Common Criticisms of PPP Projects
in the Water Sector:

Reality, Myth, or Just Too Early to Tell?

By Matthew Hensley and Laila Suryodipuro

Abstract

This article is based on surveys and excerpts of reports prepared by the authors. The surveys asked respondents about their most common critiques and criticisms of PPP's. The reports were responses to a number of criticisms regarding actual PPP projects and transactions in developed and emerging markets.

Introduction

In recent years, in the wake of global recession, accounting scandals, declining capital flows, economic uncertainty, and political tension, popular support for capitalism and economic reform has waned. A New York Times editorial said "For much of the world, the market place extolled by the West in the afterglow of victory in the Cold War has been supplanted by the cruelty of markets, wariness toward capitalism, and dangers of instability". While most countries recognize that market-based approaches are the most sensible way to manage a modern economy, the fruits of the market have been to slow in coming and the weakness of nascent market-economies have been too often exposed and exploited by self-interest, mismanagement, and the clinging to monopolistic practices.

During this period of skepticism, even public-private partnerships (PPP) have come under scrutiny by skeptics who feel that they are not always in the interest of the public, result in higher prices, and are often used as "tools" for an overly greedy private sector only interested in profit not development. While PPPs have actually been one of the highlights of the economic transition in emerging markets since 1989 and a key part of the economic renaissance in high and middle-income countries since the 1970's, the general public still needs convincing as to their merit.

Generally, the critics of PPP are the same people who are associated with anti-reform movements in most countries, and are often aligned with the "old guard" approaches of welfare economies, protectionism, jobs-for-life, and a belief that a central role for governments is to directly provide and finance services. While many economists, businesspeople, consumer associations, political leaders, and other stakeholders who have directly participated in and benefited from PPP as an equitable tool for economic development and believe strongly in their efficacy, the fact remains that the critics of PPP have valid concerns and a right to express them. Whether these concerns are grounded in accuracy or are used to galvanize support for their real objectives is a complicated and difficult question to answer. However, we do know that until policy-makers and advocates of PPP in any country listen to these concerns and design approaches to policies and projects to address these concerns in a constructive and meaningful way, the merits of PPP will be overlooked and perhaps undermined by opponents fearing change. Converting opponents into proponents by demonstrating how they will benefit and how the advantages of PPP can be utilized to help them achieve the needs of their constituencies must be the priority for policy-makers and strategists interested in economic reform.

In order to understand both the concerns of the critics and the essential strategies to address these concerns, it would useful to understand the common criticisms of PPP. The following "common criticisms" are based on previous reports by the authors and a sample of surveys and questionnaires pulled from "stakeholder consultation" exercises performed in low, middle and high-income countries. While the list is by no means exhaustive, it does serve as a useful way to understand the common refrains and rebuttals in the ongoing debate regarding the use of PPP as a development and financing tool.

Common Criticisms of PPP Projects and their Rejoinders

1. PPP supporters assume that the private sector is more efficient than the public sector. If all things were equal, the public sector would be able to perform just as ably as the private sector.

It is not that the public sector is incapable of delivering services, it is the lack of incentives and competition that make the public sector the least efficient provider of services. There are good examples of well-run public enterprises in several countries. In almost all of them, there are incentives to management and labor to perform well, they operate outside of civil service requirements, and in many of them, they operate under corporate charters or have "corporatized" by-laws that allow them to act as if in a commercial environment. The private sector generally has all of the incentives built in to the corporation to perform in a competitive atmosphere. Most importantly, the private sector allocates labor and capital completely differently than the public sector and thus seeks to achieve higher levels of efficiency and customer service. If all public enterprises could operate in a competitive framework and have corporate incentives to perform, as well as utilize debt and equity effectively, than perhaps the comparison to the private sector would be more favorable. But the reality is that they are they are simply two different breeds. PPP advocates are not anti-public sector nor blatantly pro-private sector. They are generally pro-competition and pro-consumer. Once public and private sector forces realize that working together yields the greatest return for all, one can expect to see a number of partnerships emerge and with them, a greater respect for the strengths and virtues of each sector in the fight against poverty.

2. PPP results in higher prices. Prices increase because private sector companies have to make profit and pay dividends to their shareholders. Prices also increase because municipalities want to pay their debts or improve their balance sheets.

PPP often results in higher prices not because private sector companies have to make profits and pay dividends, but because the prices were too low to begin with and did not reflect the costs of operating and maintaining the system let alone expanding the system and serving the unserved population. This practice has led to governments subsidizing consumers, most of whom can afford the service. This approach is not sustainable and governments all over the world are moving away from it. The phenomenon of rising prices is being seen as governments reform the sector and is independent of whether the reform is implemented by the public sector or by the private sector.

The private sector does have costs that the public sector does not have, mainly the costs to pay its shareholders and the costs of capital. However, these costs are more than made up with savings resulting from efficient operations.

For example, while prices in Buenos Aires concession did increase, it is still lower than prices while under the public sector management even though eight years have passed since the start of the concession. In Manila, the subsequent price increase was inevitable, regardless of who was operating the system. The two private sector operators had taken over all of the public utility's significant debt (almost $900 million), which was denominated in US dollars. When the Asian financial crisis hit and the peso devalued by more than 100 percent, the project could not absorb all of the foreign exchange losses from this inherited debt as well its own debt and had to pass these costs on to the consumers. The contract, which did have some protection against currency devaluation, did not anticipate (and in fact, nobody did) the degree of devaluation that took place.

3. Private sector is not always more efficient. Comparison between public water utilities in Sweden and private water utilities in England of similar size show that the cost of private utilities is higher. Management contracts in three cases (Puerto Rico, Trinidad and Budapest) show that the private sector involvement through management contracts does not bring efficiency improvements (PSI, 2000). In France, a comparison between publicly and privately managed utilities show that privately managed utilities charge higher prices by 13% (Hall, 2001)

It will always be possible to find individual cases where the private sector is not more efficient. However, the evidence on the efficiency of private sector is extremely strong and compelling. In a comprehensive survey of 24 studies that compared public and private performance in infrastructure in the past 30 years, half of the studies found that the performance of the private sector was significantly superior to that of the public sector, seven found the difference small and ambiguous, and only five concluded that the public sector operates at a level superior to the private sector (Shirley, 2000).

In a study comparing the performance of fifty water companies in developing countries in Asia and Pacific-which is a more relevant comparison than a comparison of water companies in two developed countries¹ -it was found private water companies are more efficient (Estache, 1999).

In a very in-depth study comparing the performance of the water supply system before and after PPP in four cities (Buenos Aires, Argentina; Conakry, Guinea; Mexico City, Mexico, and Abidjan, Cote d'Ivoire), Mary Walsh found that efficiency, measured as labor productivity and operating cost as percentage of operating revenues, increased in three cases: Buenos Aires, Abidjan, and Conakry.

Evidence from developed countries would be interesting to review because the public sector in developed countries is already relatively efficient and therefore one would assume that efficiency improvements from private sector involvement would not be significant. However, the evidence does not support this assumption and is to the contrary. Trent University economist Harry Kitchen reviewed three U.S. studies from the late 1970s. One study of 112 water suppliers found public firms to be 40 percent less productive than their private counterparts. When one of the public suppliers became private, the output per employee increased by 25 percent. Conversely, when one of the private suppliers became public, the output per employee declined by 40 percent. A second study of 143 water suppliers found costs to be 15 percent higher for public firms. A third study found public modes to be 20 percent more expensive (Brubaker, 2001).

The Reason Foundation has repeatedly found private firms in the U.S. to be considerably more efficient than their public counterparts. A 1992 study concluded that contracting out water services achieved operating cost savings of between 20 and 50 percent. Examples included 40 percent savings on wastewater treatment in New Orleans and 30 percent savings on wastewater treatment in Schenectady, New York. In a 1996 study comparing the performance of ten government-owned California water companies with that of the state's three largest investor-owned water companies, the Reason Foundation calculated that annual operating expenses per connection averaged US$330 for the former and US$273 for the latter. Proportionally, the government-owned companies hired more than twice as many employees and spent almost three times as much of their operating revenues on salaries. Furthermore, they spent almost twice as much on maintenance to produce a product of the same quality. When subsidies were accounted for, water from public operations cost 28 percent more than water from private operations. Another Reason report documented savings in other jurisdictions, including those of 43 percent from the competitive contracting of operations of a water purification plant in Houston (Brubaker, 2001).

In France, the Ministry of Health compared the levels of compliance of publicly and privately operated water supply systems serving more than 5,000 people with the European standards. This showed that the private sector had a compliance rate 17% better than the public sector. In addition, the trends for compliance are continuously improving in the private sector operations, and declining in the public sector. (Ministère de l'Emploi et de la Solidarité, 1998)

Furthermore, the cases cited above as examples of inefficient private management while at times partially true, are often incorrect, do not present the full story, and can be misleading. In the case of Trinidad, for example, they report that the management contract failed to meet the objectives of the contract which were: to improve reliability; upgrade the infrastructure; and make the utility financially viable at the end of the three-year contract. They further maintain that the deficit for 1998 actually increased over 1997 to $378.5 million. The management contract also failed to deliver on the other objectives, despite cutting hundred of jobs and introducing controversial metering proposals. Due to these failures, the government rejected the private sector's proposal to extend the contract and the utility was taken back as a public sector responsibility.

The reality is that the government of Trinidad had always envisioned a management contract to be the first phase of private sector involvement to be followed by a longer-term concession if the experience in the first phase of private sector participation proves to be satisfactory. When the 3-year management contract ended, the government of Trinidad concluded that the required improvement in water and sewerage services could only be achieved through a deepening of private sector involvement with long term contracts using concessions (as opposed to management contracts) with international operators and leading local companies. The operator's proposal for transitionary management (not for the concession) was rejected because there was concern of giving this private sector company unfair advantage in the bidding of the second phase of private sector involvement.

Contrary to the common criticism, at the end of the management contract, the private sector did reach all of its targets² and pulled the utility out of financial difficulties into an operating profit, which the government gave tribute to³. While it is true that the government took over, it took over for the transitionary period only and is now in the process of bidding for a long-term operator. All in all, the involvement of the private sector for improving service delivery has been a positive one for Trinidad as demonstrated by the bidding for a long-term operator for the water sector and recently by the replication of the management contract model in the Trinidad's postal service.

In this case as in others, PPP contracts between the public and private sector are generally in the public domain. Unfortunately, critics often speculate on the terms of contracts rather than review carefully the facts. In the case of Trinidad, the critics contend that a controversial metering proposal failed, whereas metering was never part of the management contract. It mentions that one of the objectives of the contract was to upgrade the infrastructure whereas upgrading was to be undertaken by the public utility since the contract with the private operator was a management contract. Furthermore, the job cuts were welcomed by the Government and the population. One of the major problems of the old public utility was recognized by all to be massive overstaffing, caused by earlier administrations' featherbedding and cronyism. This massive overstaffing was seen to be a major cause of the continual previous major deficits, which had to be supported by subsidies of millions of dollars from the public purse over many years. Labor accepted the necessity of these cuts, and indeed the local union representative was one of the people to take up the redundancy package. Generally the parties to a PPP contract have a very good understanding of the pros and cons of any contract, as they should. Perhaps the public and private sector needs to do more to inform the public and media about the facts of contracts, to improve accuracy and transparency.

4. PPP reduces employment as a means to enhance profitability for the company

One main reason why the private sector is brought into delivery of public services, other than its access to capital, is its ability to find areas of efficiency improvements. Both the public and the private sector benefit from these efficiency improvements: the public in terms of lower tariffs or less subsidies and the private sector in terms of profits. In developing countries, labor is typically an area where there are very large inefficiencies. If the goal is improved services to the public, then efficiency in labor productivity is inevitable, whether the reforms are to be introduced by the private or public sector. In cases where reform is implemented by the public sector-something which labor groups have been promoting as an alternative to the private sector-labor productivity improvements, including labor reduction, is often part of the reform package⁴.

Furthermore, increasing attention is being given to ensure that adverse impact of labor reduction is minimized. In fact, employment reductions in the water sector are not as severe as other infrastructure sectors such as electricity and gas sectors (ILO, 1999). In the Casablanca concession, one of the contractual conditions was that the concessionaire employs 100% of the employees of the former public authority. This condition has been respected. In the Selangor concession in Malaysia, former workers are given construction contracts and workers who choose to stay are given ownership shares in the company. In Argentina, employees are given significant stakes in ownership and former employees lucrative, yet small, sub-contracts. In Indonesia, labor reduction has been minimal and the approach to increasing labor productivity was to maintain the size of the labor force as the system expands.

5. Regulation, which is supposed to prevent abuses by private monopolies, is made ineffective by lack of public access to information on the private sector. Regulators do not have power to insist on financial disclosure.

Well designed regulatory frameworks, which include the establishment of independent regulatory bodies, the development of sound contractual enforcement procedures, and the establishment of norms and standards governing the types of information reporting required of both public and private utilities discourage, and indeed, sanction abuse by service providers. Public access to information regarding utility performance can be transparently compelled if, and only if, it is part of the contracts and regulations negotiated between Governments and service providers. It is incorrect to assert that regulators do not have the ability to insist on financial disclosure. To the contrary, the standards of disclosure required by private service providers can be far more rigorous than typical standards of disclosure required by publicly owned enterprises. For example, monthly, quarterly and annual audits can be performed and tariff rate applications can be contingent upon the fulfillment by utilities in meeting those information disclosures. This represents an enormously powerful enforcement tool that empowers national and local governments. Independent regulation creates the authority and ability to use such tools and avoid the types of vacuums that exist in sectors or industries that have weak or absent regulation.

Moreover, governments, if well advised, can establish more effective bidding and procurement procedures status quo ante, whereby all pre-qualified firms agree in advance to meet such standards as a method of encouraging greater information sharing. Equally important is the capacity and operations of government, preferably local, in the monitoring and reporting of such information and performance standards. If governments are effective in contract monitoring, and the standards for meeting performance standards and information disclosure are rigid (but not onerous), experience shows that compliance by private service providers is greater than the compliance of publicly owned enterprises. In the case of PPP, government can rely on transparent and enforceable contractual provisions to demand compliance.

Public enterprises operating in monopoly environments are generally not accountable to consumers, shareholders, or even the government, their ultimate shareholder. Appeals to national or international appeal bodies, which are transparent, fair, and agreed upon within contractual documents, do not replace local authority nor or are they forced upon governments. Rather, they are part of a "menu of options" for investors and governments to agree on methods to avoid costly litigation, political intervention, or non-performance events that either private firms or governments trigger. Ultimately good governance, and the institutions required to affect it, will always be the responsibility of government and the constituents they represent.

6. Privatized concessions undermine democracy because they have frequently been negotiated with undemocratic political leaders (Jakarta, Casablanca) and are agreed in secret, without accountability to local leaders (UK, France), (PSIRU, March 2000)

If implemented under the specter of competition, PPP arrangements are by their very nature democratic. They are democratic because competition during the bidding allows government, consumers, labor, and other stakeholders to evaluate the relative benefits of various bidders costs and quality of service comparatively (amongst competing bids) and against the status quo (between the bidder and current service provider). They are additionally democratic when labor and the public, through employee ownership schemes and public share offerings are able to participate in the ownership of the utility, and when consumers are able, through regulation, to have a voice in how the utility can and should change corporate behavior.

Under public ownership and monopoly conditions, stakeholders have no choice of service, are unable to influence the behavior and performance of the enterprise, labor have little or no opportunity for ownership or meaningful management role, and consumers are unable to compel utilities to improve quality of service. In the United States and Australia, it took the introduction of competition to press publicly owned utilities to commercialize and improve quality of service. The specter of competition makes labor, consumers, and the public demand higher levels of service, greater value for money, and better returns on public and taxpayer supported funds.

Privatized water concessions awarded in authoritarian regimes such as those in Indonesia under Suharto, don't discredit the concept of private sector participation. On the contrary, they discredit the concept of undemocratic, authoritarian regimes where the lack of transparency and rule of law allow national and local governments to award contracts without competition, absent of financial controls, and with no legal accountability. In Indonesia, the problem of collusion and nepotism dominates the award of public as well as privatized projects. A leading Indonesian economist estimates that 30% of funds for public projects are corrupted. In democratic countries, market based approaches and private sector participation schemes flourish for the obvious reasons that they make economic sense, can be implemented with competition, free up public funds for other purposes, improve quality, and in some cases, represent sound investments that investors and consumers support and want to own (Ironically in many developing countries the most widely held and traded stock is the formerly publicly owned utility).

Regulators can and should use enforcement measures to penalize non-performance to protect the consumer. If service providers are not performing, or are in breach of contract, including the treatment of unionized or non-unionized employees, regulators and monitors can terminate the contract, collect liquidated damages, and rebid the contract to other willing and qualified parties. That is one of the characteristics of free markets. In non-democratic systems, those mechanisms for control and accountability do not exist, thus abuse of public funds and trust is rampant. Not just in the award of non-competitive concessions to the private sector, but in the operations and performance of public enterprises that are supposed to provide services to the public.

Accountability to local leaders is achieved through the process of decentralization and legal inclusion. In centralized countries, such as Indonesia and Egypt, traditionally, national ministries responsible for water service, construction standards, and financing public works, would dictate to local governments and utilities on the type of plant they needed, how it would be designed and operated, what type of specifications were required, who was going to build it, and what the tariff would be. Long before PPP was introduced, local leaders complained about the lack of inclusion and oversight over their own affairs. Of course subsidized tariffs made the lack of autonomy more palatable but no more acceptable. Once PPP was introduced, local leaders and utilities were compelled to voice their concerns to national Ministries demanding a role in the identification of the project, the potential approach, the quality of the service required, the acceptability of the tariff vis-à-vis value for money, and the manner in which the service provider would be regulated and monitored. Now, for example, Egyptian local utilities are the party to the contracts between PPP operators and are directly responsible for the monitoring and oversight of such contracts.

Local accountability and oversight is part of the process of decentralization. Decentralization is stimulated through, among other forces, efforts to improve utility performance through competition and PPP. Local accountability and input is part of the rationale behind sectoral reform and is more prevalent in democratic, elected regimes, but is not the responsibility of the private sector.

7. The benefits of PPP are supposed to be brought about through competition. In reality there is little competition and what is in place is collusion worldwide between a limited number of companies. These multinational corporations (MNCs) often operate jointly and restrict works contracts to their own subsidiaries. In the UK, concessions were never tendered, in France there is organized competition, and in developing countries there have been negotiated deals.

Global competition for transparent competitive tenders in the water sector is fierce. It is only less competitive when investors question the integrity of the process, or if the project is viewed as having excessive financial risks or poor prospects. It is true that the depth of private consortia engaged in the water business is not comparable to other industries such as telecommunications, energy, and transportation. However, that fact should not affect the competitive outcome and benefit of a well-structured project in a stable country where rules and procedures for procurement are followed precisely. This is especially true in an industry where the methodology for bidding requires the short-listing of no more than five or six qualified international bidders.

Recent transactions in the Middle East and North America demonstrate that competition and value are maximized when sponsoring governments prepare bid documents that clearly prohibit firms with joint ownership and or anti-competitive backgrounds from bidding, and require evidence of good standing from prior transactions or contracts. The recent contractual award for the City of Seattle's major water and wastewater plant had over 30 consortia bid for the short-listing and five major consortia, all scrupulously evaluated, qualify. The recent award of the concession for the Gulf of Suez BOT in Egypt, was awarded to the Canadian firm SNC-Lavalin, after 47 bidders attempted to make the short list, and five (U.S., French, British, Canadian, and Egyptian) qualified.

Collusion and anti-competitive behavior must be regulated by each government's own laws on procurement, competition policy, and financial reporting. Those countries that do not have legislation or fail to enforce such legislation do so at their peril. Those countries that have laws that require competitive bidding, disallow cross-ownership or anti-competitive behavior, and criminalize bribes, corruption, and unethical practices (for both public and private transactions), are usually countries with high-levels of private sector development, efficient industries, access to long-term finance, outstanding labor conditions, and higher levels of customer satisfaction and payment.

8. The common scheme in PPPs, in particular in Central Europe and Latin America, where the public guarantees profit yet the private controls management is unfair.

Actually, guaranteeing profit is a very unusual practice in PPP transactions. In fact, guaranteeing profit on publicly funded, turnkey contracts for publicly owned enterprises (the antithesis of PPP) has been much more common and predictably financially disastrous. International best practices demonstrate that governments should neither limit nor guarantee profit. Rather, governments should "cap" prices, allow the private sector reasonable, incentive-based returns, and adjust those caps and returns periodically based on both exogenous factors and the performance of the contractors. In instances where rate of return regulation is used, regulators allow utilities to achieve a fixed rate of return on their own investment capital, if and only if certain performance standards are achieved. Even then private utilities must apply for rate increases which must be justified in order to be approved.

Any operator risking millions of dollars of private debt and equity on a PPP project will require full-commercial freedom to operate according to their industry leading standards. If not allowed full commercial freedom to manage according to the terms of their contract, most PPP operators (and their shareholders) would demand that the firm not risk a single dollar in such in an environment. Rather, it would be far more prudent to require that government guarantee all of the payment for services under traditional "turnkey" arrangements, exactly the type of operations that have resulted in government deficits, under investment, lack of maintenance, low wages, high subsidies, poor performance and water quality, and an underserved population.

In many instances, governments will provide performance guarantees or sovereign guarantees to cover certain commercial risks. These guarantees do not include profit. They guarantee that government will purchase bulk water, follow the terms of their contract, provide access to land, make foreign exchange available, etc. These performance guarantees are often required, more due to the fact that government is neither willing to reduce subsidies (introduce cost recovery), nor allow operators to cut off service to customers unwilling or unable to pay. If governments were in a position to finance 100% of all capital investment and operations and maintenance as well as keep tariffs at less than the cost of service for all of the population, then private sector finance nor expertise in management would not be required. In a perfect world, that would be fair but still unsustainable.

9. The public sector option has some clear and obvious advantages in accountability. The public utility is responsible to the public authority, and that authority is responsible to its electorate for providing the service.

Publicly-owned utilities for the most part are not accountable to its public sector owner. Water companies are not regulated nor obliged to meet service targets and standards. When they perform poorly, there are few mechanisms to make them accountable, such as by terminating the managers. As to the accountability of the public sector owners to its electorate, only recently with the advent of decentralization and democratization, have these public sectors in developing countries become more accountable to its electorates-but this is a recent phenomenon.

On accountability of utilities due to public ownership, a key government official in the preparation of the Manila concession writes:

Being owned by government is a nebulous concept and to the ordinary MWSS (the Manila public sector water company) employee, it meant that there was no owner. There was a general attitude among the employees of trying to extract as many benefits as possible from the company with as little effort as possible. In board meetings, the best-prepared presentations were those that involved requests for increase in benefits. Other presentations, including those for critical projects, were often poorly prepared. (Dumoll,2000).

Even in developed countries problems of accountability by the public sector can be found. A report for the Joint Economic Committee states that constrained by rigid rules and procedures and given little discretion to operate creatively, even well trained workers can make but poor use of their knowledge. They are neither rewarded for increased efficiency nor punished for poor performance. (Brubaker, 2001)

Listed below are several "sub-issues" on the point of accountability:

• Transparency: accounts must be publicly available and clear, not withheld on grounds of commercial confidentiality - as happens in the UK - or obscured by confusion over who is paying for what, as happens in France.

Each country has different laws requiring disclosure for private companies. In the case of publicly traded or listed companies, disclosure and transparency should be comprehensive and total. Many countries have laws such as the Freedom of Information Act in the United States that requires all public agencies or publicly funded activities to disclose records and documents on a variety of matters to any member of the public. Business records or contracts between public and private parties should be within the public domain but that is a matter of local not international law. If governments want private firms to reveal non-proprietary information or information that would not violate privacy or intellectual property rights, governments and their constituents should pass legislation requiring full disclosure for both public and private corporations. In the United States, Canada, and elsewhere, any contract between governments and private firms are part of the public domain and every corporation is required to complete an annual audit and to file taxes. Any publicly traded firm must comply with far stricter disclosure requirements in order to meet financial reporting and regulatory acts.

• Public service: water and sewerage are amongst the most basic public services - they should be run by an organization responsible to all citizens, not just shareholders.

Water and wastewater are indeed public services and they can and are run by organizations responsible to all citizens. They can be run by public enterprises, by private enterprises, and by non-governmental enterprises. They can be run efficiently and inefficiently by all of the above. Public enterprises are no more accountable to citizens than private enterprises. In fact, in many countries, private enterprises are more accountable because governments have the legal right to revoke licenses, terminate concessions, compel performance, and prosecute and imprison management for acts of fraud or white-collar crime. Citizens have legal recourse to bring shareholder suits, product liability and negligence lawsuits, and compel better service though organizations such as "better business bureaus", independent regulatory bodies, and the Minister himself.

In many countries, public enterprises (supposedly more accountable to citizens) are not regulated, do not comply with health and safety standards for employees or consumers, do not operate commercially, do not meet environmental standards, do not produce auditable financial statements and records, and usually do not meet the basic service delivery standards expected of existing consumers, let alone new consumers waiting for connections.

While there are cases where public enterprises can operate efficiently, it does not mean that they are more accountable. While there are cases where non-governmental organizations operate efficiently and due to their nature as community-based organizations, are accountable; they have no financial capability to invest in new services. There are also cases where the private sector operates more efficiently but with higher tariffs, or more efficiently but with lower tariffs; the record shows that either the service is being delivered as contractually agreed or the contract is terminated. One should bear in mind, for every dollar that governments can avoid spending on water infrastructure that the private sector is willing to invest in providing "basic water service", an additional dollar or more is liberated for government to spend on other basis services such as health, education, and social security.

10. Public provision of services is the majority practice everywhere. In the European Union, for example, only in France, England and Wales is water PPP the norm.

It is true that public provision is the majority practice, however, this is not a good enough reason to remain with public provision blindly, without considering the potential benefits of private provision. Had this argument been accepted in the 1970s when similar arguments were being made about the telecommunication sector-that telecommunication is a public good and that the public sector should remain responsible for its provision-the developed and developing worlds would not see the leaps in technology, service, employment, and quality of life that has resulted from increased access and lower prices of telecommunication services from private sector participation in the last three decades.

Furthermore, it is incorrect to say that there has been little growth in PPP in the water sector globally or in developing countries. The amount of private investment has been growing steadily in the last decade with an average growth of 22% since 1995⁵ (World Bank's PPI database). If one were to count the number of projects, which would include all types of PPP projects, such as management contract projects, where there is no private investment, then the average growth is 35%.

Moreover, the so-called norm of public sector provision has not always been the norm. In the United States until the beginning of the 19th century private companies served 94% of the population and only later did the public sector step in to serve unprofitable areas. In Alexandria, Egypt for example, viable private companies have delivered water service until the state nationalized these companies in the 1950s. At the end of the day, the driving force surrounding the move back towards private participation in infrastructure services is not just the well documented poor performance of public utilities, but also the lack of financial capability and resources in the public sector to meet not only new investment needs but even the cost of operations and maintenance. Thus, most experts agree, the shift towards more and more private sector participation in water services is increasing and driven by consumers.

11. Public sector owned operations can and do raise investment finance, from all the same sources used by private sector water companies. These include local banks; international banks; government funds; international institutions such as the World Bank, EBRD, Asian Development Bank, etc; institutional investors, and bond markets. In New Zealand, some cities have better credit rating than the private sector.

The majority of local governments and utilities in developing countries do not have the same range of financing sources that private sector companies have. While it is true that they have access to government funds, multi-lateral lenders, and local bank, their access to equity and bond markets is very limited⁶ . These local governments cannot access bond markets because they have a poor credit rating⁷ , in some cases, a system for credit rating of local government is not even in place. Furthermore, in many countries, the bond market itself is still in infancy stage. Even creditworthy cities in the U.S. and New Zealand realized long ago that it is wiser to allow the private sector to finance certain capital projects so that the creditworthiness of the city can be used to raise finance for other essential activities.

This is not to say that local government and utilities should not develop capacities to access alternatives sources of finance, such as bond markets. It is unlikely that PPPs can meet all the infrastructure finance needs, therefore countries should develop capacities to access to bond markets in parallel with PPPs. Bear in mind, each time a city or government-owned utility borrows to finance infrastructure, it represents a claim on revenues and often on foreign exchange. Thus, those local governments or agencies that borrow beyond their financial limits, affect the financial position of the entire public sector, and in some cases, limit access to financial markets and may weaken national currencies. The Indonesian and Korean economies were brought to their knees, in part, due to the enormous debt owed by government owned or government guaranteed enterprises. Once those liabilities became exposed and those enterprises were unable to service their debt, lenders stopped lending, currencies depreciated, and equity markets collapsed. The development of local capital markets, including bond markets, should be a priority so that local governments can use both PPP and government financed approaches.

12. The private sector is reluctant to extend access to the poor.

It is important to bear in mind that decades of public management have very little to show in terms of extending services to the poor. A representative sample of 15 low and middle-income countries show that amongst the poorest 25% of the population, more than 80% do not have access to piped water (Tynan, 2000). The public sector has failed to extend services to the poor due to a combination of inefficiencies, absence of cost recovery policies, and well intentioned, but misdirected subsidies.

When governments decide to redress this failure and reform the sector, either through public or private management, it usually adopts long overdue cost recovery policies, however it often neglects to adopt pro-poor policies and provide safety nets for the poor. Recently there has been increasing awareness that to increase services to the poor, it is governments who need to adopt pro-poor policies, whether delivery is to be undertaken by the public sector or the private sector. In the case of PPPs, it is the task of the government to define these policies, make the necessary regulatory changes, and build them in the contract with the private sector with appropriate incentives and disincentives for the private sector to meet these objectives. Some of the pro-poor policies include, for example, reducing costs to serve poorer neighborhoods by adapting technical standards, including non-exclusive clauses that allow small providers to serve poorer neighborhoods, allowing phased payments of connection fees, addressing land tenure issues, and providing direct, well targeted subsidies to the poor. Both the public and the private sector do not perform well in extending services to the poor if pro-poor policies are not translated into well-designed regulations and programs.

Despite the absence of pro-poor policies, several PPPs have implemented programs to increase access of the poor. In La Paz, Buenos Aires, and Manila, technical standards for high quality connections were adapted so that water connection costs were reduced by two-thirds and sewer connection costs were reduced by 75%. In Manila, special schemes⁸ to expand services to the informal slum areas previously served by private vendors have reduced a typical poor household's water bill by two-thirds and greatly improved the quality and continuity of supply. These programs have been so popular that more than 40% of new connections in the west side of the Manila concession is now serving low income areas (Maynilad Water Services Inc.). In contrast, expansion of services to these same slum areas under public management was not possible because it was an acknowledgment of the legality of their settlement.

In Chile, pro-poor policies had been adapted prior to the concession agreement. The concessionaire provides subsidies to low-income households, who meet eligibility requirement and are registered under the subsidy program, and is later reimbursed by the municipalities. This subsidy program ensured that the poor did not suffer when tariffs had to be increased to cost recovery levels. In Buenos Aires, a series of programs (described in section 4 below) were implemented that more than doubled access of low-income groups.

13. Multinational corporations use PPP profits to subsidize other global investments

All corporations use profits to return value to their shareholders in the form of dividends or to finance new activities such as research and development, expansion of service, hire more staff, distribute bonuses, acquire new businesses, or keep cash reserves for changing market conditions. Most companies in the utility business, including water, are committed to long-term financial arrangements for 10-30 years where the majority of revenues (after paying operating expenses) go to retire the interest on debt (referred to as debt-serving ratio) for at least 10 or more years until servicing the principal of debt can commence. Once marginally profitable, then and only then can private water companies begin to pay taxes (taxes are based on revenues and profits), retire more debt and debt service, and generate enough internal cash flow to finance new investments in service expansion, additional staff, new technologies, etc. After many years, once profitable, world-class companies begin to provide returns to equity investors in the form of dividends and returns on equity. If companies are fortunate to have surplus profits after meeting all financial obligations including operations, taxes, debt service, and profit dividends/remittances it is very unusual that profits would go to "subsidize" other global investments. Those "profits" may go to strengthen the balance sheet of the company which may make it more attractive in the capital markets to raise debt and equity or more financially capable to raise capital for new water investments in other areas of the world. If so, that would be a positive thing for countries and industries seeking new investment.

Consider the equally common opposite of the example. In a concession that may extend for 20-30 years, what types of risk may affect a firm's profitability over that time horizon? What about those companies which lose money over the life of the concession? How are those funds made up for on the balance sheet? They come out of the value of the shareholder's equity. The risks of corporate finance are such that any long-term investment must be viewed and financed over the long run. Subsidizing global investments is as poor an economic choice as subsidizing middle and high-income ratepayers. Eventually, it will erode the financial stability and creditworthiness of a country or a company. The investors in the Buenos Aires concession, one that is being criticized for seeking "excessive" profits, are now, after Argentina's economy has collapsed, facing enormous losses and extremely bleak prospects for the future in spite of their performance in quality and expansion of service. They nevertheless continue to provide service to customers.

Conclusions

A number of criticisms in the design and implementation of PPP water projects have arisen as more and more projects are developed. A debate on those criticisms is not only instructive, but certainly healthy as governments worldwide struggle over the issue of how to provide better and cost-effective water services in environmentally challenging times. We hope the comments in this article will stimulate further discussions and we welcome your comments at newsletter@ip3.org.

Footnotes

¹The Asia Pacific study took into account factors that highly influence cost such as the source of water whereas the England/Sweden study did not. Sources of water determine quality of water and therefore treatment costs and also pumping costs.

²Payment to operator was based on a base fee and a success fee based on the accomplishment of the designated performance indicators, which were improvements in unaccounted for water, plant downtime, employee numbers, and billing and collection. The private operator achieved all of these technical targets and received 100% of its success fee (correspondence with former managers of the Severn Trent management contract)

³Trinidad Express Business, March 27, 1999

⁴Examples of countries/cities who have implemented successful public reform in the water sector and included labor lay-offs are: Honduras; Sao Paulo, Brazil; and Santiago, Chile.

⁵If the high growth of private sector investment in the early 1990s is included, then the number is much higher.

⁶Countries that have nascent municipal bond markets include: Czech Republic, Poland, Russia, South Africa, Turkey, and Philippines.

⁷Causes of poor credit rating of local governments in developing countries are typically: poor repayment history, whether to central government or other financial institutions, lack of standard accounting procedures that prevent credit rating, poor transparency and disclosure practices, and low and unpredictable own-source-revenue.

⁸Known as Bayan Tubig. These programs typically include technical adaptation such as laying pipes above ground, that reduce construction cost and make access in narrow slum areas easier, and payment of connection of fees in installments.

References

Brubaker, Elizabeth, The Promise of Privatization, Prepared by the Energy Probe Research Foundation for the Walkerton Inquiry, April 2001.

Dumol, Mark, The Manila Water Concession, A Key Government Official's Diary of the World's Largest Water Privatization, World Bank, July 2000.

Hall, David, Water in Public Hands: Public Sector Water Management-A Necessary Option, PSIRU, June 2001.

International Labour Office, Managing the Privatization and Restructuring of Public Utilities (Water, Gas, Electricity), Report for discussion at the Tripartite Meeting on Managing the Privatization and Restructuring of Public Utilities, Geneva, 12-16 April 1999, Geneva.

Maynilad Water Services Inc., Water Supply in Low-income Areas, West Zone Metro Manila.

Ministère de l'Emploi et de la Solidarité, Qualité des eaux d'alimentation 1993 - 1995, June 1998.

PSIRU, Private Water Inefficiencies, March 2000.

Tynan, Nicola, Private Participation in Infrastructure and the Poor: Water and Sanitation, in workshop on "Infrastructure for Development: Private Solutions and the Poor", May 31 - June 2, 2000.