The State Wades In; S. Hanke

Steve H. Hanke The State Wades In MANAGEMENT of water resources by the government can often encumber their wise development and use. To illustrate this problem, I offer a case study about the life and death of a private water company. A small private water company was created in 1936. Its purpose was to supply, through a central system, potable water for 300 connections in a stable, rural community. To protect the public interest, the state regulated the company through its Public Service Commission. The rates charged by the company re quired the Commission's approval. As a result of the Commission's de cisions, the company's water rates were less than the real cost of sup plying water. These artificially low prices re Steve Hanke is a professor of applied economics at the Johns Hopkins University. He served as a senior economist on President Reagan's Council of Eco nomic Advisers.

This article is reprinted by permission from Cornell Executive, Spring 1982. Facts in this study are from a recent federal court case. suIted in two problems. First, cus tomers were not given the proper in centives to conserve, so their water use increased. This growth taxed the system's capacity, particularly dur ing the hot dry summer months. Lacking the Commission's approval to raise prices or to expand capacity, the company was forced to institute water-use restrictions periodically. These were viewed by the Commis sion, local politicians, and cus tomers as symptoms of inadequate water service and poor manage ment. Deterioration of the system-the second problem-began to appear in the 1970s, when components of the original system began to leak. In 1977, the company recognized that capital improvements costing $500,000 were necessary to assure adequate service, and it planned to make these improvements in three stages.

The company's revenues for 1977, THE STATE WADES IN 661 however, were only $30,000. These were not adequate to cover its oper ating costs. Since the company could not generate investment funds ei ther by self-finance or by a new bond issue, it applied for a rate increase. This additional revenue would have allowed it to attract financing for capital improvements. The Commis sion, however, denied the rate re quest, even though the rates had not been changed since 1968. After denying the request, the Commission held hearings to deter mine the adequacy of the existing system and the need for improve ments. During these hearings, a government agency alleged that it could obtain a federal grant and that it could use the grant to purchase the company's assets, to make im provements, and to provide water at an annual cost of only $15,000. The Commission concluded that, even if the water company could fi nance its improvements, the result ing rates would be burdensome, and that the consumers would be better serviced if the government agency assumed the responsibility for water supply. So the Commission revoked the water company's right to exer·· cise its franchise. It also ordered the agency to assume operation of the system and to apply for the federal grant.

After several months, the agency discovered that it could not meet even its out-of-pocket operating expenses with the existing rates, which gen erated $30,000 per year. It, there fore, raised rates to $60,000 per year-the level that the Commis sion had earlier denied to the pri vate water company. The agency could do this because its rates were not regulated by the Commission. Shortly after assuming responsibil ity for the new system, the agency discovered that money from federal grants could not be used to purchase existing systems. This money could be used only to make new capital investments. The agency correctly concluded that its least costly option was to use a federal grant, which covered 75 percent of any new capi tal works, to construct an entirely new, duplicate system. A new sys tem was built for $1.2 million. It was financed by $900,000 from a federal grant and $300,000 from the agency.

The mismanagement by the gov ernment of a local water problem had produced three unanticipated-and unfortunate-results. A private en terprise was asphyxiated, customers received the same service at a higher price, and re~ources were wasted, since a govern$ent agency spent $1.2 million for a service that could have been provided privately for only $500,000. Moral: If you allow the govern ment to manage a water problem, you may at fir$t find the solution at tractive. In the end, however, you will pay and pay. ® Jack D. Douglas A REBIRTH OF ECONOMICFREEDOM: The De-Bureaucratization of AmericanBusiness WE AMERICANS have always cher ished our economic freedom as a vi tal pillar in the foundation of our "natural system of liberty." As in Britain before us, we have always cherished the spirit of the indepen dent yeoman or freeholder as the embodiment of this value. As the typical American would put it to day, "I don't like taking orders from anyone. 1 want to be my own boss."