1. COMPARATIVE ADVANTAGE OF PUBLIC OWNERSHIP: EVIDENCE FROM U.S. ELECTRIC UTILITIES John Kwoka Professor of Economics Northeastern University

2. BACKGROUND  Megginson and Netter (2001): “Research now supports the proposition that privately owned firms are more efficient and more profitable than otherwise-comparable state-owned firms” “Research now supports the proposition that privately owned firms are more efficient and more profitable than otherwise-comparable state-owned firms”

3.  Boardman and Vining (1989): Only “…weak support for the hypothesis that public enterprises perform less efficiently”  Peters (1993): “ The evidence indicates quite strongly that there is either no statistically significant difference …or that nonprofit [publicly owned] utilities in fact outperform for-profit utilities”

4. REASONS FOR DIFFERENT FINDINGS  Measurement: Subsidies Subsidies  Intervening factors: Regulation Regulation Competition Competition  BUT…differences in results persist even after correcting for these factors

5. THEORETICAL DEVELOPMENTS  Laffont and Tirole (1991): Manager of regulated firm is agent with two principals Manager of regulated firm is agent with two principals Dilutes incentives Dilutes incentives Creates externalities among parties with residual rights of control Creates externalities among parties with residual rights of control  Shapiro and Willig (1993): Public ownership provides Better access to information Better access to information Needed by regulator in its task Needed by regulator in its task

6.   Hart, Schleifer, and Vishny (1997): Contractual incompleteness results in Stronger incentives for private entity to pursue objective that is easily observed and rewarded Stronger incentives for private entity to pursue objective that is easily observed and rewarded Lower “quality” Lower “quality”   Laffont and Tirole (1993) conclude: “ Theory alone is unlikely to be conclusive…” “ Theory alone is unlikely to be conclusive…”

7. REASONS TO THINK THESE FACTORS MATTER  Wide range of empirical findings about public vs. private enterprise Remains true even after corrections Remains true even after corrections  Results seem to vary by industry Systematic pattern to local services Systematic pattern to local services Boardman and Vining’ s survey reports Boardman and Vining’ s survey reports - Private ownership clearly better in 6 of 9 industries - Some mix of evidence in two other cases (water, refuse) - Even division of studies in electric power - Even division of studies in electric power

8. METHODOLOGY  Examine a single industry Holds much else constant, including competition and regulation Holds much else constant, including competition and regulation Solves problem of comparison group Solves problem of comparison group  Study the electric power industry in U.S. Many public and private enterprises Many public and private enterprises Both perform similar functions-generation, transmission, distribution Both perform similar functions-generation, transmission, distribution Intensively studied industry, with conflicting results Intensively studied industry, with conflicting results

9.  Functions differ in contractible quality and informational properties Generation is Generation is Large-scale production activity Large-scale production activity Impersonal wholesale markets Impersonal wholesale markets Informed buyers Informed buyers Contractual penalties Contractual penalties Distribution is Oriented toward end-users Oriented toward end-users Numerous, mostly small Numerous, mostly small Service more important but difficult to specify Service more important but difficult to specify Weaker contractual provisions Weaker contractual provisions

10. IMPLICATIONS  Characteristics of product, buyers, and transaction suggest Public enterprise more suited to distribution function Public enterprise more suited to distribution function Private enterprise better equipped to perform generation Private enterprise better equipped to perform generation HYPOTHESIS AND TEST HYPOTHESIS AND TEST  Publicly owned and privately owned electric utilities each specialize where they have a comparative advantage  Need to look at electric utilities distinguishing each output, rather than at entire enterprises

11. DATA OVERVIEW  543 utilities in data base 396 public systems, 147 private 396 public systems, 147 private Account for 87% output in 1989 Account for 87% output in 1989   Patterns of generation 139 of 147 private systems generate 139 of 147 private systems generate Only 163 of 396 public systems do Only 163 of 396 public systems do

12. DO THEY? Only DistributeGenerate Some PowerTOTAL Public233163396 Private8139147 TOTAL241302543

13. EMPIRICAL MODEL  Basic model is multi-product quadratic cost function C(DIST, GEN) = a 1 + a 11 DIST + a 12 DISTSQ + a 21 GEN + a 22 GENSQ + a 3 DISTGEN + e  Allows for: economies of scale in distribution and in generation economies of scale in distribution and in generation economies of multi-product operation economies of multi-product operation

14.  Total cost measured by Operation and maintenance Operation and maintenance Depreciation and amortization Depreciation and amortization Cost of capital Cost of capital Public “subsidies” Public “subsidies”  Control variables include Prices of fuel, labor, capital Prices of fuel, labor, capital Number of customers Number of customers Percent generation capacity that is hydro/nuclear/steam Percent generation capacity that is hydro/nuclear/steam Purchased power Purchased power Holding company subsidiary Holding company subsidiary

15. MULTIPRODUCT COST FUNCTION WITH ECONOMIES OF SCALE AND MULTIPRODUCT ECONOMIES

16. REGRESSION ANALYSIS OF EFFECT OF PUBLIC OWNERSHIP ON TOTAL COST Independent Variable a DISTRIBUTION22.0 DISTRIBUTION SQUARED1.67** GENERATION-38.6* GENERATION SQUARED1.85** DISTRIBUTION x GENERATION-3.43** FIXED COSTS OF GENERATION10.1 PURCHASED POWER15.5** * significant at 10% **significant at 5%

17. REGRESSION ANALYSIS OF EFFECT OF PUBLIC OWNERSHIP ON TOTAL COST Independent Variable a b DISTRIBUTION22.049.8** DISTRIBUTION SQUARED1.67**1.43** GENERATION-38.6*-82.0** GENERATION SQUARED1.85**1.86** DISTRIBUTION x GENERATION-3.43**-3.16** FIXED COSTS OF GENERATION10.10.67 PURCHASED POWER15.5**14.4** PUBLIC x DISTRIBUTION-23.1** PUBLIC x GENERATION46.4** * significant at 10%, **significant at 5%

18. REGRESSION ANALYSIS OF EFFECT OF PUBLIC OWNERSHIP ON TOTAL COST Independent Variable a b c DISTRIBUTION22.049.8**44.8* DISTRIBUTION SQUARED1.67**1.43**1.56** GENERATION-38.6*-82.0**-79.8** GENERATION SQUARED1.85**1.86**1.93** DISTRIBUTION x GENERATION-3.43**-3.16**-3.33** FIXED COSTS OF GENERATION10.10.67-8.23 PURCHASED POWER15.5**14.4**12.0* PUBLIC x DISTRIBUTION-23.1**-15.8* PUBLIC x GENERATION46.4**42.6** PUBLIC-52.9**

19. Independent Variable a b c d DISTRIBUTION22.049.8**44.8**44.5* DISTRIBUTION SQUARED1.67**1.43**1.56**1.55** GENERATION-38.6*-82.0**-79.8** GENERATION SQUARED1.85**1.86**1.93**1.91** DISTRIBUTION x GENERATION-3.43**-3.16**-3.33**-3.32* FIXED COSTS OF GENERATION10.10.67-8.231.88 PURCHASED POWER15.5**14.4**12.0*11.8* PUBLIC x DISTRIBUTION-23.1**-15.8*-36.0** PUBLIC x GENERATION46.4**42.6**27.9 PUBLIC-52.9**-32.3 PUBLIC x DIST. SQUARED2.38* PUBLIC x GEN. SQUARED -15.2

20. RESULTS  Distribution output produced more cheaply by publicly owned systems  Generation performed more cheaply by private systems  Public systems also have lower fixed costs

21.  Estimates imply lower overall distribution cost for public ownership when: - 36.0 DIST + 2.38(10 -6 ) DISTSQ < 32.3(10 12 ) or DIST < 16.0 million mwh

22. ESTIMATED EFFECT OF PUBLIC OWNERSHIP ON DISTRIBUTION COST Distribution Cost PUBLIC OVERALL 16M

23. ESTIMATED EFFECT OF PUBLIC OWNERSHIP ON GENERATION OUTPUT Generation Cost PUBLIC OVERALL

24. NET SIZE EFFECTS  Results imply weakened incentives in large distribution systems, even if publicly owned  Of 396 public systems in data base, 394 have distribution output < 16.0 million mwh

25. NET OWNERSHIP EFFECT  Overall cost effect of public ownership depends on actual DIST and GEN  At mean values of DIST and GEN, net cost difference in favor of public systems = 2.5%

26. QUALITY  We need to examine quality Theory emphasizes unobservable quality Theory emphasizes unobservable quality Possible that lower costs due to poorer quality Possible that lower costs due to poorer quality  Quality evidence much sparser  Some data on System Average Interruptible Duration Index, defined as average annual number of minutes that a customer is without service

27. MEAN INDEX VALUES FOR SAIDI Ownership (a)(b) YearPRIVATEPUBLIC 1991228103 199210444 199313977 199418286 199716574 1999210107 20008623 2001174121

28. MEAN INDEX VALUES FOR SAIDI SIZE YEAR SmallMediumLarge 199779NA 162 199995206184 2000176857 2001113179166

29. CONCLUSIONS REGARDING QUALITY  No evidence that cost effect is due to lesser quality of service by publicly owned systems  Evidence is that they provide higher quality service  Best evidence also suggests that both the quality and the cost effects are size-dependent

30. METHODOLOGICAL NOTE  Past studies of the effects of public ownership come to variety of conclusions  Reasons: Inadequate controls Inadequate controls Inadequate data bases Inadequate data bases Inflexible modeling Inflexible modeling Inattention to generation vs. distribution Inattention to generation vs. distribution

31.  Inattention to distinction between generation and distribution can mislead  Regression with simple fixed effects term for PUBLIC ownership standard approach standard approach results in insignificant coefficient on PUBLIC results in insignificant coefficient on PUBLIC  This specification hides very different effects of ownership in generation vs. distribution

32. CONVENTIONAL ANALYSIS OF PUBLIC OWNERSHIP AND TOTAL COST DISTRIBUTION21.5 DISTRIBUTION SQUARED1.69** GENERATION-38.3 GENERATION SQUARED1.86** DISTRIBUTION x GENERATION SQUARED-3.46** FIXED COSTS OF GENERATION7.60 PURCHASED POWER15.4** PUBLIC-13.6 ** Significant at 5%

33. CONCLUSIONS  Substantive: No simple conclusion about public vs. private utilities No simple conclusion about public vs. private utilities Each has comparative advantage Each has comparative advantage  Methodological: Draws on modern theory Draws on modern theory Illustrates importance of flexible specification Illustrates importance of flexible specification

34.  Policy: Neither public nor private ownership is always better Neither public nor private ownership is always better Important to identify underlying conditions in order to determine which regime is better suited to circumstance Important to identify underlying conditions in order to determine which regime is better suited to circumstance - Product characteristics - Product characteristics - Transaction characteristics - Transaction characteristics - Buyer characteristics - Buyer characteristics - Market characteristics - Market characteristics