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Indiana University + School of Public & Environmental AffairsCenter for Urban Policy & the EnvironmentV. Renegotiating. the Regulatory ContractPublic utility regulation is based on an enduring social contract between the government ·and utility companies. In return for having an exclusive franchise, free from "ruinouscompetition," the utility agrees to provide safe, adequate, reliable, and nondiscriminatory servicewithin the boundaries of its service territory and subject utility investments, .rates, and returns toregulatory scrutiny. Several fundamental principles-prudence, used and usefulness, justness andreasonableness-guide utilities and regulators in these endeavors.In the changing environment of public utilities and regulation, the time is right torenegotiate the regulatory contract based on new economic, technological, and public policyconsiderations. The social contract of the past was generic; it applied to all of the public utilitysectors rather uniformly. The new social contract should be industry-specific; the needs andcircumstances of water utilities and their customers should guide policymakers as they draw up amodern social contract for the water industry.Controlling Utility Monopolies:The Fundamental ChoicesPublic OwnershipifEconomic Regulation.0,CompetitionThe traditional social contract is basedon the idea that economic regulationsubstitutes for public ownership on the onehand and competition on the other. Nowhere is this tension clearer than in the waterindustry. A leading structural characteristicof the water industry is the complex andfragmented pattern of ownership. Thiscomplexity is matched in regulation by thedifferent patterns of jurisdiction and authority for the water industry among the states.As summarized in Table 3, with each type of provider (publicly-owned, regulated, andcompetitive) different characteristics and mechanisms apply. For example, albeit anovergeneralization, municipal utilities are accountable to voters, regulated utilities are accountableto ratepayers, and competitive utilities are accountable to customers. Indeed, one sign of thetimes is the growing preference for the term "customer" over the term "ratepayer."Many water utilities welcome the idea of competition, while also being concerned aboutreconciling competition and regulation. When it emerges, competition among utilities providesthe economic discipline that the state no longer must provide through regulation. Competitionrequires willing buyers and sellers for an essentially undifferentiated product, as well asreasonable opportunities for market entry. For economic, technical, and institutional reasons,competition in the water industry may be difficult to realize. As long as monopoly powerpersists, some form of economic oversight is needed to prevent excessive profits and ensureperformance and accountability on the part of the water provider.15
Indiana University + School of Public & Environmental AffairsCenter for Urban Policy & the EnvironmentTable 3A Theory of Providers and PerformanceType of Guiding Focus of · Motivation Mechanism of Mechanism Mechanism forProvider Performance Effort Accountability for Consumer ControllingPrinciple Protection BehaviorPublicly Service Controlling Political Voters Public Elections andowned prices support ownership other politicalprocessesRegulated Prudence Meeting Compliance Ratepayers Regulatory Rules andstandards proceedings regulations'Competitive Eft1ciency Cost control Profits Customers Consumer Markets andchoice competitionSource: Author's construct.Competition in the water industry is perhaps most apparent in the area of contracts. Insome cases, utilities compete for acquisitions of smaller utilities or for extending service into newareas. Although competition for ownership in the water industry may be limited, some watermarkets appear to be contestable in this regard. A leading example is when a municipalityconsiders using powers of eminent domain to "condemn" and take over a water utility. Followingthe acquisition, the same municipality also might entertain competitive bids from alternativeproviders of operation and maintenance services. Among other things, this form of ownershiptransfer often will remove the utility from pubic utility commission jurisdiction.The contestable form competition between publicly and privately owned water utilities isgreatly distorted by the advantages of public sector in terms of tax exemptions, access to capital(including governmental loans and grants), absence of state economic regulation (for the mostpart), and the ability to subsidize the cost of providing water service. These factors combine togive municipalities a competitive advantage, especially in terms of water pricing. In theory, acontestable market provides utilities with performance incentives. Whether or not contestabilitycan provide the same level of discipline as competition or regulation (and substitute for theseinstitutional mechanisms) is not well known. 1313In Kansas, an investor-owned utility is not commission regulated if it serves only within the boundaries of onemunicipality. A "contestability" interpretation of this provision suggests that municipal control and perhaps thethreat of takeover is sufficient for economic regulatory purposes.16
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