The Effect of Restructuring Electricity Distribution Systems on Firms' Persistent and Transient Efficiency: The Case of Germany.

• Author: Badunenko, Oleg

1. INTRODUCTION

   The German reunification in 1990 is often referred to as one of the most important political events of the twentieth century and recognized as an unprecedented example of the economic integration of two neighboring regions with different structure and degree of economic development (Burda and Hunt, 2001). Within the shortest period of time, economic and political unity was achieved between the communist German Democratic Republic and the Federal Republic of Germany.

   Immediately after the reunion, a process of urban restoration and local infrastructure renovation has commenced in the eastern parts of the reunified country (Sinn, 2002). Previous literature refers especially to the telephone, water supply and waste water disposal systems as examples of the ambitious modernization of a desolate public infrastructure (e.g., Burda and Hunt, 2001; Moss, 2008).

   Compared to other urban areas in West Germany, the country's division after World War II led to a decline in population growth, a loss of market access and, subsequently, lower economic activities in western regions close to the inner-German border (Redding and Sturm, 2008). However, following the reunification, Bavarian jurisdictions adjacent to the border experienced growth of both population and local economic activities, accompanied by regional congestion and higher costs of living (Jones and Wild, 1994). Despite these immediate effects, the separation of Germany into east and west had long-run impact. Fifteen years after the reunification, regional income in eastern parts of Germany is still lower than that in the western parts due to the economic closeness and the lower level of international market integration of the former communist state (see Buch and Toubal, 2009). While the living standards, consumption behavior and purchasing power widely converged among eastern and western regions (Berlin-Institut, 2015), the labor market has not recovered yet from its poor performance documented, for example by Hunt (2001, 2002) and Snower and Merkl (2006). Evidence on the performance of distribution system operators (DSOs) in the context of reuniting the two countries and the associated restructuring process has not yet been provided.

   The focus of this paper is the analysis of the persistent impact of the restructuring--that followed the reunification--on the current performance of providers of electricity distribution services, i.e., DSOs. The service of electricity distribution is crucial for regional growth and welfare as it connects residents and local industries to the national power grid and supplies them with electrical power, which is used for business-related and every-day-life activities such as lighting, heating, cooking, communicating, etc.

   For the last twelve years of separation (1978-1990), the eastern electricity distribution sector was organized based on the former fifteen energy regions (Energiebezirke) of East Germany. This region-based structure followed an organizational but not an economic rationale (Matthes, 2000). At that time, the political and managerial decisions regarding the sector were solely made by the central state in line with the communist paradigm of a centrally planned economy, jurisdictions and private owners of electricity distribution networks have been dispossessed by the government in the 1950s.

   Subsequent to the reunification and after initial setbacks, the eastern energy sector was restructured in a rigorous way. At the very beginning, between 1989 and 1995, the transition was especially ineffective due to a large number of stakeholders, property right issues, and the required compatibility of the two technological systems. Integrating both countries' electricity sectors, thus, became the major challenge for the decision-makers who operationalized the reunion. With western structures as a role model, the eastern electricity distribution had undergone a profound restructuring process that caused a complete reshaping and involved radical changes in operating areas, operational management and ownership (Birke et al., 2000).

   During the process of reunification, the eastern enterprises were transferred to a privatization agency (Treuhandanstalt), which was responsible for conveying them into newly structured organizations. The pursued strategy for this reorganization was to broadly adapt the existing structure of the western German electricity distribution sector, i.e., implementing local and regional distribution networks. The privatization agency primarily intended to sell the enterprises to western electricity firms as they were expected to have the necessary capital and knowhow for the imminent restructuring, and hence, requiring no further subsidies. However, those eastern jurisdictions that claimed back their enterprises, which have been previously taken away from them, were successful. As a result of this restructuring, the sector in the East is composed of local and regional DSOs that operated much smaller networks than their region-based predecessors, that are both publicly or privately owned, and obviously, no longer centrally controlled.

   Another aftermath of the reunification was a massive input reallocation. On the one hand, labor force moved from East to West, and physical capital and enormous investments, on the other hand, from West to East (Burda, 2006). Between 1992 and 1998, about 72 billion euros were invested into the eastern Germany's infrastructure (Burda and Hunt, 2001) that has been run down under the communist rule. While the impact of these investments on regional growth in eastern Germany is subject to debate (Koetter and Wedow, 2013), they indisputably caused a general modernization of infrastructure. Alongside the massive capital flows, the eastern economy benefited immediately from adopting sound and well-functioning institutions as well as using the best infrastructure available at that time which is considered to be the main reason why the eastern parts of the country is vastly superior compared to the western parts (Snower and Merkl, 2006; Sinn, 2002; Burda and Hunt, 2001).

   The question arises whether such immediate and comprehensive restructuring, and in particular the modernization, and the transfer of technology and knowledge, positively influenced the performance of East German DSOs in the long-run. We analyze this by applying a state-of-the art stochastic frontier model that allows identifying determinants of time-variant (transient/short-run) and time-invariant (persistent/long-run) performance. We use a novel panel dataset of eastern and western German DSOs observed between 2006 and 2012. We approximate the restructuring by the location of the DSOs. We find that both eastern and western DSOs are equally efficient with respect to their transient efficiency. We further show that the DSOs operating in the East German areas exhibit, on average, a higher persistent efficiency than those located in West Germany.

   The remainder of the paper is organized as follows: After describing the method to the evaluation of public infrastructure in the next section, Section 3 presents the formal description of the model. In Section 4, we describe the empirical strategy and the data. Section 5 present the results of our analysis, and Section 6 concludes.

2. EFFICIENCY MEASUREMENT IN PUBLIC SECTORS

   Beginning with the seminal work by Samuelson (1954) and Tiebout (1956) allocative efficiency in local public service provision has been extensively discussed from various angles. More recently, the importance of technical efficiency, defined as the minimum input necessary to produce a certain level of output, has also been acknowledged as an important component in local public economics. Using stochastic frontier (SF) models, which directly incorporate technical inefficiency, some scholars analyze the aggregated public service provision of jurisdictions (e.g., Grossman et al., 1999), while others consider particular public services such as schooling (e.g., Grosskopf et al., 2001), libraries (e.g., De Witte and Geys, 2011) and multi-utilities (e.g., Farsi et al., 2008).

   The interest in determining the (inefficiency of DSOs stems from welfare considerations (e.g., Shleifer, 1985; Laffont and Tirole, 1993; Armstrong and Sappington, 2007) and the importance of energy supply for local economic activities. The latter is emphasized by the fact that the volume of electricity delivered are often used as proxies for regional gross domestic product (GDP) where direct measures of GDP are missing (Henderson et al., 2012). At least in developed countries where almost the entire population is supplied with electric power, the efficiency of DSOs is directly related to consumer prices. Abstracting from the complexity associated with prices, an efficient DSO uses the resources in such a way that the cost of supplying a given amount of electricity is minimized. In turn, it is expected to lower prices paid by the consumer. In developing countries where only a small share of the population is supplied with electric power and other public infrastructures, the implementation of efficient networks could help increasing the benefits from urban concentration. (1)

   There are ample empirical works estimating the extent of inefficiency of DSOs for multiple regions; e.g., Kumbhakar et al. (2015a) and Bjorndal et al. (2018) analyze DSOs in Norway, Kumbhakar and Hjalmarsson (1998) in Sweden, Filippini et al. (2004) in Slovenia, Cullmann (2012) and Hirschhausen et al. (2006) in Germany, Filippini and Wetzel (2014) in New Zealand, Giannakis et al. (2005) in the UK, Farsi and Filippini (2004) in Switzerland, and Bagdadioglu et al. (1996) in Turkey. A shortcoming of these studies is that they rely on the assumption that inefficiency is either time-variant (transient) or time-invariant (persistent). Conceptually transient inefficiency relates to non-systematic management problems that are controllable and, therefore...