The measurement and regulation of cross subsidy. The case of the Scottish water industry

There is a widespread belief that significant cross subsidies exist in the water, gas and electricity utility industries, particularly those under public ownership. In this paper we discuss the measurement of cross subsidy and its regulatory implications in the context of a publicly owned utility on the verge of being opened up to product market competition.Using the case of the publicly owned Scottish water industry the paper outlines the definition and measurement of cross subsidy in theoretical terms before reviewing the policy debate over the desirability of cross subsidy between different customer groups and services. It then explains the approach to measurement recently adopted by the Scottish Executive. Having established the size and direction of cross subsidy the regulatory implications are considered.