Thoughts on economics and liberty

Category: Economics

Cryptocurrency taxation – Take 2

I had written this around 18 months ago: How governments can benefit by imposing a range of taxes on cryptocurrency

I’ve completely changed my mind regarding capital gains tax on the increase in the value of cryptos.

Competitive neutrality requires that the government NOT tax the increase in value of cryptocurrency. If it were to do so, it would then need to allow us to debit as a capital loss the annual reduction in value in fiat currency from our income tax returns.

If cryptocurrency is an “asset” then fiat currency is a loss making “investment”.

If cryptocurrency has the characteristic that it appreciates in value over time, fiat currency has the characteristic that it falls in value over time. The mere fact that private currency appreciates while fiat depreciates doesn’t mean that one can be taxed for capital gains. Both need to be treated exactly the same. If crypto is taxed for gains, the fiat losses must be charged towards capital loss

 

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Against the government’s licensing of doctors – Milton Friedman

Adam Smith wrote against the monopolistic tendencies of doctors but Friedman’s doctoral research took him much further into this area. He then wrote a book: Incomes from Independent Professional Practice [The book is available here for download].

VIDEOS

This one.

and this:

and this:

And chapter 9 of his book, Capitalism and Freedom.

Medical Licensure

The medical profession is one in which practice of the profession has for a long time been restricted to people with licenses. Offhand, the question, “Ought we to let incompetent physicians practice?” seems to admit of only a negative answer. But I want to urge that second thought may give pause.

In the first place, licensure is the key to the control that the medical profession can exercise over the number of physicians. To understand why this is so requires some discussion of the structure of the medical profession. The American Medical Association is perhaps the strongest trade union in the United States. The essence of the power of a trade union is its power to restrict the number who may engage in a particular occupation. This restriction may be exercised indirectly by being able to enforce a wage rate higher than would otherwise prevail. If such a wage rate can be enforced, it will reduce the number of people who can get jobs and thus indirectly the number of people pursuing the occupation. This technique of restriction has disadvantages. There is always a dissatisfied fringe of people who are trying to get into the occupation. A trade union is much better off if it can limit directly the number of people who enter the occupation—who ever try to get jobs in it. The disgruntled and dissatisfied are excluded at the outset, and the union does not have to worry about them.

The American Medical Association is in this position. It is a trade union that can limit the number of people who can enter. How can it do this? The essential control is at the stage of admission to medical school. The Council on Medical Education and Hospitals of the American Medical Association approves medical schools. In order for a medical school to get and stay on its list of approved schools it has to meet the standards of the Council. The power of the Council has been demonstrated at various times when there has been pressure to reduce numbers. For example, in the 1930’s during the depression, the Council on Medical Education and Hospitals wrote a letter to the various medical schools saying the medical schools were admitting more students than could be given the proper kind of training. In the next year or two, every school reduced the number it was admitting, giving very strong presumptive evidence that the recommendation had some effect.

Why does the Council’s approval matter so much? If it abuses its power, why don’t unapproved medical schools arise? The answer is that in almost every state in the United States, a person must be licensed to practice medicine, and to get the license, he must be a graduate of an approved school. In almost every state, the list of approved schools is identical with the list of schools approved by the Council on Medical Education and Hospitals of the American Medical Association. That is why the licensure provision is the key to the effective control of admission. It has a dual effect. On the one hand, the members of the licensure commission are always physicians and hence have some control at the step at which men apply for a license. This control is more limited in effectiveness than control at the medical school level. In almost all professions requiring licensure, people may try to get admitted more than once. If a person tries long enough and in enough jurisdictions he is likely to get through sooner or later. Since he has already spent the money and time to get his training, he has a strong incentive to keep trying. Licensure provisions that come into operation only after a man is trained therefore affect entry largely by raising the costs of getting into the occupation, since it may take a longer time to get in and since there is always some uncertainty whether he will succeed. But this rise in cost is nothing like so effective in limiting entry as is preventing a man from getting started on his career. If he is eliminated at the stage of entering medical school, he never comes up as a candidate for examination; he can never be troublesome at that stage. The efficient way to get control over the number in a profession is therefore to get control of entry into professional schools.

Control over admission to medical school and later licensure enables the profession to limit entry in two ways. The obvious one is simply by turning down many applicants. The less obvious, but probably far more important one, is by establishing standards for admission and licensure that make entry so difficult as to discourage young people from ever trying to get admission. Though most state laws require only two years of college prior to medical school, nearly 100 per cent of the entrants have had four years of college. Similarly, medical training proper has been lengthened, particularly through more stringent internship arrangements.

As an aside, the lawyers have never been as successful as the physicians in getting control at the point of admission to professional school, though they are moving in that direction. The reason is amusing. Almost every school on the American Bar Association’s list of approved schools is a full time day school; almost no night schools are approved. Many state legislators, on the other hand, are graduates of night law schools. If they voted to restrict admission to the profession to graduates of approved schools, in effect they would be voting that they themselves were not qualified. Their reluctance to condemn their own competence has been the main factor that has tended to limit the extent to which law has been able to succeed in imitating medicine. I have not myself done any extensive work on requirements for admission to law for many years but I understand that this limitation is breaking down. The greater affluence of students means that a much larger fraction are going to full time law schools and this is changing the composition of the legislatures.

To return to medicine, it is the provision about graduation from approved schools that is the most important source of professional control over entry. The profession has used this control to limit numbers. To avoid misunderstanding let me emphasize that I am not saying that individual members of the medical profession, the leaders of the medical profession, or the people who are in charge of the Council on Medical Education and Hospitals deliberately go out of their way to limit entry in order to raise their own incomes. That is not the way it works. Even when such people explicitly comment on the desirability of limiting numbers to raise incomes they will always justify the policy on the grounds that if “too” many people are let in, this will lower their incomes so that they will be driven to resort to unethical practices in order to earn a “proper” income. The only way, they argue, in which ethical practices can be maintained is by keeping people at a standard of income which is adequate to the merits and needs of the medical profession. I must confess that this has always seemed to me objectionable on both ethical and factual grounds. It is extraordinary that leaders of medicine should proclaim publicly that they and their colleagues must be paid to be ethical. And if it were so, I doubt that the price would have any limit. There seems little correlation between poverty and honesty. One would rather expect the opposite; dishonesty may not always pay but surely it sometimes does.

Control of entry is explicitly rationalized along these lines only at times like the Great Depression when there is much unemployment and relatively low incomes. In ordinary times, the rationalization for restriction is different. It is that the members of the medical profession want to raise what they regard as the standards of “quality” of the profession. The defect in this rationalization is a common one, and one that is destructive of a proper understanding of the operation of an economic system, namely, the failure to distinguish between technical efficiency and economic efficiency.

A story about lawyers will perhaps illustrate the point. At a meeting of lawyers at which problems of admission were being discussed, a colleague of mine, arguing against restrictive admission standards, used an analogy from the automobile industry. Would it not, he said, be absurd if the automobile industry were to argue that no one should drive a low quality car and therefore that no automobile manufacturer should be permitted to produce a car that did not come up to the Cadillac standard. One member of the audience rose and approved the analogy, saying that, of course, the country cannot afford anything but Cadillac lawyers! This tends to be the professional attitude. The members look solely at technical standards of performance, and argue in effect that we must have only first rate physicians even if this means that some people get no medical service—though of course they never put it that way. Nonetheless, the view that people should get only the “optimum” medical service always lead to a restrictive policy, a policy that keeps down the number of physicians. I would not, of course, want to argue that this is the only force at work, but only that this kind of consideration leads many well-meaning physicians to go along with policies that they would reject out-of-hand if they did not have this kind of comforting rationalization.

It is easy to demonstrate that quality is only a rationalization and not the underlying reason for restriction. The power of the Council on Medical Education and Hospitals of the American Medical Association has been used to limit numbers in ways that cannot possibly have any connection whatsoever with quality. The simplest example is their recommendation to various states that citizenship be made a requirement for the practice of medicine. I find it inconceivable to see how this is relevant to medical performance. A similar requirement that they have tried to impose on occasion is that examination for licensure must be taken in English. A dramatic piece of evidence on the power and potency of the Association as well as on the lack of relation to quality is proved by one figure that I have always found striking. After 1933, when Hitler came to power in Germany, there was a tremendous outflow of professional people from Germany, Austria and so on, including of course, physicians who wanted to practice in the United States. The number of physicians trained abroad who were admitted to practice in the United States in the five years after 1933 was the same as in the five years before. This was clearly not the result of the natural course of events. The threat of these additional physicians led to a stringent tightening of requirements for foreign physicians that imposed extreme costs upon them.

It is clear that licensure is the key to the medical profession’s ability to restrict the number of physicians who practice medicine. It is also the key to its ability to restrict technological and organizational changes in the way medicine is conducted. The American Medical Association has been consistently against the practice of group medicine, and against prepaid medical plans. These methods of practice may have good features and bad features, but they are technological innovations that people ought to be free to try out if they wish. There is no basis for saying conclusively that the optimum technical method of organizing medical practice is practice by an independent physician. Maybe it is group practice, maybe it is by corporations. One ought to have a system under which all varieties can be tried.

The American Medical Association has resisted such attempts and has been able effectively to inhibit them. It has been able to do so because licensure has indirectly given it control of admission to practice in hospitals. The Council on Medical Education and Hospitals approves hospitals as well as medical schools. In order for a physician to get admission to practice in an “approved” hospital, he must generally be approved by his county medical association or by the hospital board. Why can’t unapproved hospitals be set up? Because under present economic conditions, in order for a hospital to operate it must have a supply of interns. Under most state licensure laws, candidates must have some internship experience to be admitted to practice, and internship must be in an “approved” hospital. The list of “approved” hospitals is generally identical with that of the Council on Medical Education and Hospitals. Consequently, the licensure law gives the profession control over hospitals as well as over schools. This is the key to the AMA’s largely successful opposition to various types of group practice. In a few cases, the groups have been able to survive. In the District of Columbia, they succeeded because they were able to bring suit against the American Medical Association under the federal Sherman antitrust laws, and won the suit. In a few other cases, they have succeeded for special reasons. There is, however, no doubt that the tendency toward group practice has been greatly retarded by the AMA’s opposition.

It is interesting, and this is an aside, that the medical association is against only one type of group practice, namely, prepaid group practice. The economic reason seems to be that this eliminates the possibility of engaging in discriminatory pricing.8

It is clear that licensure has been at the core of the restriction of entry and that this involves a heavy social cost, both to the individuals who want to practice medicine but are prevented from doing so and to the public deprived of the medical care it wants to buy and is prevented from buying. Let me now ask the question: Does licensure have the good effects that it is said to have?

In the first place, does it really raise standards of competence? It is by no means clear that it does raise the standards of competence in the actual practice of the profession for several reasons. In the first place, whenever you establish a block to entry into any field, you establish an incentive to find ways of getting around it, and of course medicine is no exception. The rise of the professions of osteopathy and of chiropractic is not unrelated to the restriction of entry into medicine. On the contrary, each of these represented, to some extent, an attempt to find a  way around restriction of entry. Each of these, in turn, is proceeding to get itself licensed, and to impose restrictions. The effect is to create different levels and kinds of practice, to distinguish between what is called medical practice and substitutes such as osteopathy, chiropractic, faith healing and so on. These alternatives may well be of lower quality than medical practice would have been without the restrictions on entry into medicine.

More generally, if the number of physicians is less than it otherwise would be, and if they are all fully occupied, as they generally are, this means that there is a smaller total of medical practice by trained physicians—fewer medical man-hours of practice, as it were. The alternative is untrained practice by somebody; it may and in part must be by people who have no professional qualifications at all. Moreover, the situation is much more extreme. If “medical practice” is to be limited to licensed practitioners, it is necessary to define what medical practice is, and featherbedding is not something that is restricted to the railroads. Under the interpretation of the statutes forbidding unauthorized practice of medicine, many things are restricted to licensed physicians that could perfectly well be done by technicians, and other skilled people who do not have a Cadillac medical training. I am not enough of a technician to list the examples at all fully. I only know that those who have looked into the question say that the tendency is to include in “medical practice” a wider and wider range of activities that could perfectly well be performed by technicians. Trained physicians devote a considerable part of their time to things that might well be done by others. The result is to reduce drastically the amount of medical care. The relevant average quality of medical care, if one can at all conceive of the concept, cannot be obtained by simply averaging the quality of care that is given; that would be like judging the effectiveness of a medical treatment by considering only the survivors; one must also allow for the fact that the restrictions reduce the amount of care. The result may well be that the average level of competence in a meaningful sense has been reduced by the restrictions.

Even these comments do not go far enough, because they consider the situation at a point in time and do not allow for changes over time. Advances in any science or field often result from the work of one out of a large number of crackpots and quacks and people who have no standing in the profession. In the medical profession, under present circumstances, it is very difficult to engage in research or experimentation unless you are a member of the profession. If you are a member of the profession and want to stay in good standing in the profession, you are seriously limited in the kind of experimentation you can do. A “faith healer” may be just a quack who is imposing himself on credulous patients, but maybe one in a thousand or in many thousands will produce an important improvement in medicine. There are many different routes to knowledge and learning and the effect of restricting the practice of what is called medicine and defining it as we tend to do to a particular group, who in the main have to conform to the prevailing orthodoxy, is certain to reduce the amount of experimentation that goes on and hence to reduce the rate of growth of knowledge in the area. What is true for the content of medicine is true also for its organization, as has already been suggested. I shall expand further on this point below.

There is still another way in which licensure, and the associated monopoly in the practice of medicine, tend to render standards of practice low. I have already suggested that it renders the average quality of practice low by reducing the number of physicians, by reducing the aggregate number of hours available from trained physicians for more rather than less important tasks, and by reducing the incentive for research and development. It renders it low also by making it much more difficult for private individuals to collect from physicians for malpractice. One of the protections of the individual citizen against incompetence is protection against fraud and the ability to bring suit in the court against malpractice. Some suits are brought, and physicians complain a great deal about how much they have to pay for malpractice insurance. Yet suits for malpractice are fewer and less successful than they would be were it not for the watchful eye of the medical associations. It is not easy to get a physician to testify against a fellow physician when he faces the sanction of being denied the right to practice in an “approved” hospital. The testimony generally has to come from members of panels set up by medical associations themselves, always, of course, in the alleged interest of the patients.

When these effects are taken into account, I am myself persuaded that licensure has reduced both the quantity and quality of medical practice; that it has reduced the opportunities available to people who would like to be physicians, forcing them to pursue occupations they regard as less attractive; that it has forced the public to pay more for less satisfactory medical service, and that it has retarded technological development both in medicine itself and in the organization of medical practice. I conclude that licensure should be eliminated as a requirement for the practice of medicine.

When all this is said, many a reader, I suspect, like many a person with whom I have discussed these issues, will say, “But still, how else would I get any evidence on the quality of a physician. Granted all that you say about costs, is not licensure the only way of providing the public with some assurance of at least minimum quality ?” The answer is partly that people do not now choose physicians by picking names at random from a list of licensed physicians; partly, that a man’s ability to pass an examination twenty or thirty years earlier is hardly assurance of quality now; hence, licensure is not now the main or even a major source of assurance of at least minimum quality. But the major answer is very different. It is that the question itself reveals the tyranny of the status quo and the poverty of our imagination in fields in which we are laymen, and even in those in which we have some competence, by comparison with the fertility of the market. Let me illustrate by speculating on how medicine might have developed and what assurances of quality would have emerged, if the profession had not exerted monopoly power.

Suppose that anyone had been free to practice medicine without restriction except for legal and financial responsibility for any harm done to others through fraud and negligence. I conjecture that the whole development of medicine would have been different. The present market for medical care, hampered as it has been, gives some hints of what the difference would have been. Group practice in conjunction with hospitals would have grown enormously. Instead of individual practice plus large institutional hospitals conducted by governments or eleemosynary institutions, there might have developed medical partnerships or corporations—medical teams. These would have provided central diagnostic and treatment facilities, including hospital facilities. Some presumably would have been prepaid, combining in one package present hospital insurance, health insurance, and group medical practice. Others would have charged separate fees for separate services. And of course, most might have used both methods of payment.

These medical teams—department stores of medicine, if you will—would be intermediaries between the patients and the physician. Being long-lived and immobile, they would have a great interest in establishing a reputation for reliability and quality. For the same reason, consumers would get to know their reputation. They would have the specialized skill to judge the quality of physicians; indeed, they would be the agent of the consumer in doing so, as the department store is now for many a product. In addition, they could organize medical care efficiently, combining medical men of different degrees of skill and training, using technicians with limited training for tasks for which they were suited, and reserving highly skilled and competent specialists for the tasks they alone could perform. The reader can add further flourishes for himself, drawing in part, as I have done, on what now goes on at the leading medical clinics.

Of course, not all medical practice would be done through such teams. Individual private practice would continue, just as the small store with a limited clientele exists alongside the department store, the individual lawyer alongside the great many-partnered firm. Men would establish individual reputations and some patients would prefer the privacy and intimacy of the individual practitioner. Some areas would be too small to be served by medical teams. And so on.

I would not even want to maintain that the medical teams would dominate the field. My aim is only to show by example that there are many alternatives to the present organization of practice. The impossibility of any individual or small group conceiving of all the possibilities, let alone evaluating their merits, is the great argument against central governmental planning and against arrangements such as professional monopolies that limit the possibilities of experimentation. On the other side, the great argument for the market is its tolerance of diversity; its ability to utilize a wide range of special knowledge and capacity. It renders special groups impotent to prevent experimentation and permits the customers and not the producers to decide what will serve the customers best.

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Nineteenth century London water supply: Processes of innovation and improvement – Nicola Tynan

This paper is worth a read. Publishing a truncated HTML version, will read and annotate later, as time permits.

  1. Introduction

At the turn of the nineteenth century, those London households with piped water supply received their water untreated, intermittently and at low-pressure. By 1901, the majority of London’s households had piped supply, with 95% receiving water continuously, at high-pressure, and filtered if coming from the rivers Thames or Lea. London water supply was transformed during the century by processes of experimentation and innovation undertaken by London’s water companies during a time of significant uncertainty in the water and sanitation sectors. Government intervention also increased, with at least some negative consequences.

London’s water companies have received little credit for the investment in innovations that not only improved water supply for Londoners but were exported to other cities in England and abroad. The general perception of the water companies is one of failure to invest to improve public health and meet the demands of customers. In trade literature on water filtration, there is little recognition of the role played by London’s water companies in technological innovation.1

Most of the negative perception of London’s water companies can be traced back either to Edwin Chadwick, whose views were conveyed to economists via John Stuart Mill (1851, 1871) and to historians via S.E. Finer (1951) and R.A. Lewis (1952), or to the London County Council and other advocates of municipal ownership.2 The most frequently stated charge against the companies was an insufficient quantity of water, with the connection to public health emphasized. Then, as now, public health played a major role in policy debates regarding the ownership of water works; in many British and U.S. cities this debate resulted in a switch from private to municipal ownership and control.3 A perception of public health improvements in cities switching from private to public ownership provided evidence of prior market failure. When looking at London’s water supply at any given moment, critics have been quick to point out the imperfections in private supply with any government action indicating the superiority of government control.4

London’s waterworks were privately owned throughout the nineteenth century. Private companies had first offered pipe delivery of water in 1582 and continued to do so until 1904, after Parliament’s 1902 approval of a switch to public ownership (Tynan 2002). During this time period, private companies invested heavily in service improvements, though investment came in waves and with some companies proving more entrepreneurial than others. Investment was particularly heavy during the 1800s, as the demand for piped water increased. Companies moved to supplying filtered water, increased the volume of water delivered, introduced high-pressure and continuous supply, and extended their networks to the majority of homes in the metropolis. Public health improved: London experienced its last Asiatic cholera epidemic (England’s major health scare during the nineteenth century) in 1866, long before government purchase of the waterworks and earlier than many European and American cities that suffered high mortality rates during the 1892 cholera outbreak.

In this paper, I assess the economic history of water supply in nineteenth century London, using a process approach rather than one of static efficiency at any given moment in time. Following Mises (1966) and Kirzner (1997), the paper emphasizes entrepreneurship, focusing on the companies that provided leadership in R&D and quality improvements, while identifying the particular challenges of operating in a time of uncertainty due to competing theories of the connections between water, sanitation and disease, and changing government regulation.5 During the early to mid-1800s, London’s water companies experienced brief periods of rivalrous competition (Graham-Leigh 2000, Tynan 2002: 354-355). Over the longer-term, competition for consumers encouraged companies to offer a better commodity: improving water quality by moving intakes and investing in filtration, and improving service by upgrading pipes, installing more powerful pumps, and expanding reservoir capacity.

In Parliamentary and other public debates on water supply, reformers argued that private water companies failed to provide a sufficient quantity or quality of water to prevent the spread of cholera. Following both entrepreneurial and Parliamentary response through time shows that parties on both sides were trying to improve conditions in the face of epidemiological and technological uncertainty. 6 A comparison of company investment and government intervention shows that companies responded to water quality concerns and to evidence suggesting cholera was water-borne at least as fast as public authorities, with at least one company investing in filtration or moving its intake prior to regulation. Government regulation generally imposed on all companies the innovations already undertaken by the most entrepreneurial.

Larger volumes of water and network expansion offered health benefits, but only when combined with an appropriate wastewater and sewerage technology. Non-network sewage removal was dominant in London until the second half of the nineteenth century, and urban households without a sewer connection periodically paid collectors to empty their cesspool (Fletcher, 1844:156; Halliday, 1999:34). By embracing an erroneous miasma theory of cholera transmission, government officials such as Edwin Chadwick and John Simon were responsible for the deterioration in water quality. The public health effect of the move from cesspools to sewers was initially negative as household sewage polluted the rivers Thames and Lea that were the source of most companies’ water.

Towards the end of the century, there is evidence that regulations requiring Parliamentary approval for additional investment slowed improvements in water infrastructure providing possible illustration of Kirzner’s claim that regulation “may discourage, hamper and even completely stifle the discovery process” (1985: 141).

This paper adds to the literature challenging the negative impression of private water provision, particularly regarding public health, that justified government appropriation of water works. Troesken (1999) shows that during the progressive era private water companies in US cities invested in filtration at a faster rate than public utilities; a switch from private to public provision played little role in reducing typhoid rates. For English cities during the nineteenth century, Hassan (1985) provides evidence that public ownership of waterworks generated external benefits in the form of reduced fire costs and more abundant supply for industrial users, but finds little evidence of an improvement in public health. This paper focuses on nineteenth century London as a particularly rich case study given its long and contentious history of private provision.

  1. Overview of Demand, Supply and Technology Changes

Nineteenth century London experienced rapid population growth. In 1801, the metropolis had a population of 959,000, living in approximately 200,000 houses in and around the densely populated City (the original square mile of fortified London). During the century, soldiers and expatriates returned home after the war with France, people migrated from Ireland and rural England, and the mortality rate fell. In 1851 the population had risen to over 2.3 million and the number of houses to 300,000. By 1900, London had a population of over 4.5 million; the area supplied by London’s water companies – known as Water London – had a population of 6.3 million and covered 620 square miles.7 Population growth was not evenly spread, however. During the first 50 years, population density in the City remained stable (with population remaining about 128,000) and grew rapidly in neighboring parishes. By the second half of the century, population density in the City fell, while it rose rapidly in the suburbs as trains allowed people to live further from their work and London absorbed many peripheral villages. In response to these population and territory increases water companies made continual investments – laying pipes to extend their networks and increasing reservoir capacity – that meant people did not have to rely on London’s deteriorating wells.

During the nineteenth century, water and sanitation technologies changed quite dramatically from one still found in urban areas of many developing countries to the core of Greater London’s current water and sanitation system. In 1800, most households received unfiltered water delivered intermittently at a low pressure and many relied on communal pumps.8 Households had private cesspools and much non-human waste still flowed into open street drains, though within central London most sewers running through residential streets were covered by the early 1800s (Sunderland 1999: 354-5). By 1900, water companies delivered potable water continuously and at a high-pressure to almost the entire metropolitan population, London’s sewerage network was complete, and wastewater ran through underground drainage pipes. Much of the nineteenth century debate over water and sanitation can be traced to the difficulties of shifting from one set of technologies to the other.

Before 1800, the primary service supplied by water companies was the transportation of large quantities of water directly to consumers’ homes and businesses.  Taking advantage of economies of scale, piped water offered high-volume consumers an alternative to water carrier delivery or to collecting water themselves. Population growth and rising middle class income in the late 1700s and early 1800s raised the demand for piped water, particularly for high-pressure service that would enable households to receive water directly to the top floors of their homes. More households and businesses demanded a connection to one of the companies’ networks, while existing customers demanded increasing quantities of water and new service attributes. Customers who installed water closets (flush toilets) and baths demanded larger quantities of water, and many expressed a preference for continuous service.9

Entrepreneurs responded to the growing demand for water in two ways: entry and innovation. Seven new companies entered the London water market between 1805 and 1822 – the West Middlesex, East London, Kent, Pocock’s, and Grand Junction companies north of the river Thames; the Vauxhall and Southwark companies south of the Thames – resulting in eleven water companies supplying London in 1822. Entrants built new infrastructure or took over and expanded existing networks. Incumbents and entrants invested in new technology. Water companies employed engineers to design powerful pumps that would allow them to offer ‘high’ service and installed iron pipes able to withstand greater pressure than wooden pipes. After 1822, some companies merged or took over smaller rivals with eight companies surviving to the end of the century to have their assets purchased by the Metropolitan Water Board.

At the same time, government officials made changes in sanitation technology. In 1815, households were allowed to dispose of waste from cesspools and house drains through London’s sewers for the first time (Halliday, 1999: xii). In 1848, the Metropolitan Commission of Sewers, faced with calls to do something following the cholera epidemic of 1832-33 and convinced that the vapors from household cesspools were a primary source of the disease, mandated household connection to the sewers. This change in policy increased sewage pollution of the Thames, most companies’ source of water.

Contemporary advocates of sewerage, who believed in a miasma theory of cholera, implemented policies that replaced the local external costs of cesspools with the more public costs of dumping untreated sewage in rivers. Everyone was acting in a period of uncertainty. With hindsight, we know that the theory of miasma accepted by Edwin Chadwick, 10 William Farr, 11 and John Simon,12 amongst others, was incorrect. Knowing that John Snow’s theory of cholera transmission proved correct calls for a re-assessment of the actions undertaken by London’s water companies and government bodies.

  1. Water Pollution and Entrepreneurial Response

In 1800, London’s four main water companies in terms of customers supplied were the London Bridge Water Works Company, the New River Company, the Chelsea Company, and the York Buildings Company, all operating north of the river Thames. The London Bridge and New River Companies were London’s oldest companies, established in 1582 and 1613, respectively. The London Bridge Company drew water from the Thames south of the City, while the New River Company built the New River to bring water to London from Hertfordshire. The York Buildings Company entered London’s water market in 1691 and the Chelsea Company in 1722, both drawing water from the Thames. A few smaller companies supplied areas that would later become part of London as the metropolis grew during the nineteenth century.

The rising demand for water in the early 1800s coincided with two technology related developments. Firstly, pumping technology had improved significantly during the 1700s partly through adoption and experimentation by London’s water companies. According to W. Dickinson, “the fact, far too little recognized hitherto, will emerge that London has had a notable share in the development of the steam engine” (1954: 59). By ‘London’, Dickinson primarily means London’s water companies. Secondly, improvements in the manufacture and design of iron pipes and joints, combined with a fall in the price of iron, made it cost effective for companies to substitute iron pipes for wood throughout their networks (Dickinson, 1954: 118-119; Graham-Leigh, 2000: 18, 28). Changes in market demand and technology encouraged entry, with new companies initially operating outside existing companies’ supply areas but soon competing directly with them for customers.13 In addition to competing by offering a better commodity, London’s water companies also competed on price until the price competition started to constrain their investment.

Increasing availability of water and, for some households the lower price, had implications for sanitation and wastewater removal. In 1800, a typical London household relied on a cesspool below or near their home to dispose of human waste. London’s system of public sewers was designed primarily for rainwater and drainage; private connection to public sewers was illegal. London’s City Corporation and other Sewer Commissions in the metropolis imposed fines on offenders with a view to preventing pollution of public waterways.14 The re-invention of the water closet as an alternative to cesspools coincided with greater availability of piped water.15 This made flushing a lower-cost option than carting cesspool waste out of town and pressure for private connection to the sewers increased.16

In 1815, London’s eight Sewer Commissions decided to allow private sewer connections conditional on households paying their own construction and maintenance costs. The private cost for sewer connection could be quite high, partly due to vestries’ requirement that construction be undertaken by an official bricklayer (Jones 1929: 103).  Because households had to pay for sewer connections, the demand for water closets started fairly slowly; by the 1830s and 40s demand for water closets increased more rapidly. As the volume of wastewater flushed into London’s sewers increased, so did the quantity of human waste joining the animal and industrial wastes polluting the rivers Thames and Lea.17

Despite the pollution, London’s Sewer Commissions remained strong advocates of sewerage and, in 1834, immediately following London’s first Asiatic cholera epidemic, saw their responsibility not explicitly as the protection of public health but “to effect the mechanical transmission of the superfluous fluids to the Thames” (Fletcher 1844: 164). The result was an increase in the negative externalities imposed on anyone relying on the Thames for their water. To be fair to the Sewer Commissions, their harshest contemporary critic, Edwin Chadwick, was also a strong advocate of sewerage: he criticized the Commissions for their inefficiency in sewer construction and their inadequate flushing of the sewers.18 The period was also one of competing theories regarding the spread of disease. The theory that cholera could be transmitted via fecal pollution of water had not yet been advanced in the literature although some people did believe that sewers could spread cholera (Sunderland, 1999: 371).

By the mid-1820s, London water quality became a serious issue. More recent research has shown that after 1815 the quality of water in the Thames started to deteriorate (Wood 1982: 17-21). For those companies that obtained their water from the Thames, the quality of water they distributed also fell. By the mid-1820s, companies and consumers could clearly observe this deterioration in quality and critics started to condemn the companies for delivering impure water.

Aware of complaints about deteriorating water quality and at risk of losing customers, the Chelsea Company responded rapidly. A solution was needed, but was neither obvious nor readily available. The Company’s engineer, James Simpson, started to experiment with filtration technologies in 1825. Water filtration was still in its infancy. In 1806 and 1808, two water companies in Glasgow, Scotland, had built filtration plants with only limited success (Matthews 1835: 147).19 Robert Thom, another Scot, developed a sand filtration system for Greenock around the same time as James Simpson.20 In January 1827, the Chelsea Company directors were persuaded by the efficacy of Simpson’s system and shifted all the company’s R&D funding towards filtration. Simpson increased the scale of his experiments, traveled to Glasgow to talk to other engineers, and devoted himself full time to the development of filtration beds. In January 1829, the Chelsea Water Works Company opened London’s first sand filtration plant (Matthews 1835: 84). James Simpson was later employed by the Lambeth Company and completed their first filtration works in 1841 (Luckin 1986: 36). James Simpson’s innovation should not be downplayed. Although Simpson was not the only one developing sand filtration at this time, the process introduced for the Chelsea Company “remains the basis of water filtration to this day though it was sixty years before Pasteur’s work revealed that the sand provided a biological as well as a physical barrier to impurities” (Halliday 1999: 25). 21

A more recent entrant to London’s water market, the Grand Junction Company, received a large share of water company criticism. Incorporated in 1811 to supply water to Paddington and adjacent areas to the west of the City, the Grand Junction Company had a difficult beginning. The company took over powers obtained by the Grand Junction Canal Company in 1798 with a view to supplying water from the rivers Brent and Colne, via the Grand Junction canal, through stone pipes which they believed would be superior to iron pipes. Stone pipes proved unsuitable as they failed under pressure; in 1813, the company decided to switch to iron pipes and abandon stone. (Graham-Leigh, 2000:40- 41). The company had marketed itself as offering higher quality water and continuous supply superior to the intermittent supply available from competitors. During 1814-16, however, the company suffered unexpected periods of pollution of the Grand Junction canal resulting in a decision to abandon the river Brent as a source of water.22 In September 1820, the Grand Junction Company switched to drawing water from the Thames at Chelsea forcing it to renege on initial promises to provide continuous service and higher quality water to all customers (Richards and Payne, 1899: 19). These failures were all important in terms of a dynamic process of discovery: stone pipes were tested and shown to be inferior to iron; the rivers Brent and Colne were found to be inferior to the Thames as sources of water; and continuous supply was shown to be difficult to provide with existing technologies. Such experimental failure is a necessary part of entrepreneurial failure that provides information to all market participants. By attempting to provide continuous service to all customers, the Grand Junction Company highlighted what could be possible and would become standard practice by the end of the century.

Despite the Chelsea Company’s introduction of sand filtration, most companies did not follow suit. The emphasis was on a physical barrier that removed water contaminants and the advantages of filtration over settling reservoirs and screen filters were still being debated. During the 1830s and early 1840s, most of London’s water companies invested in screen filters, settling reservoirs, and moving their intake upriver, as ways to improve the quality of water from existing sources. By the mid-to-late 1840s, however, other companies decided to invest in sand filtration to satisfy the demands of their customers for improved quality. The Kent Company did so in 1845. The Lambeth Company committed to invest in 1848 and by 1851 had completed a filtration plant at their new site at Long Ditton. By formally committing the Company to filter water before distribution, the Lambeth Company’s Act of 1848 was the first Act to incorporate a water filtration clause.4

Early Parliamentary Investigation of London’s Water Supply

Between the years 1815 and 1818, after a brief period of competition north of the Thames, the New River, Chelsea, Grand Junction, and West Middlesex companies reached agreements to limit their supply areas and no longer compete directly. This allowed them to raise prices to pre-competition levels (Graham-Leigh 2000: 52-61, Tynan 2002: 355-6). Rivalrous competition had initially been important for entrepreneurial network expansion, but price competition reduced revenue and had started to undermine companies’ ability for further investment. Unsurprisingly, the price increase outraged many customers. Customers of the West Middlesex and Grand Junction companies were particularly outraged, leading many of them to form the Anti-Water Monopoly Association to petition Parliament with a view to transferring the private companies’ assets to local vestry control (Mukhopadhyay, 1981: 5). In response, the House of Commons established a committee of enquiry in 1821. The committee found the water supply of London superior to that of any city in Europe, but agreed that the companies were acting as monopolies by limiting supply areas in a way unintended by Parliament. It recommended a four year trial limit on prices and the establishment of ‘referees’ to hear customer complaints. Since these recommendations were weaker than critics had hoped for and were not supported by the companies, they were not acted upon (Clifford 1885: 137-143).

By 1827, customers had become more concerned about water quality. An 1827 pamphlet, “The Dolphin,” by Mr. J. Wright condemned the Grand Junction Water Company for locating its intake so close to a major sewer outlet (Clifford 1885: 143).  [Sanjeev: This is clearly a government created problem: they are the ones who were putting out sewage into the Thames]

Although moving close to the Chelsea Company’s intake,23 the Grand Junction faced particular criticism because it had initially promised such high quality water from the Grand Junction canal. In response, a Royal Commission was established in June 1827 to look into the Thames as a source of water. The Commission reported in 1828 and recommended that Parliament consider other sources of water supply. The Commission’s report had brought forth many proposals for schemes – most impractical and costly – to bring pure water to London.24 In 1828, Parliament established a House of Commons select committee to consider these alternative sources of supply; in 1834, Parliament established a second committee; and a third in 1840. None of these committees could conclude that an alternative source of supply would justify the cost (Clifford 1885: 148- 151).25

Critics of private water supply could point to the Royal Commission’s report in 1828 as evidence of relatively rapid government action regarding London water quality compared to the opening of the Chelsea Water Company’s filtration plant in January 1829.  While this static perspective seems to support the superiority of government action, it is inaccurate because it does not take into account the time involved in constructing water works or preparing a government report. It fails to acknowledge that the Chelsea Company started research into filtration in 1825 before Parliament committed to formally investigate concerns about water quality; construction of the first successful sand filtration plant was well underway when the Royal Commission was established in June 1827. [Sanjeev: Private enterprise solutions preceded any societal concerns] Since the Chelsea Company was already building at the time of the Commission’s investigations, the timing does not provide support for market failure to respond to the problem of water quality. It also ignores the scientific uncertainty regarding disease transmission facing private and public actors. Parliamentary committees, local government bodies and the water companies were all trying to respond to water quality and sanitation problems for which no one had a clear solution.

The same applies to the 1852 London Water Act’s requirement that all companies move their intakes and invest in filtration. As Bolton (1888:18) notes, “in 1847, the Lambeth Company took the initiative by preparing to remove its intake to Thames Ditton.” The Kent, Chelsea, Lambeth, and Southwark & Vauxhall companies had all started their investment in water filtration before 1852. It is also worth remembering that the focus by Parliament-appointed committees on alternative sources of water was never implemented, even after purchase of the water companies in 1904, while the pipe and filtration technologies developed by the Chelsea and other companies remain in use today.

  1. Cholera: Uncertainty, Error and Discovery

Cholera played a signal role in debates about London water supply and sanitation during most of the 1800s. Asiatic cholera arrived in observable waves, spread fast, and killed many people in a short period of time. During an epidemic year, deaths from cholera could outweigh deaths from other causes in cities struck by the disease. The fear of an impending cholera outbreak did much to heighten public anxiety and to intensify demand for a solution.26

Londoners experienced four cholera epidemics: in 1832-33, 1848-49, 1853-54 and 1865-6. The death rate from cholera rose in the second epidemic compared to the first – about twice as many people in London died from cholera in 1848-49 as had died in 1832-33 – but fell during the next two (table 1). Between the first and the second epidemic, many households installed a water closet and connected to London’s sewers to remove the fumes from their cesspools that were believed to be spreading disease. The sewer connection rate increased even more rapidly after 1848 and by 1866 the water closet (either in-house or out) was an almost universal feature of London homes.

By 1848, all of the companies operating north of the river Thames had either invested in sand filtration or moved their intake upriver and constructed large settling reservoirs. Not all of the companies moved their intake sufficiently far up-river to avoid all sewage pollution, but their moves almost certainly helped reduce the severity of the epidemic.27 In the 1848-49 epidemic, the only districts suffering cholera death rates above 1% (100 per 10,000 population) were south of the Thames.28 Households in these districts received water from either the Southwark & Vauxhall or Lambeth companies. The Lambeth Company had started building its filtration plant at Long Ditton in 1848, but it was not operational until 1851. The Southwark & Vauxhall Company had built a filtration plant when they moved their intake from London Bridge to Battersea in 1845, but it was not considered effective and pollution of the Thames at Battersea in 1848 was greater than at London Bridge in 1832. By 1853-54, the Lambeth Company had completed its sand filtration plant and moved its intake up-river. As a consequence, cholera rates were far lower in those districts supplied by the Lambeth Company than in those supplied by the Southwark & Vauxhall. It is largely because of the differences in technology resulting from competition between the water companies that John Snow was able to test his theory. Snow discovered that cholera rates were higher in the Southwark & Vauxhall’s supply area than in the Lambeth’s area proving to his own satisfaction that the cholera germ could be transmitted orally via a fecal-water route rather than arising from miasmas (Snow 1855).

The timing of the 1848-49 cholera epidemic – London’s worst in both absolute number of deaths and deaths per capita – is significant for another reason: it immediately followed the Metropolitan Sewer Commission’s 1848 decision to make household sewer connection compulsory. In 1847, Parliament created the Metropolitan Sewers Commission to consolidate London’s eight Sewer Commissions and to hasten the construction of a sewerage system. The Metropolitan Commission immediately compelled the connection of all private cesspools to the public sewers and required all new houses to include a sewer connection. This move rapidly increased pollution of the Thames, lowering the quality of many water companies’ major input, something they had no power to prevent.29

In 1852, the Metropolis Water Act was implemented as the first government Act specifically to address water quality. The Act required all companies drawing water from the rivers Thames or Lea to move their intakes above the tidal part of the river and to invest in sand filtration. The Chelsea, Grand Junction and East London companies had already moved their intakes, but the Act required them to move their intakes again. The Act also required the Southwark & Vauxhall and West Middlesex companies to move their intakes above Teddington Lock. The Lambeth Company had moved sufficiently far up river in 1851. In response to the 1852 Act, the Grand Junction, Southwark & Vauxhall, West Middlesex, and New River companies built new filtration plants along the lines of the successful filtration works of the Chelsea, Lambeth, and Kent companies.

Debate leading up to the 1852 Act raises the possibility that public opinion, as expressed through Parliamentary debate and legislation, may have sped up the process of investment in water quality improvements. The 1852 Act required laggard water companies to follow the innovators, possibly faster than they might otherwise have done but even this is uncertain. An 1848 editorial in The Lancet, written before the Lambeth Company moved its intake, suggests that the laggard companies would have soon moved their intakes voluntarily: the author conjectures that should the Lambeth Company’s move up-river be approved, “it would be the signal for the removal of all the other waterworks … out of the sphere of the impurities” (The Lancet, 1848). The Act of 1852 does not indicate a failure of private water supply or a superiority of regulation. It was water company entrepreneurs and scientists who successfully identified solutions to London’s water quality problems so, at best, the legislative process sped up quality improvements for some consumers.

Static analyses of London’s water companies fail to take seriously the uncertainty amongst scientists and policy makers regarding water quality and pollution during the nineteenth century. In 1832, doctors and scientists understood very little about the nature or transmission of cholera. Even worse, much of what they thought they knew was wrong (Halliday 1999: 125-141).30 Even after the 1853-4 epidemic, by far the majority of doctors, public health officials and clergy continued to support the miasmatic theory, though they now saw sewage polluted water as one of the many predisposing factors.31, 32

Changing water and sanitation technologies takes time, particularly when a new system requires large-scale investment and integrated network infrastructures. Often the process of investment can take different paths before a fully integrated system is complete.

Understanding that cholera can be spread via sewage contaminated water suggests that the path taken in London might not have been the best available: it is difficult to view a process involving the pollution of public water sources with cholera-contaminated sewage as other than an error. With hindsight, this path chosen by London’s Sewer Commissions and the Metropolitan Sewer Commission appears particularly bad even if understandable at the time given contemporary knowledge and pressure from homeowners installing flush toilets. [Sanjeev: we see government failure not market failure, here] Public authorities’ decision to compel house connections to public sewers four years before requiring water filtration provides some evidence of government failure worse than the failure by some private companies to invest in filtration earlier.33 A more positive lesson is the importance of potential and reputational competition between companies and, possibly, between the companies and Parliament in stimulating entrepreneurial discovery and correcting erroneous decisions.34

Only in 1856, with Parliament’s creation of the Metropolitan Board of Works, did the decisions of London’s sewer authority take an anti-pollution direction.  The Metropolitan Board was specifically created to address the problem of river pollution and given a mandate to ensure the separation of waste from water flowing into the Thames (Halliday 1999: 68). The Board proposed a system of intercepting sewers to transport sewage five miles below London before disposing of it into the Thames.  In 1858, the year of the Great Stink, Disraeli authorized the Board to start work immediately.35 As with most large-scale projects, the intercepting sewers took longer to construct and cost the public a much larger amount than estimated.36   The intercepting sewer system was initially predicted to take three years to construct and the official opening took place in April 1865, but the work was not completed until 1875.37 Sewage pollution of the Thames within London finally ended in the late 1880s, making the time it took to achieve the Metropolitan Board’s mission over 30 years, with Londoners living under the specter of cholera (Halliday 1999: 106).

Water companies’ investment in filtration and moving intakes up-river had contributed to the lower death rates in the 1853-54 and 1866 epidemics compared to 1848-49. By 1866, both water company investment in filtration and much of London’s intercepting sewer was complete. After the Metropolis Water Act of 1852, the East London Company had moved its intake upriver, invested in impounding reservoirs and sand filtration; it also built a 4-mile intercepting sewer to carry wastewater and sewage below its intake from the river Lea (Hogg et al. 1986: 19). 38   Unfortunately, this intercepting sewer was not sufficient to prevent pollution of the river Lea and, when cholera hit Europe in 1866, London’s east-end was not yet connected to the London’s intercepting sewer system. In 1866, the majority of London’s cholera deaths were concentrated in the East London Company’s supply region. It was this concentration of deaths in one water company’s supply area, where the prevention of sewage contamination was not yet complete, that finally persuaded William Farr that John Snow’s theory was superior to his own (Farr 1868). In response to the 1866 outbreak, the East London Company moved its river Lea intake further up-river, added additional supply from the river Thames, and built new filtration plants.

  1. Investment and Criticism after Cholera

Throughout the second half of the nineteenth century, the population of London continued to grow rapidly, particularly in the suburban periphery (where the population rose more than eight-fold). Water companies saw an increasing demand for new connections and an increase in the volume of water demanded by each household; they were continually investing in response (Luckin 1986: 177). The number of customers  supplied by the private companies increased substantially. For example, the New River Company supplied water to 52,000 households in 1800, 100,000 in 1848, and 178,000 by 1903. London’s younger companies expanded even faster, with the number of households receiving water from the East London Company rising from 11,000 to 224,000 between 1809 and 1903.39 Overall, the number of customers supplied by London’s eight water companies more than doubled between 1866 and 1903, rising from 440,000 to 970,000.40

Despite water quality improvements, increasing per-capita volumes, extension of service, and a switch to continuous service for an ever larger number of households, London’s water companies continued to face criticism by supporters of government water provision. Critics continued to raise the issue of water quality, although it was now a smaller issue than quantity and frequency. Fears of another cholera outbreak in London were occasionally raised in newspapers, particularly as other cities in Europe suffered during the 1892 outbreak. Typhoid also played a small role but, unlike in many American cities, it did not play a signal role in arguments for government ownership largely because the death rate from typhoid was lower in London than most British cities with municipal water supply (Shadwell 1899: 64).

Customer complaints were mostly a result of customers not receiving a connection or continuous service as fast as they would like and were generally short-lived. The wait for a connection was due either to the time required to lay new pipes or to a customer’s failure to install appropriate indoor fittings. Nevertheless, the water companies moved towards continuous supply. In 1885 about half the houses in London had constant supply (Clifford 1885: 172) and by 1899 most of London’s households did, with over 90 per cent of the East London, Chelsea, Grand Junction, Kent, and Southwark & Vauxhall companies receiving constant supply (Shadwell 1899: 90-91).41

Throughout the century, the water companies needed to seek approval to undertake additional investment or expand supply, either from Parliament or from another public body. Since the Lambeth Company’s request in 1847 to move its intake above Teddington Lock, for example, water companies had to obtain permission to abstract water from the Thames, first from the London Corporation and then, after 1857, from the Thames Conservancy Board. Payment from the companies to the Conservancy Board was added in 1866 in exchange for an increase in the companies’ abstraction rights (Shadwell 1899: 44-47). Fortunately for the companies and their customers, the Thames Conservancy Board approved requests to increase water abstraction rights fairly readily in return for increased payments. [Sanjeev: the government received good revenues for the public resource: the Thames]

During the second half of the century, government investigations into alternative sources of water supply under management by a public body were ongoing despite the generally positive impression of the companies reached by public inquiries (Clifford 1885: 159- 167). In 1867, a House of Commons committee inquiry into the 1852 Metropolis Water Act found Thames water supply more than satisfactory in quantity and quality. At the same time, a Royal Commission investigated an alternative supply of water from the high grounds of England and Wales. Reporting in 1869, it found the current supply was sufficient to meet the needs of the projected increase in population. The Commission did urge a move to continuous supply, resulting in the Metropolis Water Act of 1871 that required companies to switch to constant supply. The Act also authorized the Board of Trade to appoint a water examiner to test London water quality (Clifford 1885: 171).

Bills were introduced in 1878 to supplement London’s existing water supply and to purchase the metropolitan waterworks but neither were considered by either House of Parliament (Clifford 1885: 177-8).

With the creation of the London County Council (LCC) in 1889, London’s water companies acquired particularly effective critics.42 W.H. Dickinson, chairman of the LCC’s water committee, argued the case for LCC purchase of the water companies verbally and in print (e.g., Dickinson 1897). While the LCC was ultimately unsuccessful in gaining control of London’s water supply, its attempt to do so fueled the debate that resulted in takeover of London’s water companies by a newly created Metropolitan Water Board (Mukhopadhyay 1981). In response to the LCC’s queries, a Royal Commission was established in 1892 to determine whether the Thames and Lea were sufficient to meet the demands of a growing population in the areas currently relying on these rivers as a source (Shadwell 1899: 80). Chaired by Lord Balfour of Burleigh, the Balfour Commission reported in 1893 that current sources were sufficient in both quantity and quality for the foreseeable future, a finding that should have made it difficult for the LCC to bring the issue before Parliament again. Unfortunately extreme weather – an extreme frost followed by drought in 1895, drought in 1896, and severe drought in 1898 – caused problems for the East London Company that gave the LCC an opportunity to re-open the debate.

In early 1895, frost shattered many pipes leading to customers’ homes across east London resulting in excessive waste of water just as the country faced a summer drought. To reduce waste, the East London Company switched to providing intermittent supply while pipes were repaired during summer 1895 and more briefly during 1896 (Shadwell 1899: 99). For those customers with constant supply who had no cistern to provide a back-up this was a significant disruption. In response to customer complaints, a Local Government Board inquired into the East London Company’s actions but found them a necessary response. In 1898, another drought caused the company to again switch to intermittent supply and opened the way for new bills from the LCC to end private provision. Part of the blame for the switch to intermittent supply must lie with the LCC itself (Shadwell, 1899: 106-113). In 1893, the East London Company petitioned Parliament to expand its reservoir capacity but the LCC argued successfully against the bill. Had the bill passed, and the company been allowed to invest, the temporary inconvenience would likely have been prevented.43

While no major technological innovations were undertaken during the late 1800s, the companies continued to invest with the goal of improving their service, despite constant criticism, threat of takeover, and the LCC’s obstruction of their bills. The LCC’s efforts to prevent even fairly routine investments provide a particularly egregious instance of (local) government regulation preventing entrepreneurial action (Kirzner 1985: 141). [Sanjeev: This is a key issue – government actively preventing innovation]

Although additional regulation and the threat of government purchase did not prevent all entrepreneurial action – the water companies were innovative throughout the nineteenth century – fewer major innovations during the later part of the century suggests that it may have slowed it down.

Conclusion

Private companies’ failure to consider public health externalities is one argument that continues to be made in favor of public rather than private water supply. It was one argument used in the takeover of London’s eight water companies. Taking a static view and looking at water and sanitation in London at any time during the nineteenth century, it is possible to identify actions that the water companies could have taken to improve public health. Taking an Austrian process approach, however, shows that companies were continually investing to increase access to piped water and to improve water quality during a time when they and the government faced quite severe knowledge problems and uncertainty. For every regulation imposed on London’s water companies with a view to improving public health, at least one company had already implemented the improvement and the regulation imposed the innovations of the most entrepreneurial companies on the others. The market discovery process led to long lasting innovations, such as sand filtration, that remain the basis of current technology.

Government agencies made some early errors that imposed pollution externalities on the private companies so that companies suffered from pollution externalities more than they caused them. By providing the data that allowed John Snow to convince others of his theory of cholera transmission, competition between London’s water companies generated external benefits in the form of improved medical knowledge, in addition to investment in water quality and other product improvements. Competition improved knowledge faster than would have been the case with only a single municipal utility.

Further research is needed to determine whether the net impact of regulation was to hinder water quality and service improvements due to a negative impact on investment and innovation or to advance them by imposing on all companies those innovations undertaken by the most entrepreneurial.

ADDENDUM: further readings

BROICH, JOHN. “Great Expectations: The First Efforts to Reform London with Water.” London: Water and the Making of the Modern City, University of Pittsburgh Press, Pittsburgh, Pa, 2013, pp. 31–64. JSTOR, www.jstor.org/stable/j.ctt5hjn4d.6.

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COASE AND WATER – Nicola Tynan

6  COASE AND WATER – Nicola Tynan
Introduction

Water is a scarce resource. While this may sound obvious today, a century ago it was not. A recurring criticism of London’s private water companies during the nineteenth century was that they failed to provide a sufficiently large quantity of water for flushing and street-cleaning at a time when water was considered unlimited in supply, if not from the Thames then from Wales. Globally, the majority of institutions for water resource allocation were developed on similar assumptions, though the institutional details differ between countries and even regions within countries (Glennon 2009: 122). For water in rivers and lakes, legal institutions implicitly assumed that surface water could be allocated to consumption uses without a negative impact on the quantity or assimilative capacity of the instream water. Similarly, groundwater rights were often tied to land ownership on the assumption that water withdrawals would remain below recharge rates so use by one landowner would not negatively impact a neighbour.

Though not universally true even in the nineteenth century, for many places the assumption of unlimited water resources was reasonable. More recently, the tide has turned. Driven largely by population growth, water use has increased and water stress – defined as withdrawal in excess of available renewable supply – has increased globally, not only in arid and semi-arid regions.1 Groundwater aquifers are being depleted in many locations – from Mexico, where groundwater pumping has resulted in a clearly observable sinking of Mexico City, to India, the world’s largest groundwater user.2 Shortages of surface water are causing more frequent conflict in the western and southern US and more frequent water use bans in the UK. We now have to face the reality that one person’s use of water often has a negative impact on others, either today or in the future, and, increasingly, the impact is being felt today. Flush toilets capture this change in our understanding of water. We have moved from the competition between toilet brands on the basis of how much they could flush – with names such as ‘Niagara Falls’, ‘The Deluge’ or ‘The Dreadnought’ – to today’s low-flush toilets competing on how efficiently they can flush using the least amount water. Flushing accounts for nearly one third of domestic water use. Households with water meters who pay a volumetric fee have an incentive to reduce water use; low-flush toilets can deliver long-term savings at relatively low cost. Water meters help us move closer to full-cost pricing for domestic water.

  • For a map of global water stress, see http://w w w.w ri.org/our-work/project/ aqueduct/aqueduct-atlas (accessed 3 July 2015).
  • World Bank (2010). For example, according to the Water Governance Facility (2013: 5) ‘governing the groundwater has become a growing challenge in large parts of the country where the water table is steadily sinking’.

It takes time to change indoor plumbing. It takes even longer to change long-established institutions. The problem presented in Ronald Coase’s ‘The problem of social cost’ (1960) is one where the actions of one user have harmful effects on others but where the relevant costs to be considered are the joint costs of preventing the harmful effects.3 This is exactly the situation we face with water resource management today. In improving water resource management policies, we need to determine whether ‘the gain from preventing the harm is greater than the loss which would be suffered elsewhere as a result of stopping the action which produces the harm’ (ibid.: 27). Full-cost pricing and clearly defined rights for all water resources can help make this determination.

Clearly defined property rights

One challenge facing the water sector globally is the weak or now inappropriate definition of property rights. Coase explained that, as long as property rights are clearly defined and transactions costs are low, market transactions will result in the most efficient outcome. He also argued that clearly defining property rights and reducing uncertainty will itself reduce transactions costs.

For surface water, property rights tend to be use rather than ownership rights, often connected to land-ownership (riparian), first use (prior appropriation) or state licence.

  • For further discussion of this tenet of Coase’s argument, see Veljanovski’s introduction to this book.

Even in the western United States, where property rights are seemingly well-defined under a prior appropriation system, there is significant uncertainty because rights were over-allocated in ways that make it uncertain who has the right to use water from a particular source, and there was a failure historically to recognize the value of instream flows. The problem is exacerbated in locations where surface water rights are not tradable, which prevents them being transferred to the highest value user.

Groundwater is more frequently connected to land ownership, in some places as use rights, in others as full ownership rights to the water. Because the difference did not matter too much when withdrawals were below aquifer recharge rates, there is often uncertainty regarding water rights. Robert Glennon highlights this uncertainty within the western US (Glennon 2009: 128):

Property-rights advocates often argue that property owners have an inherent right to drill wells on their property. Restrictions on this right, it is claimed, would violate the takings clause of the U.S. Constitution and require government compensation. But groundwater is not a private resource owned by the overlying landowner. It’s a public resource owned by the state. Citizens can use it, but use rights differ profoundly from ownership rights.

Even use rights can call for compensation if restricted in ways not allowed for in advance. A bigger barrier to the creation of water markets and compensation through the purchase of water rights results from the requirement, in many locations, that landowners use their water themselves.

Water is essential for life. This fact underlies the resistance to water pricing and water trading that has resulted in numerous books, documentaries and public protests attacking ‘water commodification’ in recent years. Making sure that everyone has access to sufficient clean water for survival and general well-being is a crucial policy goal. It is also a goal that some countries have failed to achieve under any institutional structure for water provision. Private participation in domestic water provision has been introduced to improve quality, extend access and improve the efficiency of failing utilities. While poorly implemented policies have made access to water more difficult for some people and communities, private participation elsewhere has improved access for many. In all cases the problem, as explained by Coase, ‘is to devise practical arrangements which will correct defects in one part of the system without causing more serious harm in other parts’ (Coase 1960: 34). To do this we need to ‘compare the total social product yielded by these different arrangements’ rather than focus on a less-than-ideal outcome in one part.

Some instances of conflict surrounding the introduction of private participation in water treatment and distribution have resulted from either ill-defined rights to water or water rights defined in such a way that prior users of water are excluded without compensation. This was a major issue in the notorious case of water privatisation in Cochabamba, Bolivia. Textbook explanations of the Coase Theorem often focus on Coase’s examples of low transactions costs where the initial allocation of property rights does not influence the efficiency of the outcome. For water resources, however, transactions costs can often be high. Where transactions costs are high, Coase argues that ‘the initial delimitation of legal rights does have an effect on the efficiency with which the economic system operates’ (ibid.:16). A human right to a limited quantity of water for essential domestic uses is not incompatible with pricing water in the majority of uses. Indeed, pricing water to prevent it being wasted in low-value uses today may be essential to ensure its availability for higher-value uses in the future.

one consequence of the perceived abundance of water is that water is often treated as a free good, with charges being made only for the infrastructure, energy and other operational costs of treating and transporting it, often with energy costs also subsidised. Clearly defining property rights will raise the price of water in ways that reflect its value as a scarce resource. Pricing water serves to generate information on the value of water in alternative uses, providing information on the cost of replacing one use of water with another. It also gives current holders of rights to use water an incentive to conserve and transfer their rights, increasing transparency while potentially reducing resistance and conflict. Recognizing the role of transactions costs means that it is not only important to determine property rights but also to think about how these rights are assigned. This makes the problem ‘one of choosing the appropriate social arrangements for dealing with the harmful effects’ that will likely differ across countries or watersheds (ibid.: 18). The appropriate social arrangement should be the one that operates at lowest cost when all costs are taken into account. What works as an appropriate social arrangement at one period of time with a given population and technology may not be appropriate at a later date with a larger population, living more densely in urban areas, higher standards of living and new technologies.

Integrated water resources management

Water resource institutions are facing a time of change. Internationally, there has been a move towards integrated water resources management (IWRM) as recommended by the Dublin Statement of the 1992 International Conference on Water and the Environment. IWRM focuses on managing water resources in ways that are economically, socially and environmentally sustainable. Importantly for water markets, the Dublin Statement explicitly recognised water as an economic good in all its uses. This approach fits with Coase’s emphasis on total social benefits: where overlapping legal jurisdictions draw water from the same basin, IWRM focuses on water basin benefits rather than individual user, community or even country benefits (Sadoff et al.: 26–27).

The Dublin Statement recognising water as an economic good noted that ‘access to clean water is a basic right of all human beings’, highlighting the positive connection between treating water as an economic good and improving access to clean water for the poor. Whatever their income level, people are willing to pay relatively high prices for the first litres of water they consume. In most places today, marginal user values for water are much higher for municipal and industrial uses than for agriculture. While many water trades take place between those with similar uses, for instance between two farmers, the fact that water is currently used for low-value agriculture while high-value domestic uses are not satisfied means that more extensive water markets are likely to see water move away from agriculture to domestic, industrial and instream uses.

A number of countries have already adopted IWRM, including developing markets for water trading to various degrees. A recent study (Grafton et al. 2011) compares the performance of water markets in five countries: Australia, Chile, South Africa, the US and China. These are all places sharing the following characteristics to varying degrees:

(1) they are semi-arid regions either experiencing or facing the threat of water shortages; (2) water has different values across uses; and (3) there is sufficiently strong institutional governance and legal capacity allowing for broadly accepted reform. As the authors argue, none of these countries score equally well on measures of efficiency, equity and environmental sustainability and all have room for improvement. However, they each do some things well and can provide guides, if not models, for policy makers elsewhere.

Australia

Australia provides a model of a country that has embraced full-cost water pricing comprehensively, while recognising that institutional details will need to adjust over time. In June 2004, the Council of Australian Governments (CoAG) signed the Intergovernmental Agreement on a National Water Initiative (NWI) and established a National Water Commission. With a goal to ‘improve the management of the nation’s water resources and provide greater certainty for future investment’, the NWI built on the prior experience of water rights trading within the Murray-Darling Basin and explicitly embraced water rights, water trading and improved water pricing. Under the NWI, each state or territory is required to clarify and improve the certainty of water rights and to maintain a registry of water titles recording access entitlements, ownership and transfers. on the 10th anniversary of the NWI, Australia’s National Water Commission stated that ‘although the full extent of the National Water Initiative’s aspirations is yet to be realised, we have a framework that 10 years on, is proven and robust.’4 This assessment is reflected in the relatively high scores that Australia receives in Grafton et al.’s integrated assessment (Grafton et al. 2011: 222, 229, 232).

The need for institutional reform in the management of water resources was first acknowledged within the Murray-Darling Basin in the 1980s through an embargo on new licences and projects to replace open channels with pipelines for the delivery of irrigation water. As a result of this early start, water markets are well-established within the Murray-Darling Basin. Entitlements to water from the

http://w w w.nwc.gov.au/nw i/nw i-10 -year-anniversar y (accessed 3 July 2015).

basin may be either high reliability, where rights holders can expect to receive their full allocation each year, or low reliability with the possibility of no allocation in dry years. Trades may take one of two forms: permanent transfer of the water right or transfer of a single year’s water allocation. The Murray-Darling Basin has experienced substantial trading, with about 20% of water rights traded at a value of $1.8 billion in 2009 (ibid.: 229–30). A number of brokers operate in the market to reduce transactions costs.5 New trading rules introduced on 1 July 2014 aimed to reduce uncertainty by requiring the reporting of all trade prices and limiting restrictions on trade to four clearly stated circumstances, including impacts on third parties.6

Australia’s NWI has struck an appropriate balance between security of water rights and adaptability to changing circumstances. As statutory rights, water rights can be modified by state governments without compensation. In practice, governments have purchased water rights to increase environmental flows. Such commitments to compensate rights holders are clearly stated in the recent Intergovernmental Agreement and National Partnership Agreement for the Murray-Darling Basin agreed between Commonwealth and New South Wales in February 2014. These agreements state the need for an additional 2,750

gigalitres of water to remain in the Basin annually for ecosystem protection; they agree that the additional instream flow will be achieved through a combination of infrastructure and environmental works aimed at water recovery plus the purchase of water rights up to a maximum of 1,500 gigalitres.7 The state’s strategy has been to purchase permanent water rights to protect instream flows when necessary but to sell temporary use rights when water is surplus to environmental needs.

United States

California’s three-year drought, ongoing in 2015, renewed criticism of the system of rights based on seniority rather than highest value. While failure of the existing system of water rights is recognised and water trading is well established in some places (resulting in market transactions with a value of over $3 billion between 1987 and 2007), in other parts of the state there is strong resistance to moving to full-cost water pricing and transferable water rights (Anderson et al. 2012: 24). Rather than seeing this as an opportunity to transfer water to its highest-valued uses, those who currently hold senior water rights fear that institutional change will result in a loss of rights to water without compensation. Clarifying water rights requires information on how much water is actually used by rights holders. In California’s Central Valley, where over half the

irrigation water comes from wells, some farmers explicitly resist water metering from a fear that this will allow the state to restrict the amount of water they pump, again without compensation.

New housing estates increase water demand. Recognising that Utah’s water was over-appropriated, possibly by as much as 45%, Jerry olds, the state’s engineer from 2002 to 2008, stopped issuing new permits for some basins in the state. He also defined property rights more precisely, to allow transfer and sale of water rights, and to tie development approval to water rights (Glennon 2009: 234). New users, particularly developers, are now required to obtain water rights from those with existing claims. These constraints have not caused Utah to stop development but have required developers to ‘purchase and retire some other water user’s right’ showing that the development is a higher-valued use (ibid.: 237). Although rights transfers can involve significant transaction costs when individual developers are required to seek bilateral deals, because of search costs and uncertainties in the approval process, brokers and an exchange have arisen to lower these costs. This would not have surprised Coase, who encouraged economists to ‘study the work of the broker in bringing the parties together’ (Coase 1960: 18).

The New Mexico city of Santa Fe followed a similar policy requiring developers to acquire water rights from a willing seller before requesting a building permit. In response to developers’ concerns that they would pay for water rights but then might not receive the permit to build for other reasons, the city of Santa Fe established a water bank that allows developers to deposit water rights for future projects (Glennon 2009: 240).

While the western US is making some progress towards integrated water markets the assessment by Grafton and colleagues shows that much remains to be done. In the fast-growing southeast, the need for institutional change has, for the most part, been ignored. Residents of coastal Georgia and South Carolina draw groundwater from the Upper Floridan Aquifer. Heavy pumping in Savannah, Georgia, has reversed the flow of groundwater resulting in salt water contamination of domestic water supply. The state’s Environmental Protection Agency responded with regulations in 2006, 2008 and 2013 to reduce withdrawals by existing permit holders and place a moratorium on additional permits, but did not move towards tradable water rights.

Further south, Florida, Alabama and Georgia have been fighting over water from Lake Lanier since 1990 in what has become known as the tristate water war. Property rights to water from Lake Lanier are ill-defined, giving the city of Atlanta no economic incentive to limit extractions. Even though the water is crucial for ‘sustaining Florida’s $134 million commercial oyster industry’, Florida fishermen have no way to compensate Atlanta for allowing water to continue into the Cattahoochee River from Lake Lanier (ibid.: 29).

Critics of water trading argue that the environment will be the loser as the rich will pay to take water for wasteful purposes. Terry Anderson of Montana’s Political Economy Research Center (PERC) shows that this is not the case even when instream flows are not explicitly protected as they are for the Murray-Darling Basin. Water rights trading allows environmental groups to purchase water rights to protect or enhance instream flows.8 For example, in 2006 the oregon Water Trust kept water in the John Day River to protect Chinook and steelhead salmon by purchasing water rights from a local ranching family (Anderson et al. 2012: 11). By contrast, the regulatory approach creates uncertainty for both rights holders and those wishing to protect fish habitats. In 2014 California’s Water Resources Control Board implemented regulations limiting water use during the summer months to ensure sufficient instream flows for fish in the Sacramento River, curtailing farmers’ rights to water and generating threats of lawsuits against the Board.

PERC’s research highlights the role of ‘enviropreneurs’ – Coase’s brokers – in identifying environmentally beneficial gains from trade and bringing together buyers and sellers. As the value of maintaining instream flows increases, farmers who hold transferable water rights will be encouraged to conserve water to sell some of their allocation and, in some cases, may no longer farm their land (Coase 1960: 4). In Arizona, the Yuma Desalting Plant was completed in 1992 to treat agricultural return flows and reduce the salinity of water in the Colorado River flowing into Mexico. Rather than operate the plant, however, it was cheaper to divert the saline water and obtain flows

-ronald-coase (accessed 3 July 2015).

for the Colorado by paying farmers to fallow unproductive fields (Glennon 2009: 149). Water banking offers another way to realise these gains from trade: senior rights holders can ‘bank’ water that would have been applied to low-value uses, allowing it to be purchased by environmental organizations for higher-valued instream use (Anderson et al. 2012: 8).

South Africa

Before 1998, water rights in South Africa were not clearly defined but were generally connected to land as riparian rights or rights to drill wells. The National Water Act 1998 (NWA) introduced a system of public trusteeship combined with private use rights allocated through licences. South Africa’s water policy is best known for its formal recognition of a right to sufficient water for domestic purposes, a right included in sections 2 and 4 of the NWA.9 While this right to clean water for basic needs has not been achieved for all citizens, there has been significant improvement following the reform of water institutions. According to the World Bank’s World Development Indicators, the percentage of the rural population with access to improved water sources increased from 65% in 1995 to 88% in 2012.

In introducing a radical redefinition of water rights, South Africa recognised that the transition to new institutions can impose losses on some individuals despite an

  • Water supply sufficient for domestic purposes is defined as ‘25 litres per person per day accessible within 200 metres’ (Pienaar and van der Schyff 2007: 185).

overall social gain. With the state now formally custodian of the country’s water resources it has the power to award water use rights, but built into the NWA is the requirement that the state cannot take away water rights without due process and cause. To ease the institutional transition, the NWA included a right to compensation for prior owners of water rights who were negatively affected by the change (Pienaar and van der Schyff 2017: 187).

Based on an integrated water resources management approach, South Africa’s NWA requires that water leases take into account environmental protection. While the NWA was understood to allow for the trading of water leases there is significant uncertainty about the legality of individuals selling or otherwise transferring rights to water. For example, a North Gauteng high court ruling in August 2011 approved the transfer of water rights between farmers but the transfer had been denied by the Minister of Water and Environmental Affairs with subsequent appeal to the Water Tribunal delayed due to the tribunal’s suspension. Such uncertainty over the legality of transferring water rights means that trades have been few, particularly those transferring water between uses (Grafton et al. 2011: 229).

Chile, China and India

Institutional reform of water markets is being undertaken to various degrees elsewhere. Chile has the longest experience of water rights and is often used as a model for water market reform. Strong private property rights in water were established with Chile’s 1981 Water Code and updated with the 2005 Water Code Reforms. Chile’s reform was undertaken before and outside of an IWRM approach. This has resulted in property rights to water that have fewer restrictions on use and transfer than in other countries, generating a fairly substantial market for water rights but less consideration of third-party effects (ibid.: 229, 232). Water rights in Chile have allowed water to move to some higher-valued uses, particularly mining, but concerns remain that water is not going to its most valued uses now that Chile’s five-year drought has reduced overall water availability. Recent calls for reform within the country remind us that in making changes ‘the total effect of these arrangements in all spheres of life should be taken into account’ (Coase 1960: 43).

China has made moves towards allowing trade in water rights in its Water Law of 2002, focusing on trades between municipalities.10 Trades have taken place at directly negotiated prices rather than prices set by market transactions. The Yellow River Conservancy Commission has had the most success in implementing reforms to limit water withdrawals, largely due to an improved monitoring system. Even here, municipalities often violate their limits or withdraw water from tributaries before it reaches the Yellow River rather than purchase rights from other municipalities.

India’s increasingly severe water shortages, considered a crisis by the national government, is driving a review of water institutions (Water Governance Facility 2013: 11). The Supreme Court’s recent interpretation of the public trust doctrine identifies the state as responsible for water as a natural resource, despite the common law tradition that landowners have unlimited rights to extract groundwater from beneath their property. In India, water regulation is the responsibility of states, so the central government issues Model Bills as guidelines. The latest 2011 Model Bill includes a right to water of acceptable quality, specifying 70 litres per capita per day as a minimum, and recommends a separation of land and groundwater rights. The federal government’s 2012 National Water Policy and 2013 draft Framework Law on Water provided further nudges to reform. Despite central government encouragement, however, few states have taken steps towards water markets and IWRM. The state of Karnataka introduced a Ground Water Act in 2011 requiring the registration of existing wells and prior permission for all new wells but a perceived lack of legitimacy has resulted in low levels of compliance. The act was modelled on prior Model Bills so did not include aspects of IWRM included in the 2011 Model Bill. This may partly be due to uncertainty created by the Model Bill itself: the bill has existing water rights expiring after one year but without compensation for lost rights, creating uncertainty that will generate resistance within states considering adopting such regulation. It also fails to make clear whether the trading of water rights is allowable.

Conclusion

The move to IWRM and an acceptance of more clearly defined property rights, water pricing and water markets is happening slowly but the idea has gained a foothold. The countries discussed above are not the only examples; within Europe, Spain’s 1999 Water Law Reform opened the door to water rights trading. The institutional details necessarily differ across countries. This is beneficial because countries differ in terms of water resources, existing institutions and in many other ways that will require different social arrangements to achieve the largest social product. It is also beneficial because competition between, or at least a comparison of, different institutional details provide the information that makes innovation and learning possible.

In the introduction to this book, Veljanovski notes that it took 67 years from Coase’s work for the United States FCC to adopt a spectrum market. Spectrum markets now have broad acceptance although, as expected, the institutional details differ across countries. Applying Coase’s insights and using markets for water resource management faces even stiffer political challenges, but it has the potential to deliver crucial social and environmental benefits.

 

 

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