Washington, D.C, June 14, 2004
MR. BOURGUIGNON: Welcome everybody. I am Francois Bourguignon, the Chief Economist of the World Bank, and responsible for the Development Economics Department in the Bank. I'm very happy to be with you today to launch this policy and research report entitled "Reforming Infrastructure - Privatization, Regulation and Competition."
I don't think it is really necessary to stress the timeliness and the importance of this book. Infrastructure industries are, of course, crucial for economic growth, for poverty alleviation, and for international competitiveness in most developing countries. And we know that there are major needs which are still unmet as of today. Developing infrastructure is definitely a priority. And it is a high priority in the World Bank agenda.
There are on earth 1.1 billion people who lack access to safe drinking water, 2.4 billion without adequate sanitation, 1.4 billion without access to electricity.
The second part of the title is also similarly important. As you know, the past two decades witnessed far-reaching reforms in the field of infrastructure: restructuring, privatizing, and establishing a new approach to regulation. And the idea behind those reforms was really to try to attract private financing in infrastructure to accelerate the development of that sector.
Now, this report draws the lessons from the experiences that we have witnessed over the last two decades, some of which, as you know, are often quite controversial. And I want simply to point out several conclusions which I think are of crucial importance.
The first point is that when we think about these reforms, we have to keep in mind what was the initial situation, what was the status quo. What was the state of infrastructure delivery when it was mostly done by state-owned companies? They were often inefficient, practicing underpricing, which made them totally unable to finance expansion and not to be able to rely on other sources to finance expansion of infrastructure. That's the first point.
The second point which is emphasized in this report is that there is no universal reform model. The result of a reform will depend very much on the sector. Things will be different in telecommunications or in water and sanitation. It will also depend very much on the country in which you are operating and the social environment of these countries.
The important conclusion is that, in general, reforms, if we look at those experiences, increased the performances quite significantly in the field of infrastructure.
The second very important conclusion is that effective regulation is the most critical condition for reform to protect the interests of both private investors and consumers. And, indeed, effective regulation is the only way to be able, at the same time, to attract private funds toward infrastructure, and to get social support for these reforms.
The third important conclusion, privatization must come, only after restructuring and introducing competition. There is not much point in privatizing pure monopolies. Privatizing for privatization’s sake is not an objective per se. We know that privatization will work only when there is a competitive structure behind the scene. And, again, this is an important contribution of this report.
Now, we know that there may be big differences between a scholarly assessment of those reforms, and public perceptions of all of this. And we know that there has been very intense debate on this.
Now, of course, there have been failures in all these reforms, and we all have in mind cases of this type. There has been much debate on the distributional impact of those reforms, which has often been seen as very negative. But the conclusion of the report is that it is important to identify the reasons for failures and successes. When we do that, this leads us back, more or less inevitably, to the effectiveness of the regulatory authority.
Also, when we look at the distributional impact, which has often been seen as negative, it is crucial that the regulatory authority get the right information on what will be the distributional impact of a reform. We observe that the information necessary to assess the distributional impact of reforms in infrastructure is often lacking. In the past, probably not enough attention has been paid to the distributional impact, simply because that information was not available. It is an essential condition for success in the future that this weakness be corrected.
The report concludes by saying that there are substantial benefits to be expected from the reforms. But, given all the conditions I have just indicated, it is certainly not the case that those reforms can be applied blindly as has been the case, at some stages in the past. It is important to make sure that all the tools necessary for assessing the impact of reform are available, and that there is no doctrinal view that will overcome what those tools may bring us as information. So this is the essence of this report.
I am very pleased to introduce a full panel. First, on my right is Ioannis Kessides, who is Lead Economist in the Research Department in Development Economics in the Bank, and who is the author of this study. And I must say I'm extremely grateful for the very valuable contribution that Ioannis made with this book.
I'm also very pleased to have two other colleagues of the Bank: on my immediate left, Nemat Shafik, who is Vice President of the Bank's Infrastructure Department, who is, of course, directly concerned with the message and the analysis in this book; and on my extreme left, Michael Klein, who is Vice President of the Private Sector Development Department, which is shared by the Bank and the International Finance Corporation, and Michael is also the Chief Economist of the IFC. And I thank both of them for being here today.
So the format of this session will now be the following: We'll give the floor to Ioannis who will get into a little more detail than I did about the conclusions of the report, then I will offer the floor to my two other colleagues, and then we'll open the debate with you. Thank you.
MR. KESSIDES: Thank you very much, Francois.
As Francois has mentioned, during the past two decades there has been a profound reassessment of public policy towards the infrastructure sectors. In both the advanced industrial economies and also the developing and transition countries, views have changed dramatically on how the network utilities should be owned, organized, and regulated.
I will now briefly explain why this policy redirection has taken place, what has worked, what hasn't, and how to move forward.
I would like to begin by noting that the report's focus on the infrastructure sectors is motivated by the critical role that these sectors play for sustained economic growth and international competitiveness. They provide crucial services for manufacturing and commerce. Widely available, reliable, and reasonably utilized infrastructure services can facilitate a robust investment climate and can promote entrepreneurship at the grass-roots level.
As a historical perspective for much of the 20th century and in most countries, infrastructure services were provided by state-owned utilities that were vertically integrated. In most countries, they were under direct ministerial control. Although this model initially produced some good results or reasonably good results, it ultimately led to very serious problems for the public interest, especially in the developing countries. These problems included underinvestment, in large part caused by underpricing; low productivity; poor service quality; theft of service; long queues and large portions of the population without access to basic services; lack of transparency; and damaging political interference in the operations of these infrastructure entities.
In the face of this extraordinarily weak performance of infrastructure, and also the debt and fiscal crises that emerged in the early 1980s in many developing and transition countries, these countries then adopted far-reaching privatization, restructuring, and regulatory reforms in infrastructure. These reforms were introduced because of the general belief that they would increase private investment, that they would provide strong incentives for operating efficiency, that they would restore the financial viability of virtually bankrupt state-owned network utilities, especially through the promotion of more rational pricing policies, that they would improve service quality and eliminate service backlogs, introduce greater transparency in the operations of these industries, and also insulate the operating infrastructure entities from damaging political interference.
This new infrastructure model that, again, involves privatization, competitive restructuring, and some form of independent regulation, holds considerable promise, but also entails significant risks, especially in the developing and transition countries. For these types of reforms to achieve their public interest objectives, they require, first of all, cost-reflective tariffs. They also require a good competitive environment and transparency, especially procedural transparency. And last, and perhaps most importantly, they require credible and effective regulation. As we say in this report, restructure, regulate, and only then privatize.
Did the reforms live up to their promise? As Francois has accurately noted, there has been a gap between popular perceptions and reality when it comes to infrastructure reform and privatization. And we argue in the report that privatization's bad reputation perhaps is not fully deserved. Some of the difficulties that we have experienced have resulted perhaps for the disillusionment and misunderstanding by the general public and also perhaps because of poor communication by political leaders.
The public, understandably so, has shown some impatience with the time required for the benefits of privatization and related reforms to emerge. But we should note that even in the advanced industrial economies, it took several decades for major institutional reforms to achieve their intended outcomes.
Also, frequently, governments have not publicly and carefully articulated the economic and social rationales for the infrastructure reforms, nor have they informed the public about the risks of the new infrastructure model.
Negative popular perceptions also might reflect a reform process that has at times been deeply flawed. It frequently lacked procedural transparency. It benefited well organized and powerful interest groups. And in some cases, perhaps, it resulted in too rapid price increases that adversely affected the poor segments of the population.
Privatization also has frequently been oversold as the solution to all the problems facing the developing and transition economies. They were exposed to risks in the absence of the needed institutional safeguards in some cases.
Despite these problems, however, the emerging empirical evidence suggests that, by and large, these reforms have led to significant improvements in performance, and that indeed there are grounds for cautious optimism.
The reforms have led in some countries, and in some sectors, to significant increase in investment; services have expanded, quality of service has improved; and to some sectors like the communications actually, better services have been offered at lower prices. And also prices have been adjusted to better reflect cost and therefore they restored their financial viability in many cases of the operating entities.
Many, if not most of the post-privatization problems that have emerged relate to the difficulties of establishing credible regulation. Governments in many instances have been very reluctant to regulate the important regulatory function to independent regulatory agencies, and therefore, in many cases regulatory independence has been compromised. Regulatory proceedings also often lack the requisite transparency, and most of the developing and transition countries lack the needed technical and economic expertise to carry out complex regulatory functions.
So what we have learned so far from the reform process and where do we go from here? Again, the outcomes of these reforms depend a lot on the effectiveness of regulation, and therefore we believe that the World Bank and other international financial institutions have a responsibility not only to provide continued support and advice in designing privatization and regulatory frameworks, but also in solving the emerging regulatory problems in the developing and transition countries. Therefore, technical assistance to enhance regulatory capacity is a critical component. It is critical for the success of the reform process.
Also further pricing reforms are essential for the benefits of privatization or restructuring to fully obtain and to be sustainable in the long run. However, what we need is pricing policies that strike a more satisfactory balance between economic efficiency and social equity.
Finally, we should also recognize that even if these reforms are fully implemented, there might still be an investment shortfall in some countries and in some sectors, especially in the current adverse investment environment. Therefore then, there is a need for continued role of the international financial institutions in addressing that investment shortfall.
MR. BOURGUIGNON: Thank you very much, Ioannis, for this very complete overview of this report.
May I now give the floor to Nemat?
MS. SHAFIK: Yes. First let me say how timely this report is, both in terms of what's happening in the world and what's happening within the World Bank. I'll just make three brief points.
First, the financing needs for infrastructure in the developing world are vast. We estimate that between 550 to 600 billion dollars per year are required to finance infrastructure in the developing countries. About half of that is for operations and maintenance, and about half of that is for new investments. That means about a doubling of current levels of spending in the infrastructure sectors, and clearly no one source of financing can meet that scale of requirements.
As has been mentioned by both Francois and Ioannis, private financing of infrastructure fell by about 60 percent between '97 and 2002 after the East Asia crisis from about $127 billion at its peak to only $47 billion last year. And the World Bank's own lending in infrastructure declined by 50 percent over the last decade. We went from almost $10 billion of lending in '93 to about $4.7 billion last year. So to meet the financing needs, no one source will be enough and we need to look across the spectrum.
Second key point: that reality has been very much reflected in the Bank's own view about where investment for infrastructure will come from. Our view at the moment is very clearly that you must work across the spectrum of public and private ownership, and we have translated that view into very clear guidance to our own staff in a series of guidance notes that we've prepared for every infrastructure sector, water, transport, energy and so on, to give staff a sense of what the options are in terms of meeting infrastructure needs, both public, private, and increasingly mixed options that blend public and private financing.
We are open to providing and supporting privatization programs and have found in many countries, like Chile, for example, where electricity losses were halved as a result of private participation, but we're also open to financing well-performing public utilities as we are currently doing in Burkina Faso, where a private sector management contract is supporting the public water and sanitation authority which is delivering good service and good value for money.
So for us, it's not about ownership. It's about performance, and performance is largely driven by competition and the regulatory environment as Ioannis has pointed out.
Last point really is in terms of going forward. We have launched what is called an infrastructure action plan, which we took to our Board of Directors last summer. It will drive a major revitalization of our infrastructure business going forward. Last year, as I mentioned, we lent about $5.4 billion in infrastructure last year. We expect that to go up to at least $6 billion this year and at least $7 billion next year. That action plan reflects the new thinking that is reflected in this book, which is an openness to working with the public and the private sector, and a strong focus on who delivers services most effectively, and openness to blending public and private financing and working with new instruments, and a commitment to maintain our current level of safeguards and environmental standards.
MR. BOURGUIGNON: Thank you very much.
Now I give the floor to Michael Klein.
MR. KLEIN: Just a few extra perspectives on this. On privatization, as has been mentioned before, has been a bit polarizing in a number of contexts. Now, some people think it's a miracle cure and some other people have said it's the end of decency itself. But the issue is, of course, getting infrastructure done. It's going to be done by people, few of whom are saints and most of whom are sinners, whether they live in the public sector or in the private sector, and the design of policy has to live with that.
When we look at that from that perspective, neither will things be perfect in one system or the other, but we might just want to keep the following in mind.
Number one, regulation. Sometimes people say when we move from the public sector to the private sector we face this issue of regulation, and then a lot of countries have very weak capacity to do regulation well. Hence, we should be very careful with moving towards privatization. The issue here is that the regulatory problems, what are they? It is who sets the prices, who sets quality standards, who monitors the stuff, and who enforces it? And that's relevant in the public sector just as well as in the private sector. It's just that in the public sector the regulatory issue tends to be discussed either not explicitly or is swept under the carpet, and it comes out more clearly when privatization happens. That's just one perspective to keep in mind.
Second point about regulation. A lot of people say regulation is complicated and we need training, et cetera, et cetera. Training is certainly necessary. But one thing also here to keep in mind - compare water and telecommunications. Telecommunications, conceptually, requires more difficult regulation than water regulation. You have issues of interfaces between competitive segments in the telecommunications and noncompetitive segments. You have interconnection issues between various providers of telecommunications services. Both these special features are not there in water. Water regulation, conceptually, is easier than telecommunication regulations.
So where do we see more problems as exemplified by fights about regulation in political terms? In water. It's the easier one where the fights are. Why is that? It's probably because, I would argue it's because in water prices are typically, as Ioannis has pointed out, a major distance from where costs are, namely, much below, whereas in telecommunications, traditionally and still so today, prices tend to exceed costs. So in telecommunications when you have a fight you can sort it out. There's enough to go around to solve the problem. In water, there isn't. That's another perspective.
And finally, people say, well, but pricing itself is a problem. We're dealing with the poor. We have to raise prices. That's not good, so we need subsidies. Maybe it should stay in the public sector.
Two points here. Number one, subsidies can be paid in the private sector or in the public sector. Provision of the service can happen in the private or the public sector regardless of whether there are subsidies or not. And second, most of the poor are not connected to systems of infrastructure, to modern systems, be it water, electricity and so on. So the really poor, de facto, pay a lot more than the people who are connected to systems regardless of where the prices of those are at the moment. So for most of the poor, just better service, extension of service is a benefit. The distributional issues are typically amongst those who are already connected and the way in which these issues are being dealt with.
So those are the comments I wanted to make.
MR. BOURGUIGNON: Okay. Thank you very much, Michael.
Now we have time for a joint discussion with exactly 45 minutes in front of us, and I forgot to mention in my introductory remarks that at 2:15 there will be a reception taking place in the Info Shop, and if you want the author of this report to give you a signed copy of this book, Ioannis will be very happy to write nice things on the first page of the book.
So who would like to start making questions to the author and to members of the panel? Yes?
QUESTIONER: Thank you. My name is Neal Bandari (ph). My question is for Ioannis. When he said, and we all agree that institutional reforms, regulatory reforms take decades, and yet in our projects we always want to have results by the end of the project period, and we want to measure those results. I don't how you reconcile our anxiety to measure results even at the end of the project, or is it the fact that it historically takes decades to achieve these kind of results?
MR. KESSIDES: Clearly, the anxiety is well placed. Institutional reforms do take time, and one of the problems with this whole process is because precisely the mismatch of the time scale between the privatization transactions and the time it will require to establish effective regulatory institutions. Still we have to monitor progress, clearly, but as the report points out, in many instances sufficient time has not elapsed and therefore one should be cautious about providing continued assessments about how much progress has been made so far.
MR. BOURGUIGNON: Yes?
QUESTIONER: I'm Mr. Ikada, I'm an Associated Press reporter for Latin America.
I have a question on Peru. As you know, the private decision process in Peru has come to a halt with weak government as Peru has with the President about 5-percent popularity with regions in an uprise in protest for previous privatization. How can you restart moving the privatization process in a country with a political situation like Peru?
MS. SHAFIK: Given the specificity of the question, I may, if you don't mind, ask Luis Guasch, who has been working on the privatization program in Peru to take that question.
Luis? If we could pass the mike to him. And while you're at it, Luis, you may want to make a more general comment, in terms of Latin America. That may be also of interest to you.
MR. GUASCH: That's actually a very appropriate question. The feelings about privatization are really very strongly entrenched. I'll give you an example, which as the survey in Peru, your country case, on attitudes toward privatization. Perhaps surprisingly enough, there are also focus groups, and it came out that even those that did benefit from the surveys, that is to say, in the focus group with the people that benefitted and people that lost. Those that benefitted were those that did have the service now and did not have it before, and actually we found there was not a statistical significance and any difference in the perception of one to the other. That shows you how entrenched, again, the feeling against privatization is.
Quite often it has failed in the sense that it was not fair if you went by benefit, and the funds were not apparently used, a number of things that in a rational frame perhaps ought not to play a major role, but they do.
The critical thing is the process of privatization, and that's fairly common, as we all know, was not properly solved. There was not really an accompanying campaign and showing why were things done and what the benefits were. That's regardless, again, of what the outcomes. It happened. So we think that's a key issue.
The attitude that, the case you are talking about that the government is doing now, it's basically coming from the top down in the sense, inasmuch as before, it was the central government taking an action on privatizing, concessions and this or that. As of you now, what you see is basically going to the local communities or the regions because, barring telephone, which is a federal level, everything now is very local, like an efficient distribution, and again things are coming at the regional level.
Again, as was seen in the case of Peru, strong progress. Part of it is the process of decentralization that has provided a strong ownership at provincial governments, and they are engaging in the process in seeking figures for development, sometimes resources. So, indeed, the newest strategies, that bringing reforms from the top--from the bottom up, and then again providing and doing a campaign stating perfectly or much clearer than before the benefits of privatization. I think we see that across the region. So that is the key factor that we're seeing there.
MR. KLEIN: And what gives us hoe that this might actually work? Peru is one of the few cases where there were opinion polls around the distribution company privatization efforts in the country, where people asked more than the general question that Latino Barometer has asked typically, "Do you like privatization or not?" But they asked specifically, "Under what conditions you would like privatization and what would you think about privatization?"
And, in general, at that time, when the opinion poll was done two years ago, the general question of, "Do you like privatization?" I think attracted about 28 percent of the people or so who were in favor. Whereas, when you said, "Would you appreciate privatization if regulation were well done, if investment came to improve, if a transparent procurement process were used, if decisions were made by regulators in transparent ways?" two-thirds of the population in Peru supported privatization under those conditions.
The question then, along the lines that Luis mentioned, is how can a government credibly put in place those conditions?
MR. KESSIDES: We should also note that the post-privatization period has been characterized by a microeconomic international crisis, the international financial crisis, the stock market collapses and so on. So there has been a tendency to blame many of these problems on privatization.
MR. BOURGUIGNON: I would also like to add one word on this. I think that the issue that was mentioned about the impact in the public of privatization is not necessarily different from the result or from the reception made to other reforms, trade liberalization, financial liberalization. There is, very often, some ambiguity about who are the gainers, who are the losers, and it is sufficient to be able to identify very precisely who the losers are and less precisely who the gainers are for this kind of public negative attitude toward the reform to take place.
What is really missing or what we must be extremely careful in this respect is to make sure that at the time the reform is launched that there is an announcement which is clearly made about who will be benefitting and who might be losing from the reform, and if there are losers, what is the kind of compensation that may be given to the losers?
If there is no, this kind of transparency in reform, than most often it is bound to find this kind of public negative receptivity.
QUESTIONER: I just had a general question in relation to the challenge that Africa has with infrastructure development. In the work that you did, I'd be interested in what the key constraints or lessons were for Africa. Basically, because the African experience maybe also is a demonstration that, in terms of you mentioned the investment climate, but also the thing is, the presence of infrastructure within an economy, in addition to helping defend the business environment, fits into things like competitiveness, not just domestic business expansion, but in fact the rate at which you can provide the specifics of this and the quality of the service in one environment versus your competitor next door.
And so many people feel that this is a fundamental area which Africa has had trouble establishing, and I would just be interested, which is key to its future growth, so what the key lessons are for Africa.
MS. SHAFIK: You're quite right, that there are huge needs in Africa. The experience I think that we've had so far is that, like in other parts of the world, telecommunications has been quite easy in terms of attracting investment. And, in fact, today, in Africa, you have more mobile lines than you do fixed lines, and that has been technology, which has served Africa incredibly well in terms of the growth rates of service to quite broad segments of the population.
In power, there have been fewer successes, in terms of private participation. And where we've had some, they have namely been private participation in the power sector, in terms of PPAs and build, operate, transfer type arrangements, with very few real competitive markets in the power sector. And in transport, the toll road experience has been very narrow and small--a few in South Africa. And in the water sector, there has been actually quite a lot of progress we think with management contracts in the water sector and concessioning, with limited time periods, as opposed to outright ownership. So we've had a slightly nuanced story by sector.
One of the big challenges I think in Africa, in terms of increasing access--and the needs are huge. I'll just give you the numbers for electricity. Only 8 percent of the population in Africa has access to electricity today. That means 92 percent of the population has no access, which is a phenomenal gap in terms of service. Water access is better. Telecom is better.
But one of the big challenges, of course, is that the size of the markets are often small, and the scale of--there's an inability to take advantage of the economies of scale that are needed, less so in water, but more so in some of the other sectors. And I think there we have had some very interesting work done at the regional level and an increased emphasis on looking at regional solutions--so, for example, the power pool in Southern Africa, so that we're looking at some transport corridors in East Africa, a gas pipeline along in West Africa, and I think these kinds of solutions, although will not be a complete solution, but in many infrastructure sectors in Africa, those provide some cost-effective solutions which are also attractive to private investors, and that will be an important part of the future.
MR. KESSIDES: Just a couple of points. Given the unique socioeconomic characteristics of many of the African countries, clearly, extreme care has to be placed on proper pricing reforms and the ability of poor people to pay for these services.
On the other hand, given the long covenance issues, perhaps then there would be a scope for a much more aggressive market liberalization and competitively structured than in some of the higher-income developing countries. After all, the poor are not being served in many of these sectors in most countries, and it would be appropriate perhaps to eliminate pricing restrictions and other structural restrictions so as to deal with the service backlog.
In terms of investment climate, one of the issues that the report emphasizes is, that is very critical, is the ability of governments to credibly commit to specific policies, therefore, overall policy stability, and that is of course problematic in some African countries. But, nevertheless, some exciting initiatives have, in the last years, been undertaken, but have improved the capacity of governments to credibly commit. For example, in West Africa, the fact that there has been some regionalization of the regulatory oversight of the communications might assist with the problem of the capacity of the governments to credibly commit.
MR. KLEIN: Nemat mentioned that only 8 percent of people in Africa have access to electricity. Most people in Africa, in most countries, in most circumstances, have the choice between two options. Either they get electricity from the national monopoly, which may or may not be good at delivering it, or they buy themselves a standby generator, which is sort of expensive or relatively speaking expensive.
There's a third option which is forbidden in most other countries, and that is to buy a standby generator--for a standby generator to be bought by an entrepreneur, and then to string wires to the neighbors and to share in the benefits of this, in those few cases where it has been allowed, it has led to significant increases of coverage in the countries, without having big foreign investors, without having investment bankers, lawyers, et cetera, falling over each other, et cetera.
And one of the most spectacular "successes" in this area are in Southeast Asia, in Indochina. Vietnam has one Southern province where, in the water sector, in this case, 65 percent of the population have been connected to piped water through small systems, community-based, private, mixes thereof, et cetera, within a period of 10 years, and where another 35 percent of the population, bringing it to 100 overall, are expected to be connected in the next 5 years.
In Cambodia, there's another case where entry into the electricity business, in the way that it is described, has been allowed. And there are some 600-odd companies providing electricity service, and a lot of that would also happen in Africa if it were allowed. In cases where there is no law applied, it happens anyway. So, in the North of Somalia, in the East of Congo, you have such schemes, but a lot more could happen if that were allowed.
QUESTIONER: I'm Jeff Volkan [ph]. I've been working infrastructure, and I'm a now a CS consultant.
I have a question for Nemat. It may be in your infrastructure plan, but I wonder if the compendium to this work of Ioannis, the Bank is operationally developing an analysis of certain well-known case studies like AES in Georgia, the power distribution or some of the failures of Vivendi in water supply, where there was good intent, but, A, your shareholders took a several hundred million bath on that project.
I wonder if the Bank could write up a case of it, of what the Bank did or didn't do. And in the case of what it didn't do and wasn't involved, such as the AES--of course, I know we were not directly involved--could the Bank, in its policy dialogue, have done something differently that would have assured a bit more safe comfort guarantee to the shareholders so that they, in the next 10 years, might feel some inclination to take projects like that on?
MS. SHAFIK: Yes. In fact, we have launched, actually, we're looking at projects both successful and unsuccessful over the last few years and trying to look intensely at precisely those kinds of questions. It's too early to draw the specific lessons, but I think there are some themes that clearly emerge:
First, that in the case of AES in Georgia, which I don't know if you're familiar with, there's actually quite a wonderful film which describes that story called, "Power Trip." And it's the most compelling--I know energy sector reform is not the obvious topic for a gripping film, but contrary to your prior prejudices, it's actually one of the most compelling stories I've ever seen because it, A, shows you how critical power is to daily life, and you know the tragedies of the poor old widows sitting in the dark and living all alone because the power shortages and the blackouts are so intensive, but also what it does to business and jobs.
But what emerges from those kinds of stories is the need to do serious public education on the issue of theft, and the need to move more gradually on tariffs, and increasing tariffs after you improve service not before, because it's very hard to maintain public support when tariffs go up with the promise of better services in the future.
And I think that's a case, those kinds of lessons, for us, point to the need for us to be a little more realistic about the pace of tariff reform and a willingness to finance utilities on their way to getting reform, but against very clear benchmarks because we, ourselves, I think one of the other lessons from looking at past Bank work in this area, is that we ourselves have been guilty of pouring money into poorly performing utilities for years without demanding serious improvements in performance. So one has to get that balance quite right in our own work.
But I think there will be more lessons from those kinds of experiences, and I would be happy to share those when we get them.
QUESTIONER: Just a few questions. Actually, it's along the lines that Minouche was talking. The question is the issue of social tariffs, and the Bank believes that when we got involved, we were not, let's say, too--maybe "eager" isn't the right word. We did not work tremendously on that. The question is that in the report as well as the new thinking of the Bank, where do (?) stand by and what kind of instrument we're using, because there are a number of ways that we can finance that.
Second, and complementary to that issue, in addressing some of these elements that Michael was describing, on the one hand, we desire them, but the other question would be: Would they stifle these new incoming cheap, low providers coming into the system? How do you reconcile those two elements? This is the first question.
The second question is something that really concerns me in the sense that I think by now we know quite a bit about both design and regulation. Yet my concern is that we see mistakes being done as we speak across the board. Many of them are non-Bank projects. Some of them are Bank projects. So my question is that how can we somehow leverage our efforts so as that (?) at least 80 percent of those mistakes could be and should be avoided, yet we see them repeated. Now, that's on design.
Then on implementation, along the lines all of you were discussing, how can we convince or propel governments to have faith and strengthen regulation? All of us believe on that point, yet, you know, you talk with individuals, with these governments, and you still see a disconnect. Sometimes they want to remain involved in the sector, complete control, yet is there any instrument, any lessons that we have so as that we can be more effective in truly convincing, again, that the full belief in regulation which ultimately we think clearly is an indicator of performance?
And the last question is on the coverage relating to the first one. What we see quite often when there is a reform process, you know, being concession, implementation, what have you, we see a fairly quick impact on many components, particularly coverage. Yet after a year or two years, again, we see like stagnation, like somehow do the unfulfilled demand, the issue that how can we sustain this increased coverage that we all want because, clearly, this coverage is going to be affecting the poorer and poorer segments. So maybe such (?) as the other one, but, I mean, how can we involve our projects and our assistance so as that we see this coverage takes place.
MR. KESSIDES: I will address the first issue, that is, social tariffs. The report argues that perhaps that's the last and, arguably, the most challenging policy frontier confronting the developing and transition countries.
There are a number of different elements that add to the complexity of designing and implementing efficient tariff policies. And we should note that, first of all, regulating tariffs in these countries because of informational and other problems is quite difficult for the regulatory agencies. And, therefore, what we are arguing for is for according the operating entities considerable pricing flexibility; in other words, to decentralize the pricing and regulatory function away from the regulatory agencies, in other words, the operating entities.
So what the report proposes is, among other schemes, to have one where there are tariff ceilings that are based on well-known cost concepts, and perhaps will rely on international benchmarks, and also tariff floors, but within those tariff floors and ceilings, the operating entities to be accorded considerable pricing flexibility and to price according to demand and other characteristics.
So that is one approach that will deal with both the level of structural prices that, as we know, are far removed from economic allocation levels at present, and to move away from the prevailing pricing uniformity that is characteristic of this sector in most developing and transition economies and to a small differential pricing schemes.
And I should add to that that if we move towards more differentiated pricing schemes, then in order to achieve revenue adequacy, perhaps one would not need across the board very aggressive rebalancing schemes that, arguably, will run against social pricing constraints in many developing and transition countries. In other words, by according them pricing flexibility, that might have significant implications for revenue adequacy without again requiring very aggressive price increases.
In terms of the concession design and regulation, I think that you are quite correct that by now we know what bad regulation is, what are some of the mistakes that we should avoid and so on. But in that respect, in that sense, I should mention that as we have not addressed this issue in detail in the following sense, that many of these countries are repeating the mistakes that the U.S. regulators made a few years ago, and especially the experience of U.S. regulation has not been sufficiently understood or analyzed in many of our client countries. And the report provides several examples of such mistakes that are being repeated in countries like Argentina and so on.
But, also, we should keep in mind that many of the regulatory rules, like pricing or access to bottlenecked facilities or so on, they were developed in the context of the advanced industrial economies. And as we very well know, the characteristics of the markets that this industry has seen in the developing and transition economies are entirely different. And, therefore, there is some question as to whether the rates of validity of this regulatory model extends to the characteristics of the developing and transition countries. And that's one area perhaps that we and other financial institutions might provide some valuable assistance to support work that tries, again, to modify the existing models, perhaps make them a little bit more simple, to reduce their information requirements, and, therefore, to enhance the possibility that they will be successfully implemented in those countries.
MS. SHAFIK: Just three quick examples to follow on Ioannis in terms of how we're operationalizing this new thinking on social tariffs.
First, lifeline tariffs I think have become a very standard part of Bank policy recommendations, and so in virtually every sector now it has become much more common for very low levels of consumption to have highly subsidized initial prices and then have a shift up as high levels of consumption occur, which is a fairly easy way to do targeting. And I think that's not a bad way.
The second thing is connection subsidies, and now through output-based aid and other types of performance-based service delivery mechanisms, the Bank is on a much more common basis subsidizing connections to poor households. And I think that's ultimately the solution to the coverage issue which you raise. And I think it's a key part of the solution in Africa, for example, and now in Cambodia, for example, we just did a project in the water sector where the Bank is actually financing the connection for every poor household. It was bid out competitively. The average connection cost was about $350, which is almost half of what it used to cost under public provision. Households, once connected, can easily afford to pay the running costs because it's cheaper than the informal alternatives that they had before that. So connection subsidies I think are a big part of the solution.
Then, lastly, I think in terms of the Bank's broader thinking on social tariffs, we're doing some very important work, I think, with the Research Department to look at the composition of a poor household's consumption and to try and make sure that our advice to governments on where tariffs should be is consistent with what's affordable for the average poor household.
As a rule of thumb, a poor household shouldn't spend more than about 15 percent of its expenditures on infrastructure services. And I think as we set lifeline tariffs and think about connection subsidies, we need to keep those kinds of parameters in mind, and the data that we're generating in the Living Standards Measurement Surveys that we're doing with the Research Department will help us, I think, give better advice on what social and affordable tariffs will be.
MR. BOURGUIGNON: Michael?
MR. KLEIN: Let me first underline what Minouche was saying. Lifeline tariffs are a mechanism of targeting the poor, getting to the right people. And then the second aspect of tariff design is making sure tariffs are only--subsidies are only paid when performance is there. So the output-based schemes like connection subsidies will only be paid out when a connection has actually happened, not in the cheap financing terms up front. So these are two key features of that.
The other question was at the end--and initially we see, after privatization, technical improvements, more connections, and then it sort of peters out. I think the basic story is it petered out in the period of the last decade because prices were not set at levels that encouraged further investment. And that's the broad story.
So if these tariff issues can be solved with appropriate design of social tariffs, that is the key strategic action to get this going and to sustain an investment in connections.
Last, this argument about how can we convince governments to see the wisdom in regulation and how to make it work and all of that, well, like all these things, it means governments have to tie their hands or have to be willing to tie their hands. And convincing somebody to tie his or her hands is always a little hard. And so it's like how could one convince central bankers to become--or governments to allow central banks to have some independence. Over time, wisdom is seen and builds up. I don't think there's any neat miracle solution towards this one here.
But yet, again, when we think about this, before we despair, we have to once again recognize that the public sector is plagued by the regulatory problems just as much as the private sector because there, again, somebody has to set those prices, somebody has to set those quality standards and monitor and enforce all of that stuff. So the regulatory issue is there just as well.
MR. BOURGUIGNON: Maybe a last point on these social tariffs. We know from public economics that there are various ways of redistributing income. One way is through prices and through subsidies, and this is what social tariffs are about. Another way is through income, through income transfers. And I think that we--it is certainly not something which is applicable to all countries in the world, but I think that it is worth stressing the fact that in several middle-income countries, and in particular Latin America, that some income redistribution schemes have appeared in the last ten years or so, are becoming extremely effective, are gaining very much momentum. This is the case of Progresso Opportunidades (ph) in Mexico, (?) Famiglia (?) in Brazil. There is the same kind of program in Chile, in Colombia, in many countries. And if we go in that direction, then it might not be necessary anymore to use the tariffs or subsidies to make sure that we are able to reduce poverty.
This is an old result in public economics, but I think it is a result which is worth to keep in mind.
Another question? Yes, please?
QUESTIONER: This issue of linking regulation and competition and privatization is somewhat slightly disturbing. Let's take two or three examples.
In the U.K., for example, I hope (?) that U.K. regulators don't need technical assistance, but, still, the failure of the Labor Party was blamed on the poor regulation where the regulators were well established. And (?) what condition is set for effective regulation are really enormous. We know technical assistance doesn't always work, even though he says that it's the cornerstone of making regulators effective. On the other hand, there are issues of corruption and there other issues. So it could take years, maybe 20 years, before (?) certifies that regulation is now good and we can go ahead with privatization.
In the meantime, SOEs are just about to collapse, so I think we need to think a little differently how privatization can work and how some regulation can be provided, and what Michael said--I don't know what kind of regulation was there when those small groups are providing water or electricity. After all, there are many parties to this whole issue. There are consumers, there are providers, and there are very interested groups. And regulation cannot be just a created body of officials who will provide regulation. I think we have to keep trying and experimenting and some other things will balance out instead of just putting them in a queue, okay, first we have set up a competition, then we have regulation, and then we go ahead with privatization. I think privatization is very urgent, and we have to keep going, and sort of trying to balance these as we go along.
MR. KESSIDES: I agree that the policy preconditions that are so indispensable for effective privatization to be implemented and the benefits to fully obtain are rarely met. So then there is a dilemma here. Should you delay the process until those institutional preconditions are met, or should you proceed and hopefully also have some policy dynamics, so then as information is gathered about the workings of these systems, then regulatory rules would be adopted, and therefore you have some regulatory adaptation.
Therefore, then I think it's a comparison of the risks with maintaining the status quo versus the risks of adopting these reforms in the face of those institutional imperfections. And I think that the judgment in many countries that it would appropriate actually to proceed with privatization and restructuring even in the absence of institutional and regulatory safeguards, I think was the right one.
Given the magnitude of the performance problem and the importance of these sectors for the overall--for sustaining economic or authentic international competitiveness. And that is a dynamic process of lending by doing, and I don't think that we should be pessimistic about how regulation is going in many of these countries. It is very true that they have not yet obtained the basic elements of effective regulation. On the other hand, there is progress that is being made in some countries, in some sectors more than others. But nevertheless, there is definite progress.
Also the other thing that perhaps we have underestimated the importance is that we should discuss much simpler, elegantly simpler regulatory mechanisms, and I think that the regulatory mechanisms of the United States or even the United Kingdom, with all that informational requirements and so on, might be appropriate. Therefore then I think that the focus should be on devising some very simple regulatory mechanism that perhaps rely on second best alternatives, but nevertheless that they have some chance of practically being applied in these countries.
So not all hope has been lost. I think that there is progress that's being made.
MR. BOURGUIGNON: Michael, do you want to add something?
MR. KLEIN: Yeah. I would think the--if the question is: should we wait until all the perfect conditions for right regulation are in place until we do something? That applies to any governance issue that we have. We might as well stop all development activities and wait until countries have perfect governance systems in place.
The real question is--the regulatory agenda is there for the public or the private sector. It doesn't matter which ownership there is. And the question is: under what overall package of measures, including ownership, is this going to improve the sector faster here or there? And it will be tradeoffs that Ioannis described.
QUESTIONER: My name is Humila Guliani (ph). I'm in the African Urban and Water Unit in Eastern and Southern Africa, and I was wondering if Ioannis and the other panelists like Michael and all of you, could comment on regulation in increasingly decentralized environments? So what we're seeing in Eastern and Southern Africa is political decentralization to local government, and in the urban sector, for example, we are working rather hard to try and get to where its good local governance, which means increasing discretion over tariffs, over the way that service is provided either through the private sector output base stage or whatever it is.
But all of this is happening in a context of extremely weak capacity even at the national level. So we've heard a lot of questions on regulation and its issues in Africa, and when you get to a little local government somewhere, then we get a little exacerbated.
So I was wondering if any of you have any thoughts on this issue, and what you would advise us on this, both on regulation, tariffs and the variation across local governments on this issue? Thank you.
MR. KESSIDES: Perhaps the--the answer to the question of course depends on what type of sector you are dealing with and the characteristics of--the economic characteristics of the sector, and the water is a good example. While of course quite a bit of water provision is local or regional in its character, therefore then it would be appropriate to decentralize the regulatory function, therefore the regulatory function will more accurately reflect local economic and other conditions, and also the formation of problems perhaps is less severe. When you decentralize, again, you come closer to the source of demand and supply.
On the other hand, as you correctly pointed out, the lower the tier of government that you go, the less capacity that you have. That is a serious problem. Indeed, regulatory capacity at a local or regional level is exceedingly weak in some of these countries, but even national regulatory capacity is weak.
Therefore then, what types of mechanism you might devise to enhance that capacity, of course--I feel the others will have use on this also--but one of the approaches is to still have some central authority that perhaps will provide technical assistance on economic and other matters, and for the local agencies, nevertheless, to have the final say. So the central regulatory authority will provide nonbinding, perhaps technical and other guidelines for these regional regulatory authorities to follow.
I should also mention that the demarcation of responsibilities between national, regional and local regulatory authorities has been problematic in many countries. At times these regulatory responsibilities are split up, frequently, actually, in a very counterproductive fashion. So we also have to keep in mind that there is a need for some harmonization despite again the urgency for decentralizing the regulatory functions.
MR. BOURGUIGNON: Do you have a reaction to this?
MR. KLEIN: Let's just push it a little bit. If one really thinks that there is no capacity somewhere, that strengthens the argument for having things private and unregulated. And the kind of schemes that I mentioned, small water schemes, small electricity schemes, sometimes are very--either unregulated completely or just minimally regulated with safety standards only, for example, but no price regulation, et cetera.
And the counter-factual here to look at, where do we find something like that? Somaliland happens to be one of those places in the world where that is the case. Is that the end state of development? Is that what we aspire to? No. But if we're really asking if there's no capacity, et cetera, there is scope there for tinkering with models in these tradeoffs which have relatively low levels of regulation.
QUESTIONER: Can I push that a little bit? I actually am a big fan of provision of services like electricity by independent providers, and I actually did a study in which we had a firm in India hook up a whole lot of funds around it, and the whole deal was to convince the state electricity board in India to do this, and in fact, it's a hugely successful model that we've argued should be replicated.
However, when you look at water, for example, in Hungary when they started to decentralize they created several hundred of local governments, and you need a little bit of--and every local government wanted their own water utility. It didn't make any sense. And in Africa we've had a lot of colleagues who are trying to have little local governments federate, come together and pick one provider. But it's really hard to do because the politics changes, and you know, tomorrow the deal will fall apart.
The second issue is that as in any local finance, and Francois can come in over here, the idea is you don't want to tax or charge people in your own district. So if you have a water source and you're delivering to a next local government, the tariff for them is $1 per liter or whatever, per meter cube, and for yours it's free. And we're seeing schemes like that in Kenya in village locations. So it becomes an urgent problem. I mean it's a really good idea to allow unregulated provision to happen, and it does happen, but there is extortion on certain services like water, which is why I think regulation is required. And if you could comment on that a little bit.
MS. SHAFIK: No. The problem you identify is very real, and I think--I'd go back to what Ioannis was saying, which is in the end, you know, it's an illusion for central governments when they decentralize in this way, that they're getting these obligations, service obligations, financial obligations off their books, and so given the kind of coordination and externality problems that you identify, I think there is no escaping from the fact that somebody, probably the central government, in some countries regional governments can play this role, need to provide some support in terms of standardizing contracts, providing--brokering these kinds of multi-entity contracting.
What you have to do--I mean, even in the UK which is a very advanced economy, when they started the private finance initiative of encouraging private provision along the lines that Michael was saying, they provided central support to local governments in the UK who had to use certain standardized contracts and standardized contracting methods, and often forced them to bundle their contracts because they were too small.
So I think in the end that has to be part of the solution really, practically.
MR. KESSIDES: Just as a final point along the lines of Minouche, we have to recognize that there are significant fixed costs associated with regulation, and therefore those fixed costs limit the extent of which you can decentralize, like a--the assumption here is that if you have a very large country and the regions and the states are large themselves, then it might make sense to decentralize. On the other hand, if you take a very small country, then the scope for decentralizing for the regulatory function might be much more limited.
On the other hand, I also agree with Michael that the face of very weak regulatory capacity, be it at the local level, at the regional level, or even at times in the national level, then the scope for very aggressive liberalization, restructuring and perhaps the regulation might be extensive, might be appropriate under those circumstances to let things go and not try to regulate, and I feel that we have not explored as much as we could that option.
MR. BOURGUIGNON: I'm afraid that we have reached the end of our time. Let me simply add one point on this discussion which just took place on decentralization and regulation, which is that I think it is typically an area where we should capitalize on our knowledge, and it is quite surprising that we have not yet been able to put together all the experiences the Bank and all the institutions have been participating to in terms of water supply under local government authorities to learn exactly what does work under what circumstances, what kind of regulation is being put in place, and what is the end result of that regulation.
And from that point of view I think that a lot of effort has to be made in order to make sure that all information that we can get on this is truly utilized. There is this very interesting study which is cited in the report. In Argentina water supply is under local government responsibility and there is this fantastic study of people who have tried to look at whether in municipalities where a water supply was under private management, were doing better in a social dimension than in other municipalities, and their criterion was under five mortality, and very surprisingly they found that indeed in municipalities where you had the private management on water supply, under five mortality was lower.
Now, what is missing in that is the fact that we don't know why. Is it because there is more coverage? Is it because the quality is better? Is it because the local government is fundamentally different to have chosen to go through the private sector? We don't really know that. And what is missing is this kind of knowledge, and I think that we in the Bank should put our efforts together in order to make progress precisely in that knowledge.
I'm not sure that pure fury and pure principles will be able to give the answer that we are looking for.
So given that, I thank all the members of the panel. I thank all of you for coming to this presentation, and I remind you that now if you want to go to this reception in the Info Shop, and if you want to get copies of the report, you are most welcome.
Thank you to everybody.