How does private investment affect performance? A clear-cut answer to this question remains elusive for a number of reasons. Unlike goods and services produced in competitive markets, utilities are often monopolies and their actions have a substantial impact on the social and political discourse. The problem is further complicated by the lack of strong evidence to clinch the issue for any side. This is especially so in developing countries, where a weak legal and institutional environment compounds the problems.
But a recent study by the World Bank has sought to put an end to the confusion by collecting evidence on a global scale using rigorous methodologies to overcome the disabilities of earlier attempts. Extensive in scope, the study examines the impact of private sector participation in water and electricity distribution using a data set of more than 1,200 utilities in 71 developing and transition economies. The sample includes 301 utilities with private participation and 926 state-owned enterprises with more than a decade of operation. The study was a major improvement over earlier ones, which depended on samples or case studies.
The results of the study, entitled Does Private Sector Participation Improve Performance in Electricity & Water Distribution? shows that the private sector fully delivers on expectations of higher labour productivity and operational efficiency, convincingly outperforming a set of comparable companies that remained state- owned and operated.
While the clear improvement in operational performance is encouraging for proponents of private participation, the results also make it clear why there is such hostility to these efforts. This is because the improvement in labour productivity gains came mainly from the reduction of employees in both water and electricity. The study found that the introduction of private participation reduced employment by around 24% in electricity and by 22% in water. Thus, private investment in utilities pushes policymakers to weigh a trade-off between an increase in output and service quality and reduction in staff.
Another disturbing aspect was the impact of private entry in investment. Proponents have always believed?and political leaders sometimes rashly promised?that greater private involvement in utility services would help sizably step up investments, thus helping to build greater capacity and coverage. But the study surprisingly finds mixed evidence on this and cannot conclude that investment always increases with private participation.
In the case of tariffs, except for electricity concessions, the study finds no evidence of a systematic change in residential prices as a result of private participation. This is surprising, as below-cost pricing of essential utility services is well documented in most developing countries and higher tariffs for all but the poorest households are often recommended as part of reform. But the lack of any substantial difference in tariffs between privately- and state-run utilities could have two explanations: tariffs changed in equal measure in both categories, or they did not change significantly in either of them. The second explanation seems more likely in countries where affordability is a real concern for much of the population.
This evidence may also point to the economic and political difficulties of aligning tariffs with the cost of service provision. Its implications for revenue streams call into question the sustainability of private involvement unless there are explicit subsidy payments. The result might also explain the lack of public or private investment.
The following are some significant performance indicators witnessed after the introduction of private participation:
* A 12% increase in residential connections for water utilities.
* A 54 % increase in residential connections per worker for water utilities and a 29% increase for electricity distribution companies.
* A 19% increase in residential coverage for sanitation services.
* An 18% increase in water sold per worker (following the introduction of concession contracts) and a 32% increase in electricity sold per worker.
* A 45% increase in bill collection rates in electricity.
* An 11% reduction in distribution losses for electricity (following partial divestitures) and a 41% increase in the number of hours of daily water service.
It is difficult to ignore the larger question of what happens to the efficiency gains associated with the entry of a private operator if they do not translate into higher investment or lower prices? One possible explanation is that services are initially so under-priced that even significant efficiency gains do not produce a financial equilibrium or justify lower prices. Instead, the efficiency gains translate into better operational performance, such as reductions in distribution losses, and the government spends less subsidising its utilities.
Yet another explanation may be that the private operator reaps gains through profits. Given the young regulatory environments in developing countries, which often lack sufficient capacity to supervise public-private contracts, this possibility needs to be considered. But the broad conclusion still is that this study produces clear findings that the private sector delivers on operational performance and labour efficiency.