Infrastructure and Public Utilities Privatization in Developing Countries
| Author | Emmanuelle Auriol; Pierre M. Picard |
| Profession | University of Toulouse I; University of Manchester |
| Pages | WPS3950 |
Page 1
Over the last 25 years low-income countries have reduced their share of state ownership by more than half.1 In most cases, governments have privatized public assets because of critical budgetary conditions.2 While international donors and creditors, like the World Bank or the IMF, made privatization programs a condition for economic assistance during the 1980s debt crisis, governments have been keen on using privatization proceeds to relax their budget constraints.3 Privatization yielded about $50 billion per year in non-OECD countries, no less than one-third of the worldwide proceeds of privatization (Mahboobi, 2000; Gibbon, 1998, 2000). The fiscal benefits of privatization are not limited to the divesture proceeds of state owned enterprises (S0E). They also encompass the possible termination of recurrent, ine[ffi]cient subsidies to the latter. In particular, when govern ments hardly discriminate between good and bad projects and/or management teams, they are likely to transfer too many resources to public firms. Privatization eliminates governments' legal obligations to subsidize unprofitable firms. In practice, privatization reforms have resulted in substantial decreases of government subsidies to former SOEs.4
The present paper aims to study the impact of poor fiscal conditions on the privatization decision in regard to infrastructure and public utilities in low-income countries. Privatization brings well-known economic costs when industries are characterized by strong economies of scale. By giving up the direct control of firms' operations, govern ments lose control over prices to the disadvantage of consumers. Private firms benefit from large market power and have large incentives to enter. In practice price increases Page 2 are often organized by the governments. Indeed, they have the choice between auctioning of markets on the basis of either the highest fee payment or the lowest product/service price (see Estache, Foster and Wodon 2002). Guasch (2003) shows in a survey of 600 concession contracts from around the world that in most cases contracts are tendered for the highest transfer or annual fee. Because fee payments rise with the profitability of the privatized firms, many governments choose policies that increase the firms" profitabil ity such as exclusivity periods and price liberalization.5 Prices are sometimes increased ahead of privatization in order to reduce the SOE financing gaps and attract buyers. This has been for instance the case in Zimbabwe, Kenya and Senegal, where governments in creased electricity prices by 10 % after reaching an agreement with Vivendi Universal (see AfDB-OECD 2003). An unaccounted part of price increases stems from the termination of illegal electricity connections (Birdsall and Nellis 2002, Estache, Foster and Wodon 2002, AfDB-OECD 2003).
The present paper studies the privatization decision as the result of the government's cost-benefit analysis where the social benefit obtained from the termination of subsidies to unprofitable public firms and the fiscal benefit from the cash-flows generated by the public firms" divesture are balanced against the loss in consumer surplus induced by the higher prices in privatized industries and to the social cost of the foregone taxable revenues that are available in profitable public firms. To get clear cut results privatization is treated as the move from public ownership with entry and price regulation to private ownership with price liberalization.6 Privatization is close but not equivalent to laissez-faire because entry remains regulated (i.e. through license and entry fees). If, as we show, privatization with Page 3 such price liberalization dominates state ownership with full price regulation, privatization also dominates in more realistic situations where prices are liberalized to a lesser extent and are kept under some governmental control.
The present paper shows that a main factor in privatization decisions is the opportunity cost of public funds, which captures the tightness of government budget constraints.7 The role of budget constraints in the privatization decision is not obvious because, under perfect information, governments should be able, at worst, to mimic the outcomes of private monopolies. However, under asymmetric information between governments and firms, public finance matters and privatization may dominate public ownership because subsidies are socially costly. To illustrate this result consider the specific case where the government cannot finance an infrastructure project (e.g. a road). Privatization is an appealing alternative as it is better to have a privately owned and operated infrastructure, even with monopoly distortion (e.g. a toll), than no infrastructure at all. By continuity the result still holds when the government is able to finance the infrastructure. We hence show that when the profitability of the industry is low, as it is for instance in the case of transport or the water industry, the privatization decision is a monotone function of the opportunity cost of public funds.8 That is, for low opportunity costs (i.e. for wealthy governments) public ownership dominates privatization, whereas the reverse holds for large opportunity costs (i.e. for financially strapped governments).
Nevertheless, the above monotonic relationship between privatization and tightness of budget constraints breaks down when natural monopolies are su[ffi]ciently profitable and when governments are not able to recoup large enough franchise fees or divesture proceeds. In that case, we show that privatization is optimal only for intermediate opportunity costs of public funds. Such situations often stem from the di[ffi]culty met by developing coun tries to attract investors when they auction of profitable SOEs.9 Indeed, according to Page 4 Trujillo, Quinet and Estache (2002), there exist rarely more than two bidders who partic ipate in developing countries" auctions for major concession contracts. Therefore, SOEs are often sold at a discount (see Birdsall and Nellis 2002).10 Hence, with underpriced public assets, privatization decisions are non-monotone functions of the opportunity cost of public funds. The intuition goes as it follows: as before, when opportunity costs of public funds are small, the bailouts of firms by governments are cheap and it is opti mal to keep regulated publicly owned firms, to set prices close to marginal costs and to subsidize the firms to guarantee a break-even situation. For higher intermediate oppor tunity costs of public funds, bailout becomes costly and governments prefer to privatize the public firms, cash the divesture proceeds and let private entrepreneurs manage firms.
Yet, for high enough opportunity costs of public funds, the privatization decisions difer as governments may find it valuable to "hold-up" on profitable industries. Governments then prefer not to privatize profitable public firms; they operate the firms by themselves and they possibly set prices close to private monopoly prices to reap the maximal rev enues. This non-monotonicity result has potentially important policy implications. That is, while divestiture of profitable public firms may be optimal in developed countries, it is not necessarily so in developing countries where budget constraints are tight and market institutions are weak.
Finally, when firms' profitability substantially rises, the market leaves room for more than one firm. Market liberalization then corresponds to the divestiture of a historical monopoly and the introduction of new entrants. In the framework of the model the di vestiture of the historical monopoly is motivated by smaller fixed costs and/or by larger product demand. The mobile and internet segment of the telecommunication industry provides a good illustration of such technical and demand changes. The paper then shows that privatization with price liberalization is no longer optimal. Indeed, when a second Page 5 firm is introduced, the information costs in regulated firms diminish more than the so cial costs induced by excessive prices and entry prevailing in private Cournot oligopolies.
The advantage of private unregulated structures disappears for large, profitable markets. For instance the experience in industrialized countries shows that regulation of access pricing to bottleneck facilities (e.g. fixed-line network) is a key component of successful market liberalization. As illustrated by the empirical evidence, price and entry regula tion is a problem in developing countries which usually lack the human resources and the institutions to enforce effective regulation. Since privatization reforms cannot be success ful without effective regulation of entry and prices, developing countries are better of at keeping their profitable utilities public as long as they cannot establish credible regulatory bodies.11
To continue reading
Request your trial