Published online: 24 Aug 2007.

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1 This article was downloaded by: [Vrije Universiteit Amsterdam] On: 08 August 2013, At: 01:28 Publisher: Routledge Informa Ltd Registered in England and Wales Registered Number: Registered office: Mortimer House, Mortimer Street, London W1T 3JH, UK Applied Economics Letters Publication details, including instructions for authors and subscription information: Fair competition in the refuse collection market? E. Dijkgraaf a & R. H. J. M. Gradus b a SEOR-ECRi, Erasmus University Rotterdam, The Netherlands b Vrije Universiteit Amsterdam and ECRi, Erasmus University Rotterdam, The Netherlands Published online: 24 Aug To cite this article: E. Dijkgraaf & R. H. J. M. Gradus (2007) Fair competition in the refuse collection market?, Applied Economics Letters, 14:10, , DOI: / To link to this article: PLEASE SCROLL DOWN FOR ARTICLE Taylor & Francis makes every effort to ensure the accuracy of all the information (the Content ) contained in the publications on our platform. However, Taylor & Francis, our agents, and our licensors make no representations or warranties whatsoever as to the accuracy, completeness, or suitability for any purpose of the Content. Any opinions and views expressed in this publication are the opinions and views of the authors, and are not the views of or endorsed by Taylor & Francis. The accuracy of the Content should not be relied upon and should be independently verified with primary sources of information. Taylor and Francis shall not be liable for any losses, actions, claims, proceedings, demands, costs, expenses, damages, and other liabilities whatsoever or howsoever caused arising directly or indirectly in connection with, in relation to or arising out of the use of the Content. This article may be used for research, teaching, and private study purposes. Any substantial or systematic reproduction, redistribution, reselling, loan, sub-licensing, systematic supply, or distribution in any form to anyone is expressly forbidden. Terms & Conditions of access and use can be found at

2 Applied Economics Letters, 2007, 14, Fair competition in the refuse collection market? E. Dijkgraaf a, * and R. H. J. M. Gradus b a SEOR-ECRi, Erasmus University Rotterdam, The Netherlands b Vrije Universiteit Amsterdam and ECRi, Erasmus University Rotterdam, The Netherlands We estimate whether fair competition exists for tendering refuse collection in the Netherlands. The results indicate that concentration increases prices and offsets the advantage of contracting out. The presence of competing public firms might be essential to ensure fair competition. I. Introduction In an overview, Domberger and Jensen (1997) show that contracting out refuse collection suggests cost savings in the order of 10 30% without sacrificing the quality of services provided. For the Netherlands, Dijkgraaf and Gradus (2003) found a cost decrease of 15% when waste collection is contracted out. However, Shepherd (1997) and Bel and Costas (2006) point out that a tendency towards concentration may diminish the advantage of contracting out. A high degree of market concentration may weaken competition and, therefore, makes it difficult to obtain benefits from contracting out. This article extends the literature by empirically investigating this issue for the Netherlands. We show that in concentrated regions cost savings due to contracting out are substantially less. Moreover, the results indicate that involvement of public firms in the tender process may be important, because it offsets the disadvantage of concentration. II. The Dutch Refuse Collection Market Dutch municipalities have a legal obligation to organize a refuse collection infrastructure. They are free to choose whether to provide this task themselves or to contract out refuse collection. In 2002, 37% of municipalities have contracted out refuse collection to a private firm and 17% to a public firm. A third group of municipalities (19%) collect the refuse by a municipal service in cooperation with neighbouring municipalities. The other municipalities (26%) collect the refuse themselves. Based on a national market the Herfindahl index for private firms is 0.27 for the Dutch refuse collection market (left-hand side of Table 1). 1 Compared with a threshold value of 0.18, used by the US Federal Trade Commission, the national market is concentrated. The C3-ratio is also high (0.76). If the relevant market is the province, concentration is higher, especially in some provinces. 2 However, if municipalities decide to contract out refuse collection not only private firms are available as a potential contractor. In the Netherlands, public firms behave more and more as competitors for private firms. On a national scale the Herfindahl index is now only 11% suggesting a competitive market (right-hand side of Table 1). Still, concentration might be present at a provincial level as for most provinces the Herfindahl index is high. *Corresponding author. dijkgraaf@few.eur.nl 1 The Herfindahl index is the sum of the squared market shares. The C3-ratio the sum of the market shares of the three largest companies. 2 Due to (past) Dutch legislation there is some evidence that the relevant market is the province. Till recently the market was regulated on a provincial level. Applied Economics Letters ISSN print/issn online ß 2007 Taylor & Francis DOI: /

3 702 E. Dijkgraaf and R. H. J. M. Gradus Table 1. Concentration indexes Private competitors Private and public competitors Herfindahl C3 Herfindahl C3 Drenthe Friesland n.a. n.a Flevoland n.a. n.a Groningen Limburg Zuid-Holland Zeeland Utrecht Noord-Holland Overijssel Noord-Brabant Gelderland The Netherlands High concentration may result from cost minimizing behaviour if increasing returns to scale exist and fair competition is present. In the literature some evidence is present for economies of scale, especially for low-populated municipalities (e.g. Stevens, 1978; Dijkgraaf and Gradus, 2003; Bel and Costas, 2006). Thus, small municipalities have an incentive to choose the company which already serves in the same region. If a priori enough regional competitors are present, however, private firms can not transform scale effects in excess profits. In this case no significant relationship should be found between market concentration and collection costs of municipalities using private firms. On the other hand, if a significant relationship is found this indicates that private firms can make excess profits. III. Methodology and Data We test whether concentration influences refuse collection costs by an Ordinary Least Square (OLS) estimation of a standard log linear total cost function. This function includes as production variable the number of collection vehicle stops and a number of exogenous factors like the time needed to arrive at the pick-up points, the time needed to collect the waste and the waste composition (Dijkgraaf and Gradus, 2003). 3 Furthermore, three dummies are included that measure whether the waste collection firm is public, private or an inter-municipal cooperation. Municipalities that collect the waste themselves are the benchmark for these variables. Finally, variables are included that measure regional concentration. We test three alternatives:. First, we include Herfindahl indexes measuring provincial concentration. As public companies compete with private companies both are included in this variable.. Second, we include provincial C3-ratios (also with both public and private companies).. Third, we include dummies for regional private competition (C P ) and public competition (C I ). For municipalities that use a private waste collection firm C P is one if there is a municipality in the neighbourhood that uses a competing private collection firm, while C I is one if there is a public collection firm in the neighbourhood. 4 The dummies are zero if no regional competitors are present or the municipality has a different mode of production. The fair competition prior is that we will find no significant relationship between regional concentration measures and costs of municipalities using private firms. In this case the coefficients of the regional concentration (dummy) variables should be insignificant. 3 Note that factor prices are not included as no reason is present why they should differ between municipalities. We only present the estimations for the exogenous market factors. Results for other variables are available upon request. 4 As a starting point we include only municipalities within a distance of 15 miles. As the Netherlands is densely populated this means that the average municipality has 6 municipalities within this distance. Substituting this distance for 25 miles does not influence the conclusions.

4 Fair competition in the refuse collection market? 703 Table 2. Estimation results: effect on total cost waste collection Independent variable Model 1 Model 2 Model 3 Model 4 Effect for municipalities with collection by: Inter-municipal cooperation 0.04 (0.03) 0.04 (0.03) 0.04 (0.09) 0.06** (0.03) Public firm 0.06** (0.03) 0.06** (0.03) 0.06** (0.09) 0.03 (0.03) Private firm: all 0.07*** (0.03) 0.13*** (0.04) 0.28*** (0.09) Private firm: effect of Herfindahl IþP 0.16* (0.09) Private firm: effect of C3-ratio IþP 0.26** (0.10) Private firm: private competitors present C P Private firm: public 0.09*** (0.03) competitors present C I R 2 -adj Note: SE in parentheses. Coefficients with *, ** and *** significant at 90, 95 and 99%. Data for the type of collection (by municipal itself, public firm, private firm or an inter-municipal cooperation), the C3-ratio, the Herfindahl index, waste composition and total costs come from the Dutch Waste Management Council. Total costs are calculated by multiplying the average municipal tariff per household (excluding VAT) with the number of households per municipality. If actual tariffs do not cover total costs, we use the coverage factors to calculate cost-covering tariffs. Other data for exogenous variables come from the Dutch Bureau of Statistics. Distances between municipalities are based on data from a standard route planner. All data are for In total we have 453 observations as for 43 municipalities data are missing. IV. Results According to the first estimation, private collection is 17% cheaper than collection by municipalities (Table 2). 5 This result is consistent with the literature. Collection by a public firm is 14% cheaper than collection by municipalities. Although the coefficient for private firm collection is somewhat higher than for public firms, a Wald test does not reject the hypothesis that they have the same size. Apparently, the most important factor influencing collection costs is not ownership but contracting out (compare Domberger and Jensen, 1997). Moreover, the difference between collection by an inter-municipal cooperation and collection by the own municipality is insignificant. The second estimation shows that the coefficient of the Herfindahl index is significant at 90%. This means that costs of private provision are dependent on regional concentration. At the average value of the Herfindahl index the effect of private provision on collection costs is 18%. With a Herfindahl index of 1.00 (monopoly) total costs even increase with 8%. At the other hand, cost advantages of private collection are much higher if enough competition is present. A Herfindahl index of zero (maximal competition) results in an estimated cost decrease of nearly 30%. This is interesting as this might give an explanation why studies differ with respect to the effect of private provision (remember the 10 30% range found in the literature). In the third estimation, the coefficient for the C3-ratio is significant at 95% and again indicates that the cost advantage of private provision depends on regional concentration. 6 At the average value for the C3-ratio the cost advantage of private provision is now 16%. Note that for low values of the C3-ratio, i.e. 0.5 for Gelderland, the cost advantage of private provision is 35%. A C3-ratio of 1.00 (monopoly) results in a cost decrease of 6%. A Wald test shows that these values are within the ranges generated with the second estimation. The results of the second and third estimation indicate that regional concentration results in excess profits for private collection firms in the Dutch waste collection market. 5 As the estimations are in logs the effect can be calculated using e x 1. Note that this effect has to be multiplied by 2.5 as collection costs are on average 40% of total costs. 6 Substitution for the C4-ratio does not change the results significantly.

5 704 E. Dijkgraaf and R. H. J. M. Gradus In the fourth estimation, the collection costs of municipalities that use a private collection firm are lower when a public competitor is present in the neighbourhood (the coefficient is significant at 99%). 7,8 In this case total collection costs diminish with 21%. Municipalities with private contractors and only private competitors in their neighbourhood have comparable costs with municipalities that collect the waste themselves or by a public firm. These results indicate that private companies might materialize excess profits in regions where not enough public competitors are present. This is interesting as this suggests that the simultaneous presence of public and private companies is an effective instrument to enhance competition. 9 V. Conclusions The literature shows that contracting out refuse collection implies cost savings of up to 30%. In this article we show that an explanation for this broad range could be that concentration offsets the advantage of contracting out in some regions. To verify this conclusion more studies in other countries and for more years should be done. Nevertheless, our results strongly advocate that there is a clear role for the government in promoting anti-trust policies in the refuse collection market and give public firms a chance to enter the market as well. References Bel, G. and Costas, A. (2006) Do public sector reforms get rusty? An empirical analysis on privatization of solid waste collection, The Journal of Policy Reform, 9, Dijkgraaf, E. and Gradus, R. H. J. M. (2003) Cost savings of contracting out refuse collection, Empirica, 30, Domberger, S. and Jensen, P. (1997) Contracting out by the public sector: theory, evidence and prospects, Oxford Review of Economic Policy, 4, Shepherd, W. (1997) The Economics of Industrial Organization, Prentice-Hall, New Jersey, NY. Stevens, B. J. (1978) Scale, market structure and the cost of refuse collection, Review of Economics and Statistics, 60, We can not estimate the effect of private collection when no competitors are present in the neighbourhood as we have not enough observations for this variable. 8 We tested for spatial autocorrelation as the neighbourhood effect might result from a process where municipalities look at the costs of neighbours before they decide on their own costs. Comparing Moran s I for different subsamples leads to the conclusion that spatial autocorrelation does not drive our results. Statistics are available upon request. 9 Estimation of separate models for small and large municipalities reveals that the concentration effect on costs especially exists in larger municipalities. For instance, the coefficient for C I is negative at 99% significance for large municipalities and insignificant for small municipalities.