Economies of scale and capital utilisation in the English and Welsh water supply industry.

Abstract

This study estimates a variable cost model of the UK water industry. From this variable cost function, estimates of economies of scale and economies of capital utilisation and capacity utilisation are made. The data used in the study consists of 20 English and Welsh water companies. The results suggest that only slight, albeit, significant dis-economies of scale and substantial dis-economies of capital utilisation exist in the industry. These estimates indicate that if output increases, with or without holding capital constant, variable costs would increase at a level above the proportional increase in output. Both these results indicate that if the water industry has not been in long-term equilibrium (in terms of capital) both merger and acquisition amongst water companies (a process that is occurring) is not justified in terms of cost efficiency. A low level of capital utilisation is indicated for the water industry. It is shown that the level of capital utilisation does increase over the sample period to approximately 30 per cent in 1996, indicating disequilibrium, in terms of capital, is present in this sector.