Privatization in water and electricity

An exhaustive study of private sector participation (PSP) in water and electricity distribution by the World Bank have come up with several ineresting findings that appear to go against the conventional wisdom in the sector.

The study uses a data set of more than 1,200 utilities in 71 developing and transition economies, of which 301 utilities have PSP and 926 are state-owned enterprises (SOEs) with over more than a decade of operation. It also includes all the electricity distribution and water and sanitation companies that experienced PSP between the beginning of the 1990s and 2002. However, the study has a very strong regional bias towards East and Central Europe and Latin America and the Carribean.

Its major findings include

1. While full privatization in terms of complete sale of assets is rare, it finds a broad range of PSP options - private sector—management and lease contracts, concessions, and partial as well as full divestitures. While divestitures (full and partial) account for most PSP cases in electricity distribution, concessions account for most in water and sanitation.

2. Confirming the widely held impression that state-owned utilities are over-staffed, following the introduction of PSP, average employment falls by 24% in electricity and by 22% in water. In other words, a major chunk of the efficiency and operating profitability imrovement comes from staff reductions.

3. Contrary to conventional wisdom that greater private involvement in utility services would lead to vastly greater investment and thus to greater capacity and coverage, the study finds no such conclusion. The evidence points to a lack of
investment — public or private — in the maintenance and expansion of utility
networks as a general rule, even where PSP leads to an increase in operational
efficiency, raising concerns about the long-term sustainability of the operational improvements achieved.

4. Except for electricity concessions, the study finds no evidence of a systematic change (increase towards cost-recovery) in residential prices as a result of PSP. This finding reflects the massive challenge economic and political difficulties of aligning tariffs with the costs of service provision, thereby calling to question the sustainability of private involvement unless there are explicit subsidy payments.

5. It finds clear operational improvements over a five year period or more, over and above those recorded for the state-owned companies
a) A 12% increase in residential connections for water utilities
b) A 54% increase in residential connections per worker for water utilities and a 29% increase for electricity distribution companies
c) A 19% increase in residential coverage for sanitation services
d) An 18% increase in water sold per worker (following the introduction of concession contracts) and a 32% increase in electricity sold per worker
e) A 45% increase in bill collection rates in electricity
f) An 11% reduction in distribution losses for electricity (following partial divestitures) and a 41% increase in the number of hours of daily water service.

Most often the arguement about private sector participation in the management of public utility services revolves around the superiority of private companies. The question asked is - Are private companies more efficient that public sector companies in the management of public utility service providers? The answer would be yes.

But this may the wrong question. The question should have been - In a context where tariff increases are difficult, governments are resource strapped to subsidize consumers, and issues like staff retrenchment are deeply politicized, is private sector management of utility services likely to produce efficiency gains and service delivery improvements?

The public-private debate on the management of public utilities should not be held hostage to an intellectual or ideological exercise in highlighting the relative superiority of two opposing systems. Instead, it should focus on the challenge of tailoring alternative, second-best approaches to managing public utility services in complex economic and political environments. This requires abandoning old shibboleths and ideological predelictions of the ivory tower academics and constructing management approaches that marries the best in public and private sector for the real world in which the utility operates.

Supporters of private participation in civic infrastructure have been selling it on the grounds that it leads to increased investments and lower prices for consumers. This becomes the USP of privatization or PPPs when selling the same to the political stakeholders. However, the study finds no evidence of higher investments or lower prices and also raises the important question of where the gains from efficiency improvements accure. Though it feels that the low initial user charges dwarf any gains from the efficiency imrovements, the study also points to the strong possibility of the private operator reaping all the gains through increased profitability.

I will list out the possible areas of efficiency improvements in public utility services and indicate where public or private sectors have a relative advantage.

1. Introduction of newer and more efficient technologies to minimize recurring expenditures and thereby life-cycle costs. Requires huge capital investments, which private provider cannot afford without higher user charges and government utilities do not have the resources to make them.
2. Better maintenance schedules to minimize break-downs and interruptions, which in turn translates into increased sales and greater revenues and profits. Private providers are very good at these operational improvements and squeezing out wastages. But increasingly, the better run government utilities too have achieved considerable success on this.
3. Reduction of losses in distribution and supply so as to increase the metered and accounted for sales. Both private utilities and better run government utilities have achieved great success on this front.
4. Increase coverage to make optimum use of the sunk investments in distribution and transmission lines/pipes, sub-stations and treatment facilities. Private utilities are better positioned to do this, thanks to the flexibility in connection service charges etc.
5. Reduce manpower and re-deploy them more effectively. Also increase the productivity of existing manpower. Very difficult, even impossible for government utilities to achieve this. I am inclined to believe that the sample of utilities where the private provider was able to cut employees were precisely those small number of utilities where (for whatever reasons) such retrenchments were possible.
6. More efficient purchases of consumables and contracting procedures without glaring leakages. Increasingly, the better run government utilities have achieved considerable success in procuring their requirements more efficiently. But this activity can be outsourced.
7. More effective supervision of the operations to improve the quality of supply. Private sector is certainly superior to the government agencies in this.
8. Introduce technology (especially IT related) to increase productivity and improve monitoring standards. Capital intensive and therefore a constraint for both private and government agencies.

In light of the aforementioned, it may be possible to design appropriate hybrid models of private participation, different from the conventional approaches, to suit the myriad local (market) conditions and requirements. I will explore such models in subsequent posts.