Monday, August 18, 2003

Utility Privatization in the Developing World
Whenever word gets out that some Third World country intends to privatize (via Africapundit) its' water, electricity or telephone system, a hue and cry is raised by the many NGOs who make it their business to promote what they suppose to be the interests of the less well off. The problem with the debates that usually arise in such situations is that there is usually very little substance to them - they are usually a matter of glib soundbites and glittering generalities.

In listening to those who oppose private-sector provision, one quickly becomes aware that they are working with a set of implicit and highly flawed assumptions, not the least of which are:

  1. that publicly run utilities in developing countries operate in environments in which corruption is unknown, and subsidies intended for the poor will never be diverted to political allies and supporters

  2. that public-sector workers are any more noble or less self-seeking in their motivations than their private-sector contemporaries, and have an incentive to be just as productive, despite the soft budget constraints faced by publicly run organizations able to make claims on government funds

  3. that the governments of poor countries either have unlimited investment capital at their disposal, or are able to borrow as much as they desire for nothing on the international capital markets.

All of these arguments are, to say the least, dubious in the extreme, as anyone who has spent a good deal of time in such countries will testify, but rather than generalize from personal experience, I've decided to look for studies on this issue that actually address the realities of public versus private-sector provision in an objective and rigorous manner. How well do public utilities stand up to their private counterparts, and what are the actual effects of the various schemes governments devise to ensure the universality of service provision? Is there even any real reason for government interference in the provision of supposedly "essential" services?

One paper that addresses these questions is the following, whose contents are (heavily) summarized below:
G.R.G. Clarke, S.J. Wallsten - Universal(ly Bad) Service: Providing Infrastructure Services to Rural and Poor Urban Consumers
(Page 4) "Although much of the discussion about regulatory reform and privatization of infrastructure has focused on efficiency, distributional issues have strongly influenced public policy towards infrastructure in both developed and developing economies. Most countries specify universal access to certain infrastructure utilities, including telecommunications, electricity, and piped water and sewerage, as a public policy goal. Specific laws and objectives differ by country and by industry, but the general goal is to ensure access for all people at affordable prices. Most universal access laws and regulations have a geographic component meant to promote service in rural areas and a targeted component meant to help the poor afford service. At least in theory, countries traditionally financed these obligations through cross-subsidies: low-cost and high-income consumers paid prices above cost to subsidize high-cost and low-income consumers, who paid prices below cost.

Some observers have worried that even if privatization and competition in infrastructure utilities increase efficiency and improve average consumer coverage, such reforms could hurt the poor in at least two ways. First, new market structures, including competition, make cross subsidies difficult to maintain and raise the possibility that private firms will "cream skim" - serve the most profitable customers and ignore the unprofitable ones (i.e., poor and rural consumers). Second, reforms often necessitate "tariff rebalancing" - increased prices in order to cover costs. Even if such rebalancing is necessary to ensure viable service over time, higher prices could make service increasingly unaffordable for the poor ...

We find, overall, little evidence that subsidies have, in fact, been used to meet universal service goals under monopoly provision: outside of Eastern Europe, infrastructure connections to rural areas and the poor are distressingly low. Moreover, many mechanisms ostensibly intended to help the poor end up helping only the wealthy. Subsidized service prices, for example, tend to benefit the wealthy since they are more likely to be connected to the network and consume the service, while poor households without direct connections receive nothing."

(Page 10) "Politics often affect the distribution of subsidies even when subsidies were originally intended to promote equity. Once subsidies are introduced, they are often expanded to cover increasingly large portions of the population. For example, Boland and Whittington (2000) note that most water supply utilities subsidize much higher levels of water consumption than is necessary to meet basic needs. They note that although a household with five members would only need to consume between 4 and 5 cubic meters per month to meet internationally cited standards for basic water use, 15 of the 17 water utilities in Asia for which they had data subsidized more than this level of consumption, and five utilities subsidized over 20 cubic meters per month. In other words, the biggest beneficiaries of the subsidies were large consumers, who are more likely to be wealthy. Further, they note that users reach the highest tariffs at only very high rates of consumption-for example, about 80 times basic needs for a family with five members in La Paz, Bolivia (Boland and Whittington 2000)."

(Page 15) "... One problem with subsidizing service in high cost areas by keeping prices below cost is that while low prices will generally increase demand in these areas, they will simultaneously reduce providers' ability and incentive to serve those regions. Even worse, potential competitors have no incentive to serve high-cost areas if they are forced to charge low prices to everyone who happens to live there regardless of their willingness and ability to pay. The result of a policy of geographic price averaging can easily be no service or only limited

There are many examples from developing countries where cross-subsidies have had this effect. For example, Wellenius (2000) notes that in the 1980s nearly 400,000 Brazilian farmers and rural cooperatives were willing to pay the full cost of obtaining telephone service, but the monopoly provider was not allowed to charge them more than it charged urban customers, with the result that the firm provided no service in these areas. Similarly, Ménard and Clarke (2002a) note that the national water supply enterprise in Côte d'Ivoire expanded service in the low-cost area (Abidjan) far more rapidly than it expanded service in higher cost secondary centers in the late 1980s and early 1990s."

(Page 23) "One final point is that although many subsidies are focused on usage prices, it might be more appropriate to focus upon connection fees, especially in countries where coverage among low- income households is initially low. While usage prices were often low, connection prices have often been quite high-and in many cases, actual connection prices are much higher than listed prices when bribes are required to actually get service. While long waiting lists for service demonstrate that there is demand for service even at high prices, extremely high connection charges make a mockery of any policy intended to connect the poor. In Nigeria in 1999, for example, the connection charge for a telephone line was $210 (Onwumechili 2001), high even by standards for industrialized countries, and even higher considering that per capita income in Nigeria is about $260 (World Bank 2002a) ...

Opponents of liberalization worry that reforms will hurt the poor even if they improve efficiency. If new entrants are interested in providing service only to profitable high-income and business consumers, competition might force the incumbent provider to either abandon cross-subsidies or be left serving only unprofitable low-income and high-cost consumers. Further, critics claim that competition will erode monopoly profits, forcing governments to find new sources of funds to finance access for high-cost and low-income consumers—something that could be very difficult in developing countries with inefficient and distortionary tax regimes.

The implicit assumption behind these arguments is that countries have successfully managed to promote access for vulnerable groups and to target cross-subsidies towards them prior to reforms. With the exception of Eastern Europe, the evidence suggests that monopolies have not used subsidies to serve the poor."

(Page 34) "Cross-country evidence from the DHS+ surveys comparing countries with public and private operators does not generally support the assertion that public operators are better at serving low- income households than private operators ... On average, coverage among households headed by an individual with no education appears slightly lower in countries with public operators (25.4 percent) than it is in countries with established private operators (30.6 percent). Coverage for households headed by individuals with no education was higher in Côte d'Ivoire than in 11 of 17 countries with public operators and higher in Guinea than in 9 of 17 countries. Conclusions are similar when comparing countries based upon the share of connected households with no education as a percentage of the share of connected households with a secondary education (i.e., essentially controlling for the general development of the sector).

Cross-country evidence on access to telecommunications services in Africa and Latin America leads to similar conclusions (see Table 5). Coverage for households headed by individuals with no education is similar in African countries with public operators and privatized operators. In Latin America, coverage actually appears lower in countries with public operators than it is in countries with private operators; coverage among households headed by individuals with no education is lower in both countries with public operators than in any of the four countries with privatized operators."

(Page 35) "Time-series evidence from the DHS+ surveys is also generally consistent with the hypothesis that private sector participation does not harm, and may actually help, low-income households ... In a recent paper, Ros (1999) found that higher residential subscription prices were correlated with higher coverage in a sample of 110 developed and developing countries. He interprets this as indicating that supply-side constraints were more important than demand-side constraints."

(Page 38) "Most countries have an explicit policy goal of promoting universal access to certain infrastructure utilities. When service was provided by monopolies (typically state-owned, but occasionally private), these obligations were, in theory, funded through cross subsidies: high-income and low-cost consumers were charged prices above cost to finance service to low-income and high-cost consumers, who paid prices below cost. While this arrangement sounds simple, in practice it has not worked well. Cross-subsidies have often been poorly targeted and have typically failed to reach poor consumers. Although low prices might increase demand for infrastructure services from poor and rural consumers, they also lead to supply-side distortions that might lessen or nullify their impact. Moreover, the opaque nature of cross subsidies also makes it difficult to determine who pays and who benefits from them. In practice, there is strong evidence that public and private monopolies failed to ensure access for rural and low-income urban consumers, especially in Africa. Indeed, the relatively wealthy appeared to benefit from subsidies far more than the poor ...

Moreover, entry and competition allows entrepreneurs to discover and try new methods of providing service to poor and rural areas, generating a wealth of service, price, and quality options. Maintaining state-owned (or regulated private) monopolies might stifle innovative solutions to providing access to the poor. In fact, if competitive entry and privatization increases efficiency, areas and customers that monopolists found unprofitable might either become profitable or, at least, require smaller subsidies. Some regions and users thought to be unwilling or unable to pay for service have turned out to be profitable customers, as evidenced by creative entry mechanisms from new competitors."

Other Online References on Utility Privatization
G. Cannock - Telecom Subsidies: Output-Based Contracts for Rural Services in Peru (2001)
O. Chisari et al - The Needs of the Poor in Infrastructure Privatization: The Role of Universal Service Obligations (1999)
H. Cremer et al - The Economics of Universal Service: Theory (1998)
H. Cremer et al - The Economics of Universal Service: Practice (1998)
P. Beato, J.J. Laffont - Competition in Public Utilities in Developing Countries (2002)