DP8423 | Enhancing the Efficiency of Water Supply ? Product Market Competition versus Trade

Publication Date

01/06/2011

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Abstract

In most developed countries, the provision of water is organized at a local level. The costs and tariffs vary significantly, even between adjacent water utilities. Such heterogeneity is an obvious indication of the sector?s overall inefficiency and stresses a need for institutional adjustments. We show that cooperation by water trade and the introduction of competition by common carriage between adjacent utilities are valuable alternatives to improve the industry?s efficiency, even when mergers are not feasible. Because both approaches require the physical connection of neighboring networks, they may have similar effects. This paper analyzes and compares the relevant welfare gains and shows that production efficiency and retail prices may differ depending on the initial cost differential, the application of regulations and the distribution of bargaining power. Using a theoretical model, we show that at higher initial production cost differentials, welfare is higher under competitive conditions, even in a lower-bound benchmark case without any regulation.