July 21, 2003

The World Bank Starts Rethinking Utility Privatization

The World Bank starts rethinking the benefits of utility privatization. On the one hand, when a public utility doesn't cover its costs--either because it has become a dumping ground to pay salaries to the politically well-connected, or because governments like to promise low rates--somebody else pays. In developing countries, that somebody else is usually somebody poorer than the customers who are hooked up to the water and power lines. On the other hand, utilities are natural monopolies--and we know that markets don't work very well and are not very competitive in the case of natural monopolies...

WSJ.com - The World Bank Wonders About Utility Privatizations: The World Bank, the apostle of privatization, is having a crisis of faith. What seemed like a no-brainer idea in the 1990s -- that developing nations should sell off money-losing state infrastructure to efficient private investors -- no longer seems so obvious, especially when it comes to power and water utilities.

Investors who once seemed eager to risk their money on Brazilian power plants or African sewers are pulling back. Commercial banks' power-project financing in the developing world and former Eastern Bloc nations, which peaked at $25.9 billion in 1998, totaled just $5.7 billion last year, according to Dealogic, a British data firm.

Consumers, feeling deceived, increasingly associate privatization with higher rates for them and higher profits for foreign companies and corrupt officials. Rate increases have spurred violent demonstrations against a water concession in Bolivia and private power plant projects in Peru. A 2001 survey of 17 Latin American nations by Latinobarometro, a Latin American polling company, found that 63% of respondents felt that privatization of state companies hadn't been beneficial, up from 45% just three years earlier. The result of this widespread disappointment is that across Africa, Latin America and Asia, some privatization contracts are being renegotiated and a handful of projects -- concentrated in toll roads, power and water -- have been canceled. Fewer new projects are getting off the ground.

Privatization hasn't always gone badly. Telecommunications deals have generally been much more successful than water or power projects. When it comes to phones, technology and privatization conspire to provide the public with service that is less costly and better. The advent of cellphones, for example, has made it simpler to introduce competition to improve what was once a state exclusive.

But water and power are tougher. They naturally lend themselves to monopolies, not competition. Why build parallel, competitive sewer pipes or power lines? And, since the public often views low-cost water and light as rights, not privileges, privatization has been the focus of popular discontent.

The unexpected turn of events has left privatization enthusiasts at the World Bank -- the main tool the wealthy nations have to influence economic policies in the poor ones -- wondering what went wrong. "There's certainly a lot of soul-searching going on," says Michael Klein, the World Bank's vice president for private-sector development.

Each case, of course, has its own idiosyncrasies. But an electricity project in Armenia offers a typical problem case. In a recent study of the case, the World Bank found that its own staffers had radically underestimated how much electricity prices would jump -- nearly 50% -- and consumption would fall -- 17% -- when the national power company was put on commercial terms in preparation for eventual sale. In the end, the government didn't collect nearly as much new revenue as it had hoped, while the poor -- the intended beneficiaries of World Bank projects -- grew increasingly likely to fall behind in paying their electric bills. Many were left scrounging for wood to heat their homes, causing unforeseen environmental damage. The Armenia study landed with a thud at the World Bank; it implied that free-market ideology had trumped clear thinking when the World Bank had prodded the Armenian government to commercialize the power company.

"There was never an actual policy that said you shall privatize everything that moves," Mr. Klein says about the World Bank's strategy over the past decade. "But some people interpreted it that way." And that's how many countries interpreted the World Bank's advice, which carries the weight of the West behind it -- not to mention a lot of cash. The World Bank, for instance, pushed the Comoros Islands, off Africa's east coast, to put its power company under private management, an arrangement that ended in bitter squabbling. "We had no option but privatizing," says Mahmoud M. Aboud, charge d'affaires at the country's U.N. mission. "When it didn't work, we ended it."

World Bank officials have now decided it doesn't matter so much whether infrastructure is in public or private hands. What matters is that it be run in a business-like manner, perhaps more frequently combining public ownership and private management. But above all, they now say, bureaucrats, investors and, yes, the World Bank itself must pay far greater attention to the fiery politics of privatization and especially to the effect of rising prices on the poor and disaffected.

On average, the rates charged by state water companies in the developing world were so low that they covered just 30% of their costs in the early 1990s, while power companies recovered only 60% of their expenses, according to World Bank figures. Governments covered the gaps, draining public coffers...

Posted by DeLong at July 21, 2003 09:41 PM | TrackBack

Comments

"But water and power are tougher. They naturally lend themselves to monopolies, not competition. Why build parallel, competitive sewer pipes or power lines? And, since the public often views low-cost water and light as rights, not privileges, privatization has been the focus of popular discontent."

Whatever could they have been thinking - so presumptuous to expect power and clean water. That's the problem with these people, they just aren't willing to pay for what they need. Look at those darn Iraqis - still complaining about lack of water and power when the temperature is only over a 100 degrees daily.

Posted by: Ian Welsh on July 21, 2003 11:08 PM

Read the quote more carefully, Ian. It talks about LOW-COST water as a right. What that generally means, of course, is HIGH-COST to the taxpayer, perhaps crowding out education or welfare spending. Contrary to what many people seem to think, water, electricity and gas are not free to distribute.

At the same time, having recommended myself that some utilities be privatised and some be kept in the state sector, I am not blind to the faults of poorly conceived or inappropriate privatisation. In particular, you need good regulation of utilities, with the right incentive structure on the utility and the right duties for the regulator, and with governments kept as far away as possible. Meddling is what governments do most of, and they find it very difficult to give this up.

Posted by: PJ on July 22, 2003 12:47 AM

The privitization of natural monopoly industries, prima facie, could only serve to enrich investors and screw everyone else. Its basic economics that a company with a monopoly will take advantage of their position. The World Bank's position was flawed on its face, and the notion it would benefit anyone but the investors is nonsensical.

The *only* way privitization might have some chance of helping people is if all natural monopolies had to be non-profits. Period.

Posted by: Lorenzo on July 22, 2003 07:29 AM

Organizations have a tendency towards self perpetuation and growth. Turning natural monopolies into non-profits would not solve this.

Posted by: James on July 22, 2003 07:40 AM

Privatized needn't mean laissez faire. Regulate rates so that the first x liters of water are at a low price, then allow cost-based, or market, or whatever, rates. Regulate to require a sufficient level of purity. Regulate transmission of power, but allow a market in generation and delivery. (Like phones, where in the US the wires are regulated, but the service is less so.) By all means, regulate the natural monopolies. But don't assume that higher prices to consumers mean something is wrong. It may just mean the government was charging too little, and letting taxpayers (or less favored customer classes) pick up the bill.

Posted by: rvman on July 22, 2003 08:07 AM

Privatized needn't mean laissez faire. Regulate rates so that the first x liters of water are at a low price, then allow cost-based, or market, or whatever, rates. Regulate to require a sufficient level of purity. Regulate transmission of power, but allow a market in generation and delivery. (Like phones, where in the US the wires are regulated, but the service is less so.) By all means, regulate the natural monopolies. But don't assume that higher prices to consumers mean something is wrong. It may just mean the government was charging too little, and letting taxpayers (or less favored customer classes) pick up the bill.

Posted by: rvman on July 22, 2003 08:12 AM

This argument needs to be put in the proper perspective of the early 80s deregulation and the break up of ATT. This line of reasoning not only lead directly to the debate in the Wilson Era in CA which caused the utility privatization but also lead to the Telecom madness of the late 90s stock market boom, or should I say bomb. The pretext has always been that the government should not be involved because the government is inherently inept while private business is efficient and innovative. Thus we get Enron and WorldCom and ATT goes broke. The RBOCs are still virtual monopolies and the World Bank is rethinking utility privatization.

Or something like that.

Posted by: Bruce Ferguson on July 22, 2003 08:13 AM

Technological changes promise to erode the natural monopoly of power supply over the next few decades. If they come to pass, it should make it easier (not easy) to develop market efficiencies like those being seen in phone service provision.

Even with improving technologies, the politics of water supply promise to be a huge headache. The risks of inadequate water are simply too high. It makes the problems of low investment, poor management, etc. that much worse while also placing limits on how to deal with it.

Posted by: Stan on July 22, 2003 08:16 AM

Remember the experience of California during the "energy crisis." The crisis was in fact produced by private energy suppliers who manipulated the California market and cost the people of California billions of dollars. Los Angeles experienced no energy crisis, but Los Angeles is served by a public utility. Private is fine for natural monopolies, as long as there as tight tight controls.

Remember Enron? The dears were happily planning the future of New England when we found out how rotten they were. Whew!

Posted by: anne on July 22, 2003 08:17 AM

http://www.nytimes.com/2003/07/20/opinion/20SUN1.html?8bl

The Rigged Trade Game

Put simply, the Philippines got taken. A charter member of the World Trade Organization in 1995, the former American colony dutifully embraced globalization's free-market gospel over the last decade, opening its economy to foreign trade and investment. Despite widespread worries about their ability to compete, Filipinos bought the theory that their farmers' lack of good transportation and high technology would be balanced out by their cheap labor. The government predicted that access to world markets would create a net gain of a half-million farming jobs a year, and improve the country's trade balance....

Posted by: anne on July 22, 2003 08:23 AM

http://www.nytimes.com/2003/07/22/opinion/22TUE1.html

The Great Catfish War

For Tran Vu Long, who lives atop his floating catfish trap on the Mekong River near the border with Cambodia, the recent biannual harvest day was not the joyous payday it usually is. Mr. Long, a 35-year-old Vietnamese catfish farmer, sold his flapping fish 40 tons' worth, all painstakingly weighed and carried in bamboo buckets onto the trading company's launch at a loss of some $2,000, a small fortune here.

Mr. Long, who stood sullenly to the side as his hired hands scooped out seemingly endless gaggles of fish from underneath the space that doubles as his living room, has Washington politicians to blame. "The United States preaches free trade, but as soon as we start benefiting from it, they change their tune," he said....

Posted by: anne on July 22, 2003 09:20 AM

Private utilities are no good because their regulators will always be subject to capture by the wealthy and very involved regulated (the utilities themselves).

Private monopolies should be public. There will be inefficiencies but the goal is to make those inefficiencies less than the inefficiencies of a monopoly.

Water and electricity rates that are lower than cost and subsidized by a progressive tax system are an efficient means of stimulating demand and boosting the current state of the world economy.

Posted by: Dan on July 22, 2003 09:28 AM

Lemmie mess around with this last paragraph a bit:

On average, the "toll" rates charged by "the State Department of Transportations in America" were so low that they covered just "X"% of their costs in the early 1990s... Governments covered the gaps, draining public coffers...

Oh, but highways are an engine of economic growth, and apparently electricity and clean water aren't.

Idiots.

Posted by: a different chris on July 22, 2003 09:31 AM

Developed nations are terrific at touting privatizing and competition for poorer nations, but when it comes to protecting these poorer nations against misuse of market power developed nations turn away.

Posted by: anne on July 22, 2003 09:35 AM

The California energy crises is a better example of government regulation failure, than pure market system. The original system was deregulated such that purchase price on the power production side was subject to market interaction and the sale price on the power distribution side was fixed. Politically this ensured that the voters received a fixed rate. The second political decision was to prevent the creation of new power plants inside the state. This occurred even though the demand for power in California has been steadily increasing through the 90's. Neither of these choices represent a true shift from a government regulated industry to a true market run industry.

Posted by: James on July 22, 2003 09:46 AM

The Wall Street Journal reports, "In a recent study of the case, the World Bank found that its own staffers had radically underestimated how much electricity prices would jump -- nearly 50% -- and consumption would fall -- 17% -- when the national power company was put on commercial terms in preparation for eventual sale."

The Wall Street Journal ALSO reports, "On average, the rates charged by state water companies in the developing world were so low that they covered just 30% of their costs in the early 1990s, while power companies recovered only 60% of their expenses, according to World Bank figures."

Hmmmmmmm...

Let's think about how we could calculate this, if we could calculate:

If only 60% of expenses are recovered by state-run electrical utilities, the cost to cover 100% of expenses would rise by 100%/60%...or 66.7%.

But costs actually only rose by "nearly 50%." Now, I'm not an economist, but perhaps part of the reason was that demand fell "by 17%."

In other words, what exactly is puzzling to the World Bank?

This seems to be just one more example of why the World Bank should be abolished...or at least the U.S. should stop funding it.

Posted by: Mark Bahner on July 22, 2003 09:58 AM

James
Your first point is pointless - Yes the retail side of CA energy was price fixed, but all that means is the local utilities paid the price rather than the consumer. Regardless of who ultimately paid the price, the producers have been proven to have manipulated the market. This would not have changed if the local utilities had been able to pass the cost to the consumer.

Your second point is also pointless. CA can easily import energy from other states as long as those out of state providers are not manipulating the market. Claims about a lack of distribution capacity have been proven false.

Other states have shown a willingness to pollute themselves in order to export energy. CA has chosen to stay cleaner and import energy. CA never agreed to being gouged by the energy industry.

Posted by: Dan on July 22, 2003 10:04 AM

Dan

Please. California must have agreed to be gouged by the energy industry. Must have, must have. The Wall Street Journal assured us how wonderful our deregulation plan was. They assured Argentina how wonderful the dollar peg was as well, but that is another matter. No, the problem was those awful environmentals. Never the energy industry which California agreed to be gouged by.

Posted by: lise on July 22, 2003 11:16 AM

If the state run utility is corrupt and does not deliver clean water to people, what should be done? If the government puts friends into positions of power at the electric company (pun intended) what should be done?

The World Bank is rethinking its reliance on privatization, but that does not mean it is always a bad way to go. If the government is corrupt, what good is regulation? How do you get water to the people who need it? Those are the problems facing the World Bank.

In response to evidence that privatization may not always be the best tool, the World Bank is returning to that policy to see if there is a better way. I think this is a good thing.

Posted by: Bill Nazzaro on July 22, 2003 11:16 AM

The World Bank is only opting for a more flexible set of approaches, that will be more closely tailored to a particular society's needs.

Posted by: anne on July 22, 2003 11:32 AM

California got hammered because they limited the ability of utilities to contract for power. In essence, all wholesale power got sold in a single day-ahead market, which made it impossible for utilities to contract for long-term deliveries of power, and easy for generators to pick and create short periods of high demand and (artificially) low supply in which to gouge said utilities. This is basically equivalent to making it illegal to buy food before you want to eat it, and then allowing grocery stores to ratchet up prices between 5 and 7 pm. This was in the law -it was a regulatory failure, not a market failure. (That said, some of the generators and power marketers were predatory and deserve punishment. Many of the offenders are now, in fact, bankrupt and under criminal investigation. The market and the government nailed them.)

Posted by: rvman on July 22, 2003 01:26 PM

Why privatise?

Other countries had sold off a few companies before, but privatisation as a major plank of a government's economic policy was an English answer to the poor performance of the country's nationalised industries relative to the rest of the economy between World War Two and 1979. The results were widely admired (though by no means universally) overseas in the 1980's and 1990's and the privatisation model was exported overseas, often with an explicit acknowledgement of the British influence, to many different countries from Argentinian energy to Japanese railways.

In his outstanding memoirs, the former British Conservative finance minister Lawson lays out five goals for nationalisation:

1) the improvement of industrial relations
2) the promotion of full employment
3) the gain in productivity from the removal of absentee [shareholder] ownership
4) the efficient regulation of monopolies
5) the replacement of short-term profit maximisation by wider national and social policies.

He considered, and it is difficult to dispute, that nationalisation failed in all five of those aims. For example, the nationalised industries demonstrated much worse labor relations than the private sector. And full employment was not best served by employing people in make-work positions, then firing them when the losses became insupportable. As he memorably added, "you can no more make a State industry imitate private enterprise than you can make a mule into a zebra by painting stripes on its back". State-owned industries respond to different incentives. The pricing structures and industrial relations are heavily politicised, and the customer generally comes a bad last in their priorities, after the unions, the government and their management perks. The main reason to privatise is to put the shareholder first, then ensure that the shareholders put the customer first through effective regulation (regulation as a substitute for competition), as happens in private industry, in theory anyway. In England (railways apart), the government has gained directly, firstly from the proceeds of the sale of these industries, and secondly from the tax paid as loss-making state owned enterprises are transformed into profitable private sector companies.

America has privatised much less than England. Prime candidates for privatisation in America today are water utilities and the United States Postal Service. But England and the United States are industrialised countries with long histories of independent regulation, efficient capital markets and deep respect for private property rights. What is appropriate for them when it comes to privatisation may not always be appropriate for third world countries with tiny capital markets, endemic corruption and weak property and contractual rights. But nationalisation is hardly an ideal cure for these ills either.

Posted by: PJ on July 22, 2003 03:04 PM

On the surface, there's no compelling reason for a utlity to be publicly owned if it's not a natural monopoly (and they evetually get killed off by technology). A good regulatory system should be able to keep agressive rent-seeking behaviour in check and ensure reasonably efficient delivery of the service. There are often problems with over-capitalization if a firm can goose up its bottom line by investing "too much", but hey, this is a second-best world.

However... in terms of privatization, there have been some big-time botch jobs in the last few years, especially in the energy sector. There has been one ugly constant, a lack of capacity. It appears privatization schemes (regulators) have not provided investors with the certainty they need to increase capacity during the bridge years. New investment dries, demand increases and voila... a full blow brown out crisis.

I have no idea how to reassure investors. But often their so-called prudence is just a ploy to obtain government guarantees to cover their arses, it all smacks of corporate welfare. Moreover, most customers are just as concerned with security of supply as they with prices. I can see why the World Bank might be reconsidering its point of view.

There is one further caveat, drinking water is also in the sphere of public health policy. To that extent, I do see a role for governments to own systems or impose very strict standards (but I see some problems in terms of moral hazard, monitoring costs, etc. for the latter).

Posted by: Stephane on July 22, 2003 07:04 PM

I think it is important to remember that the debate over the World Bank and the IMF programmes is different from Californians (or Ontarians) debating their own privatization programmes. The WB and IMF privatization programmes have been imposed from outside rather than selected by voters. As a result, they must surely have to meet much higher standards of "proof" before they can be considered legitimate.

Judging by the debate, there is a lot of uncertainty over their effectiveness. Therefore, it is wrong for the WB and IMF to impose them.

Posted by: Tom Slee on July 22, 2003 08:52 PM

PJ,

I was, obviously, wielding a broad brush of sarcasm.

My fundamental point was that water is a necessity (arguably electricity isn't, though I think that is arguable in the modern day and age.)

Because it is something that everyone needs, and because it is a natural monopoly (building more than one set of pipes is absurd) it seems only reasonable to keep it publicly owned. Yes, the taxpayer will have to pay - but some things are a public good and making sure that people have sufficient potable water is one of those things. You don't want people who can't afford it going off the system - because leaving aside the inhumanity - you're more likely to get disease of various sorts - and deaths - as we witness over and over again when water delivery is disrupted.

As for whether privatization works - it does sometimes and it doesn't sometimes. The same is true of public monopolies. Coming from Canada I'm aware of public monopolies that don't work (say Ontario Hydro) and ones that do (The BC Auto Insurance and the Ontario Liquor Board). There's no defacto reason for public monopolies to be run badly - only a tendency caused by the ability to go to the public trough. But that tendency can be overcome by good management. And since public companies don't have to make a profit they can be cheaper.

Moreover in natural monopolies the monopoly is going to have to be heavily regulated anyway - so you might as well cut out the shareholders.

Posted by: Ian Welsh on July 23, 2003 12:01 AM

The California power fiasco was not an example of "privatization" (the utilities were already private). It was a misguided attempt to introduce "competition" into a market where it was doomed to fail. A competitive market for electricity (a non-differentiable commodity which cannot be stored) will tend to drive the price down to marginal cost. And since the marginal cost of electricity is well below the average cost (most costs are fixed), all electric providers in a competitive market will eventually be driven bankrupt. This is the same reason deregulated airlines go in and out of bankruptcy at regular intervals. (Except for Southwest, which maintains a lower cost structure than the majors it competes against. Once it is faced with other airlines like JetBlue that copy it's cost structure, Southwest will go bankrupt too...) The regulators didn't "botch" the California plan: they did exactly what they intended to do, they just didn't understand what they were doing...

Posted by: jimbo on July 23, 2003 08:43 AM
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