal for measuring productivity performance

“…Some have evaluated the impact of privatization on the efficiency and productivity of water companies (Ashton, 2000;Parker, 2000, 2001;Marques, 2008). Other have focused on evaluating the impact of regulation on productivity growth (Saal and Reid, 2004;Erbetta and Cave, 2007;Saal et al, 2007;Bottaso and Conti, 2009;Maziotis et al, 2009;Portela et al, 2011;Maziotis et al, 2012Molinos-Senante et al, 2014Maziotis et al, 2015) Despite of the wide number of studies aimed toward assessing the productivity change of the regulated water industry in England and Wales, to the best of our knowledge, none of them extended their methodologies to setting the X factor for the English and Welsh water and sewerage regulated companies. Researchers have developed DEA (Coelli and Walding, 2006) or index-number approach Bernstein et al, 2006) to measure productivity growth and propose X factors in regulated industries that include the water supply industry in Australia, the electricity network in New Zealand, and the telecommunication industry in Peru.…”