Infrastructure privatisation: “Oversold, misunderstood” … and heavily subsidised

26 July 2004

While Bank critics welcome increased flexibility in infrastructure investment, there are fears that a planned expansion of the commercialised model may undermine poverty reduction efforts.

The Bank estimates that, in order to reach the Millennium Development Goals, developing countries will have to double their spending on infrastructure. In 2005, the Bank is increasing its lending for infrastructure to $7 billion, an increase of $1 billion over the previous year. However, expanding lending in the form of subsidies for private providers may result in a re-run of the problems of corruption, inefficiency and low access witnessed over the past decades.

A June report from the World Bank says that the privatisation of infrastructure has been “oversold and misunderstood”. The report’s author, Ioannis Kessides, an economist in the development research group, concedes that “privatisation was heralded as an elixir that would rejuvenate lethargic, wasteful infrastructure industries and revitalize stagnating economies.” The failure to do so has led to widespread “skepticism and outright hostility toward privatisation.”

privatisation was heralded as an elixir

However, despite the “significant risks” posed by infrastructure privatisation if not accompanied by appropriate structural and regulatory safeguards, the report concludes that it “offers benefits too big to ignore for governments, operators, and consumers.” The success of privatisation efforts, says Kessides, varies greatly by sector: telecommunications offers the most compelling case for privatisation, while transport networks, electricity and water supply are “more problematic”.

In a paper for the Citizens’ Network on Essential Services, Tim Kessler argues that in such “problematic” sectors, “guarantees and subsidies that help to ensure corporate profitability can pose serious risks and costs for taxpayers.” In the face of rapidly declining private sector interest in infrastructure since 1997, the Bank has focused on promoting a range of instruments to attract private sector participation.

Some fiscal supports for private infrastructure, such as construction subsidies and tax holidays, have been around for a long time. More recently, the World Bank has pioneered ‘output-based aid’ where the Bank agrees with the government to pay private providers for services actually delivered. Kessler argues that “figuring out whether a subcontractor is doing its job well and for the right price is costly and requires technically qualified staff.” The same regulatory capacity, which “far exceeds” that available in most developing country governments, is needed if subsidies are used to ensure access for low-income citizens. Governments must make long-term estimates of the subsidies required; this demands a degree of fiscal continuity which many developing countries subject to IMF fiscal austerity measures may be unable to meet (see box below).

IMF accounting: the genie in the ledger

The Fund is under pressure both from borrowing countries and lenders to relax its fixation with fiscal responsibility to allow for greater infrastructure investment. Pressures to run budget surpluses under Fund-supported programmes have contributed to insufficient spending on infrastructure. However, to address this gap, the Fund is open to charges from within and from outside that it risks governments de-prioritising social spending, crowding out private investment and racking up unsustainable debts.

A further complication arises over how the ‘fiscal balance’ is to be defined. The Fund has decided that it should cover the whole of the public sector excluding commercially-run public enterprises. However, this has raised concerns amongst civil society observers that only investment in publicly-run infrastructure will be restricted by fiscal austerity measures, creating a bias towards private provision. In response to these critiques and to pressure from the Brazilian government (see Comment, Update 40), the Fund is to allow the Brazilian government to similarly exclude investments by publicly-run enterprises from the calculation of government budget targets on a pilot basis.

The Fund is also considering how to better reflect the fiscal risks of public-private partnerships (PPPs) in government accounts. There is support for disclosing the potential future costs to government from such arrangements. This would respond to a long-standing civil society critique that PPPs are simply a way to bypass spending controls, while the government still bears most of the risk. In the absence of internationally agreed guidance on how to do this, the Fund has decided that “the known and potential future cost of PPPs should be disclosed, and taken into account when undertaking debt sustainability analysis.”

Kessler argues that even more worrying than output-based aid are those corporate subsidies which create liabilities “whose financial impact and timing governments cannot predict”. This includes purchase agreements, where governments agree to buy the output of a private provider, usually in hard currency, regardless of changes in demand or fluctuations in the exchange rate. Recessions, devaluations and unfavourable contractual terms have brought several utilities to the brink of financial collapse. Similar risks are posed by guarantees which lock-in price levels.

Kessler concludes that the Bank’s eagerness to promote private provision arrangements stems from the belief that the public sector cannot be reformed. Ironically, public service providers often become more efficient as a precondition of privatisation.

Government officials in the Philippines, responding to World Bank and ADB pressure to privatize the National Power Corporation, plan an 80% increase in electricity rates. The increase is aimed at making the power industry attractive to investors who have been hesitant to enter. Activists are planning mass mobilisations if the government goes ahead. Freedom from Debt Coalition says that Philippine electricity rates are already the fourth highest in the world.