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Home > Global Institutions & Politics (GIP) > Water & Electricity Services — Menu > Article
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Policy Series on Essential Services — Paper No. 1Putting the Private Sector in its Place — Part I"Issues and Evidence in the Reform of Water and Electricity Services"Part II Tim
Kessler
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The agenda of public sector reform in developing countries is being radically changed within G-7 governments, the multilateral lending institutions they control, and transnational corporations that influence both groups. Disappointment with decades of foreign aid has transformed that agenda into a debate about how – rather than whether – to privatize1 basic services. [TOP] The purpose of this paper is to present analytical and political reasons for private sector participation (PSP) in services to remain one option among others, rather than a policy goal in itself. Its central premise — one often supported by market enthusiasts more in words than in deeds – is that policy-makers and the public need to know whether the prerequisites for equitable private provision of services exist before proceeding with reform. A. One Option Private provision of essential services is accelerating throughout the developing world, largely as a result of policy initiatives led by international financial institutions (IFIs) that lend to developing countries. In February 2002, the World Bank adopted a private sector development (PSD) strategy that promotes an unprecedented expansion of PSP in infrastructure and social services in developing countries. (It is worth noting that most of the governments that control that institution still provide such services themselves.) [TOP] The strategy could make lending to the poorest countries contingent on agreement by borrowing governments to delegate service provision to private firms or non-profit organizations. In March 2002, the World Bank also unveiled its Water Resources Sector Strategy, which makes the privatization of water supply and sanitation, irrigation and dams a cornerstone of its new approach to development. Only a decade ago, multilateral lenders were focused mainly on reforming, rather than replacing public utilities. Since the end of the Cold War, botched or corrupted private provision in transition and developing countries have transferred massive amounts of public assets into a few hands. Yet these same institutions now pronounce as conventional wisdom that PSP in provision is usually the best choice for delivery of infrastructure and social services. The intellectual breakthrough making this change possible is the argument that such essential services are most effectively delivered when driven by economic, as opposed to social principles. Proponents do not deny the social importance of water and electricity, but maintain that market forces will achieve social goals – including poverty reduction — more effectively than government. Critics have responded that using only economic principles in policies for reforming essential services, especially water and sanitation, may undermine social goals of infrastructure. (Gleick 2002; McCully 2002) That is, efficiency does not automatically (or even usually) promote equity. As argued below, the assertion that PSP is always, or even usually, the best option for achieving universal and affordable access to utility service is not the result of evidence or systematic analysis. Indeed, available research and case studies often suggest the contrary. More importantly, the adoption of PSP has not been the result of democratic processes within developing countries. The multilateral lending institutions that support infrastructure reforms have developed a robust rhetoric about the importance of popular participation in policy-making. Especially in very poor countries eligible for debt reduction, the World Bank has articulated the need to consider viable reform alternatives and include civil society in the debate over balancing objectives of fiscal discipline, economic efficiency and poverty reduction. [TOP] However, in practice, the inclusive process implied by this commitment has been largely absent, even in debt relief and poverty reduction operations in which civic participation is formally mandated. Typically, participation has consisted of a few meetings with community leaders who are able to express general concerns and environmental priorities and social welfare. The actual measures taken to address those priorities – the reforms themselves – are decided in secret between lenders and high level government ministers. The proof is in the policy. In country after country, however, it has become clear that there is really only one option: private provision. Alternatives that can be legitimately debated are often limited to which form of PSP is most appropriate. When the reform decision begins as a fait accompli, the only meaningful selection criteria become government’s willingness to pursue the policy change, or the lender’s ability to convince the government to privatize. Moreover, the decision to privatize is not regularly subject to public discourse. Indeed, even elected representatives are often unaware of detailed plans to reduce or eliminate the role of government in the provision of basic services. (News and Notices, May 2002) An even more insidious development that undermines democratic governance is social marketing for PSP. As a condition for receiving assistance, the World Bank has forced some governments to pay for advertising and carry out “information campaigns” that promote the idea of private participation in infrastructure and defuse opposition to such reforms. (News and Notices, May 2002) The practice not only institutionalizes a conflict of interest, but also makes a mockery of the concept of “country ownership.” [TOP] Perhaps the most devastating blow to ownership is conditioning loans, grants or debt relief on requirements to privatize. Indeed, there is growing evidence that debt relief operations have been suspended at least in part because of governments’ refusal to comply with the scope or pace of PSP conditions of the World Bank or IMF. Privatize provision of infrastructure is pushed indirectly by rich countries in their role as major shareholders of the IFIs. It is also being pushed directly through bilateral aid programs, and especially through pressure on developing countries in the WTO to include their utility sectors in the General Agreement on Trade in Services (GATS). In April 2002 a leaked confidential document drafted by the European Commission revealed not only its close cooperation with transnational companies, but also extraordinary efforts to influence poor countries to open up traditionally government-operated sectors such as water, energy and transport. Governments that decide (or are persuaded) to include these sectors in their GATS commitments may limit their ability to pursue developmental or social goals through subsidies, procurement preferences or other instruments that “discriminate” against international competitors. [TOP] Solutions for provision of essential services are political choices, not technical imperatives. But when international organizations seek to impose solutions on developing countries, they circumvent the political system and undermine democratic governance. Making democracy a priority does not negate the importance of technical analysis in any reform decision. Indeed, such work should be a central part of public discourse over alternatives. But when policy reforms are undertaken without the knowledge and consent of citizens, analysis will not generate political legitimacy. This is particularly the case for private provision of public services, which are highly visible and have traditionally been the responsibility of government. [TOP] B. Moral Case for Private Provision
C. Scope of the Paper II. Evidence in Support of Private Provision of ServicesA. Can a hundred studies be wrong? Probably not, but they can be irrelevant. The vast majority of research on privatization focuses on firms which produce goods and services for competitive markets, and on countries whose assets and capabilities are generalized for the rest of the world. Yet water and sanitation are typically natural monopolies, making competition a moot point, while Chile – the perennial example of success – is hardly representative of developing country economies or institutions. Study after study confirms that privatized state-owned enterprises in Latin America, East Asia and the post-Soviet countries firms perform better than they did while run by the government. Yet such research does nothing to bolster the position for privatizing utilities. There are several reasons:
B. Relevant research There are, however, preliminary analyses that do focus specifically on the impacts of privatizing public infrastructure. The World Bank widely circulates Philip Gray’s “Private Participation in Infrastructure: A Review of the Evidence” (2001) to provide the empirical basis for its Private Sector Development strategy. A review of this analytical cornerstone study is revealing. One would expect that a development strategy supported by the world’s largest development organization would be informed by extensive research and evidence confirming the effectiveness of the approach, especially for the most controversial and socially sensitive sectors. One would also expect a careful analysis of cases in which the strategy has failed, so that lessons for avoiding such problems could be drawn. [TOP] In the case of PSP in infrastructure, one would be disappointed. A brief content analysis of 29 cited references in Gray’s paper about the impact of private sector participation in utilities reveals the following:
Not surprisingly, the most beneficial effects – and the most diverse empirical record – are found in the telecoms sector. Because of technology improvements, this is the area of infrastructure most characterized by low barriers to entry and robust competition. References for the energy sector are less robust, given that most were produced “in-house.” Moreover, for both telecoms and energy, the good news comes disproportionately from a few middle income countries, especially Chile and Argentina, which have unusually high levels of development and human capital among Bank borrowers, as well as some developed countries. As for negative impacts, in spite of enormous scandals and political turmoil causes over privatized infrastructure all over the Global South, none are discussed.3 (See following section.) So much for learning from mistakes. [TOP] In the water sector, references are both minimal and completely dependent on World Bank research – as opposed to independent analysis. Moreover, the outcome measured in the water cases is productivity, not affordability or access for the poor, much less public health.4 Again, it is hardly surprising that private companies can produce water more efficiently than governments. But from a poverty reduction perspective, evidence about who gets that water and at what price is needed. . [TOP] III. Beyond Theory: Privatized Services in the Real WorldLike mainstream economics itself – and in the absence of much supporting evidence — theories predicting the benefits of privatizing essential services depend on critical assumptions that are rarely valid in the context of developing countries. In this section, we take a closer look at real world constraints that limit positive impacts of private provision, while increasing social and economic vulnerabilities consumers and taxpayers, especially the poor . A. Performance-Based Contracts PSP enthusiasts propose the mainstreaming of “output-based aid.” This is the development community’s synonym for performance-based contracts (PCBs), which have a long history between firms, as well as between firms and governments in developed countries. While currently pushed through pilot studies in the World Bank’s Private Sector Development strategy, the U.S. government is seeking to make OBA the dominant mode of aid delivery. (Kessler and Alexander 2002) [TOP] The logic is simple: “You don’t get paid until you deliver exactly what we agreed on.” This is supposed to shift the risk away from the tax-payer and onto the private provider. Moreover, because private firms compete through bidding to determine who can deliver for the lowest price, the public is assured the best deal as well. The incentives structured through PCBs lay the basis for their superior efficiency, product quality, and even investment in the poor. Notwithstanding the enthusiasm of free market enthusiasts, PCBs are problematic in the real world. As two researchers put it: “performance contracts are not self-administering, self-correcting, or self-improving. Performance contracts do not quickly or automatically solve the problems of vendor performance.” (Behn and Kant, p. 471-48) In terms of delivering value to consumers, PCBs have a number of general weaknesses, including:
In the aftermath of the Bush Administration’s announcement of its Millennium Challenge Account, a US initiative to increase bilateral aid and make it more effective, the provision of grants to corporate and non-profit providers is being touted as a way to overcome such obstacles. Yet such largesse will do nothing to improve longstanding weaknesses of most subsidy targeting mechanisms, and may provide disincentives for private providers to increase efficiency. [TOP] 1. Obstacles to effective performance contracts Although private provision of government services has not been subject to systematic analysis in developing countries, it has been in the North. Such studies reveal a very mixed record in the developed countries, ranging from much better, to much worse, to about the same performance as the public sector. According to a review of evidence from the US conducted by Elliott Sclar, private providers tend to do a better job than government performing simple, low-skill activities, and a poorer job with more complex activities. Indeed, privatized services often cost government more than when the services were provided in-house. The reason is transaction costs. As services become more complex – and as the economic and social outcomes they are supposed to achieve become more difficult to measure with simple indicators – the public sector inevitably gets involved. Governments often impose strict requirements on contractors regarding production processes and outputs, as well as information and reporting requirements. These details become part of excruciatingly complex and highly legalistic contracts, and end up raising the costs of producing the desired services. From a developmental perspective, Sclar’s study is revealing in two ways. First, it dispels the myth of the superiority of private management of public services by demonstrating just how difficult it can be to adequately specify terms in a performance contract. Even when well-paid lawyers, accountants, bureaucrats and technicians work together to ensure that payment is based on objectively measured outputs, the record has often been disappointing. Second, Sclar’s study implicitly raises serious questions about the ability of governments in poor countries to even produce, much less enforce, the complex contracts involved in transferring responsibility for public services to profit-motivated agents who are likely to have far more information than the principals. Typical Southern borrowers cannot begin to match the expertise, experience or autonomy of American institutions of public governance. Yet under the World Bank’s PSD strategy, they are still being pushed to enter into complex contractual relationships with highly capable – but not necessarily transparent — national or transnational corporations. [TOP] Research such as Sclar’s begs the question: Which reform is harder to achieve? Theory and evidence about contracting in developing countries demand that this be explicitly asked in each reform case. Yet the question seems to have been dismissed – the universal answer being obvious – by PSP proponents. The assumption that the constraints to PSP are always easier to overcome than those to public sector reform makes an ideological agenda apparent.
C. Governance and accountability 1. Regulation One issue on which all sides of the reform debate agree is the role of governance in delivering public services. Whether the utility service provider is a government, a private firm or a non-profit, monitoring and enforcement are essential for success. The provider’s actions and outputs must be transparent, and there must be institutions through which it can be held accountable by the people who rely on its services. An immediate lesson from this agreement is that prior to adopting private provision, the viability of public regulation should be firmly established. Given the capacity and behavior of a country’s (or municipality’s) existing governance institutions, it is essential to determine which reform option is most likely to ensure that utility services are transparent and accountable. Yet blanket support for PSP in services anywhere carries with it an implicit and peculiar argument: the same government that lacks the competence or incentive to provide basic infrastructure services to its citizens, despite decades of trying, is expected to regulate private providers – who have greater expertise and information, and often political influence over country officials — in a very short time frame. [TOP] In an ideal auction, private bidders win concessions based on promises over tariff levels, investments in network expansion, and service quality. Making sure those promises are kept becomes the responsibility of government (as well as service users) the day the firm opens for business. As an applied economics researcher states, “Given the high stakes involved in resetting prices, which transfer rents from one side of the market to the other, a satisfactory dispute resolution procedure is required and needs to be specified clearly in advance of privatization.” (Newberry, p. 19; emphasis added) The World Bank echoes this advice for investment commitment. “Connection targets should be carefully monitored and enforced with financial penalties.” Day-to-day disputes over service provision – reliability, quality, over-charging – clearly require an independent authority to hear and arbitrate complaints. When firms provide or manage utility services, the government must enforce commitments about prices, investment and quality. According the World Bank, for a management contract to work two requirements are essential: “clear and indisputable performance indicators and a monitoring agency or official with the skills and budget to do the job, and the strength, integrity and autonomy to do it independently.” (Cowen 1997) Regulation of wholly owned concessions will be an even greater challenge. What is striking is how frequently the Bank supports private solutions in utilities, and how rarely borrowing governments have monitoring agencies that come even close to satisfying the criteria described above. The Bank’s response to the lack of home-grown governance is to contract regulatory functions themselves to private firms. Such an approach largely untested in the developing world. More seriously, it makes a mockery of the World Bank’s stated objective to strengthen governance capacity of the state. Indeed, this remarkable advice is simply to privatize governance itself. As the Bank itself acknowledges, “No regulatory rule for private participation, no matter how precisely written, can remove all discretion from regulatory decisions, and the exercise of this discretion cannot be contracted out.” (Cowen 1997). However, the exercise of discretion requires access to information and expertise – precisely the capabilities lacking in many developing country governments, and likely to whither still more after they lose basic regulatory responsibilities. [TOP] In addition to monitoring and ensuring compliance with performance standards, regulators must also enforce rules governing environmental protection and consumer safety. As Philip Gray argues in his review of private participation in infrastructure, “[U]nlike their public sector counterparts, private operators have stronger incentives to comply with quality standards and other regulatory obligations, as failure to do so is more likely to result in fines or other penalties.” (p. 4). Not surprisingly, the author does not produce even a World Bank reference to support such a remarkable statement. Companies confronting the U.S. Environmental Protection Agency, an institution with immeasurably greater resources than those found in developing countries and a massive judicial system to back it up, have violated regulations for decades. Faced with costs of upgrading equipment or changing production processes, private companies operating in a weak governance environment have strong incentives to ignore or bribe regulators. [TOP] In the absence of a capable, trusted and autonomous regulator, only empowered consumers are capable of achieving accountability. A new question emerges: under what circumstances are consumers, especially marginalized citizens, likely to have influence over providers? Governments are notorious for neglecting poor people, but in the end they are political institutions that respond to organized action and mobilization. That means that accountability can be achieved, where freedoms of speech and association are respected, if citizens work together. Firms also neglect social goals – but they were not created pursue such goals. In the end, they are accountable to shareholders, and without public authority to discipline their actions, they can hardly be expected to respond to civic action. According to a management professor in Columbia University’s School of International and Public Affairs, “where accountability is a critical value in the execution of a program, that program tends to be best implemented directly by the government.” (Cohen, p. 434) [TOP] 2. Market Imperfections The intellectual core of the entire PSP agenda is the salutary effect of competition, which should provide consumers with the best service at the lowest price. Especially when part of a utility is a natural (or de facto) monopoly, or when barriers to entry are high, private provision requires that government and the contracts they approve address imperfect markets. As
the World Bank’s Private Sector Development strategy states,
“In noncompetitive Even when appropriate conditions are clearly lacking, proponents search for ways to justify private provision, not rethink the strategy. For example, two PSP specialists from the International Finance Corporation who now lead the PSD strategy argue that contracts can address this issue even within problematic economic environments.
Such optimism would be more convincing if it were accompanied by compelling and representative examples of this having happened, especially in developing countries. The constraints on making such a time-bound contract work in the real world are considerable. Some of the more obvious ones include:
Not surprisingly, effective competition requires a conducive market structure as well as an effective regulatory authority. An independent empirical assessment of electricity generation and supply reveals that the introduction of competition has worked well:
To sum up, competition is most likely to be enforced where private providers are plentiful and public regulators are highly capable, hardly common characteristics of typical developing countries. [TOP]
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