PRIVATIZATION, NATURAL MONOPOLIES & SECTOR REGULATORS: AN INTERNATIONAL PERSPECTIVE

1. PRIVATIZATION, NATURAL MONOPOLIES & SECTOR REGULATORS: AN INTERNATIONAL PERSPECTIVE by Philippe Brusick Former Head, UNCTAD Competition & Consumer Policies Branch Conference on Competition Policy & Privatization Cairo, January 28, 2008

2. Railways . . . . . Electricity . . . . . Water . . . . . . Gas . . . . . . . Telecoms . . . . Rail Network Distribution Network Pipes, Sewage Pipe Network Fixed Tel Network TRADITIONAL NETWORK INDUSTRIES

3. Sector: City Bus Transport Ports, Shipping Airports, Natl.Airline Radio, TV Post Banks Insurance Tobacco, Matches Reasons: Traffic fluidity, Nat. Security, Sunk Inv. Nat. Sec, Prudential Security, Political Nat. Sec. Prudential Prudential Fiscal revenue OTHER TRADITIONALLY STATE-OWNED INDUSTRIES

4. CHARACTERISTICS OF NETWORK INDUSTRIES • Network Monopoly • Large Sunk Investments • Economies of Scale • Universal Service « NATURAL » MONOPOLIES TRADITIONALLY STATE-OWNED

5. TECHNOLOGICAL CHANGE AND THE CHALLENGE OF COMPETITION • Introduction of Cell-Phones • Competitive Challenge • New Technology requires Huge Investments • Failure of the State • Shrinking of Monopolies • Privatization for Technology & Capital

6. PRIVATIZATION TRENDS • International Competitive Pressures (IMF, WB, OECD, WTO, EU). • « Washington Consensus » • Structural Adjustment Programs • Market-Oriented Economic Reforms • Transition Economies

7. PRIVATIZATION MECHANISMS • Prior-Transformation of SOEs • Corporatization of SOEs • Direct Award to Private Investors • Auction Procedures for: • Management or Service Contracts • Award of Concession • Outright Sale to Private Sector.

8. DIFFICULTIES ENCOUNTERED IN PRIVATIZATION • Political Criticism over Price of Privatization; • Domestic viz. Foreign Direct Investment • Opposition of Civil Servants/Unions • Prices Rise Instead of Falling • Universal Service Undertakings are difficult to Fulfill.

9. THE RIGHT PRICE FOR PRIVATIZATION • Opponents Criticize the Cheap sale of the « Jewels of the Crown » • When Stock Price fall, Shareholders accuse the State of Ripping them Off. • In order to Maximize the Price of Privatization, the State is often tempted to grant Long-Term Monopoly Rights.

10. PRIVATE MONOPOLY REPLACES STATE MONOPOLY • Sales and Concessions have often been accompanied by Grant of Long-Term Monopoly by the State (Eg. Argentina, Chile, Mexico). • Absence of Competition pushes Prices Up and reduces Incentives to Innovate. • Inadequate Investment, Breach of Contract leads to Cancellation of Concession.

11. STRICT PRIVATIZATION RULES FOR NETWORK INDUSTRIES AND NATURAL MONOPOLIES • Strict Competitive Auctions • Avoidance or Minimization of Monopoly • Creation of Sector Regulator

12. STRICT AUCTION PRINCIPLES • Transparency • Due Process • Non-Discrimination • Periodic Review Process for Concessions • Restraint from Granting Long-Term Monopoly rights whenever possible • Control by Regulator when natural Monopoly

13. MINIMUM MONOPOLY • Reduce the Monopoly to the strict Network Portion of the Service • Introduce Competition in all Non-Network Components of the Industry • Ensure Network Monopoly Does not Abuse its Dominant Position over the Essential Facility

14. SECTOR REGULATOR • Create a Sector Regulator for the « Natural » Monopoly Segment (Eg. Essential Facility or Network-Owner). • Make Sure Sector Regulator is Not Captive of Regulated Industry. • Give Supervision Powers to Competition Authority to Avoid Abuse of Dominance.

15. CASE STUDY: Water Concession in Argentina • A 30-year concession was awarded in the Province of Tucumán (1.1m people) in 1995 to Vivendi, the French global utility company. The concession had been awarded by a Peronist government, but a new governor belonging to the Radical Party was elected soon after. Only a few months after operations began, Vivendi doubled water tariffs. Service quality did not improve and in addition, water became "inexplicably" brown. In protest, 80% of residents stopped paying their bills. Accordingly, the new governor started a campaign that ended up with the cancellation of the concession in October 1998 and taking over of water operations by the provincial government. Vivendi then filed a US$100m suit against the government. • Source: Nickson, A. (2001), “The Cordoba Water Concession in Argentina” Working Paper 442 05, GHK International and University of Birmingham.

16. CASE STUDY: Network industries in Bolivia • This study shows that divestiture of large, “strategic” SOEs is much more complicated than privatization of smaller, strictly commercial public enterprises. Many large SOEs enjoy substantial market power that insulates them from competitive market discipline. Part of this power is often created artificially by government imposed barriers to competition, but part also derives from natural monopoly, especially in a small country such as Bolivia where the size of the market cannot support more than one or two efficient firms in activities subject to economies of scale. In either case government policies should be revised prior to divestiture to avoid private exploitation of monopoly rights: without fierce competition private ownership per se is not likely to lead to much improvement in performance. • Source: Mallon, Richard D. 1994. "State-Owned Enterprise Reform Through Performance Contracts: The Bolivian Experiment," World Development, 22: 6, 925-934.

17. CASE STUDY:Electricity Sector in Chile By late 1980s, the Sector was dominated by two publicly owned companies, ENDESA and Chilectra, responsible for 90% of generation and 89% of electricity distribution. The monopolistic position of ENDESA provided it with the power to determine its own tariff sturcture. The sector was characterized by high production and delivery costs, with tariffs set below long run marginal costs. Management was poor and maintenance neglected. Between 1986 and 1995, the market was segmented into four generation and transmission markets. Two most important markets accounted for 97.6% of total electric power: the Sistema Interconnectado del Norte Grande (SING) and the Sistema Interconnectado Central (SIC). After the reforms, despite price reductions, prices were different between different regions, due to differing transmission costs. It has been suggested that the dominance of ENDESA which owns the grid, creates concerns that the company could abuse its monopoly position (Covarrubias and Maia 1994). (Cont’d)

18. CASE STUDY:Electricity Sector in Chile (Cont’d) Improvements in the Chilean electricity industry are considered to have been largely determined by regulatory reform rather than as a direct consequence of privatization (Galal et al. 1994; Spiller and Martorell 1996). Where governments initially lack the capacity to instigate large-scale private investment, preference should be given to an incremental approach to privatization, through the preliminary use of service contracts or lease contracts until experience is gained in operating regulatory regimes. Once a comprehensive regulatory framework is in place and an attractive investment environment has been created, governments can move on to more complex privatization practices such as concession allocations or full privatization. Source: Cook, P. “Privatization and utility regulation in developing countries: the lessons so far” Annals of Public and Cooperative Economics 70:4 1999. pg. 565-571

19. CASE STUDY: TELECOMS in Japan, Malaysia, Philippines • The relative performance of three Asian telecommunication firms--Nippon Telegraph and Telephone Company (NTT), Telekom Malaysia (TM), and Philippine Long Distance Telephone Company (PLDT) is analyzed following privatization and introduction of competition in Japan, Malaysia and Philippines. A number of findings relating to the pre- and post-restructured performance of these privatized firms are reported offering a comparison of accounting-cum-financial indicators of this industry over forty-two years in aggregate. Statistical tests on the pre- and post-values of these firms suggest statistically significant overall gains after privatization using this restructuring policy tool. The findings of the study show evidence that performance and efficiency improved after simultaneous adoption of privatization and competition reforms in Asian telecommunications. First, the profitability measure of performance increased significantly in Malaysia but not in Japan or the Philippines. Second, operating efficiency rose significantly in the three cases post-privatization, compared with the period under State monopoly control. Third, capital expenditure also increased significantly in the Philippines (but not Japan and Malaysia) as a result of, and response to increased competition (full liberalization) in the market. The empirical tests suggest that after privatization of the firms, the main outputs increased significantly (without raising employment), while productivity, technical efficiency and consumer welfare also improved. • Source: Ariff, Mohamed. 2002. “Performance gains through privatization and competition of Asian telecommunications,” ASEAN Economic Bulletin, www.highbeam.com

20. THANK YOU FOR YOUR ATTENTION philippe.brusick@prbrusick.org www.prbrusick.org