In this video we'll move beyond a historical almost biographical explanation of the full divestiture deal structure for the privatized England and Whales water industry. We're going to outline four specific local context conditions that we think were prerequisites for this full divestiture in the England and Wales case. We'll see that it was not just influential personalities that mattered here. Four sets of status quo conditions mattered, too. These were, one, the historical organization of the England and Wales water sector. Two, the state of the network, three, the ability to learn from a parallel, wider program of privatizations. And four, adequate time in institutional capacity to iterate proposals before eventually committing to the full divestiture of water privatization. Much of the detail here comes from a 2006 joint Defra and Ofwat report on the history of the England and Wales water industry. By the time of the privatization of the England and Wales water industry in 1989, a set of ten major so-called regional water authorities already existed. These bodies were the culmination of quite a long historical water development path. And included earlier private water supply as in parts of the UK as shown in this plot. We described this historical path and several proceedings sentries of development of water institutions in the UK in our part one MOOC. Here, it's crucial to understand that a small number, specifically ten, regional water authorities had been organized. And been operating around pioneering integrated river base management principles for 15 years already before the privatization took place in 1989. These regional water authorities were the result of major public water sector restructuring efforts that were legislate around 1973 and 1974. Seeing the England and Wales water industry as it is now and as it's been for the past almost 30 years or so, it's easy to underestimate the significance of these precursor steps. The 2006 joint Defra Ofwat report gives us helpful details. In 1963, a decade before the ten river basin focused public utilities were created, legislation had created 27 public river authorities. Whilst perhaps the model of these 27 authorities blazed a trail for the ten regional water authorities that followed. The 1963 legislation did not in fact reconfigure the provision of piped water and sewage services. Municipal authorities, joint water boards and statutory water companies still delivered water and sanitation services. Sewage disposal authorities remained responsible for sewage treatment. The 1963 legislation revised the oversight structure for the water resources management and conservation issues. Water resource managers were confronted with the challenge of meeting the needs of economic growth and at the same time struggling with management of droughts and floods. And these river authorities, created in 1963, primarily replaced similar organizations known as river boards, that had been created by even earlier legislation in 1948. By 1973 there were nearly 200 statutory water undertakings in England and Wales, involving municipal authorities, joint boards, and statutory water companies. There was still almost 1,400 sewage and sewage disposal authorities. From this constellation, the 1973 legislation then created just ten water authorities based around the ten major river basins in England and Wales. These regional water authorities took over all of the functions of the previous hundreds of water undertakers and over a thousand sewers and sewage disposal authorities. That's some consolidation. And on a scale rarely seen in the public sector. Organizing the regional water authority using the principle of integrated river basin management was also a world first in the eyes of participants in the process at the time. About 15 years ago as part of my research, I interviewed one of the people involved. He told me how he and his peers really felt that they'd cracked it at the time by instituting management of the whole water cycle at river basin scale. It was seen as a significant, progressive step forward. The regional water authorities also took over some roles that had been played by central government Including water resources planning. The 1973 legislation also changed financial arrangements. Local control over investment was transferred to central government. Capital expenditures could then be financed by borrowing from central government, as well as by revenues from customers. At the same time, the 1973 legislation introduced a requirement for the regional water authorities to operate on a full cost recovery basis. The importance of this step again cannot be overstated. Most water utilities around the world to this day as we've seen have not codified or the principle of full cost recovery. Interestingly the 1973 legislation also required that the regional water authority regulate themselves. They took over the oversight roles from the 27 former river authorities. The 1973 legislation also standardized a professional management structure, addressing corporate, divisional and operational functions. Across all ten of the regional water authorities. You can see this structure in the diagram here. Each authority had a kind of non-executive panel with a chair person appointed by government and representatives of central government and district and county council levels. This panel directed day to day operations through an executive board featuring a management team that could typically include a chief executive. And directors of operations, scientific services, resource planning, finance, and administration. The 1973 legislation also created an independent statutory body called the National Water Council, made up of the ten chair persons of the water authorities, plus ten independent members appointed by government. The previous National Water Resources Board was also replaced by a Central Water Policy Planning Unit that was to coordinate national water resources planning. And would over see water quality and pollution prevention matters would also conduct research and development. And would advise the government The National Water Council and the Regional Water Authorities. Although this body was later abolished in 1983, It's easy to see that there was a high degree of institutional capacity in England and Wales long before privatization. We would argue that this institutional foundations set the scene for the various institutional changes needed. Of course, this capacity was part of the local context and may well not exist in other countries around the world. To embark on any form of privatization without this strong institutional foundation may lead to different outcomes. To recap this consolidation prerequisite, many developments took place here. Showing us clearly how the kind of ideology driven by a graphical account of events we reviewed in the previous video is lacking. Over 1000 discrete locally operated municipal and statutory undertakings had been consolidated into ten large river basin scale, regional water authorities, over a decade before water privatization was proposed in England and Wales. Take a look at this map it shows the geographic boundaries of these ten regional water authorities from 1974. Now, compare it to this map of the geographic boundaries of the ten major water and sewerage companies created following the England and Wales water privatization in 1989. Now, look again. What do you think? They are remarkably similar, aren't they? Do you think the ten main private water and sewerage companies offered for sale in 1989 would have been an attractive proposition without these proceeding steps of consolidation that we've described? And what about the institutional capacity building that went hand in hand with these consolidations? We saw a pioneering use of integrated river based and management principles in England and Wales before privatization. We saw a transfer of financing arrangements away from perhaps more parochial local authority politics to permit borrowing from central government. We saw water resource planning and pollution control arrangements improved. We saw recognizable corporate management structures introduced and standardized. And finally, we saw implementation of a full cost recovery requirement for the capital and operating budgets of the public regional water authorities. And we mustn't forget, as discussed in our part one MOOC about the UK's water development path, the UK also had a workable property tax based system for charging for water and sanitation services. And this was for several centuries beforehand. And I haven't even mentioned some other related developments that would also facilitate effective post-privatization operations of the England and Wales water industry, and regulation of it. Like the separate 1974 legislation allowing the regional water authorities to use a polluter-pays approach to pollution control. All in all, this is a pretty good foundation for a water privatization, right? And would we expect to find all these factors already present in a typical about to be privatized water utility in say, a developing country? You may be thinking of this point with all these developed institution in place by 1989, why privatize the England and Wales water industry at all? This looks like an ideal water utility set up, no? It's at this point we do have to recall the UK political economy of the 1970s and 80s that we reviewed in our previous video. The UK was in poor financial health. There was high inflation, high unemployment and there was no political will to raise prices to customers for any public utility services. The ten post 1974 regional water authorities were very well organized, but they had no money. They could not raise capital for network maintenance or Improvements, because there wasn't political will to raise tariffs. And the central government did not have financial resources to provide further subsidies. And yet repairs and enhancements were badly needed. This photo is from a decade before the water privatization. Please excuse the quality, it comes from a 1979 Annual Report by the North West Water Authority that serves the Manchester here and the surrounding North West of England region. It shows a road failure due to a sewer collapse in Middleton, Manchester. Such failures were not uncommon. The joint Defra Ofwat history of the industry notes that in 1986 North West Water Authority had on average 23 such serious sewer collapses per 100 kilometers of sewer each year. Neighboring Yorkshire Water Authority to the east was even worse. It had 64 significant sewer collapses per 100 kilometers of sewer per year. The overall UK average was 16. Other common problems included poor drinking water quality, high levels of corrosion in the iron pipes of the water supply network, low water pressure, regular service interruptions, and some serious environmental pollution of multiple water courses. To give some context here, some of the pipe networks can be around a century old at this point. Also at this time, according to Karen Bakker's book on the UK water industry, around 60% of sewage treatment works were failing against their pollution standards. And these standards were already lower than might be expected of a modern water industry, as they'd been devised at the end of the 19th century. The overall 1974 water sector had 75,000 staff, an annual revenue of 2.6 billion pounds, and an annual capital spend of 2.2 billion pounds as stated in 2003, 2004 prices. The combined population of England and Wales was around 49 million people at this time. So on the face of it that's around 53 pounds per capita, capital spend each year at this time, again, in 2003, 2004 prices. But the industry also had an annual operations and maintenance spend of 2 billion pounds. So it was spending over 4 billion pounds a year against annual revenues of around 2.5 billion. In other words, it was running up debt at the rate of about 1.5 billion pounds a year. And this situation had been going on for some time. By the time it was consolidated in 1974, the industry had accumulated 13.6 billion pounds of debt from local authority, central government, and other sources, again in 2003, 2004 prices. Customer water bills were not allowed to rise above inflation until the early 1980s. So by 1982, the total capital spending of the water industry permitted by government was only around half of what it had been spending in 1974. Worse still, following the UK joining the European Union in 1973, large capital investment needs loomed on the horizon for the UK for it to be able to meet EU surface water quality standards. It was estimated, problematically, as we'll briefly see in our next video, that around 28 billion pounds of investment was needed to meet these EU standards, that would soon become binding on the UK. This plot shows the annual capital expenditures of the ten major water and sewerage companies in England and Wales, and of their preceding regional water authorities and other equivalent, and some utilities across the period 1921 to 2015. This plot is in constant 2011 prices. It allows us to see the drop in capital spend from around 1974 to about 1989 that I've just described. Water bills were eventually allowed to increase above inflation from around after 1982. The Public Water Industry managed to reduce its debt to around 9 billion pounds by 1987, again, 2003, 2004 prices here. Capital investment and revenue increased from 1984 onwards. Operations and maintenance expenditure also increased from about 2, to about 2.5 billion pounds. So clearly the dip in capital spending in this graph here was only a temporary situation, and it was related to wider economic conditions. But the lingering consequences of this under investment period. And the upcoming 28 billion pounds of needed investment were nevertheless a strong prerequisite for the later England and Wales water privatization. Our third prerequisite is the existence of a broader UK wide privatization program across a range of UK public utilities and industries. In 1979, tenants in UK public housing, known here as council houses, had been given the right to buy their house, effectively privatizing the state provided housing sector. From 1979, oil and gas company British Petroleum, later known simply as BP, was partly privatized when the UK government sold off 5% of its shareholding. Thus reducing it's holding from majority 51%, down to 46%. The British National Oil Corporation, BNOC, a nationalized body was sold off as Brit Oil, and in fact in 1988 was acquired by BP. The national telecoms industry, British Telecom, or BT, was privatized in 1984. As well as, the gas sector in 1986, airports in 1987, electricity in 1989 and others that followed. Lessons learned from these earlier privatizations were probably brought to bear on the privatization of the England and Wales water industry. In particular, the UK had developed capacity in the field if economic regulation that would be required to control the newly privatized industries. We'll return to this more in a later session. But here we should mention that especially the UK had innovated in new forms of economic regulation, in an attempt, in theory at least, to incentivize utilities to operate and invest more efficiently. Nevertheless, it has been rightly argued that in spite of this experience, water was still different from the privatizations that preceded it. For water, the privatization would involve the creation of ten new private companies, and not simply the creation of a single private company to replace a single state actor. Privatizing telecoms, for example, was also easier to justify, in that it was seen as being able to transition to a competitive commercial market quite quickly. Particularly due to the fast pace of change in telecoms related technologies. It was not so obvious that this competitive market aspect was easily transferable to a regional monopoly configuration that made the most sense to use for the water privatization. The new private water companies also were known to need to make large capital investments to meet EU environmental goals. Which was different from other earlier privatizations again. Due to the ongoing wider program of privatizations, there was also the time and the skills and capacity and willingness not to have to get the proposals for the England and Wales water privatization right first time as it were. Indeed, the first proposals in a UK government Department of Environment discussion paper around 1986, there, the proposal was simply to sell off the entire existing regional water authority model. This would have meant the new private water companies in 1989 operating as both poacher and gamekeeper, as I've heard it described. The private firm might pollute the environment, but it would also be responsible for monitoring, reporting, and controlling its own potentially polluting activities. This was seen as unacceptable. In the 1987 Conservative Party Manifesto, this proposal was modified. It promised a separate, independent environment regulator would be formed for the water privatization. This would be the National Rivers Authority, which later transformed into the wider ranging Environment Agency that we have here in the UK today. Whilst seeing as necessary, to have an independent body regulate the waste water discharge and water cost quality standards of a firm operating in the private sector. This step was criticized as undermining the earlier triumph of integrated river basin management. No longer would a single public authority be responsible to manage the whole water cycle within its river basin boundaries. A commentator I spoke to remembers how deflated he felt after years of championing this principle when he saw the exact wording of the legislation. Simply stating, the loss of integrated river basin management is regrettable, full stop. At the same time, the 1986 discussion paper included many elements that did make it all the way into the 1989 Water Act legislation that underpinned the England and Wales water privatization. In part, this was because the government had commissioned a report into economic regulation options in 1986. The 1986 discussion paper was therefore able to propose many of the elements that were finally enacted in 1989. First, it was proposed that the performance of the ten private water firms should be periodically benchmarked against each other to incentivize better performance. This approach is called comparative competition. Second, whilst the prospect of competition for customers was seen as low in the 1986 paper, it was proposed that private firms would have to compete in capital markets to support their investments. Again, this was seen as a way of driving efficiency into the system. Third, price cap economic regulation was proposed for the privatized water industry. It was already in use for British Telecoms, and was seen as simple, cost effective and adjustable over time. We'll return to this form of regulation in our final session. Fourth, regulation to control quality of service was seen as necessary. It was believed that prices could be inflated whilst underlying costs were reduced by cutting service quality levels, otherwise. Fifth, the 1986 paper discussed but rejected the French model of concession. This is deal structure six from our last session. This is where the public water utility retains asset ownership, but a private firm receives a revenue string from customer. The 1986 paper considered that opportunities for franchise competition would be minimal. Termination cost would be high and would require franchise lengths of around 25 years. So there may not be incentives for franchisees to invest in new infrastructure. A legally binding step with significant social, economic and political ramifications, like a water privatization, is very detailed and complex. So it's clearly a useful prerequisite in the England and Wales case that there had been time and the capacity for several years of consultation on and iteration of the proposals. It's worth pointing out a little bit of the detail of the proposals here for a moment. It affects some of our assessment later of the outcomes of the water privatization. The slide here shows a simplified scheme of how the newly privatized water companies in London and Wales began to operate. And which elements would and would not be subject to economic regulation and environmental regulation. This illustration is adapted from a thicker by Gene Shaoul and her co-author Julie Froud. The Appointed Business, as it's called, that was setup as the core business to deliver water and sanitation services to customers in England and Wales, is shown inside the red box. Legally, this was typically a private limited company, as shown by the letters LTD. Above this, the firm usually formed a separate parent or holding company that would oversee any service companies, land asset management issues, and enterprise or diversify companies. This is the Public Limited Company, the PLC, and it's this part that is typically floated on the stock exchange by offering shares to the public. However, Shaoul and Froud have pointed out that it is only the core or appointed business that is subject to economic and quality regulation by the various bodies. Here, shown as Ofwat. And then the Environment Agency, or EA. There are implications for the perceived, legitimacy and fairness of the financial operations of the private water companies from this decision, that we'll come back to later when we look at outcomes. Finally, it's also worth taking a critical view on, what cause the actual core business that was privatized during 1989? What was it expected to do? Economist Dieter Helm has written about this in a paper in 2005. He took the view that there were three core business activities. The first is probably the business activity you'd expect. That's providing day-to-day utility services of water supply, wastewater removal and customer service to domestic and industrial customers. The second is extensive renewal of what Dida Helm labels antiquated Victorian legacy assets. Here, Helm is referring to the extensive water supply and sanitation systems built in the late-19th century in the UK. This activity has been and remains a major part of the capital program of the England and Wales water industry. So much so, in fact, that Helm asks the question in this paper as to whether the appointed business is actually more of an infrastructure investment business. Where water and waste water products and the customer service that accompanies them is in reality only a marginal cost. This is a controversial point that is disputed by some inside the water industry. Nevertheless, it's interesting to consider, as it relates to the implicit incentive structure in the sector. And may give us a good idea s to some of the investment behaviors and problems we might later expect to encounter. The third business that Helm argues was not sufficiently accounted for at the time of privatization. This is undertaking major environmental quality improvements on a scale far beyond what was originally foreseen at the time of privatization. The real problem here is, Helm argues, that because this environment improvement are so large, should there be more discussion about who they benefit? And who should pay for them? The 4.2 billion pounds Thames tunnel that's currently being bored out underneath the UK capitol city of London to make up for design flaws in the original 19th century London sewer system is a case in point here. We discussed this case in our part one MOOC. The Thames tunnel will capture discharges from London's old interceptor sewers that combine highway and rain runoff with sewage in a single system. This system was built to overflow into the river Thames that runs through the center of London, as a safety valve instead of flooding London's businesses and homes. The 15 million water and sanitation customers of the private firm, Thames Water, will be paying for it. At an estimated additional cost on their annual water bill of around 20 to 25 pounds. And that's on top of an average annual water bill at the moment of about 365 pounds. But who really does benefit here? The whole of the UK from the improved international reputation, tourism, and inward business investments that might float from a cleaner River Thames? So should there be a national tax for this scheme instead? Are the beneficiaries really the customers of the private firm, Thames Water, just because that's how its area of service boundaries were set up at the time of privatization in 1989? Or are the beneficiaries only, say, the 1.4 million households in inner London who might regularly get to see and enjoy the improved environment of the River Thames? These decisions matter. This final option for just the $1.4 million in London households to be charged would mean ten times the additional cost on their household bills. Say adding 250 pounds to an average 364 pounds annual bill rather than just the 20 to 25 pounds. The Thames tunnel case is so large, more than double Thames Water's annual revenue in 2015 in fact, the debates around who benefits and who pays have had to happen for this case. But there are many other significant projects that perhaps have not been subjected to such scrutiny. In our next video, we'll look at the next step in the England and Whales water privatization process. Beyond the historical setting and the four prerequisites we've seen in this video. That's consolidation, investment shortfalls, learning from earlier privatizations, and iterating proposals. We'll move to look at the difficult issue of setting a sale price for the water privatization. Thanks for watching this video.
