In this video, we'll look at some apparent bad news outcomes of the England and Wales water privatization case. We'll examine some data and analysis from a relevant 2001 report by the Public Services International Research Unit, or PSIRU, based at the University of Greenwich here in the UK. We'll also use a 2004 book by Massimo Florio, attempting a wealthy impact assessment of all the British privatizations, including water, from 1979 to 1997. We should note though that neither of these sources provides a dynamic baseline for counter factual. In other words, there's no comparison of water privatization with what would have happened if the England and Wales water sector had not been privatized. We have only a comparison of what happened with the status quo conditions before privatization. So we'll present some of our own views to provide a more balanced assessment. You may also want to think about what pieces of evidence you feel are missing here to complete the story and what kinds of questions you might have to start asking to find them. We can recall from our earlier video that one promise of privatization was that in the private sector, the water industry might be motivated to be more efficient. This could be due to more access to professional management approaches, adaption or development of better technologies, and being able to capture profits rather than returning this to the state. One aspect of criteria efficiency could be labor productivity. This is a measure of the amount of GDP produced per hour of labor. On this first possible measure, Florio's book suggests that there is only weak evidence for any significant upward trend after water privatization, at least in the period of his analysis up to 1997. Second, Florio states that whilst most public offerings like this are usually underpriced then underperform, the England and Wales water industry, he feels, was underpriced but then outperformed. The bad news outcome here is what Florio calls persistent excess profits, presumably above and beyond what he might reasonably have expected. The PSIRU report also highlights a laxity, as Florio would call it, in regulatory controls over these early post privatization monopoly profits. The PSIRU report indicates a 147% rise in pre tax profits across the period from 1990 to 1998, and this was certainly bad news for the water companies. It generated much bad publicity for them, and reinforced perceptions about financial abuses in the England and Wales privatized water sector that persist to the current day, as we'll see. But this was also an area where the water sector regulators did respond with tighter price controls. This was particularly the case in 2000, with a one-off over 10% cut in prices. This was spearheaded by the then-director general of Ofwat, Sir Ian Byatt. In fact, Sir Ian had already called for a one-off cut of around 20% before negotiations brought this figure down. To track the duration of any apparent persistent excess profits, it's useful to look at the plot of the sectors post-tax rate of return over time. You can see in this plot how the 12 to 13% post-tax rate of return permitted in the early days of privatization slowly tailed off towards 2000. It later then stabilized at a lower rate of around 6%. Of course, there was no pre-privatization rate of return indicator for the ten major regional water authorities for us to compare to here, but we do know the pre-privatization profit cap on the smaller water-only companies. That's the smaller firms that were always operating in the private sector, even before privatization. These water only companies represented about 6% of the overall modern equivalent asset value of the overall England and Wales water industry and privatization in 1989. And they were regulated with a simple cap on their profits at a maximum rate of return of 5%, I'm quoting here the PSIRU report. So the later rate of return figure for the ten major water and sewage companies does not seem too far from this already accepted rate. And we know from our earlier video on the water privatization sale price, that there was also higher inflation and higher interest rates in the early 1990's, so these early post-privatization rates of return must be understood against that wider economic background too. Turning to Florio's third piece of apparent bad news, he considers that water price rises above inflation after privatization were regressive for consumers. One upward pressure on prices was, as we've mentioned in earlier videos, the implicit environmental tax, as Florio labels it, embedded in prices to meet future increased environmental standards. Florio further notes that construction costs are decreased after privatization, but that these did not translate into lower water bills for consumers. Fourth, Florio considers that the whole program of British privatizations, including the water privatization in England and Wales, resulted in a dramatic fall in the UK public sector's net worth. A fifth aspect of Florio's welfare impact assessment was to look at employment conditions and labor relations. Florio's main points here are that privatization marginalized trade unions in the water sector. Although this was also a byproduct of the post privatization diversification behavior of the privatized water companies into some areas that had a lower degree of unionization. We noted in an earlier video that the England and Wales water sector in public operation had about 75,000 employees in 1974. By 1980, this had apparently reduced to around 60,000. Then, by 1988, just before privatization, the figure was down to around 40,000, or down about 30%. There had always been waves of recruitment at key movements in the public sector water industry. This was whenever budgets and political priorities had permitted it, such as during the reorganization into Regional Water Authorities in 1974 that we've mentioned before. There were also additional few thousand staff working in the environmental and flood defense functions on top of these numbers in the 1980s, perhaps as many as 7 or 8,000 people. Part of the reason, perhaps, that Florio fails to find much of a labor productivity increase after privatization, is that from 1989 to 1992, direct after privatizations, staffing levels increased back up to 55,000, seemingly not far from the original 1980 levels. We should point out that there can be counting errors here, though. A separate source, a report from Peter Bailey in 2003, who was an environment agency research fellow at the Center for the Study of Regulated Industries at the University of Bath School of Management, puts the number of staff in 1990-1991 at more like 46,000. Peter Bailey also suggests the opposite of Florio and shows a significant rise in revenue per employee directly employed by the England and Wales water industry. This is over the period of 1985-1986 to around 1990-91 and beyond. The issue here is various new jobs were created, that is roles for regulators, consultants, contractors and so on in privatization. So direct numbers here of employees can be misleading if they're used in labor productivity calculation. More broadly, Florio does not find much evidence of major changes to work conditions for employees, at least up until the end of his analysis in 1997. This is even though before privatization, there had been concerns about say, salary reductions, overtime entitlement reductions, increases in job duties, decreases in job security, or increased difficulties in securing promotions. From my own research, a related bad news issue has been a perception of the England and Wales privatized water industry as a fairly unattractive career for young graduates. This has reportedly led to difficulties in finding recruits with the right skills in the sector, and difficulties in holding onto them for longer periods whenever they are found. But in my view this is not a bad news outcome that is directly attributable to privatization. It perhaps reflects wider changes in the UK and global labor markets. This graph shows the staff numbers for the precursor to the regional private water company for Manchester and its surrounding area. United Utilities, formerly known as North West Water Limited, and before that the North West Water Authority. During its time as Northwest Water Authority, leading up to privatization, staffing levels were cut by almost 24% between 1980 and 1989. Some water authorities cut more, like Thames at Anglian, at more like 37%. This next chart shows staffing levels up to 1999. Six of the ten major water and sewage companies cut staff numbers over this period, from 1990 to 1999. Two had fairly consistent staffing levels, and only one of the major privatized water companies, Northumbrian, increased it's number of employees here. Perhaps the overall trend here seems like a privatization bad news outcome, say if you were an employee in the privatized water sector. But from a labor productivity point of view, there may be some good news here. This is indeed directly suggested by Peter Bailey's analysis, which caveats about direct employee numbers accepted. Shows an increase from 82,000 pounds revenue per direct employee in 1985, 86, to 200 pounds revenue per direct employee in 2000, 2001. Both of these figures being in 2000 to 2001 prices. That's an almost two and a half fold increase in labor productivity. Looking again at our local privatized water utility for Manchester, United Utilities, this latter assessment by Bailey seems to ring true, as the longer term trend, perhaps. Say, instead of Florio short term, post privatization bad news on this point. United Utilities moved from around 3.2 million connections, that's households and businesses combined, serviced by 7,000 employees in 1990, to roughly the same number of connections serviced by just 4,200 employees in 2011. This represents a change from roughly 457 water and sewage connections per UU employee in 1990 to around 762 connections per employee in 2011. That's a more than 60% efficiency improvement, at least in terms of the number of connections per direct employee again. This is perhaps good news for customers and investors, yes? So again, it's worth stressing that good or bad news outcomes here are highly dependent on the perspective we take and on the time period we choose to look at them over. The excess monopoly profits that Florio has highlighted is certainly an issue that's worth discussing in a little more detail here though. Living in the UK over the years, I've seen many headlines criticizing the salaries of the heads of the England and Wales privatized water companies. Try Googling fat cats, water, and UK, and you'll see what I mean. Newspaper media and public outcry around these salary levels has often been linked to particular problems certain water companies have faced since privatization. So again, it's context specific. For instance, you're likely to pick up the water company Yorkshire Water in your Googling about water fat cats, if you're looking in 1990s. That's because Yorkshire Water's customers suffered a severe drought in 1995 and Yorkshire Water was widely criticized here for its poor response. In my research I've recalled meeting a plastic water pipeline supplier and installer. They'd been contracted to connect very quickly parts of the Yorkshire water pipe network to alleviate these drought problems. The contractor had delivered sections of pipe over hard to access parts of the Penine Hills that run through the center of England by helicopter before installing them. He definitely enjoyed this rare experience, but he was the first to admit it wasn't particularly a cost effective approach. In response to media and public outcry, and under regulatory pressure, Yorkshire did eventually take strategic decisions to integrate its clean water pipe network into one system. This overcame water resource problems it had faced previously with its patchwork of unconnected reservoirs and water supply infrastructure. Nevertheless, it's not surprising to come across headlines, say, in the Independent newspaper in 1998, with the headline fat cat Yorkshire Water chiefs get 30% pay bonus. The legitimacy of the sector in the eyes of citizens and in the way the sector is being represented in the press has been seriously undermined by such events. And this problem has not gone away. It remains a bad news story that reappears from time to time. For instance, let's fast forward to 2010. Then you'll find this headline in the Daily Mail newspaper. The 10 million pound water fat cat Unions savage pay-out to boss who quits for another monopoly. This concerns former chief executive of private water firm Anglian Water, Johnson Cox. He was given a so called golden handshake on severance paid package of nearly ten million pounds when he left Anglian in 2010 to move up head UK coal. An interesting footnote here is that Johnson Cox since became the chairman of the England and Wales water sector economic regulator Ofwat. At the same time though, we should balance our bad news account of this public and media legitimacy problem for the privatized water companies. The board of neighboring water company, Scottish Water, which remains in public sector ownership and operation, has also been criticized in the Telegraph newspaper in 2012. This was when salary bonuses of up to 370,000 pounds Sterling were awarded to its board. This mimicry of salary levels in neighboring organizations in the same field as it were, one private one public, is something that deserves more attention. But it's beyond the scope of what we're attempting here for now. Similarly we should note that fat cat behavior was not universal in the privatized water sector of England and Wales. This table shows remuneration levels of the highest paid directors in the ten major privatized water companies from 1990 to 1998. Some private water companies have been worse offenders than others. For instance Anglian already mentioned shows a 200% increase in constant 1997 1998 prices in this table. There's also a 150% increase here for NorthWest Water, now United Utilities. However, SouthWest Water here, slightly reduced the salary of its highest paid director of this period. And for Thames Water, the increase was only a more modest 7%. Another exercise in Googling you might wish to undertake, is to search for UK Water and Corporation tax. You're likely to return headlines such as these from the Telegragh newspaper in November 2012. Britain's largest water companies pay little or no tax, or this one from the The Daily Mail in June 2013, 1 billion pound tax dodge by water profiteers. As your bills soar, seven of the UK's foreign owned firms pay peanuts in tax. Or even this one from June 2013 on BBC News. Thames Water paid no UK corporation tax for the year. This reported tax avoidance, whilst clearly not the same thing as illegal tax evasion, is a bad news outcome from the England and Wales water privatization. This kind of corporate behavior is also an unwelcome trigger, when thinking back to our strong ancient instincts about putting a price on water. Part of the problem here is the appropriate design and accountability of taxation policy for private companies, like these privatized water utilities. A related problem though, is just how difficult it is to gain transparency, and to understand where the money is going within the current day structures of some of these privatized water companies. And then to design and implement national tax policies that can have any effect here. This picture shows the structure of Yorkshire Water. This is the privatized water company that supplies my own home where I live some distance outside Manchester. I'm taking this diagram, again, from the Director of Strategy at Ofwat, Andrew Beaver. And I should point out that it's already a simplified ownership structure. At the top of this diagram, we have venture capital firm, Citi Infrastructure Investors with a 47% stake in the Yorkshire Water structure. Then we have global investment firm, GIC Infra Holdings with a 33% stake. And then there's European infrastructure investor, intercapital partners nearly 20% states. Undernet this is a scale of independency of Jersey, which has a corporate tax of zero, then scale the gate of company is then a series of intermediate holding companies of an entity that's called Soltaire Water. This is the holding company of the group of private investors above it that bought Kelda Group PLC in 2008. Yorkshire Water PLC, which was the holding company of the regional water authority that was privatized in 1989 renamed itself the Kelda Group PLC in 1999. The company underneath, Yorkshire Water Services Limited is the actual regulated water and sewage company that serves me. This is the name that I see on my annual water bill. Kelda Group also has a set of non-regulated, diversified companies. These are Loop Customer Management, which provides call centered services to customers of Yorkshire Water and Kelda water services, an infrastructure services business that is base on Yorkshire's experience with large scaling infrastructure investment. And finally, these key land developments described on his website as a team of property and planning professionals specializing an unlocking development potential of underutilized planned. Operating across Yorkshire for over 20 years and regenerating Yorkshire waters redundant sites. Are you keeping up? It's a complicated structure, isn't it? And this is just an example for only one of the major ten water and sewage companies in the Wales. Arrangement cells were vary from the structures shown here, as Yorkshire is held by a group of private investors. That means it's no longer listed on the London Stock Exchange, unlike some of the other major water companies. The complex flows of money within such structures and the degrees of separation from the customer facing company in this example, my supplier, Yorkshire Water is a challenging issue, but is it necessarily bad news? That's hard to say, but our opinion is yes. To summarize, in this bad news water privatization outcome video, a balanced view seems to be that we've seen a mix of both perceived bad news and some actual bad news. Some of the bad news outcomes, like corporate salary and tax avoidance successes were probably avoidable. Stronger corporate social responsibility and better regulatory controls could perhaps have avoided these altogether and even in our actual bad news, we've had to be careful about the perspective and the time period we've considered. Certainly, post-privitization excessive monopoly profits a bad news for citizens. But in the longer term, these seem to be addressed back down to more acceptable levels. Similarly, nobody wants to see people lose their jobs. There were some upward and downward trends here. But overall, the staffing levels in the privatized England and Wales water company seem to have reduced. From anther perspective though, this seem to have brought increased deficiency from labor productivity at least perhaps after the short-term period following privatization where the evidence seems less clear. You’ll note that given the complexity in scale of the task of assessing the outcomes of the Edenton, Wales’s water privatization. We've already to keep our evidence here to strictly black and white good news, and bad news outcomes in these videos. In our final video, we'll walk into seemingly more muddy of muddier waters and look explicitly at a set of unclear outcomes. These are areas where there seems to be very little evidence or adjustment of the outcome requires seeing how certain underlying trends play out in the future. Thanks for watching this video.
