Doc. INFRASTRUCTURE.ZZ

THE ROLE OF TRANSNATIONAL

CORPORATIONS IN INFRASTRUCTURE IN

DEVELOPING COUNTRIES

BACKGROUND PAPER AND LITERATURE REVIEW

Prepared for UNCTAD1

Zbigniew Zimny

Geneva, October 2007

1 The paper has served as a background study for World Investment Report 2008. Transnational

Corporations and the Infrastructure Challenge (New York and Geneva: United Nations, 2008).

2

Table of contents

Introduction

I. FORMS OF TNC INVOLVEMENT IN INFRASTRUCTURE

A. Private greenfield investment

B. Public-private partnerships

C. Mergers and acquisitions

D. Forms of investment and FDI data

II. TRENDS IN FDI IN INFRASTRUCTURE

A. A shift from public to private provision of infrastructure services

B. Trends in private investment in infrastructure

1. Growth and decline

2. Regions

3. Sectors

4. Forms

C. The role of FDI

D. TNC players and home countries

III. IMPACT

A. What infrastructure TNCs offer to developing countries?

B. Impact in individual infrastructure sectors

1. Telecommunications

2. Electricity

3. Transportation

a. Rail

b. Ports

4. Water

C. Impact by areas

1. Supply and coverage

2. Efficiency

3. Quality of services

4. Fiscal impact

5. Employment

6. Prices

7. Impact on the poor

8. Conclusion

D. The sources of discontent

IV. POLICY ISSUES

A. Policy reforms

B. FDI policy: to what extent countries allow FDI and TNCs in

infrastructure?

C. Policies to benefit and address concerns

D. The role of international agreements

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Boxes

1. Infrastructure needs of developing countries

Figures

1. PPI in developing and transition economies, 1990-2005

2. Private investment in infrastructure by region, 1990-2005

3. Private investment in infrastructure in developing countries by sector, 1990-2005

4. Forms of private investment in infrastructure in developing countries, 1990-2005

4. Restrictiveness of FDI policy in 50 developing countries in service industries, 2004

5. Restrictiveness of FDI policy in infrastructure by regions and industry, 2004

6. Restrictiveness of FDI policy in infrastructure in developing and transition economies,

2004

Tables

1. The top 10 TNCs in private infrastructure projects in developing countries, 1990-2001

2. The share of FDI in total investment in infrastructure in developing countries

3. Annual growth rate of telecommunications lines in reforming and non-reforming

countries of Latin America

4. Competitive and non-competitive segments of infrastructure industries

REFERENCES

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Introduction

Physical infrastructure – transportation infrastructure (roads, ports, airports, etc.)

telecommunication, electricity, water, sewage and waste treatment – is a backbone of any

economy. Good infrastructure facilitates economic activities. Bad infrastructure hampers

these activities, making them costly and uncompetitive. Missing infrastructure (e.g.,

roads or power) makes it impossible to undertake production or trade, thus making it

impossible to exploit potential for larger output (e.g., in mining or tourism). Infrastructure

produces also basic services for households and consumers, determining their well-being.

It also determines living standards of high-income consumers. For example, tourism

relies heavily on all components of physical infrastructure. On the other hand, access to

water and electricity is among chief concerns in the fight against poverty. As regards

FDI, the quality and prices of infrastructure have always stood high in rankings of the

determinants of inward FDI. Excellent infrastructure has been credited, among others, for

spectacular success of such countries as Singapore or Ireland in attracting FDI and using

it to promote development. Poor infrastructure reduces potential to attract FDI in many

African countries.

Markets for infrastructure services are prone to market failures (because of natural

monopoly element, externalities, very high capital intensity or uncertain returns). Some

are public goods while the provision of others is strongly affected by social

considerations such as universal access to basic services by remote areas and

disadvantaged segments of population. It was, therefore, long thought that the best way to

provide these services is through government controlled or owned companies. Such was,

indeed, the infrastructure paradigm after world war two in developing and developed

countries. Given increasingly disappointing performance of many state-owned

monopolies, during the 1980s and 1990s of the past century, however, an old paradigm,

has been replaced by a new one, that is, the private provision of infrastructure services,

manifested by the deregulation of service markets and massive privatization in developed

and most developing and transition countries.

In privatizing infrastructure, many countries turned to foreign investors for participation

in sales of state-owned enterprises (SOEs) (especially countries in Latin America and

Africa as well as transition countries) or for undertaking greenfield investment (East

Asia). FDI in infrastructure, especially in telecommunication and electricity, surged

during the 1990s, fuelling FDI in general and an increasing role of services in inward FDI

of developing countries. According to the Private Participation in Infrastructure (PPI)

data base of the World Bank, during 1990-2005 developing and transition countries

received $962 billion of investment commitments into some 3360 infrastructure projects

with private participation. TNCs participated in 83-85% of these projects. Private

investment and FDI in infrastructure peaked in the second half of the 1990s (1997-1998),

and have fallen ever since.

The decline was partly due to the fact that many developing countries (including large

ones such as Brazil, Mexico or Argentina) which decided to turn to FDI for the private

provision of infrastructure services completed their privatization programmes. Further

5

FDI in such countries has taken the form of re-investment to expand supply capacity

(such investment is typically much smaller than original huge sale transactions). The

giants of Asia, China and India, have not joint in with privatization programmes,

although they allowed some private participation in the form of greenfield investment and

concessions. Partly, foreign involvement in some infrastructure industries (roads, airports

and airport management, water and waste management) takes the form of non-equity

arrangements (such as concessions, leases or BOT arrangements) that go unrecorded by

FDI statistics.

But there have also been reports on disillusionment and disappointment with many

projects on the part of foreign investors and the governments and the public in developing

countries. Some of high-profile have been cancelled or renegotiated. Around 2000 FIAS

wrote that “nightmare stories abound of investors experiencing lengthy delays or project

cancellations because of political, administrative and legal impediments”.2 In some parts

of the world public opinion has become disappointed with the private provision of

infrastructure services, although there have been, so far, few attempts to revert to the

public provision of these services

So, the situation is as follows. After enthusiasm of the 1990s concerning the participation

of TNCs in infrastructure, reflected in huge FDI and many non-equity agreements, the

period of cooling of and perhaps reflection has followed, and FDI has subsided. Investors

(both TNCs and financiers – large projects are often financed by consortia) have lost

some appetite for this investment. Governments are caught between huge, virtually

unlimited, investment needs, far exceeding the capacity of the public purse, and

disappointment of parts of populations with expensive and often unaffordable (though in

most cases better than before) services.

Thus, the challenge to the WIR is to find out what went well and what went wrong and to

propose realistic policy options. The time perspective – ten years after the infrastructure

FDI peak – should provide enough material for cool and reasonable analysis. There have

been also some new developments and issues which require attention. One is, for

example, the growing public private partnerships (PPPs) legislation. PPPs are seen by

some as a new avenue for infrastructure investment. Another is the emergence of

infrastructure TNCs from developing countries. There is also a growing interest in how to

link better FDI and ODA in infrastructure. And after a period of heavy criticism,

governments, international organizations and TNCs are finally seriously considering how

private provision of infrastructure services can benefit more the poor.

I. FORMS OF TNC INVOLVEMENT IN INFRASTRUCTURE

As in other sectors, FDI is not the only form of TNC participation in host countries’

infrastructure. In fact, in some infrastructure industries it is rather an exception than a

rule. Consequently FDI data do not adequately reflect trends in, and scope of, TNC

2 FIAS (2000). Attracting FDI Into Infrastructure. Why Is It So Difficult?, The IFC and the World Bank,

Washington D.C., p. xvii.

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operations in the sector. What follows is a discussion of these forms and their incidence

in individual infrastructure industries and developing regions.

A. Private greenfield investment

The problem with identifying FDI in infrastructure starts with greenfield investment.

There has been a lot of greenfield investments in infrastructure in developing and

transition countries, with foreign companies building, or participating in building, roads,

tunnels, bridges, power plants, ports, airports, telecom mobile networks etc. But at the

end of construction, facilities are rarely, if at all, owned by the builders (a requirement to

qualify as equity FDI). The ownership of assets is transferred to governments (or SOEs

acting on their behalf), immediately, or after a certain period, during which a foreign

company operates the facility under lease, concession or operation and management

contract.3 Under such contracts, during their duration, the foreign company recovers

investment and operating costs as well as return from revenues generated by the project

from fees charged to service users, without any recourse to the balance sheets of sponsors

of the project or the host government. Given huge amounts of capital involved in

infrastructure projects, long-periods of construction and many non-typical risks involved,

it is rare that such projects are undertaken by a single private company – domestic or

foreign. Typically a consortium is formed, including not only several private investors

but also lenders, which establish a project company in a host country (thus separating its

activities from their own balance sheets). Therefore, for example, the World Bank, while

listing TNCs involved in infrastructure projects, describes them as “sponsors”, suggesting

that they play a key role on the projects, but are not the only parties involved.

Initially such projects commonly took the form of BOT projects, where “B” always

stands for “build”, “O” for “operate” (but sometimes for “own”) and “T” always for

“transfer”. With time, other combinations have emerged, adding to a complexity of forms

under which greenfield infrastructure projects are undertaken. Here are typical ones

where the initial phase always start with building a facility:

BOOT build-operate-own-transfer

BOO build-operate-own

BTO build-transfer-operate

BLT build-lease-transfer

BLO build-lease-operate

DBOM design-build-operate-maintain (similar to a BOT or BOO, but in

addition the project company is responsible for the design of the project.

The purpose of investment can also be not to build a new facility from scratch but to

undertake investment in rehabilitating an existing facility. Then “R” replaces “B”:

ROT rehabilitate-operate-transfer

3 Such contracts give rise to what is known as non-equity forms of FDI (see below). Some of them

(concessions) may be accompanied by an equity participation in the project. If the equity exceeds 10% of

the capital, then the project is qualified as FDI and should be reflected in FDI data.

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ROO rehabilitate-operate-own

ROL rehabilitate-operate-lease

There are also hybrid arrangements such as DOT (develop-operate-transfer) under which,

in addition to BOT arrangement, the company receives development rights to adjoining

property. None of these forms (except for BOO, build-operate-own) is a classic FDI and,

as such, will not be reflected in FDI data.4 Exceptions can be found in mobile telephony,

where projects typically take the form of equity FDI, that is, foreign investor, after having

received a mobile telephony license, establishes a foreign equity affiliate, which builds,

owns and operates a network, as in “classic” FDI.

B. Public-private partnerships

Then there is a question, what are public-private-partnerships (PPPs), an increasingly

popular form of investing in infrastructure, and how do they relate to grienfield

investment and cross-border M&As. PPPs can be any of the above arrangements (and, in

addition, a joint venture), if the host government participates in financing the project,

typically in exchange for equity (proportional to capital contribution), to support

commercial viability of the project.

There are several explanations of the recent resurgence of PPPs,5 but a plausible one is as

follows. Initially private projects in infrastructure were based on the belief, that it is

possible to provide infrastructure services at no cost to the public. But many projects ran

into problems and were either canceled or required difficult renegotiations. The East

Asian and Argentinean financial crises undermined economic viability of many

infrastructure projects and revealed their high-risk nature. As a result, private investment

in infrastructure fell drastically during the late 1990s and at the beginning of 21st century,

as investors and lenders were put off by the risks involved and unaccounted for in the

original contracts. On the other hand it turned out that in successful private projects in

developed countries (and most likely in developing ones) in the early 1990s the cost of

private provision of services was often much higher “than could have been achieved

under the standard model of public procurement” (http:/en.wikipedia.org/wiki/Public-

private_partnership; and FIAS, 2000). In addition, private investors received a rate of

4 They should find their way to other items of the balance of payments such international loans, trade in

services (construction or engineering services) or transactions related to labour movement (if foreign

workers were involved in construction). 5 Authors of studies and papers on PPPs take it for granted that there has been a recent growing interest in

PPPs and, as a result the number of PPPs has grown, but, surprisingly, none of the papers on PPPs reviewed

for this study has provided evidence for this growth. Hodge and Greve state that “PPPs are enjoying a

global resurgence in popularity” (2007, p. 545). The IMF study describes the situation as follows: “It was

at this time [late 1990s] that PPPs began to emerge significantly as a means of obtaining private sector

capital and management expertise for infrastructure investment, both to carry on where privatization had

left off and as an alternative where there had been obstacles to privatization. After a modest start, a wave of

PPPs is now beginning to sweep the world” (IMF, 2004, p. 4). A UN ECE expert on PPPs G. Hamilton

refers to “thousands of PPPs transactions completed” but does not give any details (Hamilton, 2007). My

explanation is, as argued in the text, that PPPs are, in spite of some claims to the contrary, nothing else than

versions of the forms of PPI with some participation of the public sector. Another IMF study uses PPI data

as a proxy for PPPs (Hammami et.al., 2006, pp. 11-12).

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return that was higher that government’s bond rate. So, one can say that PPPs have

emerged in reaction to failures of infrastructure projects in developing countries and their

successes (excessive profitability) in developed ones.

Initially, most PPPs were negotiated individually, as one off-deals. But after a number of

studies in Australia and the United Kingdom concluded that private schemes were often

inferior to public procurement (see, for example, EPAC, 1995, a and b), based on

competitive tender, countries started introducing PPP legislation to provide a framework

for financing, risk sharing, mutual responsibilities and, more importantly, for introducing

a systematic framework for assessment procedures. While the initial approach aimed at

avoiding public expenses, a new one involved an appropriate allocation of risks so that

governments could obtain “value for money”. So the idea of purely private financing of

infrastructure projects has given way to the recognition that that public money should be

involved, in exchange, however, for a redefined sharing of risks and responsibilities. The

1992 Private Finance Initiative of the United Kingdom was the first systematic

programme aimed at facilitating PPPs under the new approach. Australia and many other

countries, including developing ones, have followed, introducing legislation guiding

PPPs. As it is easier to say than to implement the rule that governments should seek

“value for money” in PPPs, the debate on how to do it continues (Hodge and Greve,

2007; Spackman, 2002; and Monbiot, 2000). But PPP legislation is spreading to an

increasing number of both developed and developing countries.

C. Mergers and acquisitions (M&As)

M&As as a form of FDI in infrastructure result, as in other sectors, from the sale of state-

owned or private assets to foreign investors. In developing and transition economies,

before they embarked on the path towards the private provision of infrastructure services,

these services were typically provided by SOEs. Therefore this type of FDI initially

involved almost exclusively the sale of SOEs to foreign investors, of course in countries,

which decided to allow FDI in privatizations. Although listed under “M&As”, such

transactions have been acquisitions. They are often called, in an alternative to

“privatizations”, “divestitures”. Infrastructure-related cross-border M&As were the

driving force of FDI in general in a number of countries, when they implemented mass

privatization programmes. Notable examples include Brazil and Argentina as well as a

number of transition economies (UNCTAD, 2004).

A number of SOEs had been privatized to domestic investors, which after some time of

(often successful) operations were purchased by foreign investors. A case of a Chilean

power company, Enersis, is illustrative in this respect. Having emerged from

privatizations, during the 1990s it became a leading regional TNC, acquiring assets in

Argentina, Brazil, Colombia in Peru. In 1997, Enersis sold some 30% of its equity to a

Spanish TNC, Endesa, which, by acquiring further 32% in 1999, took over control and

management of Enersis (ECLAC, 2006, pp. 144-145). With more and more private

companies – domestic and foreign – operating in infrastructure of developing and

transition economies, cross-border M&As more often take the form of acquisitions of

private companies, while privatization-related M&As have subsided.

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D. Forms of investment and FDI data

To summarize, private participation in infrastructure, including that by TNCs, can take

various forms, which, in the case of TNCs involvement can lead to either equity and non-

equity forms of FDI, or both. For conceptual clarity and statistical purposes (for example,

in the World Bank’s data base on Private Participation in Infrastructure, PPI, World

Bank, 2003) four principal forms of private involvement are typically distinguished:

Management and lease contracts. For the duration of a contract a TNC manages

an SOE, which is owned by the government. The public sector takes investment

decisions and assumes financial responsibilities.

Concessions. A TNC manages an SOE. The difference from the management

contract is that the TNC contributes also capital and thus assumes an investment

risk during the contract.

Greenfield projects. A TNC or a public-TNC joint venture builds and operates

an infrastructure facility during the duration of the contract. But as it is clear from

the earlier discussion of BOT agreements, the final phase of the contract may

involve the return of the facility to the public sector, ownership of the facility by

the TNC or operation of the facility under a non-equity form such as a

management or lease contract.

Privatizations/divestitures. A TNC buys an equity stake or the entire equity in a

SOE and, as a result, owns or controls it (in line with FDI definitions a stake of

10% qualifies as a controlling stake).

FDI data include only projects with at least 10% of foreign equity. So called non-

equity forms, giving a TNC control of a foreign affiliate on the basis of an agreement

without an equity stake are not recorded in FDI data. But they are commonly called

non-equity FDI, because the control is strong enough to manage the affiliate. In

addition, except for capital,6 various components of the FDI package, such as

technology, knowledge and better management are typically transferred to the host

country.

Of the four forms listed above, only the case of privatizations is straightforward as

regards FDI. The acquisition of equity by foreign investors is normally reported in

FDI flows and stocks. Management and lease contracts, not involving equity, are not

included in FDI data. The situation with concessions is unclear. They might meet FDI

criteria, if a TNC provides an equity above 10%. In addition, debt financing by the

parent should be added to FDI flows. But since concessions are limited in time, it is

uncertain if they meet the criterion of “the long-term interest and commitment” by the

parent company.

The situation with greenfield investment is unclear, too. A TNC contributes capital

for the construction of the facility, but the project goes through several phases and it

6 Even though under non-equity forms a TNC does not contribute capital directly, a contract with a TNC

may greatly facilitate obtaining financing from foreign sources.

10

may end up being owned (and operated) by the public sector, a TNC or owned by the

public sector and operated by the TNC under a contract involving or not involving

equity. Wherever the TNC provided enough equity this should qualify as an FDI

project. Debt, if it is provided by the (foreign) equity investor, should also qualify as

FDI. Typically in BOT-type projects and concessions equity tends to be significantly

smaller than debt flows. But on the other hand TNC sponsors of the project tend to

rely on commercial lenders for debt financing (FIAS, 2000, p. 149). In general

information on the financing of such transactions is difficult to obtain.

Further complications arise, because the boundaries between the four categories are

not always clear, and some projects have features of more than one category (World

Bank, 2003, p. 7; in the World Bank PPI data base, which will be used later on,

projects are included in the category which better reflects the risk borne by private

investor).

II. TRENDS IN FDI IN INFRASTRUCTURE

A. A shift from public to private provision of infrastructure services

Until the early 1990s, most developing countries and all transition economies relied on

state-owned enterprises (SOEs) for the provision of infrastructure services. In the 1980s a

few developing countries started liberalizing and privatizing infrastructure (for example,

Chile). In the 1990s, this trend gained strength and turned into a wave, which included

well over 100 of developing countries.

A common reason for this shift was an increasing dissatisfaction with the quality and

insufficient supply of infrastructure services. But disappointment had many roots. In

some countries (notably of Latin America and Africa), SOEs were badly managed and, as

state monopolies, had no incentives and funds for investment and improvement.7 Subject

to political interference, they were depleted of funds by always hungry governments,

which on the other hand subsidized services and were hostile to increasing prices to

reflect inflated costs of inefficient operations. In addition, SOEs were treated as

reservoirs of employment for politically connected. The debt crisis in the 1980s imposed

very tight budgetary constraints in these countries, excluding any possibility of large

public financing of infrastructure investment. In other countries, mostly Asian ones,

SOEs, at least in some countries, were not doing badly and governments were not

indebted. But rapid economic growth led also to a rapidly growing demand for all types

of infrastructure services, which, to satisfy the demand, required amounts of investment

beyond the means of both SOEs and governments. So in the late 1980s and early 1990s,

some 1-1.2 billion people in developing countries had no access to electricity, clean water

and adequate sanitation (World Bank, 1994, p. 1). Telecommunication in a world relying

increasingly on IT technologies was in many countries a costly (but often unreliable)

luxury. The cost of losses caused by inefficient operations of roads, railways, power and

water systems was estimated by the World Bank at $55 billion a year in the early 1990s,

or “an equivalent to 1% of the GDP of all developing countries, a quarter of their annual

7 See, for example, Panayotou (????, pp. 49-51), Kessides (2004, pp. 34-35) and Nellis (2006, pp. 5-6).

11

investment in infrastructure, and twice the annual development finance for infrastructure

in the developing world” (ibid., p. 11).

The shift towards the private provision of infrastructure has spread to former centrally

planned economies, when they started the transition towards market economy in the early

1990s. Infrastructure industries have been, however, included to a various extent in this

undertaking. Privatization has been common in telecommunications and electricity and

less common in other industries, especially in water and sanitation. Countries of Central

and Eastern Europe, which became members of the European Union in 2004, have been

obliged to implement the rules of the internal markets, which emphasized deregulation of

infrastructure industries, while leaving decisions concerning ownership matters to

individual countries.

Whatever the reasons for this shift, it was so strong that during the 1990s hundreds of

billions of private dollars were invested and, at the beginning of the 21st century, almost

all developing countries and transition economies had some private operations in

infrastructure, a huge change from the 1980 when most or almost all of them relied on the

public provision. FIAS estimates, that, among private investors, during 1990-1998, when

most of the private investment took place (71% out of almost 1 trillion dollars committed

during 1990-2005), foreign investors were involved in 83% of private projects or projects

with private participation, measured by both their number and value, in developing and

transition economies (FIAS, 2000, p. vii). During 1998-2003, the involvement of foreign

investors has further increased, to 86% of the projects measured by investment value

(Ettinger et. al, 2005, p. 15). Therefore, it is justified, in the following overview of the

investment trends to begin with a review based on the World Bank’s data base on the

private participation in infrastructure (PPI), even though in its aggregated data part the

data base does not distinguish projects with and without foreign involvement.8 But

knowing that well over 80% of the projects came with foreign involvement, the data base

reflects also well trends in TNC participation in equity and non-equity forms. On the

other hand, as it is widely known, FDI data are very imperfect and, using only these data

it would be impossible to get a picture of investment in infrastructure by regions of

developing countries, by infrastructure sectors and by forms of investment, not saying

about region/sector/forms composition. Nevertheless, available FDI/TNC data will be

used at the end of this chapter. In between, we will also review trends in FDI in

infrastructure, based on FIAS estimates for 1990-1998. They are closely correlated with

overall trends, because, as mentioned earlier, foreign investors participated in 84% of all

projects during 1990-2003.

B. Trends in private investment in infrastructure

1. Growth and decline

8 Information on foreign participants of the projects (including their financial contribution and forms of

investment) is included in the part of the data base providing descriptive profiles of individual projects.

But the data base does not distill this information and although it is publicly available, it would be very

cumbersome to do so, as by 2007 the base included 3,413 profiles. FIAS made an estimate of FDI

participation for the period 1990-1998, retrieving necessary information from 542 projects and then

extrapolating it to 1,707 projects, which took place during this period (FIAS, 2000, pp. 147-153). See

below the discussion of FDI trends, based on FIAS data.

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Annual investment commitments in infrastructure9 projects with private participation in

developing and transition economies increased very rapidly from 1990, when they

amounted to $13 billion committed to 61 projects, to 1997, when they attained, so far, a

record level of $113 billion in 359 projects. After that year this investment slid down for

several years to $54 billion in 2003, and then started growing again, reaching the level of

$95 billion in 2005 (figure 1). The growth until 1997 was driven mainly by privatizations

of telecommunication and power companies in Latin America and greenfield investments

in electricity and mobile telecommunications in Asia.

There were several reasons for the slide after 1997.

First, it was the East Asian financial crisis in September 1997, as a result of which many

projects run into problems and investors cooled off, as they realized that they under

estimated the risks of investing in infrastructure, including in this case foreign exchange

Figure 1. PII in developing and transition economies, number and value

in $ bln, 1990-2005

0

20

40

60

80

100

120

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

0

50

100

150

200

250

300

350

400

$ bln Number

risks. There were also similar crises in other countries, e.g. in the Russian Federation,

Brazil (1998), Turkey (2000) and Argentina (2001)10

with similar effects. There was also

a number of high-profile project failures, not necessarily related to financial crises11

and

an increasing number of contract renegotiations. For example, 74% of transport and 55%

of water concessions in Latin America were subject to renegotiations (Guasch et.al.,

2002). As a result of all this, the interest of large investors from developed countries in

infrastructure projects in developing countries declined. For example, a survey of 65

9 It should be noted that investment values in the data base represent commitments at the financial closure

of projects, and not actual disbursements. They include both public and private commitments. Data in the

following discussion of trends come from the World Bank’s PPI data base, unless otherwise indicated. 10

In 2002-2003, private investors in some 30 projects filed claims against Argentinean Government to

ICSID, mainly as a result of losses caused by peso crisis (Peterson, 2004). 11

Examples include toll road projects in Bangkok, Indonesia and Mexico, water projects in Argentina, and

projects in developed countries: Railtrack’s collapse in the UK, California’s power crisis and the demise of

Enron (Schur, 2005, p. 4; Wells and Gleason, 1995, p. 46).

13

foreign investors in the electricity sector, published in 2003, revealed that 52% of them

were either less interested in, or retreating from, projects in developing countries, while

only 6% responded that they were more interested (Lamech and Saeed, 2003). There has

also been an increase in popular discontent throughout developing world with the private

provision of infrastructure services, including violent incidents and street riots in some

cases (Kikeri and Kolo, 2005, p. 22-24).

Secondly, big infrastructure privatizations in Latin America and Central and Eastern

Europe came to an end. There was not much more to sell to fuel further increases in

investment and significant new countries did not join the club of “privatizers”. Most

notably, Brazil’s privatization programme, the biggest in the world, was largely

completed by 1998, which was a peak year in Brazil (UNCTAD, 2005, p.12). In 1998

Brazil privatized its largest telecommunications company, the Telebras, and several

power distribution firms. These transactions accounted for 46% of developing country

private infrastructure investment in that year, and prevented it from a deeper decline.

After 1998, Brazil’s share fell, but was still significant (20%). Overall, between 1997 and

2001, privatization-related investment declined by 80%, while those related to expansion

by only 40% (World Bank, 2003, p. 13).

Thirdly, as regards other types of projects, that are not privatization-related projects,

opportunities also diminished. Much of investment prior to 1998 took place in more

developed middle-income countries. Opportunities, which remained thereafter tended to

be in more risky and politically sensitive countries and sectors, such as roads and water

(Schur, 2005, p. 2).

Fourthly, one should not forget an economic downturn of 2001-2003 in developed

countries, which resulted in a drastic reduction of their outward FDI. TNCs, as all firms,

typically invest much less, including abroad, during recession than before or after it. As

they dominate investment in infrastructure in developing countries, as indicated above,

the downturn must also have affected this investment. As in 2004 and 2005 FDI started

rising again, so did private infrastructure investment in developing countries.

How to assess the rise and decline in private infrastructure investment? Is it a demise

after the initial euphoria of the 1990s or was it mostly caused by cyclical factors? Initially

the fall caused concern. Infrastructure needs of developing countries have continued to be

vast (box 1) and the problems many projects encountered and withdrawal or more

cautious attitudes of many large investors were indeed often interpreted as a demise.

Investors did not properly assess risks and many developing country governments did not

really understand what meant to hand over the provision of infrastructure services to the

market or, even worse, to a private monopoly. Privatization was portrayed in

oversimplified terms, oversold and consequently raised unrealistic expectations.

Disappointment was great, when delivery did not meet promises (Kessides, 2005). In

2000, FIAS published a study under a symptomatic title: why is it so difficult to attract

FDI into infrastructure? Earlier, when private investment in infrastructure started

booming Louis Wells published an article warning foreign investors about many risks

associated with this investment, saying “the theory starts with a simple principle: most

14

countries would strongly prefer local ownership to foreign ownership” (Wells and

Gleason, 1995, str. 47). This type of investment is considered very risky, prone to

“obsolescence bargaining” and from time to time such and other concerns are expressed

in the literature (see for example, Ramamurti and Doh, 2004).

Box 1. Infrastructure needs of developing countries

It is easier to say that infrastructure needs of developing countries are vast than to put realistic investment

figures on these needs. Everybody agrees that infrastructure financing needs in developing countries are

considerable or vast, “but no one really knows how much is needed” (Estache, 2004, p. 6). Yet estimating

investment needs, even very broadly, is important for this study, given many question marks and doubts

surrounding the experience with the private participation, including foreign participation, in the provision

of infrastructure services. If needs exceed the financing capacity of the public sector, they will remain

unsatisfied or the private sector has to continue investing in infrastructure. If private investors in

developing countries will not be able to finance the balance (as has been the case so far in many developing

countries), foreign investors would have to continue investing in infrastructure to fill the gap.

Economics is about satisfying unlimited people’s needs with scarce resources. So when we talk about

infrastructure needs, we have to make assumptions, what needs do we have in mind. (We would also have

to decide whether these needs will be satisfied through the market mechanism or otherwise).

Needs for water and sanitation have been estimated within the Millennium Development Goals (MDG),

considering access to safe water a fundamental human need and a basic human right (UNDP, 2006, p. 78).

At present, some one billion people in the world do not have access to clean water and 2.6 billion do not

have access to proper sanitation. Nearly 2 million children die every year of illnesses related to unclean

water and poor sanitation. MDG has thus set a modest goal of ensuring, by 2015, access to water for 900

million people and to sanitation for 1.3 billion (ibid., p. 55). Satisfying these needs with basic technologies

available today would require $10 billion of additional financing annually. (Current spending on water and

sanitation in developing countries is estimated at $14-16 billion annually without waste-water treatment).

“Providing a higher level of service while maintaining provision at current levels to people who are already

supplied would add another $15-20 billion a year. Much larger sums would be involved if the target

included costs for collecting and treating household water” (ibid., p. 58).

These are relatively precise estimates. There are many “back of the envelope” estimates for different

sectors, but there is not yet credible assessment of global infrastructure needs from a single source.

International organizations (WHO, ITU, IEA) provide estimates of financing needs in their areas of

responsibility, but these estimates are typically questioned by specialists. For example, WHO estimates for

water, $50 per year (much higher than MDG goals for water and sanitation) have been criticized by the

academic community for unrealistic assumptions: access rates unadjusted for differences in quality

(Estache, 2004, p. 6).

But estimates are needed to inform national debates on resource allocations and both the World Bank and

the United Nations have been working on this, producing some overall preliminary estimates. A UN team

led by J. Sachs has produced infrastructure investment, operations and maintenance needs for Sub-Saharan

Africa. They amount to 12 cents per person, per day (or $44 a year) in the region where more than half of

the population lives on less than $1 per day (ibid.).

The World Bank has produced detailed estimates of infrastructure investment needs for developing

countries (by regions, sectors and income groups) for 2005-2010, based on the investment12

necessary to

satisfy consumer and producer demand based on predicted GDP growth (Fay and Yepes, 2003, p. 1). The

12

Investment includes resources for maintenance (the minimum expenditure needed to maintain the

integrity of infrastructure systems) and investment needed to satisfy new demand. The study covers most

infrastructure industries except for ports, airports and canals.

15

investment needs calculated in this way amount to $465 billion per year, or 5.5% of GDP of developing

countries. Box table presents data by developing country regions.

Box table. Estimated annual infrastructure investment needs of developing countries 2005-2010, by region,

$ billion and per cent of GDP

Region $ billion % of GDP

East Asia & Pacific 179 6.6

South Asia 63 6.9

Europe and Central Asia 98 6.9

Middle East & N. Africa 28 4.5

Sub-Saharan Africa 26 5.6

Latin America & Caribb. 71 3

All developing countries 465 5.5

Source: Fay and Yepes, 2003, p. 11

By sectors, telecommunication investment needs are the largest ($187 billion), followed by electricity

($138 billion) and roads ($90 billion). Needs in water and sanitation were estimated at $39 billion annually

(ibid., p. 18).

By income group, the needs of low-income countries were estimated at 6.9% of GDP and those of middle-

income countries at 5.1% GDP per year (ibid., p. 11). Another study with a similar coverage has put these

estimates at higher levels: 7 .5-9% of GDP for the former countries and 5.5-7.7% for the latter. More

importantly, these needs are two times higher that actual spending on infrastructure in both groups

(Briceno-Garmendia, Estache and Shafik, 2004, p. 26). ___________________________________________________________

But when the investment started growing again in 2004-2005, some optimism set in, and

has given way to more realistic assessments. It was realized, that the high level of

investments was unsustainable for the reasons given above, some of which were

objective and cyclical. The 1997 peak “should probably be seen as the burst of a large

bubble of exuberance, principally in the power and telecommunications sectors” (Schur,

2005, p.4). Many projects ran into distress, but most have been renegotiated rather than

abandoned. Renegotiations are not bad when they fix poorly designed contracts: they can

be seen as a constructive solution to unpredicted problems. Cancellations of projects in

distress were rather rare. During the entire period of 1990-2002 they concerned only 57

projects, representing only 2% of the total number of projects and 3% of the total

investment value.

It is true, that a number of big TNCs have burnt their fingers in developing country

infrastructure investment and have become cautious. But other players have taken their

place, including both developed and developing country TNCs. When one compares the

lists of the ten largest private sponsors, practically all TNCs, of these projects by value

during 1990-2001 and 1990-2005, only three appear on the list in both periods

(Telefonica, Telecom Italia and France Telecom). In 1990-2005 three are new developed

country TNCs and four are developing country firms (compared to two in 1990-2001).

When one looks at the list of largest investors in the most recent period, 2001-2005, and

compares it with the list for 1990-2001, only two old-timers remain on the recent list --

Electricite de France and Telecom Italia – and the number of developing country firms

increases to six (Kerf and Izaguirre, 2007, p.3). In addition, the role of domestic private

16

investors from developing countries, often former minority partners in projects with

TNCs, has also increased during 2001-2005 (Schur, von Klaudy and Dellacha, 2006, pp.

1-3).

But more importantly, both firms and governments have learnt from past mistakes and

recently designed and renegotiated contracts are more realistic than before. As mentioned

in the previous chapter, there is more emphasis on improved risk mitigation and more

realistic risk sharing between private and public partners. Private investors are no longer

ready to take excessive risks, in particular financing and payment risks. On the other hand

governments realize that it is very difficult to develop infrastructure expecting that user

charges will cover all the costs and increasingly recognize the need to complement

revenues with public funds. Hence the growing popularity of PPPs, discussed in the

previous chapter.

* * *

There were no exceptions from the decline after 1997 or 1998, as regards regions and

sectors (figures 2 and 3), but in some regions investment quickly recovered, while in

others it remained at much lower levels than in the peak years of the boom.

Latin America and East Asia, which accounted for most of the boom and the highest

shares in the first half of the 1990s, experienced most of the decline. In Sub-Saharan

Africa and Europe and Central Asia the decline was relatively modest and investment

levels quickly recovered: in the former region in 2001 and in the latter in 2000,

fluctuating, however in the following years. By 2005 the value of private investment

commitments in Sub-Saharan Africa was two times higher ($6 billion) and in Europe and

Central Asia 2.4 times higher than in 1997. Private investment recovered also

significantly in South Asia (2.2 times higher) and to a much smaller degree in West Asia

and North Africa (by 40%). In 2005, in LAC countries and East Asia it was at much

lower levels than in peak years of the boom, respectively, at 37% and 28%. Consequently

the latest regional picture differs from that of the 1990s. In 2004-2005, the largest

investment took place in the transition economies ($50 billion), followed by LAC ($38

billion) and East Asia ($27 billion), with other regions not that far behind as during the

first half of the 1990s: South Asia ($25 billion), West Asia and North Africa ($15) and

Sub-Saharan Africa ($10 billion).

The decline affected also all sectors, including both telecommunications and electricity,

which experienced initially the fastest growth and accounted for the dominant share of

this investment. Decreases were largest in water and electricity and much smaller in the

other two sectors. By 2005, investment recovered only in telecommunications, compared

to a peak year ($60 billion vs. $ 51 billion) and nearly recovered in transportation ($16

billion compared to $18 billion). In electricity it amounted to $17 billion, or 38% of the

1997 level and in water to $1.6 billion, or only 15% of investments in 1997 (figure 3).

17

Figure 2. Private investment in infrastructure by region, 1990-2005, $ mln

0

10000

20000

30000

40000

50000

60000

70000

80000

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

East Asia&P.

South Asia

West Asia & NA

S-S Africa

LA & Car.

Europe&CA

Figure 3. Private investment in infrastructure in developing countries,

by sector, $ mln, 1990-2005

0

10000

20000

30000

40000

50000

60000

70000

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

Energy

Telecom

Transport

Water

What follows is an overview of trends during 1990-2005 from three different angles:

developing country regions, sectors and forms of investment.

2. Regions

18

Among developing regions Latin America received by far the largest amounts of

investment in infrastructure during 1990-2005: 42% of the developing country total.

Telecommunications was by far the largest sector, followed by electricity. This pattern is

characteristic for all regions. But Latin America received also significant investments in

transportation and water and sewage in distinction from other regions, where private

investments in these two sectors were low or non-existent. Privatizations and concessions

of the existing assets were the dominant form of investment, accounting for three quarters

of it during 1990-2001. In most countries of the region, opening to private investment has

been part of broader sectoral reforms, including the introduction of competition, the

establishment of regulatory agencies and tariff adjustments aimed at generating resources

to improve the coverage and quality of services. As Latin America was the first region to

allow private investment and implement reforms, initially (during 1990-1992), it

accounted for almost three quarters of developing country total. When the sales of large

SOEs were completed and other countries allowed private investment, the share of Latin

America fell to one quarter in 2003-2005.

East Asia turned to private investment mainly because of the strain on its infrastructure

caused by the rapid economic growth. Therefore letting private investment in the

countries of the region was not, in distinction from Latin America, part of broader

reforms, but rather a measure to increase the supply of services, by complementing public

sector investment. Still, the sub-region received enough investment to be behind Latin

America as a second most important destination of this investment, accounting for 23%

of it during 1990-2005. Privatizations were rather rare, and greenfield projects attracted

over 60% of this investment (during 1990-2001). The share of East Asian countries

increased from 23% in 1990-1992 to 34% in 1996-1997 and fell as a result of the 1997

financial crisis to 10% in 1998, to recover to 23% in 2003-2005. In distinction from all

other regions, where telecommunications was the leading sector, energy attracted the

largest amounts of investment in East Asia. Similarly to Latin America, East Asia also

attracted sizeable investments to transport and water sectors.

In both regions investments never recovered from the fall after the record levels attained

in 1997-1998. In East Asia they were in 2005 only at 39% of the 1997 level and in Latin

America at 28% of the 1998 level. In other regions and sub-regions investments also fell

after 1997, but they recovered: in South Asia and West Asia and North Africa by 2003

and in Sub-Saharan Africa and CEE and Central Asia by 2000-2001. Consequently in

2003-2005 annual flows of investment were more evenly distributed among developing

country regions than in the early 1990s.

CEE and Central Asia was the third region by the size of investment with a share of

19% during 1990-2005. In most countries of the European sub-region, as in Latin

America, private investment was part of broader reforms aimed at reducing the role of the

state and putting infrastructure operations on a more commercial footing. Countries,

which became members of the European Union in 2004, had to comply with the

accession requirements. Privatizations and concessions of existing assets accounted for

55% of investments in the entire region. Apart from telecom (the largest investment

19

sector) and energy, the region received also fair amounts of investments in transport and

water.

Investments in, and shares of, other sub-regions were much smaller than in the above

regions. The shares for the entire period of 1990-2005 were 7% for South Asia, 5% for

Sub-Saharan Africa and 4% for West Asia and North Africa. South Asia and West

Asia and North Africa followed a similar approach to that in East Asia: they invited

private investment to an un-reformed infrastructure system. Thus, SOEs remained largely

in place, and private investment took mainly the form of greenfield investment, which

accounted for 90% of the total in the former region and 50% in the latter. In both regions

telecommunications was the largest sector for private investment, followed by electricity.

In South Asia there was no private investment in water and sewage and in West Asia and

North Africa it began to take place on a visible scale only in 2004-2005.

In Sub-Saharan Africa telecommunications dominated investment to a greater extent than

in other regions, accounting for 70% of the total during 1990-2005. Telecom investment

took both the form of privatizations and greenfield investment in mobile telephony. There

was also some investment in energy and transport and no investment in water and

sewage.

Although, as mentioned earlier, private participation in infrastructure has spread to

almost all developing and transition economies, as with other types of investment, and

notably with FDI, 10 countries have dominated private infrastructure investment. They

were three large Latin American countries (Brazil, Mexico and Argentina leading the list

by the value of projects) and the balance Asian economies: China, Malaysia, the Republic

of Korea, the Philippines, Indonesia, India and Thailand, in that order. Top ten accounted

during 1990-2001 for 47% of the projects and 68% of the value of investment (World

Bank, 2003, p. 20). By 2005 the Republic of Korea and Thailand were replaced on the list

by the value of investment by the Russian Federation and Turkey. China advanced to the

third position before Mexico (World Bank PPI data base). The share of top ten in the

number of projects increased to 60% but decreased by value to 64%.

But when this investment is related to the size of the population or the economy a

different ranking emerges for 1990-2001. Hungary, Panama, Chile, Estonia and Belize

lead the list of top ten, based on the value of investment per head of population, while

Bolivia, Panama, the Lao People’s Democratic Republic and Cape Verde are top

countries as regards the share of private infrastructure investment in GDP. Argentina and

Malaysia are on the three lists (ibid., pp. 20-21).

2. Sectors

Telecommunications was by far the largest sector for private investment in developing

countries, accounting for nearly half of the total during 1990-2005. It was also the only

sector where investment levels in 2005 exceeded the levels attained in the peak year of

20

1998, while in three other sectors, and particularly in energy and water, they remained

after 1997 at much lower annual levels than in the peak year. In all developing regions

investment was driven by greenfield investment in the mobile telephony. In Latin

America and CEE, in addition, it has also been fuelled by privatizations of state-owned

operators of fixed-line services. Technological changes in the sector have stimulated

private investment by reducing the costs of entry and spurring competition by rapid

advances of the mobile telephony: both led to major changes in the market structure.

During the entire period (1990-2005) 41% of this investment went to Latin America, 27%

to CEE and Central Asia and 14% to East Asia.

Energy, including in the World Bank PPI data base electricity and the transmission and

distribution of natural gas, attracted during 1990-2005 31% of the total investment, with

most of this share accounted for by electricity. Private investment in electricity was

facilitated by new technologies, which reduced the minimum size of efficient power

plants. Half of electricity investments took place during 1993-1998, fuelled by the boom

in greenfield projects in Asia, based on BOO and BOT contracts, and by privatizations in

Latin America and CEE. The share of electricity in total investment fell from 41% in the

1997 peak year to 18% in 2005 on the account of falling investment levels. During the

entire period (1990-2005) 41% of this investment went to Latin America, 29% to East

Asia and 13% to CEE and Central Asia.

In transport and water and sewage private investment was much smaller than in two

other sectors. There has not been much technological change in these sectors, political

and popular opposition to reforms has been much stronger than in other sectors and sub-

national governments have often played major roles. Investments in transport, which

accounted for 15% of the total during 1990-2005, focused on toll roads, which have also

received much of the public investment. In countries which decided to go for private

investment, this investment took both the form of transferring the existing assets through

concessions and building toll roads through greenfield projects. In water, almost all

private investments occurred in East Asia, Latin America and CEE and Central Asia and

took the form of concessioning of existing utilities to private investors. There was also

some small investment activity in expanding new capacity for water treatment, based on

BOO and BOT contracts. During the entire period (1990-2005) 47% of transport

investment went to Latin America, 36% to East Asia and 10% to CEE and Central Asia.

In the case of water investment the shares of these regions were much higher because of

very small or no investment in water in other regions. East Asia took the lead with 47%

share, Latin America was second (41%), followed by CEE and Central Asia (8%).

3. Forms

Greenfield projects were the most common form of private investment in infrastructure

in developing countries, accounting for the value share of 47% during the period of 1990-

2005 (figure 4). They reached the peak of $40 billion in 1997, fell, recovered in 2001 and

increased to $53 billion in 2005. This investment was driven mainly by projects in

electricity and mobile telecommunications and among regions by projects on East Asia,

which accounted for 31% of the total.

21

Privatizations followed, accounting for the share only slightly slower than that held by

greenfield projects, 39% (figure 4). Privatization-related investment took place mainly in

telecommunications and electricity in Latina America. After reaching a peak of $48

billion in 1998, investments fell (to a low of $15 billion in 2003) and never recovered,

amounting to $32 billion in 2005. As mentioned earlier, privatizations transactions of

developing countries in 1997-1998 were significantly increased by huge privatizations in

one country – Brazil. Leaving Brazil out, there would be no decrease after 1997-1998,

but rather annual fluctuations at quite elevated level.

In distinction from greenfield investment, the potential for investments related to

privatizations is limited by the pool of countries, which decided to engage in

privatizations in a given period and, within these countries, by the pool of state-owned

companies to be sold to private investors. Once major companies are sold, it is all natural

that potential for further investment is reduced. (But, of course, new private owners can

invest in expanding capacity, which is indeed the case in most privatized companies).

This is what has happened, when countries in Latin America and CEE completed major

privatizations in electricity and telecommunications. In addition, privatizations, which

take the form of sales of assets, do not take place in all infrastructure sectors. As regards

greenfield investments, given the vast number of developing countries and their

infrastructure needs far from being satisfied, the potential for new building projects is

virtually unlimited. So when these projects fall, it may be worrying, unless the gap is

filled by the public investment, which typically is not the case.

Figure 4. Forms of private investment in infrastructure in developing

countries, %, 1990-2005

39%

47%

14%0%

Privatizations

Greenfield

Concessions

Mngmnt. & leases

Concessions were used mainly in transport and water and sewerage and, to some extent,

in electricity. The leading regions, which have granted concessions have been Latin

America and East Asia. Concessions can be alternatives to privatizations of existing

assets. As mentioned above, greenfield projects can be turned into concessions after the

construction of a utility is completed. It seems that, the former dominated concessions,

which peaked in 1997, when large concessions in a number of countries were granted,

22

such as concessions for the electricity and water utility in Casablanca (Morocco), for the

water utility in Manila (Philippines) and for transport in Brazil (World Bank, 2003, p. 5).

Management and lease contracts were used in sectors, which were not reformed, and

countries wished only to improve management, without private investors assuming

investment risks. They were not too many, only around 100 during 1990-2001. Water and

sewerage sector had 41 projects and transportation 44. Among regions, CEE and Central

Asia granted 30 concessions and Sub-Saharan Africa 25.

C. The role of FDI

As was mentioned earlier, foreign investors were involved during 1990-2005 in over 83%

of private projects in infrastructure, measured by the number of projects or total

investment value, in developing and transition economies. “The primary engine behind

this rapid expansion [of private infrastructure investment] during the 1990s clearly has

been foreign direct investment” (FIAS, 2000, p. 8). Therefore, one can be confident, that

the preceding analysis, although dealing with all private projects, reflects quite correctly

FDI trends, although there are some differences related to the use of non-equity form in

some sectors and regions. The following overview of trends in FDI for 1990-1998 is

based on FIAS estimates.

The average 83% share of FDI in all private infrastructure investment in all developing

countries during 1990-1998 masks sectoral differences, but these differences are not big.

In all sectors and transport subsectors, except for two – roads and seaports – these shares

are higher than 86%, with the highest shares in airports (100%), water (98%) and

telecommunications (98%). Very high shares of FDI reflect the lack of not only capital

but also local expertise to undertake such projects. Where the local expertise existed, as

in road construction, governments tended to rely on domestic investors, often excluding

foreign participation. Therefore the share of FDI in roads was the lowest, 37%. In

seaports it was much higher, 62% (ibid., p. 9).

As with all projects, FDI related projects and associated FDI inflows grew very fast from

1990 to 1997, from $2 billion to $36 billion per year, and fell after the East Asian crisis to

$33 billion in 1998. Only Latin America escaped this contraction, owing to large FDI-

related privatizations in Brazil. Excluding Latin America, flows inflows dropped by

44%. Overall, private infrastructure projects attracted estimated $138 billion of FDI

inflows into developing and transition economies during 1990-1998, representing the

share of over 17% in total FDI inflows into these economies.

In terms of FDI inflows, telecommunications and electricity accounted for 95% of the

total. In terms of the number of transactions, however, transportation and water

represented 1/3rd

of all projects, reflecting differences in the size of projects among

sectors. As water and transportation projects are based mainly on concessions and BOT-

type of projects, while privatizations and greenfield investment dominate in electricity

and telecommunications, similar differences occurred, as regards forms of investment.

Thus privatizations (most popular in telecom and electricity) generated 2/3rd

of FDI

23

inflows, but accounted for only 22% of the total number of transactions. On the other

hand BOTs and concessions were responsible for 30% of inflows, while accounting for

three quarters of the number of transactions (ibid., p.12).

As with all projects, Latin America attracted the largest share of FDI inflows among

developing countries, 57%, with 85% of these inflows generated by prvatizations. But by

the number of FDI-related projects, the composition was more balanced: ¼ were

privatizations, 42% concessions and 30% greenfield investments. East and South Asia

received each $18-19 billion of infrastructure-related FDI inflows during 1990-1998.

Almost all of these inflows came through BOT-type contracts. CEE and Central Asia as

well as Sub-Saharan Africa attracted FDI inflows mainly to privatizations.

D. TNC players and home countries

The top ten TNCs involved in infrastructure projects (that is in projects in which they

hold at least 15% of equity, and ranked by the total value of these projects) in developing

and transition economies accounted for 12% of the projects during 1999-2001 but for

nearly 30% of the investment value. Five TNCs originate from the European Union and

only two from the United States. Five of them, in line with the dominant role of the

sector, were telecommunication TNCs, three TNCs in electricity, one TNC in the water

industry and one a multisector TNC (table 1). The investment of three of them

(Telefonica, Carso Global Telecom and Andrade Gutierrez) was located entirely in Latin

America. Telecom Italia also “specialized” in Latin America, with some projects in the

CEE, while Deutsche Telekom in the CEE, with some projects in East Asia. The

investment of remaining top ten was spread among a couple of regions, but only three

TNCs had a presence in all regions (AES Corporation, Enron Corporation and SUEZ).

Home country data, that is data concerning all TNCs, estimated by FIAS for the period

1990-1998 (FIAS, 2000, pp. 14-15), when most of the considered investment took place,

reveal a picture in some respects similar and in others different from that, based on the

top ten TNCs. The United States, which has only two TNCs on the list of top ten is by far

the largest home country, accounting for 30% of the total of home countries responsible

for infrastructure-related FDI flows. Spain is next with the share of 15%, followed by

Germany and France (7% each), Italy (7%) and the UK (2.5%). TNCs from developing

countries account for 8% of infrastructure FDI in other developing countries.

Table 1. The top 10 TNCs in private infrastructure projects in developing countries,

1990-2001 (ranked by total value of investments in which they participated)

TNC Home country Total project investment

2001 $, billions

Number

of

projects

Telefonica Spain 35 12

Carso Global Telecom Mexico 35 5

SUEZ France 33 79

Telecom Italia Italy 31 16

24

France Telecom France 27 26

AES Corporation US 22 58

Deutsche Telecom Germany 18 18

Enron Corporation US 17 48

Electricite de France France 16 28

Andrade Gutierrez Brazil 15 9

Total 228 293

Source: World Bank, 2003, p. 15

Note: The value of investment represents total investment from all sources in projects in

which TNCs had an equity participation of 15% or more.

All TNC data confirm geographical specialization of some home countries, that is

Spanish, Italian as well as that of the United States TNCs (with almost two thirds of US

investment) in Latin America. French TNCs also prefer Latin America, with 54% of

investment there, while the balance is more or less evenly distributed over other regions

except for South Asia. Germany specializes in the CEE (almost half of its investment is

there), but has also directed one third of its FDI to East Asia. UK specializes in Asia, with

65% of its investment in that region (36% in South Asia and 29% in East Asia).

Developing country TNCs also have a strong preference for Latin America (67%). Most

likely, most of this investment is intra-regional. They also have the highest share of Sub-

Saharan Africa in their investment portfolio – 21% (next comes France with 13%).

Specialization emerges also from the home country composition of FDI in individual

sectors. US TNCs dominate electricity FDI (accounting for 45% of the share) and have a

strong but not dominant position in telecommunications, where it is challenged by the

European TNCs with a slightly higher share (40%). French TNCs (with the share of 50

%) and British TNCs (ca. 30%) dominate FDI in water and sewerage. France is also by

far the largest home country for FDI in transport, accounting for half of it, with the US

second (some 15%). TNCs from developing countries account for over 10% of FDI in

electricity, for less than 10% in transport and some FDI in telecommunications, but are

absent from FDI in water.

III. IMPACT

A. What infrastructure TNCs offer developing countries?

According to the theory, FDI – the main form of TNC activity – comprises a bundle of

assets, such as capital, technology, brand names, market access and access to inputs,

skills and management expertise, to name the most important ones (UNCTAD, 1999, p.

317). The literature terms these and other assets “ownership advantages” of TNCs.

Internalization of these advantages across borders gives TNCs an edge over other firms,

local and foreign, by, among others, allowing them to overcome the transaction costs of

arm’s length transactions when operating internationally. The ability to organize and

integrate production and other corporate functions across countries, taking advantage of

differences among countries (such as cost differences, resource endowments or market

25

size and growth) is, itself, a source of additional advantages, termed the advantages of

“multinationality”.

Some of TNC assets are proprietary assets and others are not. Proprietary assets can be

obtained only from firms that create them. Of these assets, the most prized is probably

technology. Proprietary assets can be, theoretically, copied or reproduced by others, if

they have the ability to do so. But the costs can be very high, particularly in developing

countries and where advanced technologies are involved. In addition, TNCs are reluctant

to sell their most valuable assets to unrelated firms that can become competitors or could

leak them to others who have not paid for them. Non-proprietary assets – finance, capital

goods, intermediate inputs and the like – can be obtained from the market, at least in part.

But TNCs can have and, in fact often do have, privileged access to markets for non-

proprietary assets: the may be able to raise capital, or purchase equipment, on better

terms than smaller firms or firms from developing countries. Taken together, these

advantages mean that TNCs can contribute significantly to host developing countries – if

the host country can induce them to transfer these advantages in appropriate forms and

has the capacity to make good use of them.

How does this theory work in infrastructure industries? It does, but given different nature

and economics of infrastructure industries, there are significant differences compared to

other industries, e.g., manufacturing industries.

First, all infrastructure services are not tradable across borders.13

Therefore access to

international markets and contribution to exports, valued very much in manufacturing, do

not matter as a contribution in infrastructure. In addition, this creates dangers when

countries move to the private provision of services. Infrastructure services are natural

monopolies, or at least in part natural monopolies. There is no alternative of competitive

pressure from the imports of services. If privatization transfers natural monopoly from

public to private hands, this also transfers monopoly profits to private firms14

and

deprives the country of many (though not all – the supply and quality of services may still

improve) expected benefits of private provision. Transfer of monopoly to domestic or

foreign firms is, economically, equally damaging. But if private hands are foreign hands,

the backlash is typically stronger than in the case of domestic, public or private,

companies and does not augur well for future privatizations.

Second, infrastructure industries are not, with the exception of telecommunications, high-

tech industries and hard technology is not a strong ownership advantage of TNCs. But

even in telecommunications, technology is not a proprietary asset and can be purchased

in open markets. Leading TNCs, such as Deutsche Telecom, or France Telecom, do

produce technologies, they install in fixed-line or mobile networks. It is rather the ability

13

There are some cases of cross-border trade in electricity and water among neighboring countries (e.g.,

USA-Canada in electricity or Lesotho’s export of water to South Africa), but they are so limited that trade

is practically not a delivery option for infrastructure services. 14

In practice, in many cases, this transfer is illusory, as many SOEs did not make profits before they were

privatized. Even in cases where they were relatively well managed, they operated in systems, where prices

were subsidized, so even if they showed profits, it is difficult to say if they would be able to cover costs in

competitive markets.

26

to know how to use technologies (to, for example, combine the provision of telephony,

internet and media in one service package), marketing know-how and the knowledge of

markets (what will consumers accept) and managerial expertise (including how to assess

risks in private infrastructure markets) which constitute a competitive edge of TNCs. In

the initial phase of privatization, competitive advantages of TNCs vis-à-vis many

developing country public providers were contextual. Both developing and transition

economies did not have firms and investors with the knowledge, how to operate a private

infrastructure entity. So during the transition to market-based delivery, most of these

countries did not have an alternative to turning to TNCs. But with time TNCs may lose

and in fact are losing this advantage, as domestic firms, often minority partners in TNC-

led projects, acquire such knowledge. Witness an increasing role of domestic firms in

infrastructure investment, mentioned earlier.

Third, many projects (though not all) in infrastructure are very large and are characterized

by large economies of scale. They require huge initial capital outlays, while the stream of

revenues to cover the cost of, and return on, capital spreads over many years. Therefore

risks are typically much higher than in, for example, manufacturing projects. There are

also many additional risks that are lower or not existing in other industries, such as

political risks (related to, for example obsolescence bargaining) or regulatory risks. Even

if countries decide to introduce as much competition as possible, in industries relying on

fixed-networks (such as fixed telecommunication lines, electricity distribution or water

pipes), elements of natural monopoly will always remain. They should be managed by a

national regulatory agency, which will determine conditions of access and set prices,

thus, de facto, determining the stream of revenues. For these reasons, although capital

typically is not a proprietary asset of TNCs, in infrastructure projects it practically is.

Huge amounts of capital necessary to invest in infrastructure are beyond the financing

capacity of capital markets in many developing countries. Even if they are not, given

risks involved and doubts about the ability of local investors to manage such projects,

lenders are in most cases hesitant about extending credit to local inexperienced investors.

Teaming up with TNCs may change this situation. Therefore it is quite common that

many projects are financed by consortia of TNCs and domestic investors.

To sum up, key contributions host countries can expect from an FDI package brought by

infrastructure TNCs include capital and the ability to undertake efficient investment (with

associated risks) which would be impossible or difficult to undertake by domestic

investors either because of the lack of capital or expertise how to build and/or run an

infrastructure facility as a private entity, or both. TNCs generally improve corporate

governance.

If countries decide in favour of indigenous ownership, excluding TNCs, in the absence of

well developed financial markets it often means that large “domestic privatizations may

only be feasible to certain high income groups or families, probably the same elite that

controls government” (Saha and Parker, 2002). A number of privatizations in Uganda,

Zambia, Burkina Faso and Cote d’Ivoire have involved the transfer of assets to

politicians, their families and associates on preferential terms. Such privatization may

lead to rent extraction (Parker and Kirkpatrick, 2003, pp. 20-21). On the other hand,

27

privatizations to foreigners risk the tag of “re-colonization and weakening domestic

enterprise development” (Makonnen, 1999).

Before proceeding to the discussion of impacts, based on the literature, a few caveats

need to be made.

The contents of the package and the resulting TNC contributions depend on the form

investment takes. As discussed in the first chapter infrastructure projects can take either

equity or non-equity forms, associated with different contributions. Privatizations and

greenfield projects always involve capital contributions (in the form of equity and/or

debt). While privatization-related FDI includes typically the full package content, in the

case of greenfield investment the content depends on how the project ends. If the facility

is only constructed by a TNC and at the end transferred to the government, then the

expertise how to run the facility is not part of the package. Conversely, a host country

may decide to attract only managerial expertise without a capital and risk-taking or risk-

sharing component, if it prefers a management contract or a lease type of the agreement.

Typically, governments have a choice of the type of investment (within standards

prevailing in each infrastructure industry) and therefore the contributions they expect

from TNCs. For example, countries which decided not to reform their infrastructure

system (that is not to rely on markets and private providers) have gone in

telecommunications and electricity only for greenfield investments. This means that they

expected TNCs mainly to supplement the supply of services to that from existing SOEs,

maintaining their central role in the system. In other words, their expectations concern

increased production within the system of public provision. This is the case of most

countries in Asia.

Countries, which desired to reform the system, that is to introduce market forces (to the

extent possible, given natural monopoly elements) have relied on privatizations of SOEs

and, if need be, on greenfield investment. This is the case of most countries of Latin

America and Central and Eastern Europe and some in Africa. They expected TNC

contributions to do more than to increase the supply of services. They expected private

firms to be efficient and productive enterprises not needing government support and

putting an end to subsidizing infrastructure and thus permitting governments to direct

budgetary resources to other ends. Expectations included also considerable new

investments resulting not only in considerable increase in the availability of services to

all segments of the population but also in considerable quality improvements. They

expected competitive prices covering costs or at least, most likely, did not expect price

increases in spite of discontinuing subsidies. And finally, it is expected that in

environmentally sensitive industries, such as electricity, private investors will be able to

contribute more than pre-existing SOEs. As will be seen below not all expectations have

materialized, for different reasons, not necessarily related to TNCs.

28

But what is important now, is that the division of countries into non-reforming and

reforming groups has implications for the impact discussion. There is really not much to

consider as regards impact in non-reforming countries (which does not mean that there

are no problems with the private production being part of the system relying on public

provision). Therefore, literature dealing with the impact almost entirely focuses on the

latter group of countries, focusing on comparing industry performance after reforms with

that before reforms. Sometimes comparisons concern reforming and non-reforming

countries. Unfortunately, the literature does not pay attention to the impact of foreign

versus domestic private firms. Perhaps it is so, because the ownership of infrastructure

companies is not a decisive factor, determining the industry performance after reforms.

Nevertheless, reforming countries are those which opened widely to TNCs and FDI,

which in many cases play significant or dominant roles in infrastructure industries.

Therefore the impact analysis, even if it does not distinguish ownership, deals practically

with the impact of TNCs.

As indicated above, the ownership matters, and it does so in both groups of countries, as

regards the supply of the necessary capital and the ability to undertake investment. As

mentioned below, here the role of TNCs is very substantial, as they have participated

during 1990-1998 in 83% of the projects, measured both by their number and value.

During 1998-2003 their role has further increased to 86%, measured by investment value

(Ettinger et. al, 2005, p. 15). It does not mean that over 80% of investment capital in both

periods has been contributed by TNCs. It means that TNCs participated in projects, the

total value of which accounted for 83% in 1990-1998 and 86% in 1998-2003 of the total

value of all projects.

FIAS has estimated the capital contribution of TNCs in the form of equity FDI flows

during 1990-1998. The average for all developing countries and transition economies

was 26% of the total value of the projects. The highest contribution was in Sub-Saharan

Africa (63%) and Latin America (36%) and the lowest East Asia (12%). As regards

sectors, telecommunications attracted the greatest share of FDI (44%), followed by

electricity (28%) and roads the lowest (4%) (table 2). Thus, the highest shares of equity

FDI were attracted to both sectors and regions, which relied more on privatization

transactions (this is what explains the highest share in Africa, where most private

investment went to telecommunications in the form privatization-related FDI). But FDI

inflows underestimate capital contributions by TNCs. FIAS excluded from FDI estimates

debt flows, which normally are part of FDI if debt is provided to foreign affiliates by

parents. Underestimation may be serious, as especially in greenfield transactions through

BOTs or concessions equity tends to be significantly smaller than debt flows. As a result,

debt/equity ratios in electricity, transportation and water where these transactions were

important range from 78/22 in the case of roads to 67/33 in the case of seaports (FIAS,

2000, p. 151). In telecommunications where large-scale privatizations of fixed-line

networks were a large component of transactions and investment in cellular telephony

was also based on equity FDI these ratios are 46/56 for fixed lines and 42/58 for the

cellular telephony. The implication is that TNC contribution was higher than the

estimated share of equity FDI, 26%, although it is not possible to establish how much

29

higher. In addition TNC participation in projects helps mobilize financing through debt

indirectly, as it enhances credibility of projects.

Table 2. The share of FDI financing in total investment in infrastructure in developing countries

(1990-1998, by region and infrastructure industry, in %)

Power Airports Seaports Rail Roads Telecoms Water Total

Latin America 41 5 19 14 3 51 14 36

East Asia 16 8 2 9 3 18 4 12

South Asia 16 33 34 17

Europe & Central Asia 40 13 5 38 4 32

Sub-Saharan Africa 19 57 7 3 83 12 63

West Asia & North Africa 38 33 83 11 24

Total 28 9 14 11 4 44 8 26

Source: FIAS, 2000, p. 152

B. Impact in individual infrastructure sectors

1. Telecommunications

In telecommunications reforms in both developing countries and transition countries have

been quite widespread and advanced among infrastructure industries. Typically, after

privatization the supply and density of services and productivity have increased

considerably. At the same time there have been differences among privatizing countries,

as regards (improved) industry performance, depending on the depth and scope of

reforms.

In both Argentina and Jamaica investment increased three to four times four years after

privatization, leading to accelerated capacity expansion, compared to 11 years before

privatization. In Jamaica, an annual network expansion accelerated to 18% compared to

4.5% and in Argentina, respectively, to more than 14%, compared to 6%. Also in Mexico

the supply of services accelerated (Ramamurti, 1996 and Ros, 1999).

Among countries with income per head lower than $10,000, those that permitted private

majority ownership of formerly state-owned telecom companies experienced 130%

higher growth in fixed lines per head than the remaining countries. They also had 1/3

more lines per head (Ros, 1999).

In another comparison, three LAC countries that privatized in 1990-1991 (Argentina,

Mexico and Venezuela), achieved much faster capacity expansion (even though they

granted 6-10 years of monopoly rights to private operators), measured by

telecommunications lines, than countries with state-owned companies (at that time Brazil,

Colombia, Ecuador, Peru and Uruguay). But all fell far behind Chile, whose government

introduced competition and did not give up the right to issue telecommunications licenses

at any time (table 3).

30

Table 3. Annual growth rate of telecommunications lines in reforming and non-

reforming countries of Latin America

Type of country 1984-89 1989-94

State monopoly: Brazil, Colombia, Ecuador, Peru and Uruguay 7.0 7.8

Private monopoly: Argentina, Mexico and Venezuela 6.7 11.3

Competitive market: Chile 6.6 20.5

Source: Kessides, 2004, p. 56

Similar improvements occurred in Brazil after it privatized the telecommunication sector

to foreign investors in the second half of the 1990s. In the early 1990s, the installation of

a phone line in some regions in Brazil could cost up to $2,000 and the waiting time was

2-3 years. In 1995, there were only 15 million fixed lines in the entire country. By 2003,

the number of fixed lines increased to 50 million and the cost of installation was

dramatically reduced, not exceeding $30 in many cities. Key standards of quality, such as

the network digitalization index, the average time of waiting for a dial tone, the local and

long-distance call rates and the number of orders placed for repair services per 100 public

telephones also improved significantly after FDI entry. Mobile telephony has exploded.

In 1995, there were 1.4 million mobile subscribers. By 2003, their number increased to

more than 50 million, making Brazil the fifth largest telephone market in the world

(UNCTAD, 2005, pp. 34-35). The improvements were possible owing to the significant

investments by new private owners, but initially came at a cost of reduced employment,

from 118,000 in 1997 to 105,000 in 1998. But after initial restructuring, employment

started growing again in 1999 (ibid., p. 25).

Among reforming countries those which introduced deeper reforms, achieved better

performance. During 1985-1995, among 86 developing countries from all continents, in

those which introduced a combination of reforms, that is, not only privatized but also

introduced competition and established independent regulators, productivity was 1/5th

higher than in countries with partial or no reform (Fink, Mattoo and Rathindran, 2002).

The role of competition and privatization, acting better together than either of them alone

in improving efficiency, was confirmed by Ros (1999) and, in expanding capacity in

fixed lines telecommunications, by studies covering a large number of developing

countries (Laffont and N’Guessan, 2002; Li and Xu, 2001). Another study of 30

countries in Africa and Latin America found that privatization leads to a significantly

better performance only when accompanied by an independent regulator (Wallsten,

2001).

Competition, in addition to privatization, proved to be instrumental in stimulating supply

and innovation, lowering prices and improving the quality of services in several countries

(Chile, Cote d’Ivoire, Ghana, Malaysia, Mexico, Philippines and Romania). These

stimulated demand further, including for fixed-line operators (Rohlfs et. al., 2000).

In the early stage of privatizations a number of countries granted private buyers –

domestic or foreign – monopoly rights for a period of time (e.g. in Latin America

between 5 and 10 years). The main reason for exclusivity was to maximize budgetary

31

revenues in exchange for benefits of monopoly accruing to private operators. But, as it

was thought at that time, there were also economic arguments. First, high monopoly

profits would facilitate much needed new investment to increase supply and improve

services. Second, competition would undermine the universal provision of services,

forcing privatized operators to focus on better off customers and undermining subsidies

used as part of universal provision policy. And finally, it was thought that incentives (in

the form of monopoly positions) were needed to attract foreign investors (Laffont and

N’Gbo, 2000). Exclusivity typically limited gains from privatization, although not

entirely deprived of them countries using it, compared to countries, which continued to

rely on state monopolies (table 1). Prices were high (though lower than in countries with

state monopolies), reducing demand for services (and subsequently investment) and the

growth of capacity lower (Wallsten, 2000). The literature seems to agree that market

liberalization stimulates network growth and innovation while exclusivity rights delay

them.

Consequently, with time, exclusivity periods became shorter and countries, even small

ones, were able to sell telecommunications companies without exclusivity rights,

attracting several service providers (e.g., El Salvador and Guatemala by 1998, Kessides,

2004, p. 61). On the other hand, countries which initially provided very long monopoly

rights were stuck with them, hampering the industry development. A case in point is

Latvia, which granted in 1994 a 20-year exclusivity for fixed lines to a joint venture

between the government and a foreign investor. Attempts to cut down exclusivity by ten

years resulted in a legal battle between the government and the investor, demanding very

high compensation (ibid., p. 78).

2. Electricity

It was in Latin America where privatization and liberalization of electricity provision and

distribution started among developing countries. Chile was a pioneer in this regard

(1982), followed by Argentina (1992) and several other countries during the 1990s

(Kessides, 2004, p. 172). Examples of Chile and Argentina are illustrative of the impact

of reforms:

Productivity. In Chile labour productivity, measured by generated gigawatt-hours

per employee in the largest supplier, Endesa, increased more than five times

between 1991 and 2002. In distribution, productivity increased more than ten

times (in Chilectra) between 1987 and 2002 (Fischer, Gutierrez and Serra, 2003;

and Pollit, 2003). Labour productivity accelerated after the takeover of domestic

companies by foreign investors. Between 1999 and 2002 the number of

employees in Chile’s electricity industry fell from 8,264 to 5,706 (Kessides, p.

182). In Argentina, thermal plant unavailability fell from 52% in 1992 to 26% in

2000 (Rudnick and Zolezzi, 2001). In Brazil, productivity increased by nearly

150% between 1994 and 2000, while the number of employees fell by half (Mota,

2003).

32

Quality of services. In Chile the time for emergency repair service fell from 5

hours in 1988 to 2 hours in 1994. Power outages caused by transmission failures

fell steadily as well as energy losses, including those caused by theft (from 21%

in 1986 to 9% in 1996). Losses fell also in Argentina (from 26% in 1993 to 10%

in 2000 at Edenor). In Buenos Aires hours of outages per year declined from 17 in

1994 to 5 in 2001.

Supply capacity. Capacity is measured by megawatts and the length of

transmission lines. In Chile the former increased between 1982 and 2002 2.5

times and the latter two times. In Argentina increases amounted, respectively,

between 1992 and 2002, 1.7 times and 1.3 times.

Prices. Before reforms prices did not reflect costs and were often subsidized.

Aligning of prices with costs as a result of relying on private suppliers and market

forces has led in many countries to higher prices. But in some countries prices fell

as a result of introducing new technologies and greater reliance on natural gas. In

Argentina, the average monthly price per megawatt hour in wholesale market fell

from $45 (and $70 in peak times) in 1992 to $15 in 2002. In Chile, wholesale

prices fell 37% and final prices 17%.

Company performance. In both Chile and Argentina, in spite of increased

investment and lower prices in the aftermath of reforms, companies’ financial

performance was strong, as the following examples, using return on equity,

indicate (Kessides, p. 177):

Chilectra – 32% (nominal return), 1996-1998

Endesa – 16% in 1994 (peak year)

Argentina, generation, Buenos Aires, 5.6% average during 1994-99

Transener, transmission, 5.1 in 1998

Distribution, 1994-2000, Edenor and Edesur, respectively 8.3% and 7.2%

pretax returns on net assets.

In Argentina, the industry situation gravely deteriorated as a result of the peso

crisis in 2002. Prices in most contracts were set in dollars, which until 2002 was

pegged to peso one-to-one. Un-pegging in that year, resulting in devaluation of

peso, redefined the economics of contracts. While regulated prices in pesos

remained frozen, inflation set in, resulting in plummeting revenues of electricity

companies and soaring debt (mostly in dollars) and production costs. As a result,

the companies experienced big losses, and, for example, Transener, suspended

payments on its debt. While negotiations with the government went very slowly,

the companies issued in October 2003 a warning about power crisis (Casey,

2003).

Poor. In Chile, the share of households without electricity (among the poorest

10% of households), fell from 29% in 1988 to 7% in 1998. Among the second

10% poorest the share fell from 20% to 4% (Estache, Foster and Wodon, 2002).

33

As a result of a rural electrification programme, the coverage in rural areas

increased from 53% in 1992 to 76% in 1999, exceeding the target of 75% set for

2000.

While in Latin America debt problem of the 1980s influenced the choice of methods of

privatization (sales of existing SOEs was a dominant form) as well as depth and scope of

reforms (they went farthest among developing countries), the situation in Asia, and

especially in East Asia was different. These countries were not indebted (at least not so

heavily as Latin American countries) and SOEs in electricity seemed to have been doing

better than in Latin America. But neither these companies nor governments were able to

finance investment needed to satisfy rapidly growing demand for electricity caused by

rapid economic growth. Consequently the region suffered from power shortages in the

late 1980s and early 1990s, which were particularly severe in Indonesia, Malaysia, the

Philippines and Thailand (Kessides, 2004, p. 178). To deal with the crisis, countries of

the region decided to allow greenfield private investment, but only in power generation,

without reforming the rest of the system. Consequently, private companies were selling

electricity to state-owned utility companies under long-term purchase agreements (the so

called single buyer model). The agreements typically were based on payments in dollars

(to mitigate foreign exchange risk of investors, whose debt and many purchases were in

dollars) and involved government guarantees (because default procedures against public

utilities were usually not allowed). Thus SOEs were placed between private producers of

electricity and final consumers. Tariffs remained unreformed, not reflecting the cost of

production. Initially, this model worked well. During 1990-1997, East Asia attracted $55

billion of mostly private greenfield investment in power generation, or 40% of total

private investment of developing and transition economies. But the financial crisis, which

started in 1997, undermined the rationale of this model. Devaluations of national

currencies and economic slowdown undermined or destroyed economic fundamentals of

agreements, doubling the cost of electricity (which SOEs were reluctant to pass on to end

users, as this was politically unacceptable) and changing demand projections and

associated revenue stream. This resulted in massive increase in debt of state owned

providers, typically guaranteed by governments. For example, in the Philippines, the

foreign debt of the national provider reached 20% of national debt. Some governments

tried to repudiate debt, often claiming that deals made by previous governments were

corrupt, while others rescheduled loans to avoid default. As a result, the private electricity

generation market (as well as other infrastructure projects in transportation and

telecommunications) fell into severe crisis, with projects canceled, delayed or brought to

the brink of bankruptcy (FIAS, 2000, p. 133).

3. Transportation

a. Rail

Deteriorating physical condition of railways and performance of state-owned companies

on the one hand and fiscal constraints of governments on the other have prompted a

number of developing and transition economies to restructure the industry and increase

private participation. During the 1990s more than 40 railways in 16 countries were

34

concessioned or privatized. At the beginning of 21st century railways in 7 countries were

under the process of concessioning (Thompson, 2003). During 1990-2001 more than 70

rail projects with private participation attracted some $30 billion of investment (Harris et.

al., 2003). Only few countries have fully privatized railways. In other cases, the dominant

form of private participation has taken the form of concession to operate and manage the

existing railways. Under concession, the ownership of infrastructure and assets remains

with SOEs. The concessionaire takes obligations for investment to upgrade assets by

making payments to special investment and renewal funds and is obliged to service debt

on any investment undertaken within the concession. Seven countries of Latin America

have led the way, awarding during 1990-1997 26 contracts totaling $6.5 billions. East

Asia and the Pacific issued fewer contracts, but total investment was higher than in Latin

America -- $8 billion – due to the different nature of the projects: large greenfield

investment in metropolitan areas based on BOT contracts (Kessides, p. 200).

Deregulation and privatization led to the reduction of excessive employment (an option

which did not exist before reforms), ranging from 8% in Burkina Faso and Cote d’Ivoire,

to 42% in Estonia, 66% in Mexico and 92% in Argentina. As reported in the literature,

reductions have not been associated with cuts in services. This, combined with traffic

increase, has led to dramatic increases in productivity (except for two African countries),

measured by the sum of ton-and passenger-kilometers per employee, which at least

doubled, but in most cases tripled or even quadrupled (Thompson, Budin and Estache,

2001; Thompson, 2003). In most concessions better service, flexible pricing and lower

freight rates have significantly increased the freight traffic, reversing the trend of

declining share of railroads in this traffic (e.g., in Argentina).

Among 16 privatized railroads, mostly in Latin America, 14 were able to lower freight

tariffs, compared to the pre-privatization period. Rates in LA declined between 8% and

54%, and in Cote d’Ivoire 14%. It is estimated that in six countries, which were studied,

these reductions saved about $1 billion in transport costs per year. Lower railway rates

led also to tariff reductions in other types of freight transportation (Kessides, p. 202).

In Brazil, during most of its history railway operations were unprofitable. In 1995, Rede

Ferroviara Federal (RFFSA) lost more than $300 million and its debt reached $4 billion

(Estache, Goldstein and Pittman, 2001). In 1995, Brazil cut workforce in railways,15

split

RFFSA into six private freight concessions, eliminated subsidies and gave new operators

considerable price flexibility (depending on demand and conditions of contracts). As a

result losses turned quickly into profits and rails declining share in freight traffic was

reversed. However, most operators did not reach investment levels as planned (Campos

and Jimenez, 2003).

b. Ports

During 1990-2001, $18 billion was invested in 177 private port projects, mainly in Latin

America and East Asia, with five countries accounting for 2/3 of the investment. It is

15

Employment fell to 42,000 in 1995 (from 110,000 in 1975) as a result of early retirement, voluntary

separation incentives, training assistance for outplacement and severance packages for dismissed workers.

35

expected that private operators are able to control costs, are faster than public ones to

adopt new technologies and modern managerial practices and are more responsive to the

needs of customers.

These expectations materialized in a pioneering divestiture of container operations in port

Kelang, the largest port in Malaysia, undertaken in 1985:

Crane handling increased from some 19 containers per hour in 1985 to 27 in

1987, almost matching port performance in Singapore.

An annual return on fixed assets increased from 2% during 1981-1986 to nearly

12% during 1986-1990, due to improvements in productivity, not higher prices.

Output per worker increased by 76%.

Real wages increased by 1990 by 60%.

Similar improvements took place as a result of deregulation of ports in several countries

during the 1990s:

In Colombia (between 1993 when reforms in four ports were implemented and

1996), ships’ waiting time fell from ten days to “no wait” or only hours of

waiting, depending on the port. The loaded cargo per vessel per day increased

from 500 tones to 2,500 (for bulk) and from 750 to 1,700 for general cargo and

the number of containers per vessel per hour increased from 16 to 25.

In the port of Buenos Aires (between 1991 and 1999), annual container traffic

increased from 300,000 TEUs to over 1 million, the number of cranes increased

from 3 to 13, labour productivity increased almost four times, and the average

waiting time was reduced from 2.5 to 1.3 days. As a result the port of Buenos

Aires regained its position in competition with other regional ports, surpassing by

1997 Santos, the largest port in South America, in terms of cargo handling.

Mexico’s concessioning of ports to private operators in the mid-1990s led to

much lower tariffs, significant improvements in efficiency, productivity and

profitability. This resulted in substantial investments in ports expansion and

modernization and in considerable tax revenues for the government (while before

deregulation ports depended on public support).

4. Water

Reforms in the water and sanitation sector has been slower and private participation

much more limited than in other infrastructure industries.16

During 1990-2001, the sector

accounted for 5% of global private investment in infrastructure in developing and

transition economies. Private investment in the sector in these countries peaked in 1997,

16

It is also the case in developed countries. For example, in the United States 94% of municipal water

systems, including some 5,000 separate utilities, are under public control. As most required extensive

rehabilitation and repair, at the beginning of the 21st century more than 1,000 units were operated under

private long-term concessions. Some of them ended, however, in failure. For example, a contract signed in

1999 between Atlanta and United Water, a subsidiary of Suez, was terminated in 2003 by mutual consent,

due to disagreements (Kessides, 2004, p. 241).

36

to reach $9.3 billion, and then fell to an annual average of $4.6 billion in 1999-2001.

Latin America leads the developing world in the number of projects, while East Asia in

the value of investment. But three quarters of investment was undertaken in only six

developing countries, led by Argentina and Brazil. The dominant form of private

participation are concessions, accounting for more than 80% of investment value during

the 1990s.

As reforms and private participation in water industry are not very common and most

large public-private partnerships are less than ten years old, studies on the effects of

reforms are rare. One such study (Shirley and Menard, 2002, as reported in Kessides,

2004, pp. 252-256) assesses the results of reforms in 1996 undertaken in six cities during

1989-1993. They are Buenos Aires (concession), Mexico City (service contracts), Lima

(where the concession was not implemented and the system remained under state

ownership and operation), Santiago (contracting) and Abidjan and Conakry (leases).

Although regulatory systems differed greatly in these cities, reforms brought

improvements in productivity (employees per connection). Operating costs fell below

revenues in all cities except Mexico. Water and sewerage coverage increased everywhere

except Lima. Un-accounted for water (that is, physical and commercial losses due to poor

maintenance, financial management and illegal use) fell significantly in Buenos Aires,

Lima and Santiago, with little change in other cities.

Other studies on water cited in the Word Bank report (Kessides, 2004, pp. 255-256)

found that:

In water provision, institutional capacity and the quality of governance are more

important in determining efficiency than private participation (21 African

utilities)

Private operation of water utilities is correlated with greater efficiency (50 Asian

utilities)

There was no evidence from cross-country analysis in Africa that reforms in water

and other infrastructure hurt low-income consumers. On the contrary, poor people

“seem to benefit in terms of having better chances of becoming connected to

network services” (ibid., p. 256).

C. Impact by areas

1. Supply and coverage

There is consensus in the literature on infrastructure privatization that the largest gains

have come through increased investment and supply of services and extended coverage to

previously unattended or unconnected consumers.

The results have been particularly impressive in telecommunications, especially where

competitive regimes have been established. In Latin America, the expansion of networks

has been slower in countries, which have privatized but not introduced competitive

regimes. But it has been faster than in countries, which continued to rely on public

monopolies. The improvements can be spectacular in countries with underdeveloped

37

networks, e.g., in Uganda, where the entry of mobile companies led to a big increase in

the number of connections, as these companies soon after entry dwarfed the fixed-line

incumbent.

Well designed private schemes in water and electricity have also led to significant service

expansion during the years following privatization, after many years of stagnation and

deteriorating service under public provision (Harris, 2003, pp. 18-20):

Increased access to water in nine cities in countries from Latin America, Africa

and Asia amounted to between 10% and 33% (in Manila). Only in one,

Barranquilla, it increased by 5%.

In sanitation, the increases in six cities ranged from 5-7% in Barranquilla, Tunja

and Buenos Aires to 32% in La-Paz-El-Alto.

In electricity, increases in four cities or private providers were much bigger,

ranging from almost 15% in SEEG in Gabon to over 30% in Luz del Sul and

Edelnor (Peru) and 37% in Union Fenosa (Guatemala). The privatization in Lima

has resulted in nearly universal coverage for two private companies. Coverage of

electricity increased also in Chile, with biggest increases for low-income

consumers (Estache, et al., 2000).

Expanded access to utilities can be seen in Argentina, Bolivia, Mexico, Nicaragua

and other Latin American countries. “Increased access is often large; the rate of

increase typically far exceeds that of the predivestiture period, and the Latin

American studies mostly conclude that poorer segments of the population have

benefited disproportionately from these increases” (Nellis and Bridsall, 2007, p.

22).

2. Efficiency

Another visible and rarely contested result of privatization has been improved efficiency

through reducing wasteful costs, including over-staffing, collecting fees and reducing

leakages resulting from theft, payment arrears and corruption in meter reading and billing

(in electricity and water).

Largest gains have been again in telecommunications and competition has enhanced

these gains. One study of 31 privatized companied in 25 developing and developed

countries found significant improvements in operating efficiency (Bortolotti et al, 2001).

In electricity, in Chile losses were cut by more than half after privatization (Estache and

Rodrigues-Pardina, 1998). Similar was the situation in 9 cases of private providers in

Argentina (7) and Chile and Peru (1 provider in each), though in some cases cuts were

smaller, but in others larger than 50% (Feler, 1999).

3. Quality of services

The previous section on the impact in individual industries has provided a number of

examples of the improved quality of services such as drastic reductions of waiting time

38

for phone installations and for dial tone, reductions of breaks in electricity or better

service in ports. In water, connections to networks results in health benefits. E.g., in

Argentina where during the 1990s 30% of municipalities privatized water services,

investments expanded not only access but also increased pressure, the time of supply and

reduced leakages. One study found a reduction of child mortality in the poorest areas by

25% and 5-9% on average (Galiani et al., 2002).

Another side of private provision is, that by separating oversight of utilities from

ownership, it is much easier (if regulatory frameworks are well designed) not only to

reward compliance with safety and security of supply standards but also to punish for

non-compliance in case a private provider cuts expenditures to boost profit margins. A

case in point is a $51 million fine imposed on Edesur company in Buenos Aires for a

major outage in 1995 (Feler, 2001). Such a response would have been difficult to imagine

under a public ownership.

4. Fiscal impact

Privatization has in many cases improved the fiscal position of governments through

eliminating or lowering subsidies, revenues from the sale of state-owned assets,

concession fees and taxes. Here are some examples:

Ferrocalires Argentinos, a railway company, received $1.5 billion of annual

subsidy. After private concession government expenses (related to investment)

fell to $100 million. Concessionaires started also paying $10 million in taxes

annually.

Argentina’s largest power company, SEGBA, lost $1.7 billion during the last

four years of public control. Government revenues from its sale amounted to

$110 million. In addition, after privatization SEGBA started paying taxes.

Owing to increased revenues from privatizations, many governments in Latin America

have been able to increase spending on health and education (Estache, Gomez-Lobo and

Leipziger, 2000). But some argue that public expenditure on infrastructure fell too much,

thus “taxing” infrastructure and reducing the amount left for investing and improving

services or resolving post-privatization problems. There are, however, cases when

revenues from fees from consumers were not sufficient and there were affordability

concerns, and some governments decided to continue re-oriented subsidy schemes to

supplement user fees and extend infrastructure services to rural areas and to ensure that

the poor can afford essential services (Wellenius, 1997; Cannock, 2001; and Gomez-

Lobo, 2001).

There has also been fear that increased revenues would postpone in many countries

desired fiscal adjustment and relax fiscal discipline. These fears by and large turned out

not to be justified: on the whole privatization in a sample of developing countries did

not have a negative effect on fiscal discipline (Barnett, 2000). But some countries,

notably Argentina and Brazil seem to have used revenues from privatizations to

continue unsustainable fiscal position (Nellis and Birdsall, 2007, p. 24).

39

5. Employment

Many public utilities were overstaffed and the shift to private provision has often resulted

in employment reductions to achieve more efficient levels of labour. Private participation

in railways led to reductions of 80,000 employees in Argentina and 18,000 in Brazil

(Kikeri, 1998).

Some private companies in telecommunications have, however, increased employment

where competition and falling prices stimulated increasing demand for services

(Petrazzini, 1996). In general, employment losses were short-term, with employment

increasing in medium term, with competitive restructuring completed and increasing

demand. But new job opportunities have not necessarily been exploited by those,who

have been laid off.

A suggested policy response to job reductions is to introduce schemes to compensate

workers who lose jobs and/or retraining programmes helping laid-off employees to start

their own businesses. But given weaknesses of welfare programmes in developing

countries, such schemes have rather been exception than a rule.

In some cases, employees benefited through higher wages resulting from increased

productivity and from participation in share schemes of privatized companies (Galal et

al., 1994, provides evidence for electricity, telecommunications and ports and Shirley,

2002, for Buenos Aires water concession).

6. Prices

The impact of infrastructure privatization depends on a number of factors. First, on what

was the pre-privatization level of prices compared to costs (as noted elsewhere in water

the price/cost ratio in developing countries was 30%). Second, what are post-privatization

efficiency improvements.17

Third, whether a post-privatization pricing regime includes

provisions for passing on (sufficient) cost reductions to consumers. Fourth, whether

governments eliminate subsidies or decide to continue them to compensate for

insufficient private revenues to compensate costs. And five, as some argue that private

finance involves higher costs that previous public one, this will act in the direction of

price increases.18

Opponents of private provision of infrastructure argue that privatization will inevitably

result in price increases. But, as evidence shows, this does not always have to be the case.

Here are some positive examples:

17

One study found that efficiency improvements in terms of reduced costs amounted on average to 10-30%

(Hodge, 2000). 18

The nominal cost of capital for private firms is higher than that for governments, because the latter have

recourse to taxpayers who provide an open-ended credit insurance to governments, in spite of the fact that

governments do not have superior to private firms capabilities to choose or manage infrastructure projects.

Therefore there is no reason to expect that the social cost of private finance to be higher than the social cost

of public finance (Klein, 1996).

40

In five of ten cases in Latin America, prices decreased following private

participation (McKenzie and Mookherje, 2002).

In electricity in Argentina prices were reduced by 40% post-privatization and in

Chile by 20% between 1988 and 1998 (Estache, Gomez-Lobo and Leipziger,

2000).

In spite of renegotiation of water concession in Buenos Aires, prices were still

14% lower than under public provision (Shirley, 2002).

In Cote d’Ivoire productivity gains in water and electricity were passed on to

consumers (Plane, 1999).

In Manila, initially water prices fell after the private concession in 1997, but by

2001 it exceeded the “public” level of prices.

A study, cited above, which found quite common increased access to utilities in Latin

America, also noted that “often, increased access is accompanied by higher prices (Nellis

and Birdsall, 2007, p. 23). In some cases, inexperienced regulators have found it difficult

to hold down or reduce tariffs in privatized infrastructure firms (ibid.). In other cases,

where pre-privatization cost-price discrepancy was large, efficiency improvements not

sufficient and governments not willing to continue subsidies, prices increased towards

cost-covering levels. Also, where average prices fell benefits were not necessarily

distributed among all consumers. For example, as a result of the elimination of cross-

subsidies, prices for subsidized consumers (such as residential consumers in water and

electricity and local-calls users in telecommunications) have often increased, while those

for carrying the burden of pre-privatization subsidies fell. In addition, if prices embodied

in regulatory frameworks do not reflect the cost of serving incremental consumers, price

reductions may turn out to be temporary. But as stated elsewhere, the need to raise

revenues from user fees to cover costs, in the absence of subsidies, is there, regardless of

whether provision is private or public, and many of the “private” price increases

reflected this need.

7. Impact on the poor

There is no evidence that, as some argue, the public provision of infrastructure services is

better for the poor than the private one. But this does not mean that the private provision

has improved the situation of the poor, either. This is only to say, that there is potential

for such improvement, but whether it is exploited or not, depends on post-privatization

government policy paying attention to the needs of the poor. In most cases, particularly in

the initial phase of infrastructure privatizations, governments did not pursue such policy

and attention to the situation of the poor is a recent development. In cases, where

governments wanted to help the poor with targeted subsidies, often only a small part of

these subsidies reached the poor, while most benefited better-off consumers.

There is much evidence that prior to privatization public utilities did not do a good job in

reaching the poorest consumers. In the early 1990s, in Ghana, Mexico and Peru, access to

water and electricity for the poorest 20% of the population was much lower, and in cases

of Ghana and Peru several times lower than in 20% of the richest (World Bank, 2004).

41

Furthermore a comparison of post-privatization experience in Africa found a higher

coverage of the poor by private utilities than that by public ones (Clarke and Wallsten,

2002).

In some post-privatization cases, the situation of the poor has improved:

In Chile in the case of power services access of the poor increased greatly for

low income groups during the first ten years of private provision (Estache, et

al. 2000).

In La Paz for all utilities access of the poorest 20% increased, after no change

during five years prior to privatization. In El Alto, gains were larger than in La

Paz in water and sanitation services (Foster and Irusta, 2001).

A study of ten utility privatization cases in Latin America, mentioned earlier,

than in nine cases poverty was reduced or did not change compared to pre-

privatization situation (McKenzie and Mookherje, 2002).

Improvements in the situation of the poor were also reported in three cities in

Colombia (Cartagena, Barranquilla and Tunja), and in Dakar, Senegal, in

comparison to eight publicly managed utilities in Africa (Harris, 2003, pp. 26-

27).

As mentioned elsewhere, connections of the poor to networks, where they

took place, represented also typically reduction of prices, as other sources

used by the poor before connection are more expensive (such as buying water

from informal vendors or relying on candles for lighting or batteries for

energy).

To repeat, these examples only serve to say, that private provision does not, by

definition, deteriorate the situation of the poor in distinction from public provision

which is, by definition, better for the poor. In many cases, perhaps in most, post-

privatization situation of the poor did not improve or deteriorated. Price increases,

wherever they took place, hit poor more than better-off, since poor spend much

higher share of their income on such necessities as water, local transport and

electricity. It is poor that have in most cases been victims of the reduction of leakages

of water and electricity and improved revenue collection.19

Governments have possibilities to mitigate this negative impact by subsidizing or

defraying connection costs, providing consumption subsidies such as lifeline tariffs,

which subsidize low levels of consumption. But subsidy schemes have to be designed

in a way targeting not well-off consumers but the poor ones, which is more often than

not the case with the existing subsidy schemes (Harris, 2003, p. 29).

8. Conclusion

19

In Argentina, 436,000 of the first 481,000 additional subscribers to the privatized electricity system were

those who formerly had illegal connections (Delfino and Casarin, 2001, p. 23).

42

There is consensus in the literature that in general privatization of infrastructure has

resulted in positive economic and sometimes social results. Moreover, on two counts

most often raised by the critics of privatization – unemployment and the impact on

the poor -- recent and rigorous studies have concluded that overall, privatization has

contributed only slightly to rising unemployment and inequality and that it either

reduced poverty or had no effect on it (Nellis, J., R. Menzenes and S. Lucas, 2004).

Here are conclusions from two comprehensive reviews of the literature on

privatization, dealing largely with the privatization of infrastructure:

“The vast majority of economic studies praise privatization’s positive impact at

the level of the firm, as well as positive macroeconomic and welfare

contributions. Moreover, contrary to popular perceptions, privatization has not

contributed to maldistribution of income or increased poverty – at least in the best

studied Latin American cases” (Nellis, 2006, p. 1). Furthermore in infrastructure

industries “privatization has also produced improvements in infrastructure

industries, most often and obviously in telecommunications (where technological

change has made competition relatively easy to introduce and maintain, and

private provision has become the norm) and transport, less sweeping but steadily

in electricity and more problematically in water. What is often overlooked is that,

even in the more difficult sectors and settings, private involvement in

infrastructure generally produces results superior to those previously attained by

the public provider” (ibid., p. 23).

In the extensive literature review Megginson and Netter (2001, p. 380) conclude that

“privately-owned firms are more efficient and more profitable than otherwise

comparable, state-owned firms”. After examining 204 privatizations in 41 countries

(in all sectors, but much of it in infrastructure) they put also some perspective on the

success (and failure) rate by finding that in 20% to 33% of privatized firms there was

only slight or no improvement and in some cases, performance deteriorated (ibid., pp.

355-356).

D. The sources of discontent

In spite of this generally positive assessment by the literature, privatization, including

infrastructure privatization, has not been a popular reform. An initial support to

privatization has turned into almost general rejection of it, not only in Latin America,

a leader in privatization, but also across other developing and transition countries.

Joseph Stiglitz has campaigned for slower and more deliberate privatization and

many critics have concluded that privatization should be entirely opposed (Nellis and

Birdsall, 2007, p. 1).

Thus, the question is, why there is so much discontent with infrastructure

privatization?

Popular perceptions about privatization are not shaped by academic and other studies

or by economists and other experts making balanced judgments on the basis of the

43

“majority” or “great number” of studies or “overwhelming evidence”. They are

shaped by general public and media on the basis of negative experiences of some

groups of populations or failures of individual projects, which are picked up by media

and opponents of globalization. As is clear from the previous section, that although in

minority, there has been enough negative experiences with massive lay-offs, rising

prices and deteriorations of individual situations. In addition, privatization not

undertaken in a transparent manner has been often associated with corruption, not

only in popular mind, but also in well documented cases.

Thus a picture of privatization, which has been accepted by many is that

“privatization ….. throws masses of people out of work or forces them to accept jobs

with lower pay, less security and fewer benefits; raises, too far and too fast the prices

of …….. services sold; provides opportunities to enrich the agile and corrupt; and

generally makes the richer rich and the poor poorer” (Nellis and Birdsall, 2007, p. 1).

Governments in many countries, including those which benefited from privatization

(at least according to economic and social analyses), facing popular discontent have

done little or nothing, to try to change or balance this picture. When private investors

were foreign, they turned out to be convenient scapegoats not only for media but also

for some governments. The more so that privatization redefines the balance of power

and among losers are bureaucrats in sectoral ministries, who lose their authority perks

and perhaps even raison d’etre and managers and board members of public

enterprises, to be removed, but typically well connected to the Government.

But privatization of infrastructure in many cases benefited large segments of

populations, providing them with more, better and cheaper services. How come these

improvements seem to have gone unnoticed (again, except in economic and social

studies)? As with trade and many other economic issues, explanation is that benefits

are widely dispersed while costs are concentrated and more visible. As noted in one

study “modest average price declines thrill economists but not the broader public”

(Nellis, 2006, p. 20). For example, in several Latin American countries post-

privatization real electricity prices fell by 5-10% and in telecommunications even

more. While bringing welfare gains and welcomed by masses of consumers, such

changes typically do not mobilize beneficiaries in favour of the policy or the

reforming government.

By contrast, negative effects, especially dismissals, are concentrated and thus visible,

and typically strongly opposed by powerful public sector unions. Well-off consumers

about to lose subsidies also represent a strong opposition to unwelcome changes and

often press governments not to change policy to their detriment. Thus “losses of

comparatively large magnitude, among stakeholders of this nature, typically result in

protest, direct political action, or equally (if not more) effective bureaucratic delay

and misdirection. It is easier to mobilize protest against losses, and generate sympathy

for the losers than to engender gratitude for gains” (ibid., p. 20).

In addition, at the beginning of privatizations, to gain popular support, governments

often oversold privatization as a key to rapid and sustained growth and social

44

progress. The result was unrealistic expectations and broken promises and when they

were not fulfilled, the backlash was strong. Governments typically overestimated

their capacity to manage high expectations of consumers and the electorate and have

often chosen to behave opportunistically. Many governments, which initiated and

implemented privatization, lost power and were replaced by new ones, winning,

among others on anti-privatization banners. But few of the latter, if any, have tried to

turn the privatization-clock and return to public provision.

In a dense atmosphere around privatizations, the nationality of private investors, most

of them foreign, in infrastructure and other services, notably banking, has become an

issue, not only in developing but also in developed countries. Any real or perceived

misbehavior of foreign investors catches the public’s eye and memory easier than

domestic ones and becomes often an election issue, reducing the pool of future

potential investors in infrastructure in the absence of domestic alternatives.

This is of course not to say that the criticism of infrastructure privatization is not

justified. It is. There were many negative economic and social effects of privatization,

but not the majority and not across the board as it is sometimes asserted. Mistakes

have also often been made and promises have been broken but, again, in minority of

cases. Also generalizations about privatization have proven unfounded: that it leads to

(permanent) losses in employment and it is always at the cost of the poor. Overblown

criticism makes it more difficult for experienced privatizers to correct mistakes of the

past and for newcomers to learn from bad experiences of their predecessors, which

remain in most cases the only practical way ahead.

IV. POLICY ISSUES

A. Policy reforms

Since the mid-1980s, developing countries and transition economies have begun to

permit private investment in infrastructure. Today most of them have at least some

private provision of infrastructure services, which in most cases involves foreign

provision in the form of FDI or non-equity FDI.

Most countries in Asia and many in Africa have attracted private investment to

unreformed infrastructure systems. In these countries public monopolies have maintained

their central role and private providers have been expected to increase the supply of

services, which have been sold to SOEs and not to final consumers. The system has been

based, as before, on vertically integrated public monopolies, and managed by

governments which, among others, have set the tariffs and subsidized certain types of

consumers through either differentiated tariffs (called cross-subsidies) or direct payments

financed from taxes.

Conversely, many countries of Latin America and Central and Eastern Europe have

undertaken deep reforms of infrastructure industries, aimed at their rehabilitation and

expansion through increasing efficiency, while at the same time maintaining social

45

considerations such as extending services to disadvantaged, protecting the poor, universal

provision of services, ensuring safety standards and protecting the environment. As

infrastructure services are important inputs into any economic activity, increasing

competitiveness of the economy through cheaper and better infrastructure inputs has also

been often a declared consideration.

The central idea underlying reforms has been to introduce as much competition as

possible and to provide these services on the basis of economic considerations, including

incentives for cost control and pricing20

that covers not only operating costs but also

investment to expand the supply and improve the quality. This requires unbundling, that

is, the separation of non-competitive from competitive segments of each industry (table

1). Non-competitive parts typically include transmission and distribution networks:

transmission lines in electricity, cables and switching centers in fixed line

telecommunications, track, signals and stations in railways, pipes and sewers in water and

airports (landing strips) and ports in transportation. Networks, placed between upstream

production and downstream supply, are very capital-intensive, involving large fixed sunk

costs and assets that are of minimal use for other purposes. Once built, they are location

bound and cannot be moved to another location like a manufacturing plant could by

moving machinery and other equipment. It would be uneconomical to introduce

competition into these activities: too costly and too to risky to duplicate networks. They

therefore retain the characteristics of the natural monopoly. But most other upstream and

downstream segments of these activities (table 4) can be subjected to competition.

Although some also involve economies of scale and some sunk costs, these are small

compared to the network requirements. In addition, technological progress reduces scale

requirements, lowers costs and introduces new sources of competition, especially in

electricity, telecommunication and transportation.

Table 4. Competitive and non-competitive segments of infrastructure industries

Industry Segments that are usually

non-competitive

Segments that are potentially

competitive

Railways Track, stations and signaling

infrastructure

Train operations and maintenance

facilities

Electricity High-voltage transmission and

local electricity distribution

Generation and supply to final

consumers

Telecom Local residential telephony or

local loop

Long-distance, mobile and value-added

services

Water Local distribution and local

wastewater collection

Production, long-distance

transportation, purification and sewage

treatment

Air

transport

Airport facilities such as take-

off and landing slots

Aircraft operations, maintenance

facilities and catering services

20

Under the old public model, governments often kept prices well below the costs of production. At the

beginning of the 1990s, the average ratio of revenues to costs in developing countries was only 30% in

water and 60% in electricity, but 1.6 in telecommunications. Deficits were covered either by transfers from

public budgets or by deterioration of assets through inadequate maintenance (Harris, 2003, p. 13).

46

Source: Gonenc, Maher and Nicoletti, 2000, p. 65 and Kessides, 2004, p. 37.

Thus unbundling is a key component of market-based reforms in infrastructure. It should

involve not only vertical unbundling of competitive and monopoly components of each

industry, but also horizontal one (e.g. splitting a national network into regional ones

and/or permitting several producers to supply one network and sell services leaving the

network, if economies of scale can support several producers)21

to fully exploit potential

for competition. Unbundled parts and firms should be operated by different owners,

competing with one another in competitive segments. Restrictions on ownership

(including discrimination between foreign and local investors) and entry of new firms

should be relaxed or altogether abolished. Network segments involving natural monopoly

– regardless of whether publicly or privately owned – and interactions between

competitive and non-competitive segments should be regulated by special legislation,

implemented by independent regulatory agencies. And finally the provisions to meet

social objectives should be part of regulations.

Note that privatization of services delivery through divestitures or greenfield investment,

the most visible manifestation of reforms, is but one component of reforms, not

necessarily the most important one. It is unbundling, competition and effective regulation

that are the key components of successful infrastructure reforms. Witness, for example,

attempts to deregulate and liberalize services within the internal market programme of the

European Union. While doing this through dismantling monopolies, regulatory reform

and introducing more competition, the EU does not have competence on ownership

matters. As a result many infrastructure companies in Europe remain publicly or partly

publicly owned, increasingly competing with one another and with private firms. Many

of them turned into leading TNCs in infrastructure industries worldwide. It is possible,

because the reform involves the entire huge market of the European Union, which can

accommodate many companies in a single industry. There is also a little chance of

regulatory capture of a regulator – the European Commission – at the level of the EU by

companies or governments (although there are such attempts within individual countries

– witness government supported delays in opening up national markets to competition in

telecommunications in Germany and France).

But in national markets privatization of delivery is generally a natural complement to

reforms. Private companies are considered superior to public ones in efficient

performance. In a number of countries it has been hard to improve the performance of

SOEs, especially to turn round highly inefficient ones. Furthermore, it would not make

sense to unbundle a monopoly into several companies supposed to compete with one

another and to leave them under one (public) ownership. When government is no longer a

provider of services it can more easily allow genuine competition and perform regulatory

function via independent agencies. Combining ownership with regulatory function does

not work. In many countries, privatization has often preceded unbundling, regulation and

the establishment of regulatory agencies. This may be understandable, given that utilities

were worn out, SOEs were on the verge of collapse and indebted governments lost the

financial capacity to continue to support them. But unprepared and partial reforms

21

In small countries this is not always possible, given small size of national markets.

47

resulted in replacing a public monopoly with a private one. Although, as indicated in

chapter I, such a change resulted in some improvements, it also brought lasting economic

and social cost and stalled or delayed further reforms.

Introducing competition-based infrastructure reforms is a tall order, not only in

developing countries lacking institutional and regulatory capabilities but also in

developed countries, as the examples of the failure of railway privatization in the United

Kingdome and electricity shortages in California indicate. Many things, in addition to

improper sequencing of reforms, mentioned in the preceding paragraph, can and have

gone wrong, limiting and/or delaying expected positive results of reforms, reducing

public support for private provision of infrastructure services and enthusiasm of both

governments and investors. There is a large literature analyzing infrastructure reform

experiences and proposing further course of action. What follows is a brief discussion of

some key problems.

The inability or unwillingness to overcome the legacy of the past lies at the heart of many

recent problems with reforms. Prices of services, especially those of water and electricity,

have always been politically sensitive. Therefore, under the old public model,

governments kept prices well below the costs of production. At the beginning of the

1990s, the average ratio of revenues to costs in developing countries was only 30% in

water and 60% in electricity, but 1.6 in telecommunications. Deficits were covered either

by transfers from public budgets or by deterioration of assets through inadequate

maintenance (Harris, 2003, p. 13).

When subsidies proved no longer to be sustainable, governments turned to private sector

provision. Some of them, relieved from the burden of subsidies and uplifted by revenues

from the sale of infrastructure assets, have, however, overlooked the key issue of the past,

namely that services have to paid for either by users or taxpayers, regardless of whether

provision is public or private. In many cases, private operators have been able to reduce

costs so that prices that were not sustainable under public provision could not only cover

costs, but as shown in chapter II, they could even be lowered. But in other situations were

prices were much lower than costs, efficiency improvements alone could not help and, in

the absence of subsidies, tariffs had to be raised, provoking often outrage by consumers

and NGOs. Even if governments understood the need for price increases and agreed to

economically justified tariffs, they often overestimated their ability to manage the politics

of reform. In still other cases governments “behaved opportunistically, promising rational

tariffs and other policies to attract investors but then hoped to renege on these

commitments once investments were made” (Harris, 2003, p. 13), a classic case of

obsolescence bargaining.

Problems related to implementing and sustaining the reform process have been more

acute in electricity and water than in telecommunications, ports, airports and rail freight.

The latter sectors do not serve or serve less the general public than the former ones. In

addition, as shown above, electricity and water services were under-priced much more

than other services, thus requiring much larger price adjustments, and attracting the

largest amount of criticism, including from NGOs.

48

In many cases of problematic investments, investors have not been blameless, either,

overestimating the ability of governments to manage reforms, to honor their

commitments and to sustain stable macro-economic policies, excluding the risk of

devaluations, damaging business plans of projects involving foreign investors.

Miscalculation of risks and neglecting sound project fundamentals might have been

caused by the belief of some investors that, given the importance of infrastructure, should

a project go wrong, government would step in bail them out. There were also cases of

over-bidding by investors in telecommunications (for radio spectrum in developed and

developing countries) and in electricity in larger countries, caused by a perceived

pressure to take a strategic position in important markets.

Problems with a number of infrastructure projects, public disappointment with

privatization and declining levels of private investment in infrastructure have brought

back the issue of private vs. public provision of infrastructure. Governments have

sometimes made private (foreign) investors scapegoats for price increases, reinforcing

sentiment against privatization. Among many opinions evaluating the experiences with

reforms of infrastructure, a credible one seems to be that private participation in

infrastructure is neither a panacea nor the root cause of problems experienced during the

past decade. “With the new institutional arrangements brought in by private provision, it

became much more difficult to sweep difficulties such as unsustainable pricing policies

under the carpet. Legally binding contracts and hard budget constraints replaced the lack

of accountability and financial discipline by public enterprises. This flashed into the open

the problems that had been left unattended during the era of public sector provision”

(Harris, ibid. p. 15). This explains the reluctance of many governments, often critical of

private providers, to go back to the public model: governments realize that the public

provision will not solve the problem of rational pricing of utilities, as it did not in the

past. Hence the small number of cancellations, attempts to re-privatize rather than

nationalize failed projects and continued desire to attract new private investors even in

countries showing strong disappointments and policy reversals vis a vis earlier private

projects. This indicates that the only feasible solution for the future is to learn from past

experiences to improve regulatory frameworks, to strengthen institutions and wherever

needed to put projects on more realistic basis through renegotiations.

B. FDI policy: to what extent countries allow FDI and TNCs in infrastructure?

By the mid-1980s, when the process of FDI liberalization accelerated, mainly in

manufacturing, and became the norm worldwide, infrastructure services were closed to

FDI in most countries of the world. The rapid growth of FDI in infrastructure services

during the 1990s, in particular in telecommunications, electricity and water, worldwide

and in developed and developing countries, is testimony to progressing liberalization of

FDI in these services. Between 1990 and 2002, the dollar value of total inward stock in

electricity jumped by 14 times and that in telecommunications and storage and transport

rose by nearly 14 times, resulting in significant increases of the share of these industries

in world stock of FDI (UNCTAD, 2004, pp. 98-99). In spite of that, by 2004, both in

developed and developing countries, telecommunications and electricity have remained

49

the most heavily restricted industries, as regards FDI (UNCTAD, 2006, p. 19). One could

add to that list water and transport infrastructure (airports, ports and railways), which are

typically overlooked in this type of analysis. Moreover, based on data in chapter I, one

can reasonably assume that these industries are even more restrictive to FDI than

telecommunications and electricity. They are, however, more open than is the case of FDI

to TNC activities in the form of non-equity agreements.

During the initial phase of FDI liberalization in infrastructure services, there has been a

strong correlation between liberalization and FDI inflows. This is in clear distinction

from manufacturing and many other service industries. In manufacturing, all countries

are not only open to FDI but are competing with one another for certain types of this FDI,

but only a few receive it in satisfactory quantities. In infrastructure services, it seems,

most countries, which initially wanted FDI, received it. One explanation is, that the

process of FDI liberalization in infrastructure services started practically almost from

zero level some 15-20 years ago. Another is that with few exceptions, such as mobile

telephony, entry into a host country, regardless of its form (greenfield, privatization or

non-equity forms) gave a TNC or other investors a guaranteed, already existing market,

with significant potential for long-term growth, given huge unsatisfied demand for

infrastructure services. In addition, as mentioned above, in many cases entry was often

associated with a monopoly position, sometimes guaranteed in contracts for many years.

Few TNCs could have resisted such opportunity, and initially infrastructure projects

typically had several bidders, on average four in developing countries [source]. The

relationship between liberalization and FDI weakened significantly around 1997-1998,

when cracks occurred in many projects (see chapter I) and cancellations, renegotiations

and disputes multiplied.

Liberalization of FDI in infrastructure services is in some ways distinct from that in

manufacturing and many (not all) other services. FDI in manufacturing is more often than

not based on the rules -- rules of entry, treatment and operations of investors – which are

often, especially in developing countries, clearly spelled out, and legally binding in

investment codes and some international agreements (e.g. TRIMS). Even if codes or

agreements cover all industries, infrastructure industries are the most frequent exceptions,

sometimes included in constitutions. In infrastructure services, FDI liberalization has

been associated with the shift from public to private provision of services through

divestitures, greenfield projects or concessions and other types of contracts. Therefore,

allowing FDI has involved case-by-case (or rather project-by-project) unilateral decisions

of countries. Case-by-case opening is normal, given that opening to FDI has been

associated with the sale of already existing public monopolies, with state as a sole owner,

to private investors. Also in the case of greenfield infrastructure investment there has not

been a wholesale opening up to FDI, as infrastructure projects are localized and

associated with the existing market, national or regional wihin countries. Thus decisions

concerning the choice of investors are typically done through the process of bidding for

each project pre-approved by a central or local government. This resembles and old, long

abolished, FDI screening process for large projects in manufacturing industries. Even in

competitive activities, such as mobile telephony, governments can control entry through

licensing of new operators. In addition, infrastructure projects, including privatizations,

50

are typically based on agreements, with a government as a party, influencing terms and

conditions of each project and being able to impose obligations on investors – an

equivalent of performance requirements in manufacturing industries.

But still, at the beginning of the 21st century, all groups of countries are much more open

to FDI and TNC activities in infrastructure services than they had been some 20 years

ago. At the same time, FDI policy in these services is still much more restrictive than in

the manufacturing sector and many other services (such as business services or tourism).

In manufacturing, FDI policies of countries have largely converged towards liberalization

As regards infrastructure services, as hinted in chapter I, there are still huge differences

among countries and across industries as regards a degree of openness to FDI and TNC

activities.

Measuring a degree of restrictiveness or liberalization of FDI policies is difficult and

there are not too many studies dealing with this issue. Few studies which do, are based on

descriptive analyses. One study has, however, attempted to quantify a degree of

restrictiveness of FDI policy in 11 service industries, 18 sub-industries and 50 developing

and transition economies,22

including in telecommunications, electricity and

transportation (UNCTAD, 2006). Transportation includes all types of transportation, but

does not distinguish transportation infrastructure, of interest here (operation of ports,

airports, toll roads, tunnels or bridges) from other operations such as coastal

transportation, airlines or railway companies. The study covers entry restrictions,

screening and approval procedures and operational restrictions on foreign management,

expatriates and labour market or other restrictions. Every restriction is given a score,

which are then summed up for every country and or industry to determine a degree of

restrictiveness on a 0-1 scale, with 0 representing full openness and 1 a prohibition of

FDI.

In spite of the shift to private delivery and FDI liberalization, infrastructure services are

the most restrictive among services industries in developing and transition economies,

with electricity and fixed line telecommunications leading the list, with a degree of

restrictiveness, respectively, 0.6 and 0.48 (figure 2). The least restrictive service industry,

constructions, scores 0.18 in 50 countries.

22

14 countries from Africa, 13 from Asia 17 from Latin America and the Caribbean and 6 transition

economies.

51

Figure 2. Restrictiveness of FDI policy of 50 developing countries in

service industries, 2004

0 0.1 0.2 0.3 0.4 0.5 0.6

ElectricityTelecom fixed

RailDomestic air

International airTelecom mobile

FinanceTrans. Dom.

Trans. Int. maritimeRoads

BusinessTourist agency

DistributionEducation

Hotels & Rest.Construction

Source: UNCTAD, 2006, p. 36

As regards regions, Asia is the most restrictive region for FDI in infrastructure industries

among developing and transition economies regions and transition economies of Central

and Eastern Europe the least restrictive, followed by Latin America and Africa (figure 3).

As regards individual industries – power, telecommunications and transport – the pattern

of regional restrictiveness is similar to the average with, however, few exceptions. Asia is

the most restrictive region in all three industries. In telecom Africa is slightly less

restrictive than Latin America. In transport, transition economies are more restrictive than

both Africa and Latin America and in power more restrictive than Latin America, which

is thus in this industry the least restrictive region. As rankings are based on average

country and industry scores for each region, transition economies owe the best average

score to much lower degree of restrictiveness level in telecommunications than that in

other regions (figure 2). Within some regions, notably Latin America, there are big

differences among individual countries as regards an average level of restrictiveness in

the three industries. Five Latin American countries are among the ten least restrictive

developing and transition economies, but three are also among the top ten most restrictive

(seven are Asian countries). Three African countries are among the least restrictive along

with two transition economies (figure 4).

52

Figure 3. Restrictiveness of FDI policy in infrastructure, by regions and

industry, 2004

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

All Telecom Transport Power

ASIA

AFRICA

LATIN AMERICA

TRANSITION

Source: UNCTAD, 2006, p. 10.

Within individual countries the pattern of restrictiveness by industry is correlated.

Seventeen countries out of 50 has a total ban on FDI in electricity (the score equaling 1):

Kenya, Mauritius, Mozambique, Nigeria, South Africa and Tunisia in Africa; Costa Rica,

Mexico, Paraguay and Uruguay in Latin America; Indonesia, Republic of Korea,

Malaysia, Saudi Arabia, Thailand and Turkey in Asia; and Romania in transition

economies. The average level of restrictiveness of the seventeen countries in

telecommunications is 0.57, compared to 0.45 for all countries in the sample and for

transportation 0.39, compared to 0.35. The only exception is Romania, which is totally

closed to FDI in electricity and almost totally open to FDI in telecommunications (with a

score 0.08).

UNCTAD study provides a picture of the restrictiveness of FDI policy in 50 countries

representing all developing and transition country regions. Its findings are in general in

line with findings based on descriptive information on the role of SOEs in infrastructure

industries in all or most countries of these regions. (Note that the greater the role of SOEs

the less room for FDI). But there are some differences, especially as regards some regions

and countries.

Africa comes out as more restrictive than in the UNCTAD study. In most countries of

Sub-Saharan Africa the water, electricity, telecommunications, railways and airlines

industries are still state-owned and operated. The role of governments is even greater in

West Asia and North Africa, where in many if not most countries where critical services,

not only infrastructure services are still provided mostly by the public sector. Latin

America has emerged as a clearer regional leader among developing countries, as regards

privatization of infrastructure. But the privatization activity has been concentrated in two

large countries – Argentina and Brazil (Mexico is an exception among large countries)23

23

In Mexico, there are big differences among individual industries. The privatization process included

ports, several airports and railroads, while SOEs have remained in electricity, other transport,

53

– and a few smaller ones, such as Jamaica, Bolivia, Chile and Peru. In a number of other

countries of the region, state enterprises are still in operation. In Europe and Central Asia,

in spite of recent advances in privatizing telecommunications, there is still a large stock

of utilities (especially in electricity and water industries) that are state-owned. Most of

Asia (other than West Asia) has lagged behind other regions and especially Latin

America and transition economies of Europe in privatization activities, permitting private

investment, in most cases foreign, in the form of greenfield projects. In China and India,

SOEs dominate key infrastructure activities (Kikeri and Kolo, 2005, pp. 15-19).

As regards infrastructure industries, in descriptive analyses of countries included in the

World Bank PPI data base, telecommunications and electricity emerge as more open to

private activities than water and transport. Restrictiveness of transport comes as a

surprise, when compared to the UNCTAD study. But it is probably so, because the data

base covers only transport infrastructure while the UNCTAD study focuses more on

operations of transport firms. In addition the data base covers all types of private

participation, including non-equity forms. Thus in transport infrastructure nearly 60% of

all developing countries do not have any form of private infrastructure, thus excluding

FDI and TNC activities. Transport concession have been concentrated in Latin America

and East Asia, with minimal or no activity in other regions. In water, in 70% of all

developing countries there is no private participation (ibid., p. 20).

In electricity and power, the number of countries with SOEs is also relatively high, but it

is not representative of FDI or TNC restrictions, because as mentioned before, in both

industries SOEs can coexist with private (including foreign) operators. For example,

countries in Asia have retained SOEs in electricity, but a number of them has permitted

foreign investors in Greenfield projects. In telecom SOEs in fixed telephony can coexist

with private investors in mobile service.

Electricity utilities are still owned and operated by the state in 85, or 55%, of all

developing countries in the PPI data base. But a more detailed survey of 52 developing

countries shows that in many of them private independent power providers (many of

them presumably foreign) operate along with SOEs. Thus almost 70% of these countries

had not started or completed the process of bringing private participation into electricity,

while 18% had begun the process at the beginning of the 21st century. But independent

providers had been established in 67% of these countries and another 21% planned to

open electricity markets to these providers (ibid., pp. 19-20). Full state ownership of

power utilities is prevalent in low-income countries. It is so in 32 out of 47 countries of

Sub-Saharan Africa, while only eight countries have had concession contracts and seven

management or lease contracts (Gokgur, 2004).

In telecommunications, in line with previous findings, the greatest room for private

participation and TNC activities exists in transition economies of Europe and Central

telecommunications and postal services (Source: OECD, Regulating Market Activities by Public Sector, 1

February 2005).

54

Figure 4. Restrictiveness of FDI policy in infrastructure in developing

and transition economies, 2004

0.00 0.10 0.20 0.30 0.40 0.50 0.60 0.70 0.80 0.90 1.00

UgandaCzech Rep.

ArgentinaSenagalJamaica

BoliviaTanzaniaHungary

GuatemalaChilePeru

El SalvadorGhana

Trinidad &Mongolia

DominicanColombia

IndiaVenezuela

PolandPakistanEcuador

AlgeriaNigeria

RomaniaQuatar

SloveniaMorocco

EgypParaguay

BrazilRussian Fed.

Sri LankaChina

MozambiqueKenya

TunisiaSouth Africa

MauritiusEthiopia

Korea Rep. ofMalaysiaThailand

TurkeyUruguay

MexicoPhilippines

IndonesiaCosta Rica

Saudi Arabia

Asia where, respectively, in only 40% and 30% of countries telecom operators were fully

state-owned and operated at the beginning of the 21st century. In West and South Asia,

respective shares were 65% and 60% (ITU, 2003). In Sub-Saharan Africa, the picture is

varied. The main operator has been fully state-owned in 27 countries. In 17 of these

55

reforms have not started, while in the remaining 10 they have been initiated but stalled or

delayed for political and/or market reasons. The remaining 20 countries have had varying

levels of private participation, mostly foreign [CHECK], but only Somalia is fully

private. 13 countries have majority private participation, while six sold minority shares to

private investors (World Bank, 2005).

In developed countries, FDI in infrastructure takes mainly the form of cross-border

M&As: foreign investors have acquired infrastructure networks that had already been

privatized, participated in privatizations of networks and in PPPs. For example, in OECD

member countries FDI inflows into transportation and telecommunications, typically

reported together in FDI data, increased as a share of total inflows into the services sector

from 0.5% in 1990 to 16% in 2002, largely as a result of privatizations and investments in

mobile telephony and multimedia companies (OECD, 2004). During 1993-2002, the

average share of infrastructure industries in total FDI inflows of selected OECD countries

with data was 9%. For individual countries proportions varied from 6-7% in Italy and

Spain (known for the protective attitude towards infrastructure) and 16% in Sweden and

20% in the United Kingdom (Davies, 2004, p. 31), which are among the most liberal

countries for infrastructure services. Protective attitudes of some developed countries vis

a vis own infrastructure enterprises, such as France, Italy and Spain, do not prevent and

most likely help these enterprises to expand abroad in both developed and developing

countries. As a result the share of infrastructure services in outward FDI is much higher

than in inward FDI, e.g., in Spain 23% vs. 7%.

Increased role of FDI in infrastructure services of developed countries has taken place in

the context of infrastructure reforms which started in the United States in the late 1970s

and accelerated during the 1980s. These reforms in air transportation, rail, road transport,

telecommunications, gas and electricity took the form of deregulation of markets and

dismantling of private monopolies, as the United States did not have state-owned

companies. The United Kingdom, which had SOEs, followed during the 1980s and 1990s

with privatizations and deregulation. In the 1990s, the European Union joint the

reformers with a single market programme, issuing directives, which liberalized and

created a common regulatory framework in telecommunications, railways, electricity and

natural gas markets. The emphasis of the EU reforms is, as mentioned earlier, not on

ownership, but on unbundling, introducing competition and regulating remaining natural

monopoly elements.

The liberalization of FDI policy in infrastructure followed, but as with developing and

transition economies, it has been uneven across countries and sectors. Consequently,

OECD countries still have a relatively restrictive FDI environment in electricity,

transport, telecommunications and water by comparison with other industries, often

taking the form of explicit limits on foreign ownership of domestic firms (Davies, 2004,

p. 5). As regards post-entry restrictions, as measured by exceptions from national

treatment, they are also most common in infrastructure industries. On the matrix of

exceptions from national treatment, organized by OECD member countries and

individual industries, 45% of the entries fall within the category of infrastructure services,

especially air and maritime transport, postal services and telecommunications and

56

electricity (Davies, 2004, pp. 9-11). Remaining restrictions are motivated by various

reasons in different countries, ranging from national security and protectionism to

competition and consumer protection. A number of European countries pursues a policy

of promoting national champions – witness defensive actions of a number of

governments in recent years preventing national champions from foreign takeovers. With

the emergence of infrastructure TNCs from developing countries, more and more

frequent are the cases of government intervention in developed countries, directed

specifically against foreign takeovers by developing country TNCs.

C. Policies to benefit and address concerns

Given the pressing need of developing countries to improve and expand infrastructure,

very high capital intensity of infrastructure projects, low savings rates and

underdeveloped local capital markets in developing countries, FDI is likely to continue to

play a major role in infrastructure of these countries. The scale of infrastructure needs

and associated necessary financing are so vast that no viable alternative exists to satisfy

all these needs. In addition in many countries, where finance could be available, at least

partly, there will be no local investors ready to undertake risky projects at the sufficient

level of efficiency. This is not to say, of course, that all developing countries in all

infrastructure industries will have to rely on FDI or TNCs. But many of them, especially

low-income countries, will.

However, attracting FDI into infrastructure may no longer be so easy as it was in the first

half of the 1990s. Not only the internal opposition to the privatization of infrastructure

(and to infrastructure TNCs) has grown in many countries but also many investors have

been put off by failures of projects due to governments reneging on their promises,

regulatory takings or obsolescence bargaining. A number of investors withdraw from

developing countries and many are in the middle of disputes or renegotiations of the

terms of agreements with host governments. This makes investors realize that they

wrongly calculated risks of investing in developing countries and substantially weakens

their appetite for further investments. Therefore developing country governments wishing

to attract FDI will need to pay greater attention than before to reducing their countries’

risks as far as they are related to their policy, legal and regulatory environment and

handling of infrastructure FDI so far.

The key message from chapter III on the impact is that countries which went further in

reforming infrastructure services, and did it well, benefited more. Thus improving

policy, legal and regulatory frameworks and strengthening institutions and capabilities

will not only make it easier to attract FDI but also to increase benefits from FDI, or any

type of private provision of services. Reforming infrastructure is not an FDI issue. But

attracting FDI into it is, in the absence of many other investment alternatives. The fact

that TNCs have participated so far in over 85% of private infrastructure projects in the

developing world makes de facto all issues, including issues related to impact and policy

issues, TNC-related issues.

57

As is clear from preceding discussions, broadly speaking, there are two groups of

countries in the world as regards the participation of TNCs in infrastructure. One group

includes countries, which attracted FDI into a traditional public model of infrastructure

provision, relying on SOEs with heavily subsidized infrastructure services. The main

objective of these countries as regards FDI has been to increase the production of

services. Another, growing group of countries have attracted FDI into a new, still largely

experimental system, relying on the private provision of services. The (implied)

expectations of these countries vis a vis TNCs have been that TNCs will contribute to

achieving the objectives of reforms, that is, will not only increase the production of

services, but also expand coverage to all segments of population, improve the quality of

services, make them cheaper and more efficient, and provide revenues to the government

and let it get away from costly subsidies. Now, some two decades later reforming

countries are in different situations. In some, reforms are quite advanced while in others

reforms are partial. Some countries, including many LDCs have not yet started

reforming. The implication is that the needs of these countries as regards policy

improvements vary greatly. Countries with advanced and relatively successful reforms

debate how to fine tune the details, e.g., what types of tariffs are best for each industry,

what types of subsidies or policy measures best reach the poor, how to introduce more

competition and reduce the need for regulation. Others, which gave private investors

monopoly rights struggle with how to force them to share benefits with broader

population and business. Those which are about to start privatizations focus on how to

avoid mistakes made by pioneering privatizers.

As already noted, infrastructure reforms are objectively very difficult and pose one of the

greatest policy challenges to developing countries. Even pioneering developed countries

such as the United States and the United Kingdom, which had enough time to un-bundle

monopolies, prepare institutions and regulatory frameworks did not avoid some serious

mistakes. It is worth to remember that many developing countries initiated infrastructure

reforms under the pressure of the situation, with infrastructure or parts of it crumbling,

SOEs in bankruptcy and government coffers empty in the middle of the debt crisis. Many

were preparing the necessary regulatory and institutional components of reforms while at

the same time pursuing privatization and opening up to FDI (for the first time ever in

these services) in the absence of domestic investors (though in some large countries

domestic investors competed with foreign ones for the purchase of state-owned assets).

Mistakes have, therefore, been unavoidable, reducing benefits from private participation

and FDI. In many cases less than optimal choices were deliberate, given the difficult

political economy of privatization in general and infrastructure reforms in particular.

What follows is a brief discussion of key policy areas, which are important for successful

reforms, and by extension increase countries’ chances to benefit more from FDI at the

same time reducing concerns related to FDI. Privatization-related issues are omitted in

this discussion, as they have been extensively examined in UNCTAD, 2004, pp. 187-194

(see, for example, box V.2 Check-list for privatizing services through FDI, p. 190).

It is trivial to note, that for reforms or any policy to have a chance to be successful,

governments need first to establish clear objectives, to build consensus around these

58

objectives through public education and consultative mechanisms and to ensure

cooperation of government agencies in meeting these objectives. But the short history of

infrastructure reforms or rather privatization is testimony to how difficult it is to

formulate clear, realistic and consistent objectives, without misleading the public and

raising unrealistic expectations. Many countries limited their actions to selling public

monopolies to private firms and eventually introducing some monopoly regulations while

selling these actions as “reforms” supposed to achieve objectives mentioned above such

as increased production and coverage, better quality, lower prices for all, increased

government revenues and avoiding negative social consequences. However, to have a

chance to achieve most of these objectives, real comprehensive reforms are needed, in

which privatization is but one component, not necessarily the most important one. As

outlined above the idea of reforms in infrastructure is not centered around the change of

ownership, but around the possibility of introducing as much competition as possible

(through un-bundling and restructuring), regulating the remaining elements of monopoly

and addressing the issue of how services will be paid for under private provision.

Privatization alone can help achieve only some of these objectives.

Important is not only to include all these elements in the programme of reforms24

but also

their proper sequencing. Thus competitive restructuring, introducing regulation and the

establishment of an independent regulatory agency should take place prior to

privatization. Such sequence establishes clear rules of the game for future new players in

the industry. In addition it assures potential investors of both competitive and monopoly

elements. It also reduces the risk of regulatory capture and frustrating the efforts to

introduce competition by established companies.

Evidence suggests that the introduction of competition, wherever it is possible to do so,

will deliver best results and greatest benefits. But introducing competition is not equally

easy in all infrastructure industries. It has been easiest in telecommunications, due among

others to mobile telephony. In this industry competition has driven costs and price

reductions, innovation and expanded services. In a number of cases it permitted the

withdrawal of government from the regulation of tariffs. In electricity or natural gas,

competition is more difficult, but possible. Many markets are too small to accommodate

more than one supplier, making it impossible to dismantle a natural monopoly. Others

can accommodate too few to make competition feasible. In these cases it is possible to

introduce some form of regulated competition, as has been the case in Argentina, Chile

and Peru (Harris, 2003, p. 33).25

24

New Zealand introduced only competition, without regulation, in its power industry by mandating

separation of generation, transmission and distribution. But competition alone proved to be insufficient to

control pricing in natural monopolies and price control over power suppliers had to be imposed (Patterson

and Cornwall, 2001). 25

But even in large countries privatization and competition in electricity might not always be advisable. In

Brazil, for example, hydropower accounts for 95% of electricity. It is generated by large multiyear storage

dams, which are also used for irrigation and other purposes, requiring close coordination between water

authorities and power dispatchers. These conditions provide a strong argument for public ownership and

operation of the dams (Kessides, 2004, p. 43).

59

The scope for introducing competition in water and sewerage services is even more

limited than in other utilities. Local networks of pipes and sewers remain quintessential

natural monopolies. Unbundling is not especially attractive, because costs of producing

water are low relative to the value added at the transportation stage, although this may

vary across countries. Opportunities for competition are greater in sewage treatment.

Franchising is considered the best way of increasing competition (Kessides, 2004, p. 46).

Where competition can be introduced, to develop and maintain it is not sufficient to un-

bundle and ease the rules on market entry, by, for example, facilitating access to network

facilities and other infrastructure. Competition law and competition agency are necessary

supplements of a competitive environment in infrastructure services (Kessides, 2004, p.

69, after Willig, 1992 and Newbury, 2003). Competition policy can also serve as a useful

device protecting against regulatory capture and to counterbalance the power of a

regulatory agency. Competition agency should thus have the mandate to review

regulatory decisions, assess their impact on competition and take action against firms that

use the regulatory process for anticompetitive purposes. Where competition can not be

introduced, regulation serves as an alternative to competition.

Competition, while leading to welfare gains at the macro-level, will, however, typically

erode cross-subsidies26

, leading to negative distributive consequences for some groups of

consumers, including elderly and low income consumers. This might be difficult

politically, especially in electricity and water, and therefore governments night need to

consider the gradual phasing out of subsidies, addressing the problem within the welfare

system or replacing indirect subsidies with direct ones in the form of grants. In addition,

introducing competition in the markets where it has not existed, may require a support to

consumers, if they are to benefit from a change. For example, in the United Kingdom, a

consumer agency, called Energywatch, separated from the regulator, provides

information to consumers and acts as their advocate vis a vis companies, the regulator

and the government (Davies, L. et al, 2005, p. 13).

A second indispensable element of reforms is regulation and the establishment of an

agency to implement regulation. Evidence suggests that a regulatory agency that is

independent, that is, is separate from the executive branch of the government and

immune to political interference is likely to maximize benefits from reforms, balancing

the interests of consumers and services providers and sending the right signals to foreign

investors. Regulator’s independence provides the private investor with a degree of

comfort (but not guarantee) that investment will not be subjected to political intervention

or regulatory takings. An independent regulator might also act in the interest of

consumers, making sure that productivity gains are shared with them rather than taxed

away by the government.

It is not only the independence of the regulator but also the quality of regulations what

matters – the regulator will not be able to achieve much if regulation is bad. From the

26

Cross-subsidies occur when lower prices for some groups of consumers or services are subsidized by

higher prices for others. Examples include higher rates for international calls than local calls in

telecommunications and higher electricity rates for industrial consumers than for households.

60

perspective on investors regulation should provide for issuing licenses with legally

enshrined rights (including property rights where relevant) and obligations to the utilities,

include procedures for dispute resolution and provide for the possibility of adequate tariff

levels. From the perspective of consumers it may include a priori intentions that

efficiency gains should be shared with consumers. The task of regulation is also to

minimize the room for the conflict of interest between participants in the infrastructure

market: competing firms, remaining monopolies and consumers.

A key issue in any infrastructure regulations is how tariffs are set and as a result, how

regulation allocates benefits and risks among companies, consumers and government.

While choosing price regulations, countries should be aware of what they want to achieve

and what signals they sends to the industry players. These signals can lead to different

outcomes as regards the impact on the efficiency of production, efficient (not wasteful)

consumption of services, rent sharing between investors and consumers or so called

revenue adequacy of firms (which need to earn sufficiently enough to attract capital

needed for further investment) (Kessides, 2004, pp. 112-113). Basically there are two

systems of tariff-regulation: cost-plus (or cost-of-service) and price cap. Pure cost-plus

mechanism involves setting by a regulator the price covering operating expenses and

capital costs (depreciation plus an after-tax return that equals or exceeds the cost of

capital) on the basis of the bill submitted by a firm. Prices are tied to accounting costs.

Another edition of this mechanism, rate of return, involves the evaluation of capital and

operating costs, using a specific accounting system. Prices are set at the level of audited

cost plus a reasonable return. Prices remain fixed until the next regulatory review. While

the cost plus system aims at controlling earnings, the price cap system aims at controlling

prices. Under the price cap the regulator sets maximum prices that the firm is allowed to

charge. Cost-plus formula provides investors with more certainty over key variables, but

also with lower incentives for efficiency than price cap regulation. The former shifts also

more risks to consumers than the latter.27

It is probably for this reason that in Latin

America, projects based on cost-plus formula are less likely to be renegotiated than those

with price caps. In practice, most price systems have tended to be hybrid aiming at

rewarding or penalizing the regulated company for actions and factors under its control

and, consequently, not doing so in case of circumstances which are beyond its control

(Harris, 2003, p. 35).

Regulators face also a difficult task of dealing with opportunistic investors, which may

try to shift risks to consumers or taxpayers by renegotiating, without a good reason, key

elements of the regulatory framework. They may threaten withdrawal from the project,

calculating that the government, concerned with the disruption of service will give in to

the demands of investors. It may also happen that companies offer during the bidding low

tariff or high annual concession fee to win the bidding and, once established, demand

renegotiations. The decision what to do requires expertise and good judgment on the part

of regulators. If regulators are confident that they face opportunistic behaviour, some

argue that they should “stick to their guns”, that is not to give in, as happened in

Argentina, where two provincial governments refused to renegotiate the terms of

contracts in case of Rosario Port and Buenos Aires province water concession. A review

27

For an extensive discussion of pros and cons of various price systems, see Kessides, 2004, pp. 112-123.

61

of cancelled projects suggests that concerns about the disruption of services are

exaggerated. Performance bonds can help ensure that the operator remains in service long

enough for alternative management solutions to be put in place, minimizing the risk of

disruption (ibid. p. 35).

D. The role of international agreements

As noted above the liberalization of FDI policies in infrastructure services in developing

countries has proceeded mainly on a unilateral project-by-project basis. In OECD

countries, it has been based on international agreements, notably on the Code of

Liberalization of Capital Movements and on the (voluntary) National Treatment

Instrument accompanying the OECD Declaration on International Investment and

Multilateral Enterprises. Although both instruments have been fully implemented by

member countries in the manufacturing sector, it is in infrastructure services, where the

number of exceptions has been the most frequent. The internal market programme of the

European Union does neither deals with ownership issues nor with privatizations, leaving

both to the decisions of member countries. This indicates that, in both developed and

developing countries, ownership issues in infrastructure industries – and by consequence

FDI policy -- remain almost exclusively a matter of national policy, not subjected to

international agreements. Even if they are, as in the case of OECD instruments, countries

can and do easily exclude infrastructure services. But some international agreements are

relevant to FDI in infrastructure services.

Potentially, the WTO General Agreement on Trade in Services (GATS) might have had

the greatest relevance to FDI in infrastructure services. It covers all services, including

infrastructure and FDI under so called “commercial presence”. But GATS works through

voluntary commitments of countries to liberalization of the four modes of cross-border

services delivery, including FDI (along with reservations to those commitments).

Commitments can be made mode-by-mode for each industry. If a commitment to GATS

is not made, the industry is assumed (by GATS) to be closed to FDI. Once a national

commitment is made, it falls within the WTO system, including its dispute resolution

mechanism. But developing countries (as well as many developed ones) are cautious with

making international FDI commitments in services in general and in infrastructure

services in particular, preferring a unilateral route, permitting them to preserve a policy

space. As a result, very few commitments have been made by countries which have

pursued unilaterally services FDI liberalization. As a result, in 46 developing countries,

which were subject to UNCTAD restrictiveness study, the national score for FDI

restrictiveness in all services is much lower, 0.27, than that based on GATS commitments

– 0.64 (UNCTAD, 2006, p. 16). As the restrictiveness of infrastructure services is much

higher than that of other service industries and sensitivity about their liberalization much

greater, the difference in these services between the national level of liberalization and

that resulting from GATS commitments is also, most likely, much higher.

There is also some ambiguity within the GATS, which some countries have used to limit

their offers in infrastructure services to ensure policy space in the future. The ambiguity

refers to “services supplied in the exercise of government authority” that are excluded

from the scope of application of the GATS. Under one of the GATS articles such services

62

are defined as services that are neither supplied on commercial basis nor in competition

with other services. While academics debate which services these are, the European

Union, for example, interpreted them as public utilities, making them subject to exclusive

rights in its commitment schedule, such as subsidies, continued public ownership or

regulating them in any way needed to meet national policy objectives (UNCTAD, 2004,

pp. 233-234). The reservation of Brazil has gone in a similar direction. Such

interpretations will, most likely, not be helpful for increasing, in the future, the role of

GATS in infrastructure services, especially socially sensitive ones, such as water and

electricity.

But where sensitivities are lower and reforms in individual countries more advanced, in

industries such as telecommunications, GATS members have made some further

progress, by concluding in 1997 Basic Telecommunications Agreement, including

initially 69 countries, among them several developing ones. The agreement accelerated

commitments in telecommunications. By June 2005, such commitments were made by

104 of 148 WTO member countries, including commitments on basic

telecommunications by 96 governments, who control SOEs accounting for over 95% of

world telecommunications revenues. By accessing the agreement and making

commitments, these countries have also committed to overall GATS disciplines on

regulation and transparency, ensuring minimum standards of good regulatory practices.

As regards investment, according to one study,

“These commitments lay the foundation for improved market access and the

liberalization of investment, both foreign and domestic. They strengthen investors

confidence by demonstrating that a country intends to reform its

telecommunications sector in a nonreversible way. They also provide recourse to

foreign investors (through their governments) to settle disputes under the WTO

dispute resolution system.28

GATS commitments, in this way, enhance and

underpin the domestic sector reform agenda of developing countries, providing

investors with greater predictability” (Guislain and Zhen-Wei Qiang, 2006, p. 33).

Bilateral investment treaties (BITs) are relevant to infrastructure investment as they

typically include provisions protecting investors against expropriation (by defining

criteria and the rules of compensation), referring disputes to international arbitration and

more and more often allowing investors to challenge governments.29

These rules are very

important for infrastructure FDI, given the growing number of disputes and cancellations

of infrastructure projects involving foreign investors (see chapter I), requiring settlement

or renegotiations. But they are relevant, of course, only if a home and a host country have

concluded a BIT, which is not always the case. For example, problems in one of the

largest FDI power projects in India – Dabhol project valued at $2 billion – involving

three United States investors, among them Enron, could not be resolved under a BIT,

because India and the United States did not have one (Ramamurti and Doh, 2004, p. 163).

28

The first telecommunications dispute settlement case was filled in 2002 by the United States against

Mexico and ended by a ruling in 2004. But the case concerned commercial rather than FDI issues. 29

Since infrastructure projects are based on agreements between states or local governments and investors

they, most likely, contain similar provisions, perhaps even stronger than BITs.

63

BITs rules on expropriation (and those of other investment agreements) have been for a

long time dormant, as developing countries, which resorted to expropriations several

decades ago, have adopted increasingly welcoming attitudes towards foreign investors.

But growing problems with several infrastructure investments and following disputes

have brought back, in some quarters, questions about the possibility of renationalizations.

So far none has happened, but one should not entirely exclude such a possibility in

isolated cases.

But there has been an increasing interest in indirect takings, including so called “creeping

expropriations” and “regulatory takings”, common in infrastructure projects (see

UNCTAD, 2003, pp. 111-114, for extensive discussion of these issues). In many cases

governments of host countries did renege on commitments made to foreign investors,

often by changing regulations, eroding investors’ profits. As noted by one author, “thus,

even though legal expropriations of foreigners’ assets was rare as expected,

,administrative expropriations’ that eroded foreign investors’ profits was more common

than might have been expected” (Ramamurti and Doh, 2004, p. 164). The issue of

compensation for regulatory takings may, and probably will, attract renewed interest in

light of the recent intensity of regulatory takings in cross-border infrastructure projects.

As often noted in UNCTAD’s WIRs, bilateral or regional trade agreements have become

trade and investment agreements. Some of those include investment provisions on

infrastructure services, notably telecommunications. One example is the bilateral trade

agreement between the United States and Vietnam, which gives the US TNCs the right to

invest in certain telecommunications services. Another involves the provisions of the

Central American Free Trade Agreement (CAFTA), which call for the liberalization of

telecommunications in member countries and opening up to FDI. As has been reported,

CAFTA has provided impetus to telecommunications reforms in Costa Rica and other

countries (Guislain and Zhen-Wei Qiang, 2006, p. 35).

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