Private or Public Enterprises? Cost Inefficiency Limits - An Application to Water Supply Companies in Brazil

In this paper we analyze the cost inefficiency limits of firms operated by the government. First, we prove, through a simple theoretical model, the existence of a limit of the cost inefficiency that a public firm may have. Such limit depends on the market demand and cost structure. Above that limit, transferring the firm's operations to a private initiative is better. Second, using data from the Sanitation Information System of Brazil, we propose an empirical procedure based on the Laffont and Tirole (1986) model of firms’ regulation to measure the cost inefficiency of public water providers in Brazil.