Presentation by Kamal Malhotra at Seminar on “Private Interest vs. Public Good: Governance Dimensions of Regulatory Frameworks for Private Sector Infrastructure Development,” organised by the Asian Development Bank and the Organisation for Economic Cooperation and Development (OECD) on the occasion of the ADB’s 31st Annual General Meeting, Geneva, Switzerland the April 28,1998
A. OVERALL FRAMEWORK
The fundamental issue, relevant to every regulatory regime, but one which is seldom explored in detail in the course of its design, implementation or evaluation, is or should be really quite simple. What, and for whom should it be? This is the first essential question as the title of this panel discussion correctly points out.
Where am I coming from on this crucial issue and where should regulators and governments be coming from? I believe that all of us should be coming from the same perspective on this crucial question: the perspective of human development, particularly of the poor and most marginalized in society. Any public or privatized infrastructure project which does not serve the interest of the latter groups in society, especially if they relate to the provision of commonly agreed public goods (eg. water, electricity) should not pass our collective test. If this is agreed, then the answer to the question “whose interests should regulators protect?” is simple and clear ie. primarily (not exclusively, but as a matter of the highest priority) those of the poorest consumers and directly or indirectly affected communities and individuals, some or many of whom may not even be able to consume or benefit from the public goods in question if they are privatized.
What is my definition of regulation for the purposes of this presentation? I prefer to use the following: ways and means employed by society to ensure rational decisions that are in the long-term interest of society, especially its poorest and most vulnerable citizens.
This presentation also takes as its overall and starting framework that the rationale for a strong public sector has historically rested on the argument that there are many public goods which need to be provided to the poor and others as fundamental entitlements, and indeed, basic human rights. If left to an unregulated market, these goods (eg. electricity, power or roads in remote rural areas) would either not be provided at all as a result of “market failure,” or be provided at a relatively high and unaffordable cost so as to exclude the poor and other disadvantaged groups from access to their legitimate and often legally guaranteed rights and opportunities. The empirical record appears to support this contention because the link between the type of infrastructure projects that the private sector has been generally willing to support and direct poverty reduction is tenuous at best, and non-existent or even negatively correlated at worst.
Besides, there are, at the very least, serious questions both about the ability and willingness of the private sector to deliver in these areas, especially without recourse to some form of public subsidy. This is vividly illustrated by facts and figures which show that despite the huge magnitude of global capital flows to East and Southeast Asia before the region’s current economic and financial crisis, private capital flows for utility or public goods infrastructure provision have remained miniscule in comparison, with almost no flows to the poorest countries or poorer areas within countries in the region. This has been despite years of multilateral development bank (MDB) advocacy, cajoling and incentives. The response in the aftermath of the regional crisis can be expected to be even more dismal for public goods provision by the private sector in both “emerging market” and poorer countries alike.
Yet another rationale for public provision of certain goods or services is that they have such large economies of scale that they are “natural monopolies” which cannot be responsibly left to the private sector because it would either not invest in these utilities or sectors or the national interest would not be best served by such investment.
If utilities and public goods are to be privatized as many of them are being in a number of developing countries, appropriate regulation will be crucial. While there is now widespread agreement that the public sector in many countries has not performed as well as was expected, it is also now widely agreed that “market failure” in the area of the provision of public goods is equally, if not more widespread, than public sector failure. There is also considerable evidence in Asia and elsewhere ( eg. some of the East and Southeast Asian countries, the state of Kerala in India, many Scandinavian countries) that when the public sector has performed well, benefits have been spread to a much larger number of people, especially among the poor and disadvantaged, than has ever been possible in countries or situations where the provision of the same goods has been left to the private sector.
Even the World Bank , an ardent supporter of the privatisation of infrastructure admits, for example, that ” the technical performance of East Asian utilities in fields most suitable for early privatisation (eg. power companies) has been satisfactory…..” It is also the case that many public sector utilities and enterprises in East Asia have been both profitable and delivered public goods which the private sector would fail to do free or at a reasonable cost to the poor who can least afford to pay.
Moreover, many industrialized countries have privatized key infrastructure areas very little, but have done very well in terms of its provision. For example, both France and Germany, both key members of the OECD, had no private investment in telecommunications infrastructure (a key area identified for privatisation by the World Bank and others) even in 1995 while France had no private sector involvement in its power sector till that year and Germany had no private involvement in transport. Japan, another major OECD country, has very little private sector involvement in transport and none in water and sewerage systems. Overall, the weighted average of privatisation in infrastructure investment for France was only 13% in 1995, even less at 9% for Germany and only 14% for Japan.
Yet the target deemed desirable by the World Bank is as high as 70%, using the relatively recent experience of the UK as its model. While there have clearly been some benefits from UK privatisation of utilities (ie. efficiency gains), more controversial aspects from a consumer perspective appear to have been either overlooked or downplayed by the Bank.
For example, a recent study by Professor Catherine Waddams of the Warwick Business School for the British House of Commons Trade and Industry Committee, indicated that there had been cost increases for many poorer people who now have to pay cash in advance to obtain gas or electricity. In contrast, rich electricity consumers often obtain discounts if they settle their bills via quarterly debits to their bank accounts. There is also evidence that the poorest fifth of the British population spends, on average, 25% of their income on energy, and one survey showed that more than half of households using pre-payment meters had not been able to maintain their supply of gas or electricity, often for a weekend or longer. Such “self-disconnections” do not appear in official British government statistics which incorrectly indicate that disconnections are no longer a major problem.
In the area of regulation, various reports indicate that regulation of the UK utility sector has proven to be unpredictable and often weak when subjected to sustained industry pressure. Many utilities have, for example, skillfully deployed their large information and public relations resources to marshall statistics supporting their position in an effort to pressurize regulators. It is, therefore, essential to assess whether the regulator will have sufficient resources (eg. through an industry levy) and the independence and capacity to resist industry pressure and influence. The British Labour Party’s election pledge last year to levy a “windfall tax” on private utilities if it won the May 1997 elections indicated that they recognized that consumer-oriented regulation of the private sector on price issues was inadequate. It also clearly shows that regulation has to be viewed both as a political and social issue and not just as an economic and technical question as the Banks and their consultants sometimes describe and like to view it.
Indeed, it is the presence of the combination of effective transparent competition, (except when genuine economies of scale or national interest arguments can be made) and accountability both to consumers, (especially small and poor ones), and to powerless communities who are directly or indirectly affected and may not even be consumers, that should be the key indicators of good, community and consumer-oriented regulatory performance. Good legally and morally enforceable and independent regulatory frameworks to ensure such transparent competition and accountability to the poor and powerless and sound management practices are equally important attributes of desirable regulatory regimes and are much more important than ownership and privatisation.
Empirical evidence has demonstrated time and again that the private sector has no monopoly on these attributes. Indeed, in the current unregulated and global market concentration context, significant and influential segments of the private sector increasingly work in contrary ways which prevent them from developing many of the crucial attributes discussed above, leading to ineffective regulation in the public and consumer interest.
In such a private sector economics and finance dominated and led globalisation context the question posed for this panel presentation and discussion ” Whose Interests Should Regulators Protect and How?” is, therefore, an extremely appropriate and good focus for discussion. I must add that from a “consumer” or community perspective, the question posed to this panel of speakers is even more important in the context of the National Economics Research Associates (NERA), U.K. consultant’s report to the Asian Development Bank which appears to assume that the prime function of regulators is to protect the interests of private investors and that if this is done, benefits will automatically accrue or “trickle down” to consumers.
NERA also simplistically assumes, as has the ADB for this seminar, that consumers and communities affected are one and the same group and that their interests will be the same. As a result, no separate mention is made of directly and indirectly affected powerless and poor communities, many of whom have been victims of both public and privatized infrastructure projects. Ironically, many of them are forced to remain or become non-consumers of the benefits of such projects, while remaining the main consumers of their costs and mistakes.
B. KEY ISSUES FOR REGULATION
1. Following from the above, the first point I wish to make in this section of my presentation is that the categories provided us for this seminar (government and regulators as often having the same interests, private investors and consumers) are both simplistic and not comprehensive enough, especially for developing countries. Such countries have large and heterogenous population groups in both absolute or relative poverty who often comprise the group of individuals or communities who are both directly and indirectly impacted upon, often negatively, by infrastructure development projects ( eg. dams, roads, power plants). Most such groups can never hope to be consumers, except, sadly, of their negative environmental and social impacts! This is especially and increasingly true in the context of privatized, cost recovery or profit-making infrastructure regimes.
To lump such groups as consumers is, therefore, both incorrect and disempowering for them ( the latter, partly because once again they are unrepresented in discussions such as these!). It is also a major drawback of the overall regulatory framework recommended and discussed in the NERA report and of this seminar format. Non-consuming, directly and indirectly affected communities need to be treated as a fourth (or fifth, if governments and regulators are treated separately, as they should be) category, quite distinct from the broad category of consumers with which such directly or indirectly affected individuals and communities are presumably currently grouped.
2 Related to the above and the theme of this panel discussion, I further submit, as I did at the very outset, that it is the interests of consumers and such directly or indirectly impacted individuals and communities that regulators need to primarily and consciously serve, not those of private investors, foreign or domestic, or governments. The latter and their money or power, are after all merely tools and resources that should be used as instruments to serve the public good, and particularly the interests of the poorest and most vulnerable groups in society whom governments have been elected to serve as a major priority. Both governments and the private sector should be means to the attainment of such goals, not an end in themselves. Sadly, however, current mainstream literature on infrastructure development often appears to treat the successful attainment of foreign private capital flows as an end in itself, not as a means or a resource that will only be socially useful if it is adequately and appropriately regulated for the public good. This is clearly and surely the most important lesson of the current East and Southeast Asia financial and economic crisis!
3. Allowing private capital to flow across global and national boundaries in a totally unregulated manner is disingenuous and naive at best from a development, community and consumer perspective. This is because large private capital flows, even if they are forthcoming for infrastrucutre provision (which has not been the empirical evidence to-date) ” are not necessarily positive: it depends on their destination, terms and durability and whether an enforceable regulatory framework is in place to protect the public interest.” If aid agencies such as the ADB and World Bank or governments are ” to use public money for private deals, clear criteria must be drawn up on how to select projects that maximize benefits for poorer people and the environment and to ensure an open public process is followed to ensure that alternatives can be debated and negative impacts minimized.” These should be major objectives of both governments and regulators.
4. It is critically important to be clear about these objectives right from the start, especially in the area of the provision of public utilities which are widely regarded as public goods to which all citizens are or should be equally entitled. Such clarity from the outset is particularly important because, as the NERA report vividly demonstrates, (even if that was not its intention), that what is a “best practice” regulatory framework for private investors is not likely to be the “best practice” system for affected communities and poor or small consumers, especially but not just in a privatized infrastructure system.
The Orissa power sector privatisation case in India is, perhaps, a good illustration of this. The NERA study identifies this case as closest to “best practice” in a number of areas although it does qualify this by saying that there has not been enough practice to form a final judgement on this. While it may be “best practice” from the viewpoint of private investors and NERA, it certainly does not appear to be so from the perspective and recent experience of consumers. A recent April 1998 report by the PRAYAS Energy Group entitled “Regulation in the World Bank-Orissa Model : Cure Worse than Disease” highlights this.
It indicates that while the root cause of the crisis in the Indian power sector under public ownership was the lack of accountability of decision makers to the public, privatisation of the power sector in Orissa does not appear to be dealing with this issue. The independent Regulatory Commission which is now the new decision-maker seems to have a lot of discretion. This once again negates the whole concept of accountability.
For example, public hearings or complete information sharing is not mandatory. In the very first tariff revision, the Commission reduced the period for public intervention to just 10 days and rather than providing information, it asked people to obtain information from the privatized utility. This decision is neither challengable on procedural or techno-economic grounds, nor is the Commission accountable to the legislature or government.
This unregulated discretion for the independent regulator appears to be a recipe for disaster in a country like India where democratic procedures and even the law have been violated with impunity for decades!
PRAYAS, which is a consumer oriented energy policy research group in India say that they wrote to the Regulatory Commission volunteering help in their interaction with the public and NGOs but the Commission declined the offer saying ” any intermediation……should be of greater concern to the utility and the commission should not be directly involved.” According to PRAYAS, the Commission was declining an offer for the facilitation of consumer and public participation and did not appear to view its role as acting on behalf of the public. As a result, the basic problem of public utilities from a consumer perspective, (the lack of accountability to people and their inability to intervene) still remains unchanged. Indeed, under a privatized utility, PRAYAS and others believe that accountability to the poor and consumers more generally has actually declined because even the minimal governmental accountability which existed in the past no longer holds. Even more potentially dangerous is reference to this as close to a “best practice” system—-as this example shows, this will clearly not be the case for consumers and the poor unless there are major changes in the manner in which the Regulatory Commission views its accountability to them.
5. Likewise, what is good for big, industrial or urban consumers may not be good for small, rural consumers or communities. A much more sophisticated analysis of consumer and community interest than that provided in the NERA report (which is almost silent and, therefore, seriously neglectful of such perspectives) is absolutely essential.
6. This is particularly necessary because the aim of the ADB’s developing member country governments (DMCs) should be an affordable, equitable and sustainable supply of utilities to all their poorest and most marginalized citizens. If this is assumed as the primary goal, the achievement of these objectives and not narrow economic efficiency or transparency, accountability and participation by private investors should be used as the most important yardsticks for the measurement of the success of regulation. Clearly, the criteria that private investors be assured long-term and adequate profit, while important to them, should not be the prime consideration for governments, regulators or international public financial institutions such as the ADB, as currently appears to be the case in many countries and situations.
7. Yes, investors need to earn a reasonable return on their investment, but the question of who decides this and how much this should be needs to be placed in the broader context of achieving a government’s (and the ADB’s) overarching poverty reduction and equity enhancing goals. As such, it should be a matter for regulators to make judgements on this, if necessary, keeping these broader goals as the overall framework. It should certainly not be left to the unilateral desires or judgements of private investors, regardless of whether they are domestic or foreign.
Once again an Indian example may help in illustrating this. The Enron Corporation’s Dabhol project in Maharashtra has been one of the most controversial, fast-track projects since privatisation began in earnest in 1991. Analysis of the power purchase agreement (PPA) by the PRAYAS Energy Group in India indicated that the capital cost of the plant was inflated by at least 10%. This coupled with high rates of return of at least 50% per annum in US$ terms implied that electricity consumers in the state of Maharashtra will have to pay at least an additional US$ 270 million each year. The costs as a result of poor negotiation of this PPA together with two others that the state government was negotiating in late 1997 were estimated by PRAYAS conservatively to be equivalent to the total loss being incurred by the existing public-owned utility.
8. The acceptance of the legitimacy of human development goals also means that one cannot artificially segregate or separate economic and technical regulation and governance issues from social, environmental and even political regulation and governance issues. From the perspective of both the small or poor consumer and non-consumer affected communities, the latter aspects of regulation are as, if not more, important than economic and technical regulation and governance issues. Any discussion of the topic of this seminar is, therefore, inadequate and incomplete without a discussion of all these different aspects and their interrelationships. Unfortunately, there is neither the time to do this in my seven minute presentation or in the rest of this seminar. I hope, however, that the ADB will take appropriate cognizance of this comment before reaching any conclusions on its position on the topic of this seminar.
9. Another key issue in most developing countries is the weak institutional and enforcement capacity to effectively regulate. Indeed, the crucial issue in utility infrastructure provision is regulation, not ownership. Regulation remains an extremely important aspect of utility infrastructure provision, irrespective of ownership. For example, regulation is equally important regardless of whether the utility infrastructure is an integrated public monopoly or an “unbundled” private utility (a la the World Bank-Orissa privatisation “best practice” model).
The political economy of the privatisation of utility infrastructure in practice, therefore, if nothing else changes, is often that rather than encouraging competition, it leads to the creation of private monopolies which cause “market failure”, especially for those without effective demand or purchasing power in the market (eg. the poor, women). If a government is corrupt, secretive and lacking in institutional capacity to regulate the independent regulator, privatisation cannot possibly be the dream cure that it is projected to be unless the government fundamentally changes its negative attributes.
Indeed, the scope for corruption could greatly increase as a result of privatisation in this context leading to costly and bad privatisations. Proponents fail to see that under conditions of bad regulation, public ownership is likely to be less costly and a better option than private unregulated ownership. A prerequisite of the privatisation decision in these contexts (which prevail in most DMCs) is to first install good regulation and make public utilities transparent and accountable to the public—a pilot test in the public sector should be made before deciding on whether or not to privatize.
In this context, the other argument of infrastructure privatisation proponents (such as the World Bank’s Private Sector Development Group) that the poor are willing to pay for privatised utilities and social services is not borne out by most empirical evidence. This is simply because even if the poor are willing to pay they do not have the ability or capacity to pay in practice. If they are forced to pay as in many privatised infrastructure regimes, it is often at an unacceptable social or economic trade-off (eg. child labour, education or health prioritized over three or even two meals a day, inability to sell produce because of high tolls on roads which they cannot afford to travel on).
10. If the regulatory framework is not tackled first, another serious danger for communities and consumers of the privatisation of utility infrastructure and other public goods in weak regulatory institutional settings (most, if not all ADB DMCs) is that inadequate and non-independent regulatory frameworks will result, often leading to collusion and corruption between regulators and the private sector rather than competition and accountability to consumers and affected communities. In such contexts, the private sector can often criminally exploit public resources. For example, in many of the countries in economic transition from central planning to market-orientation in Eastern Europe and elsewhere, political control rights in the old system have been or are in danger of being converted into property control rights as a result of the privatisation of utility infrastructure and other public goods. The risk of collusion, although to a lesser degree, exists even in industrialized countries with much stronger regulatory institutional and enforcement capabilities, as the UK example has shown.
The implication of this for the question of “how” such regulation can be achieved is that until governments become effective regulators, citizens and consumers must guard against many of the same problems in privatized infrastructure systems that they have had to endure in government or publicly owned infrastructure schemes (eg. failure to obtain local community consent for infrastructure development, violation of environmental regulations, failure to adequately compensate local communities and people for livelihoods damaged or destroyed, failure to mitigate environmental damage). Public demand for effective regulation and public scrutiny of the government’s role as the industry’s regulator will remain essential for a long time to come for this reason.
The need for consumers and communities to organize and act against collusion between the industry’s regulators, newly privatized utilities and private companies will remain crucial in both developing and industrialized countries. They must guard against the government’s tendency for cronyism by awarding favoured foreign or domestic private companies special privileges or incentives (eg. free water, the power to expropriate land and other resources, government-guaranteed loans and revenues). Communities must also continue to demand that private investors respect their property rights (individual and community) and internalize social and environmental costs.
11. As a result of the discussion in this section of the presentation, regulators, governments, MDBs such as the ADB and private investors need to take cognizance of the serious and numerous regulatory implications of the privatization of utility infrastructure and other public goods from a development, consumer and affected community perspective.
A number of key issues need further consideration. These include the following: privatisation may not be the most appropriate answer from a consumer and community perspective in many situations and could compound problems of lack of accountability and transparency to the public rather than resolve them; it may make certain public goods inaccessible to the poor, further skewing inequality of opportunity; it is likely to have a gender bias against women; it could lead to mass unemployment for workers, many of whom cannot be retrained for alternative jobs in the private sector, and the benefits of privatisation (eg. revenue generated to finance budget deficits) could lead to the best and most profitable public sector utilities being the first to be privatised without any guarantee that the revenue earned as a result is a fair return to the taxpayer and will be used to enhance both the reach and quality of public services (eg. infrastructure facilities in remote rural areas) for the poor and needy.
12. All of the above has implications for the question of “how” such regulation can take place ie. the nature and enforceability of regulation over private investors in the consumer and community interest. This will require both a strong state in terms of the clarity of its social and poverty reduction goals, as well as in terms of its regulatory and enforcement abilities. It will also require genuinely independent regulators who do not come from the private industry sector and are clear about the overall and highest priority social goals of regulation.
Ironically, however, the weakening of the state’s role in these areas and its public goods provision function has, in numerous cases, been a direct result of IMF, World Bank and other MDB structural adjustment and other economic reform programs which have reduced the role of the state in favour of the market and private sector. As a result, this has often reduced rather than enhanced DMC state capacity and ability to enact and enforce effective regulation over private investors in the interest of the poor and disadvantaged.
13. Transparency and accountability to different stakeholders will require the availability of different types of information and consultation mechanisms. Since the NERA report is primarily concerned with facilitating private, especially foreign investors, it deals with transparency and other governance issues primarily from their perspective. Such requirements should, however, apply equally to all stakeholders, and as already indicated, the requirements and needs of private investors are likely to be very different from the requirements and needs of consumers and non-consumer communities affected.
While information about the criteria on which decisions are made or why a tender was not successful has been made available to private investors in a number of cases, equivalent information about an infrastructure project and its development impact is usually not available to local communities or consumers even in so-called “best practice” systems. At best, such information and assessments, for example on social and environmental impacts, have been made available to such groups, on demand, only after the decision to go ahead with the infrastructure project has already been taken.
14. Likewise, on the issue of participation, no differentiation is usually made as to the levels and quality of participation amongst the different stakeholders. The NERA report, for example, makes gross generalisations about participation, and it is difficult to tell where participation is claimed to have occurred, by whom, when, in what part of the process, at what level and with what quality and prior access to meaningful information. All of the latter are critical in determining outcomes and whether participation has been symbolic or genuine.
Genuine, effective and quality participation by consumers and communities directly affected by privatized infrastructure projects remains rare even in “best practice” systems with MDB participation and fundamental improvements in this area of good governance will remain a crucial component of the answer of how to regulate for the public and consumer interest.
