Tapping the Market: The Challenge of Institutional Reform in the Urban Water Sector (The Role of Government in Adjusting Econ)

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Tapping the Market The Challenge of Institutional Reform in the Urban Water Sector

Andrew Nickson and Richard Franceys

Tapping the Market

The Role of Government in Adjusting Economies General Editor: Professor Richard Batley, International Development Department, School of Public Policy, University of Birmingham Over the last two decades there has been a strong emphasis on reducing the role of government and on reforming traditional public sector bureaucracies. The new conventional view has become that, where possible, services should not be provided directly by government but be contracted out or privatized. Where this is not possible, the predominant view has been that the public sector itself should change by setting up semi-autonomous agencies and by making public management more performance- and customer-oriented. This series investigates the application of such reforms in Africa, Asia and Latin America. Underlying the enquiry is the question whether reforms which were initially conceived in countries such as Britain and New Zealand are appropriate in other contexts. How much sense do they make where levels of public management capacity, market development, resources, political inclusiveness, legal effectiveness, political and public economic stability are quite different? To investigate these issues, the series covers four service sectors selected to be representative of types of public sector activity – health care, urban water supply, agricultural marketing services and business development services. Titles include: Mike Hubbard DEVELOPING AGRICULTURAL TRADE New Roles for Government in Poor Countries Paul Jackson BUSINESS DEVELOPMENT IN ASIA AND AFRICA The Role of Government Agencies Anne Mills, Sara Bennett and Steven Russell THE CHALLENGE OF HEALTH SECTOR REFORM What Must Governments Do? Andrew Nickson and Richard Franceys TAPPING THE MARKET The Challenge of Institutional Reform in the Urban Water Sector The Role of Government in Adjusting Economies Series Standing Order ISBN 0–333–94618–9 (outside North America only) You can receive future titles in this series as they are published by placing a standing order. Please contact your bookseller or, in case of difficulty, write to us at the address below with your name and address, the title of the series and the ISBN quoted above. Customer Services Department, Macmillan Distribution Ltd, Houndmills, Basingstoke, Hampshire RG21 6XS, England

Tapping the Market The Challenge of Institutional Reform in the Urban Water Sector Andrew Nickson Reader in Public Management and Latin American Development University of Birmingham UK and Richard Franceys Senior Lecturer in Water and Sanitation Management Cranfield University UK

© Andrew Nickson and Richard Franceys 2003 All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission. No paragraph of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms if any licence permitting limited copying issued by the Copyright Licensing Agency, 90 Tottenham Court Road, London W1T 4LP. Any person who does any unauthorized act in relation to this publication may be liable to criminal prosecution and civil claims for damages. The authors have asserted their rights to be identified as the authors of this work in accordance with the Copyright, Designs and Patents Act 1988. First published 2003 by PALGRAVE MACMILLAN Houndmills, Basingstoke, Hampshire RG21 6XS and 175 Fifth Avenue, New York, N.Y. 10010 Companies and representatives throughout the world PALGRAVE MACMILLAN is the global academic imprint of the Palgrave Macmillan division of St. Martin’s Press, LLC and of Palgrave Macmillan Ltd. Macmillan® is a registered trademark in the United States, United Kingdom and other countries. Palgrave is a registered trademark in the European Union and other countries. ISBN 0–333–73620–6 This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources. A catalogue record for this book is available from the British Library. Library of Congress Cataloging-in-Publication Data Nickson, Andrew Tapping the market : the challenge of institutional reform in the urban water sector / Andrew Nickson and Richard Franceys. p. cm. — (The Role of government in adjusting economies) Includes bibliographical references and index. ISBN 0–333–73620–6 (cloth) 1. Water utilities—Developing countries. 2. Municipal corporations— Developing countries. 3. Water supply—Developing countries. I. Franceys, R. II. Title. III. Series. HD4465.D44N53 2003 363.6⬘1⬘068—dc21 2003048062 10 9 8 7 6 5 4 3 2 1 12 11 10 09 08 07 06 05 04 03 Printed and bound in Great Britain by Antony Rowe Ltd, Chippenham and Eastbourne

Contents List of Tables

viii

List of Figures

ix

List of Boxes

x

List of Acronyms and Abbreviations

xi

Preface

1

2

3

xiii

Reform of the Urban Water Sector and the Role of Government 1.1 Introduction 1.2 Rethinking urban water supply 1.3 Urban water sector reform 1.4 The New Public Management 1.5 Concepts of capacity 1.6 Study overview 1.7 Structure of the book

1 1 3 5 7 12 13 15

The Structure and Performance of Urban Water Utilities 2.1 Introduction 2.2 Organisational arrangements for service provision 2.3 Performance management 2.4 Review of organisational performance 2.5 Consumer perceptions of service quality 2.6 Conclusions

17 17 17 20 26 29 31

Explanations of Performance and Reform Responses 3.1 Introduction 3.2 Organisational capacity 3.3 Institutional capacity 3.4 Reform policies and plans 3.5 Reform processes 3.6 Conclusions

33 33 34 37 40 42 48

v

vi

Contents

4

The 4.1 4.2 4.3 4.4

Spectrum of Public Private Partnerships Introduction Factors internal to the provider The pressure from external stakeholders The argument for private sector participation in urban water supply 4.5 Vertical unbundling 4.6 The range of institutional arrangements 4.7 Conclusions

54 55 56 71

5

The 5.1 5.2 5.3 5.4 5.5 5.6

6

Addressing the Water Needs of the Urban Poor 6.1 Introduction 6.2 Serving the urban poor 6.3 Private water vendors and the urban poor 6.4 Non-government organisations and the urban poor 6.5 Government providers and the urban poor 6.6 Public private partnerships and the urban poor 6.7 Conclusions

103 103 106 108 111 113 117 124

7

Regulating and Enabling the Direct Providers 7.1 Introduction 7.2 The activities of regulation 7.3 Models of regulation 7.4 Regulation in the case study countries 7.5 The regulatory experience of low and middle-income countries 7.6 Conclusions

127 127 132 135 147

Taking Account of Capacity 8.1 Introduction 8.2 Developing the capacity to change 8.3 Capacity within the public sector 8.4 Capacity within the other partners

153 153 155 159 164

8

Challenge of the Concession Model Introduction Drivers for performance Risk transfer Buenos Aires: the concession model in operation Choosing public private partnerships Conclusions

50 50 50 52

73 73 78 82 88 95 102

150 151

Contents

8.5 8.6 8.7 8.8 9

vii

The capacity of international private operators The capacity to act as partners Capacity within the case study countries Conclusions

166 169 170 178

Reforming Urban Water Sector Reform 9.1 Introduction 9.2 The international reform agenda for the urban water supply sector 9.3 The need for reform 9.4 Specific policy reforms 9.5 Relevance of the NPM agenda and related water sector reforms 9.6 Conclusions

181 181 182 184 185 185 190

References

192

Index

202

List of Tables 1.1 2.1 2.2 2.3 5.1 9.1

9.2 9.3

The relationship between the New Public Management and reform of the urban water supply sector 11 Allocation of direct and indirect provider roles in case study countries 19 Quality of service provided by water utilities: consumer perceptions 30 Country case studies: summary of performance 31 Aguas Argentinas: contractual objectives for service coverage 93 The main areas of urban water sector reform, their NPM rationale and their adoption in the reform agendas of case study countries 183 The extent and pace of policy implementation in the case study countries 186 Global coverage of public private partnerships in water and sanitation in 2001 188

viii

List of Figures 1.1 8.1

The urban poor pay more for water The share of international private operators in the market for public private partnerships in urban water supply in middle and low-income countries (by reported population served)

ix

2

167

List of Boxes 3.1 4.1 4.2 4.3 4.4 4.5 4.6 4.7 4.8

The state-owned enterprise – an example from Botswana The service contract – an example from Santiago, Chile The management contract – an example from Trinidad and Tobago The lease contract – an example from Conakry, Guinea The BOT contract – an example from Kota Kinabulu, Malaysia The concession contract – an example from Córdoba, Argentina The joint venture – an example from Cartagena, Colombia The co-operative arrangement – an example from Santa Cruz, Bolivia Flexible arrangements – an example from Mexico City

x

42 57 60 62 64 66 68 69 70

List of Acronyms and Abbreviations ADB BOT BWUC CMF COM DWR ESD ETOSS GWSC IBT ICB ID IMF LCR LMIC LPCD LRMC MDG MJP MOUAE NGO NPM NWSDB OFWAT OSN PHED PMC PPP PSP PWVs ROCE

Asian Development Bank Build-Operate-Transfer Botswana Water Utility Corporation (Botswana) Change Management Forum (India) Community Ownership and Management Department of Water Resources (Zimbabwe) Engineering Services Department (Bulawayo, Zimbabwe) Ente Tripartito de Obras y Servicios Sanitarios (Argentina) Ghana Water and Sewerage Corporation (Ghana) Increasing Block Tariff International Competitive Bidding Institutional Development International Monetary Fund Lease Contract Rate Low and Middle-Income Countries Litres per Capita per Day Long Run Marginal Cost Millennium Development Goals Maharashtra Jeevan Pradhikan (Maharashtra State Water Board, India) Ministry of Urban Affairs and Employment (India) Non-Government Organisation New Public Management National Water Supply and Drainage Board (Sri Lanka) Office of Water Services (England and Wales) Obras Sanitarias de la Nación (Argentina) Public Health Engineering Departments (India) Pune Municipal Corporation (Maharashtra State, India) Public Private Partnership Private Sector Participation Private Water Vendors Return on Capital Employed xi

xii

List of Acronyms and Abbreviations

ROFA SAGUAPAC SAFIR SEC SEEG SOE SONEG TOR UFW USAID USO UWS WASH WHO WR WSSD WTP

Return on Fixed Assets Cooperativa de Servicios Públicos ‘Santa Cruz’ Ltda (Bolivia) South Asia Forum on Infrastructure Regulation State Enterprises Commission (Ghana) Société d’Exploitation des Eaux de Guinée (Guinea) State Owned Enterprise Société Nationale des Eaux de Guinée (Guinea) Terms Of Reference Unaccounted For Water United States Agency for International Development Universal Service Obligation Urban Water Supply Water and Sanitation for Health Program World Health Organisation Working Ratio World Summit on Sustainable Development Willingness To Pay

Preface This book originates from a research programme funded by the Economic and Social Committee on Research (ESCOR) of the Department for International Development (DFID). The facts presented and views expressed are those of the authors and do not necessarily reflect the views of DFID. The research programme, entitled ‘The Changing Role of Government in Adjusting Economies’, recognises that over the last two decades there has been a growing emphasis in OECD countries on reducing the role of government and on reforming public management by adopting aspects of private sector practice. The new conventional view became that, where possible, government should enable and regulate the private and community sectors or armslength public agencies rather than directly provide services. The research was premised on the view that similar practices were being introduced in developing countries, often in association with the structural adjustment of their economies. There has been considerable research on the difficult process of adjustment but little on the capacity of governments to manage the consequences and little on the outcome of such reforms. The research investigated the application of such reforms outside their countries of origin, in Africa, Asia and Latin America. Underlying the enquiry is the question whether approaches generated from a diagnosis of the ‘over-interventionist’ state in, for example, Britain or New Zealand are appropriate responses to other forms of state, where the levels of public management capacity, market development, resources, political inclusiveness, legal effectiveness, as well as political and economic stability are quite different. The research was undertaken through case studies of the organisation and performance of service provision in selected countries. The selection of the four service sectors – health care, urban water supply, agricultural marketing and business development – and the choice of countries for field work was intended to allow the examination of alternative possible organisational arrangements for service provision in different political and economic circumstances. It was also intended to examine whether there are organisational practices that seem to be more appropriate to particular services or national contexts. xiii

xiv

Preface

The research programme involved five British research groups: the International Development Department of the School of Public Policy, University of Birmingham; the Health Economics and Financing Programme, Health Policy Unit, London School of Hygiene and Tropical Medicine; the Overseas Development Group of the School of Development Studies, University of East Anglia; the Water Engineering and Development Centre of Loughborough University of Technology; and the Department of City and Regional Planning, University of Wales. Richard Batley of the International Development Department, University of Birmingham provided overall coordination for the research programme. The research on the urban water sector was developed and planned by Andrew Nickson and Richard Franceys. After an initial literature review by Andrew Nickson of institutional and economic perspectives on government capacity to assume new roles in the urban water sector, country case studies were carried out, with the lead being taken in Ghana by Philip Amis, in India by Richard Franceys and Kevin Sansom, in Sri Lanka by Richard Franceys, and in Zimbabwe by Richard Batley. Country collaborators in the case studies were Frank Asiedu in Ghana, Srinivas Chary in India, Harsha Aturupane in Sri Lanka and Ngoni Mudege in Zimbabwe. User surveys, which included views on water, were carried out by Carole Rakodi in Ghana and India, by Tudor Silva, and Steven Russell in Sri Lanka, and by Dorothy Mutizwa-Mangiza in Zimbabwe. This book has been written by Andrew Nickson and Richard Franceys, with Andrew Nickson taking the lead on Chapters 1, 2, 3 and 4; and Richard Franceys on Chapters 5, 6, 7 and 8. The series editor, Richard Batley reviewed and commented on the entire manuscript. We are most grateful to all the individuals who supported the country case studies, and also to Alistair Wray (DFID), Nick King (WaterAid) and David Kinnersely (independent consultant) who formed a steering committee for the urban water sector research. We also gratefully acknowledge the contribution to our thinking of colleagues in the International Development Department of the University of Birmingham, the Water Engineering and Development Centre of Loughborough University of Technology, IHE Delft and the Institute of Water and Environment, Cranfield University.

1 Reform of the Urban Water Sector and the Role of Government

1.1

Introduction

One of the most glaring failures in government attempts at service provision around the world is the shortage of water faced every day by the urban poor. According to WHO/UNICEF data (2000), 171 million people have no access to affordable clean water in urban areas of Africa, Asia and Latin America. Millions have to buy water from private water vendors (PWVs), almost always at a price many times higher than that paid by people with higher incomes whose households are connected to the pipe network of state water utilities (Figure 1.1). Rapid urbanisation throughout the developing world has substantially increased the demand for water as poorer migrants move to the cities. But in most of these countries, urban water supply (UWS) has not kept pace with this increasing demand. As a result, in many large cities in Africa, Asia and Latin America a significant percentage of the population does not have access to piped water. What is the reason for this mismatch between the supply and demand for water? In a minority of UWS systems, the explanation has to do with the depletion of natural resource endowment. In these cases, withdrawals from aquifers or surface water, usually to irrigate farmland, exceed recharge, threatening the long-term availability of fresh water. Governments in these countries face the difficult challenge of finding enormous investment funds either to abstract and transport water from long distances or to introduce expensive desalination plants. But in most UWS systems, a sufficient supply of water is available. Yet systems have been severely degraded due to chronic under-investment and inadequate maintenance of the urban pipe network, resulting in excessive water loss through leakage, poor water quality and unreliable flow 1

2

Tapping the Market

The Poor Pay More

Abidjan, Cote d’Ivoire Tunis, Tunisia Cali, Columbia Nairobi, Kenya Lagos, Nigeria Developing World Average Lima, Peru Guayaquil, Ecuador Dhaka, Bangladesh Cairo, Egypt Jakarta, Indonesia Karachi, Pakistan Port-au-Prince, Haiti Nouakchot, Mauritania 0

20

40

60

80

100

The ratio of water price paid to vendors by the poor compared with water bought by higher income groups through household connections World Commission on Water for the 21st Century, 1999

Figure 1.1: The urban poor pay more for water Source: World Commission on Water for the 21st Century, 1999.

as well as the failure to extend service coverage. In turn, this has contributed to serious disease and public health problems, especially in slums and squatter settlements. As a result, UWS systems in many lowincome countries are facing an acute crisis. Until the 1990s the world water industry was surprisingly complacent with regard to this problem. It lacked a critical awareness of its poor economic performance and its own organisational failings. Powerful stakeholders such as water engineers, international construction companies and public sector trade unions all had a vested interest in maintaining this status quo. As one observer noted, ‘What other industry would allow upwards of a quarter of its finished output to be wasted?’ (Barker 1992). But that observer was being too generous as in fact the industry was

Reform of the Urban Water Sector and the Role of Government 3

losing closer to one half of its output. The sector tended to operate within the tradition of an engineering or ‘supply-led’ approach, with only a tenuous link between revenue and expenditure estimates through the annual budgetary cycle at the highest political level. This failure to generate adequate revenue was one of the main reasons why water utilities were making a loss. Initial expectations that urban water supply could be paid for through property taxes, with only industry and commerce paying a metered tariff, led to a continuing shortage of funds for maintenance and service expansion. Even when domestic metering was introduced in some countries, the reluctance of politicians to allow state-owned water utilities to set viable tariffs compounded the problem. In many low-income countries, this imbalance between demand and supply was related to a lack of fit between a colonially-inspired urban fabric and a growing population of poorer migrants from rural areas. Design engineers often gave priority to raising the per capita level of water consumption rather than ensuring the widest possible coverage for the urban population. Rather than any lack of entrepreneurial initiative on the part of state water utilities, this was often the result of explicit government policies to not provide infrastructure in ‘illegal’ unplanned squatter settlements (Cairncross 1992). Engineers designed new systems according to arbitrary international standards of per capita water consumption that were based on an exaggerated perception of the contribution of clean water to overall economic development. For example, the standard of supply set by the government of Ghana was 110 litres per capita per day (lpcd) although no urban area in the country has ever achieved that. This figure compares with the UNCED global target for 2000 of only 40 lpcd. Little importance was accorded to the real structure of the demand for water in the planning of UWS systems. Consequently heavy investment in water production (reservoirs, treatment plants and pumping stations) was made at the expense of investment for network expansion to peri-urban areas. Engineers had been trained to build abstraction and treatment facilities, not to be water retailers.

1.2

Rethinking urban water supply

The argument in favour of the direct public provision of UWS has traditionally been based on the assumption that it is a ‘public good’. Although in common parlance ‘public good’ is usually defined as any good or service that is provided directly by the public sector, the theoretical

4

Tapping the Market

definition of what constitutes a public good is far more restrictive. The essential properties of public goods (sometimes called ‘common pool goods’) are non-excludability (that is, if provided for one person, it is automatically available for everybody else) and non-rivalry (that is, there is no less available for any one person because another person is enjoying it). According to economic theory, it is these properties that should dictate whether collective provision is made at zero direct cost to the individual consumer, with the cost financed instead out of general taxation. In fact, UWS is a private good and not a public good. It is characterised neither by non-excludability nor by non-rivalry. It is feasible and common practice both to charge users and to exclude non-payers. Although collectively provided, there are few cases in the world where UWS has been provided at zero direct cost to the consumer, as is normally the practice for pure public goods. However, although UWS is a private good, it has three production and consumption features that give rise to the likelihood of market failure (that is, the inability of an unregulated market to achieve allocative efficiency). First, UWS is usually a natural monopoly. This is a function of the economies of scale associated with pipe networks, whereby one firm can produce at lower average costs than can be achieved by two or more competing entities. These economies of scale are not simply a function of the cost of duplicating the provision of pipes but are also linked to the size of pipes and storage tanks. This is because the surface area of three-dimensional objects increases at a much slower rate than their internal volumes. For example, when a pipe diameter is doubled, its carrying capacity is increased by five times. As a result of these factors, operating costs per connection in urban areas are inversely proportional to the number of connections. Furthermore, unlike in the case of other network monopolies such as telecommunications, gas and electricity, in the case of UWS there is no significant competition between deliverers, nor from products or services produced outside the industry, perhaps due to the relatively low cost of water. In the absence of any dramatic technological advance such as has occurred in the telecom sector, this situation is unlikely to change in the foreseeable future. The urban water industry is therefore the natural monopoly par excellence (Littlechild 1986). Second, there is the issue of externalities, whereby the behaviour of one producer or consumer affects that of other parties. Where the total benefits and/or disbenefits of an activity cannot be ‘captured’ in market prices, an unregulated market system will result in a sub-optimal allocation of resources. UWS has considerable health-related externalities,


both positive and negative. For example, the provision of clean water provides enormous positive externalities to public health through the control of infectious, water-borne diseases. On the other hand, the unregulated disposal of effluent by water utilities can cause enormous negative externalities to public health in the form of environmental contamination. Third, UWS is sometimes characterised by an asymmetry of information between providers and poorly educated consumers, especially in low-income countries. The water provider often has a greater understanding than these consumers themselves of the benefits of clean water to their health and well-being. Hence UWS may be classed as a ‘merit good’, one from which the consumer benefits to a greater extent than s/he realises. These three features of UWS – natural monopoly, externalities and merit good – do not provide any argument in favour of direct public provision. However, in the event that direct provision is carried out by the private sector, they do provide a strong argument for public sector regulation in order to correct market failure and to counter possible divergences between private and social costs and benefits in UWS.

1.3

Urban water sector reform

In response to the problems created by this supply-driven approach, a growing consensus for reform of UWS has emerged in recent years among international financial institutions. This derived from two major international conferences – the International Conference on Water and the Environment (Dublin) and the United Nations Conference on Environment and Development (the ‘Rio Conference’) – both of which were held in 1992. The new consensus subsequently appeared in policy statements by the World Bank (in 1993) and the OECD (in 1994). At the core of this reform consensus are two fundamental principles: • the institutional principle – that water management should be based on a participatory approach involving users, planners and policy-makers at all levels, with decision-making taken at the lowest appropriate level according to the concept of subsidiarity; • the instrument principle – that water has an economic value in all its competing uses and should be recognised as an economic good. Managing water as an economic good is an important way of achieving efficient and equitable use, and of encouraging conservation and protection of water resources. An important corollary is that water companies should be treated as commercial enterprises.

6

Tapping the Market

This new focus on demand management in UWS arising from the reform consensus necessarily involves a greater role for market forces and thus opens the door to greater private sector participation in the sector. Basic economic principles suggest that water should be charged, not simply on a cost-recovery basis, but according to its long-run marginal cost (LRMC) of supply, namely operations and maintenance costs plus capital charges sufficient to cover new investment to replace and extend the pipe network, all suitably adjusted to incorporate environmental costs and benefits. Marginal cost pricing usually implies higher tariffs because urban water utilities have historically always utilised the nearest and cheapest water sources. For many years such a pricing policy was considered to be beyond the means of low-income residents of urban areas in the developing world. But this does not mean that the poor are unwilling to pay a reasonable amount for potable water as the recent application of the contingent valuation method for determining ‘willingness to pay’ (WTP) for piped water has shown. WTP studies reveal that the urban poor are prepared to pay in excess of the previously considered ‘affordability limit’ of 5 per cent of household income (Whittington et al. 1991; McPhail 1993). However, this preparedness to pay ‘in extremis’ does not mean that the poor want to pay such a high proportion of their income. The drive to recognise the economic value of water should not unfairly penalise the lowest income consumers who receive the poorest service. Hence there is a strong argument for a progressive tariff structure, given the fact that the LRMC usually exceeds the long-run average cost of supply. Metering is another prerequisite for the volumetric charging that is implied by such an active pricing policy designed to achieve financial self-sufficiency. In fact an influential study of water utilities in Asia concluded that demand management could not be introduced effectively so long as the consumer system is not fully and accurately metered. It recommended that the reduction in ‘unaccounted for water’ (UAW) through metering must be considered as a crucial complementary process to the implementation of demand management (Asian Development Bank 1993). One of the most crucial constraints on the improvement of utility performance in UWS has been institutional. Until recently such utilities in most countries were operated directly by the public sector, as was the case with other basic services such as electricity and telecom. In many countries one explanation for this situation has been the alleged lack of professional capacity in the private sector. Another has been the strong belief that private contractors cannot be trusted to operate UWS


without abusing its natural monopoly, externalities and merit good characteristics. Hence, a ‘second-rate’ government service has been tacitly preferred over what has been presumed to be a third-rate alternative – a private contractor regulated only by corrupt politicians. Yet, in practice, many state-run water utilities by themselves continue to provide only a third-rate service. Usually they do not have the power to set tariffs. Instead the sector has long been financially supported by central government grants. Hence government-set tariffs have not had to reflect the full cost of service provision. Given this history of heavy tariff subsidisation, governments have been unwilling to authorise tariff increases inspired by LRMC in order to introduce cost recovery criteria sufficient to meet operations and maintenance costs, as well as debt service obligations for capital investment. As a result, international financial institutions and governments alike are now increasingly exploring new institutional arrangements in their search for economic efficiency and investment finance in UWS.

1.4

The New Public Management

Starting in the 1980s many developing countries have launched major state reform initiatives. These were driven primarily by the forces of globalisation that placed tighter budgetary constraints on governments and made overall economic performance increasingly contingent upon the ability to deal successfully with intensified international competition (United Nations 2001). These reform programmes were often imposed through the leverage of IMF structural adjustment programmes and the powerful intermediary of the World Bank. In many cases the reforms were accompanied by processes of political democratisation that generated new pressures for reshaping state structures. The essence of the state reform process is encapsulated by three main tenets: (i) (ii)

(iii)

in order to overcome chronic macro-economic imbalance, the overall role of the state in the economy should be reduced; within the framework of this reduced role, the state should retreat from involvement in productive sectors of the economy but strengthen its involvement in social sectors; in those sectors where the state retains a strong involvement, it should switch from a direct provider role to that of strategic ‘conductor’, at one and the same time regulating and enabling the delivery of services by other providers.

8

Tapping the Market

An initial phase of these state reform initiatives focused on the first two of the above tenets as a means to achieve fiscal balance at the macroeconomic level, through: • downsizing strategies that started by ridding the payroll of ghost workers, followed by blanket reductions in personnel; • privatisation of state enterprises, which generated a one-off fiscal benefit; • decentralisation, which involved transferring service delivery responsibilities and greater fiscal powers to local government. There is broad agreement that these reforms were successful in reducing the fiscal deficit but that they were carried out largely without the benefit of a clear vision of the desired role of the state, except for the simplistic view that it should be ‘smaller’. For this reason, these ‘first generation’ reforms were unsuccessful in addressing the challenge of improving overall national performance in the global economy. In response, from the 1990s many developing countries have embarked upon what has been called a ‘second generation’ of state reforms that emphasise a greater concern for what has been dubbed the ‘four Es’: • the efficiency of service delivery; • the effectiveness of public sector intervention in terms of coverage and quality of service; • improved equity of service delivery through a more targeted approach to operating and capital expenditure in the social sectors (especially health and education); • the creation of an enabling environment for private sector development. This ‘second generation’ reform process has been strongly influenced by a simultaneous reform process underway over the past two decades in the public sector of many OECD countries with the aim of improving performance on the ‘four Es’ (efficiency, effectiveness, equity and enabling). These reforms, referred to collectively as the New Public Management (NPM), are increasingly been applied in low and middle-income countries. NPM has become a collective term used to describe a bundle of management techniques introduced to the public sector, many of which are borrowed from the private sector (Ferlie et al. 1996; Walsh 1995). The various components of NPM have been broadly categorised into two strands, both of which emanate from the private-for-profit sector (Hood 1991).


First, there are those intra-organisational initiatives that derive from managerialism and principal/agent theory. Its key features include: • Breaking up huge bureaucracies by disaggregating functions into separate agencies. This may involve hiving-off operational arms of ministries to form separate executive agencies. There is a clear distinction between the strategic policy core and the operational arms of the government. Each agency is no longer related to the parent ministry through the traditional departmental hierarchy, but by an armslength contractual agreement with specified performance targets. • Replacing traditional ‘tall hierarchies’ with flatter, flexible and more responsive organisational structures that are reformed around the specific operational processes at hand rather than the traditional functions of finance and personnel. • Separation between funding, purchasing and the provision of services. This involves making a clearer organisational and financial separation between, on the one hand, defining the need for and paying for public services, and, on the other hand, the actual delivery of those services. • Decentralising management authority within public sector organisations. This involves giving top management the freedom to manage while at the same time defining more precisely their managerial responsibilities through performance targets linked to fixed-term contracts. • Devolving budgets and financial control to decentralised units through the creation of budget centres. This delegation of financial responsibility gives managers greater flexibility to consider the most cost-effective means to ensure the provision of required services to a pre-determined standard. • Shift from inputs and process to an output-orientation in control and accountability mechanisms. This involves a greater emphasis on output controls in resource allocation, performance agreements, and performance-related pay. It requires managers to work to performance targets, indicators and output objectives. Second, there are those inter-organisational initiatives emanating from the New Institutional Economics that emphasise markets and competition as a way of giving ‘choice and voice’ to users and that promote efficiency in service delivery. Key examples include: • Introducing market and quasi-market mechanisms to stimulate competition between service providers, in the belief that this will

10 Tapping the Market

promote cost savings and customer responsiveness. The most common instruments are contracting-out, franchising, internal markets, vouchers, and user charges or fees. • Emphasis on quality in an effort to make public services more ‘demand’ than ‘supply’ driven. This new customer orientation is expressed through initiatives such as ‘citizen charters’. • Changing employment relations from traditional career tenure towards a preference for limited term contracts for senior staff, locally determined pay rather than uniform fixed salaries, the use of wholly monetised incentives, and the use of performancerelated pay. Under the NPM, the reassignment of roles to the actors in the process of service delivery (different levels of government and field administration, the private sector, and the not-for-profit sector) is based on both principal–agent theory and the New Institutional Economics. This involves a split between the purchaser (the central ministry) and the providers (the rest), which is driven primarily by the effort to capture gains in economic efficiency, equity and effectiveness. In the case of urban water supply, the central ministry or municipality switches from its former direct provider role into a new role as strategic director of the whole sector through its ability to ‘purchase’ services from other providers. Three new strategic concerns are paramount. First, there is the concern for operational and financial efficiency through the introduction of operational and financial indicators. Second is the concern for effectiveness through monitoring of water availability and water quality. Third, there is the concern for equity through the monitoring of the expansion of service coverage. Meanwhile, the providers, including sub-national levels of government, de-concentrated units of the central ministry, private operators and notfor-profit bodies, assume a new role in administrating various aspects of the delivery of water services on behalf of central government, to which they are held accountable. Although the NPM reforms are increasingly being applied in low and middle-income countries, little is yet known about their impact. This has raised doubts about the universal applicability of such ‘policy transfer’ (Polidano and Hulme 1999). The genesis of this book derived from evaluating the feasibility and desirability of implementing the NPM in the urban water sector of developing countries. A range of organisational reforms arising from the introduction of the NPM in the sector is shown in Table 1.1.

Reform of the Urban Water Sector and the Role of Government 11 Table 1.1: The relationship between the New Public Management and reform of the urban water supply sector Building blocks of NPM

Related NPM policies

Manifestation in the urban water supply sector

Responsibility: ensure clarity of goals and purpose

Separate policy-making from service delivery functions Shift locus of controls to lower level managers

Split policy-making role from service delivery role

Use contracts and performance agreements to promote transparency Accountability: increase accountability of managers to customers Performance: create stronger incentives for good performance

Promote client choice Develop customer charters Link reward to performance Strengthen feedback mechanisms Stimulate competition

Bureaucratic commercialisation: decentralisation and autonomous state water companies Contracting and service agreements

Collaborate with private water vendors Establish water customer committees Lease and concession contract arrangement Establish independent regulatory body Promote international bidding for contracts

If government is to move away from the direct provision of urban water supply to a more indirect role, such as regulating quasiautonomous state enterprises or private providers, then what capacities are necessary for it to take on these complex new roles effectively, and how capable do governments appear to be in performing these new functions? Given that the core ideas of NPM originated in the OECD countries, how relevant are they in the particular institutional and bureaucratic contexts of specific developing countries? This book focuses specifically upon experiences with NPM-type reforms in the urban water sector. Although the design of reform policies may be relatively straightforward, it is during implementation that conflicts between such policies and the institutional structures and capacities of a country are most likely to become apparent. As a consequence of any such ‘lack of fit’ between policies and institutions, reforms may not achieve their intended goals. On the contrary, they may have unintended and detrimental outcomes (Mills, Bennett and Russell 2001).


1.5

Concepts of capacity

One of the main arguments used to justify the need for reform of the urban water supply sector is the weak capacity of the public sector to perform the role of direct service provider. Paradoxically, questions of capacity are the main area of doubt in implementing the reform of the sector along the lines of the NPM. Here capacity requirements are reduced in some areas as the state retreats from its role as direct provider. But simultaneously, other capacity requirements emerge as the state assumes new and more complex tasks of regulation and enabling the private sector. In fact, far from reducing the need for it, greater private sector participation requires greater governmental capacity as a pre-condition for effective regulation. The discourse of ‘capacity-building’ for public administration reform used to focus on training and personnel development (Brinkerhoff 1994). However the limitations of such an approach are now widely recognised. In response, institutional analysts have broadened the framework for understanding capacity by moving from a focus upon individual needs towards a focus upon the needs of the organisation as a whole. The various approaches used to understand capacity, and that adopted by the research project, are discussed in more depth by Batley (1997). This approach considers aspects of capacity that are internal to the government organisation that is entrusted with implementation, namely human resource management, resource availability, and the appropriateness of organisational systems and structures. The framework acknowledges that coordination between the various organisations involved in performing any particular task is a crucial aspect of capacity. More broadly, the framework also considers factors external to the implementing organisation that may hinder or enhance government performance. These include the institutional context of the public sector (for example, civil service rules and regulations) and the broader societal context (for example, the macro-economic situation, political stability and the relative autonomy of civil society). This approach is strongly influenced by the New Institutional Economics, which highlights the overriding significance of institutions as the ‘rules of the games’ within which organisations operate (North 1990). However, such a broad notion of capacity may also be problematic: capacity becomes almost synonymous with development, making empirical research into the issue very unmanageable (Cohen 1995). To counter this, the research described in subsequent chapters combined


a more detailed analysis of organisational capacity with a more focused assessment of the impact of the broader institutional environment upon capacity (Mills, Bennett and Russell 2001). In short, capacity may be described simply as ‘the ability to deliver’ where ability includes concepts of ‘knowledge, skills and attitudes’. It can be more precisely defined as ‘the ability to perform appropriate tasks effectively, efficiently and sustainably. This implies that capacity is not a passive state – the extent of human resources development for example – but part of an active process’ (Hilderbrand and Grindle 1994).

1.6

Study overview

The point of departure for the discussion in this book are four in-depth country case studies of urban water supply in Ghana (Amis 1998), India (Franceys and Sansom 1999), Sri Lanka (Franceys 1997) and Zimbabwe (Batley 1998). The specific water utilities analysed were: Ghana Water and Sewerage Corporation (GWSC, now GWC); Engineering Services Department (ESD), Bulawayo City Council, Zimbabwe; National Water Supply and Drainage Board (NWSDB), Sri Lanka; Pune, Nasik, Malegaon, Nandgaon and Bodwad municipalities, all in Maharashtra State, India. These countries were selected for the following reasons: • Low income – all four are low-income countries where state capacity tends to be weaker. • Focus on South Asia and Sub-Saharan Africa – two countries were selected from each region. The majority of the poor live in these regions. Maintaining a regional focus was desirable in order to prevent too great a diversity in the culture and bureaucratic tradition of the countries studied. • Common Anglophone and Anglo-colonial heritage – this criterion was also used in order to reduce the degree of diversity in the sample and thereby strengthen the ability to generalise to other Anglophone countries in South Asia and Sub-Saharan Africa. • Weak market institutions – in each region a country was selected where formal market institutions are more strongly developed (India and Zimbabwe) and where they are relatively less strongly developed (Sri Lanka and Ghana). • Governmental capacity – in each region a country was selected with a tradition of relatively strong conventional public services in terms of administrative capacity (India and Zimbabwe) and where there


has been experience of breakdown or considerable disruption and reconstruction of the governmental systems (Ghana and Sri Lanka). • Early and late adjusters – two of the countries (Sri Lanka and Ghana) are early adjusters that embarked upon structural adjustment programmes during the 1980s. Sri Lanka was a self-motivated forerunner of the World Bank/IMF package, while Ghana is often cited as an exemplary case in Africa. The other two countries (India and Zimbabwe) are late adjusters that embarked upon such reforms during the 1990s. As later adjusters Zimbabwe and India have been able to benefit from earlier experience, especially with respect to the adoption of a more socially sensitive approach. Early and late adjusters were selected partly so that there were differences in the period over which reforms had been implemented, but also because the conditions under which reforms were started and the type of reform programme adopted may vary systematically between early and later adjusters (Batley 1997; Mills, Bennett and Russell 2001). In each country the researchers described and analysed: • the existing organisational arrangements for the provision of urban water supply; • the forces sustaining existing service arrangements and the pressures for and resistance to change; • the performance of existing service arrangements in the provision and delivery of urban water supply, with respect to both the adequacy of governments performance of its roles and the efficiency and equity of outcomes; • the factors affecting the capacity of government to undertake its roles. In addition to the analysis of policy, organisational arrangements and performance of the urban water supply sector, consumer surveys were conducted in each of the core case study countries (Mutizwa-Mangiza 1997; Radoki 1996 and 1998; Silva, Russell and Radoki 1997). These studies drew primarily upon a series of focus group discussions and explored user views on the quality of the services provided, their identification of desired improvements, and their attitudes towards private sector participation and increased cost recovery.


At the time of writing, several years after the country-based fieldwork, the national governments of the four core case study countries have yet to complete the introduction of private sector participation in urban water supply under the new paradigm of a government regulated, private concession. In all four countries, the extent of functional and geographical responsibilities that should be included in any such ‘privatisation’ package is still the subject of political debate. In order to illustrate the future challenges that decision-makers face in these countries, we have incorporated the experience of several ‘reference’ countries that have introduced private sector participation in UWS in some of their largest cities or that have succeeded in reforming service delivery without public private partnerships. These include Argentina (Buenos Aires), the Philippines (Manila), and South Africa (Durban). We have also examined the experience of the only large-scale urban water co-operative in the world in Santa Cruz, Bolivia. Urban water supply was one of four sectors studied as part of a broader programme of research exploring the application of NPM in developing countries. The other sectors examined were health, crop marketing and textile promotion (Mills, Bennett and Russell 2001; Jackson 2002; Hubbard 2002). These four sectors were selected because of the different economic characteristics of the goods and services associated with each. In turn, this might determine the appropriateness of the new organisational forms under discussion in each of the sectors. This text draws only to a limited extent upon the findings from the other three sectors. A companion volume in preparation will integrate the findings from the four sector studies (Batley and Larbi 2004).

1.7

Structure of the book

The following two chapters set the scene for the discussion of reform of the urban water sector. Chapter 2 examines the structure and performance of urban water utilities, focusing on the four case study countries. Chapter 3 seeks explanations for poor performance and the limitations of traditional reform responses. Chapter 4 reviews the debate and practice of introducing private sector participation into the sector. Chapter 5 examines the particular experience of the concession model of public private partnership. Chapter 6 reviews reform efforts to address the particular water needs of the urban poor. Chapter 7 examines the recent experience of the state in regulating


and enabling private participation in the urban water sector. The final two chapters pull together the conclusions emerging from the research. Chapter 8 looks at the crucial question of governmental capacity to regulate the private sector, how this has affected performance of the urban water sector and how such capacity building may be enhanced. Chapter 9 concludes by reflecting on the applicability of the NPM paradigm to the urban water sector of developing countries.

2 The Structure and Performance of Urban Water Utilities

2.1

Introduction

There are growing differences between countries and within countries with regard to the organisational structure of urban water supply systems, the role played by governments within these systems, and the resulting systems performance. This chapter begins by providing an overview of the basic organisational arrangements for delivering urban water, including the respective roles of the public and private sectors, and then explores the different features of sector performance. It then seeks to offer readers an understanding of how the urban water supply systems have operated in the case study countries and what these systems have achieved. Monitoring performance was not a principal aim of the study. Consequently no primary data on performance were collected. Instead researchers relied upon existing data sources. Occasionally this created problems in terms of the reliability or comparability of data. Both the performance of the sector as a whole and the performance of government within the sector are discussed here.

2.2

Organisational arrangements for service provision

Until the mid-1980s, urban water supply was the basic urban service in which the private sector was least involved (Roth 1987). As late as 1977 a major textbook on urban water supply that included chapters on economic and organisational aspects barely mentioned the role of the private sector (Feachem et al. 1977). Yet from the mid-1980s there has been a marked increase in private sector participation in urban water supply. Within the broad field of provision, and following the New Public Management approach outlined in Chapter 1 it is necessary to distinguish 17


conceptually between ‘indirect’ and ‘direct’ provision. The direct provision of UWS includes the following major activities: abstraction from the water source, purification, carriage, storage and pumping through a pipe network, meter-reading, billing and payment collection. System maintenance and expansion involves operating and capital expenditure on all of these activities. The indirect provision of UWS includes the following activities: legislating, policy-making, and standard-setting. In turn, these activities lead to the regulation and monitoring of the direct provider. Several attempts have been made to classify the variety of organisational arrangements that are currently developing around the world (Coyaud 1988; Lewis and Miller 1987; Triche 1992a). Eight main organisational forms for service provision may be identified. They are listed here in ascending order of private sector involvement: the state-owned enterprise, the service contract, the management contract, the lease contract, the concession contract, the build-operate-transfer contract, the co-operative, and divestiture (Nickson 1996). Conceptually, these eight forms may be grouped into four basic arrangements: (i)

(ii)

(iii)

(iv)

public ownership, financing and provision: government both funds urban water supply and adopts the direct role of service management and delivery – with significant differences between the approaches of government/municipal departments and corporatised state-owned enterprises; public ownership and financing, with private provision: government funds urban water supply, but adopts an indirect role of service provision by contracting-out activities to the private sector (for example, via a service/management contract or lease); public ownership, with private financing and provision: government hands over the financing and provision of urban water supply to the private sector while retaining asset ownership and price control (for example, via a concession, or build-operate-transfer contract); private ownership, financing and provision: urban water supply is transferred completely to the private sector and the government role is confined to regulation (for example, via divestiture).

In the four study countries, the first of these arrangements was predominant – public ownership, financing and provision – and involved some limited experimentation with the second arrangement – public ownership, financing and indirect provision, coupled with private direct provision.

The Structure and Performance of Urban Water Utilities 19 Table 2.1: Allocation of direct and indirect provider roles in case study countries Country

Direct provider

Indirect provider

India

Public (state and municipal governments) Public (central government corporatised utility) and private sector Public (central government corporatised utility) and private sector Public (municipal government)

Public (state governments)

Sri Lanka

Ghana

Zimbabwe

Public (central government)

Public (central government)

Public (municipal and central government)

There was a basic similarity in the organisational arrangement for urban water supply in all four study countries, with the public sector retaining a direct as well as an indirect provider role (Table 2.1.). However, the precise arrangements varied. In Ghana there was an explicit separation of the indirect from the direct provider role. This was achieved by an institutional arrangement under which the direct provider was a quasiindependent public enterprise, the Ghana Water and Sewerage Corporation (GWSC), rather than a government department. As such, it was subject in theory to the same legal requirements as private companies – standard commercial and tax legislation, accounting criteria, competition rules, and labour law – and with explicit performance agreements negotiated with central government (Amis 1998). In Sri Lanka, responsibilities were divided between municipalities and the semi-autonomous National Water Supply and Drainage Board (NWSDB), which had undergone a programme of managerial reform since the mid-1980s (Franceys 1997). NWSDB was increasingly being expected to operate as a commercially oriented utility but without having separate corporate status. In Zimbabwe, there was no such explicit separation of the direct and indirect provider roles. Local government continued a long tradition of responsibility for water treatment, reticulation and delivery, and the water utilities operated as municipal departments. Nevertheless, in practice, the water utility within the Bulawayo municipality operated with a high degree of managerial and financial autonomy. This enabled it to move towards greater cost recovery and make efforts to redress regressive tariff structures. A system of commercial charging was enforced through the elimination of budget subsidies and its internal cost centres were subject to market testing (Mudege 1997; Batley 1998).


By contrast, in India there was only limited movement towards greater managerial autonomy for state-owned water utilities. As a result, the separation between the direct and indirect provider roles within the state apparatus remained minimal. The in-country research focused on a number of cities in Maharashtra State, in all of which municipal corporations were responsible for service delivery, subject to national and state control and guidance. Decisions on investment projects were taken and implemented by state-level organisations without consideration of the ability of municipalities to take over responsibility for the completed works and to finance their operations and maintenance (Franceys and Sansom 1999). In all four countries private sector participation was apparently nonexistent or remained limited to the conventional role as contractor for new investment in construction. The only exceptions were a limited number of service contracts (for example, meter-reading, billing, and management of a discrete element of the system such as a pumping station or treatment works). However, in India, Sri Lanka and Ghana the informal private sector continued to play a major role in providing water to those poorer residents who were not connected to the pipe network and who were not served by publicly-provided standposts.

2.3

Performance measurement

A critical issue in terms of assessing organisational performance is to determine the objectives against which performance should be judged. In the case of urban water supply utilities, there is a general consensus on the technical criteria that should be used to measure efficiency, effectiveness and equity. However there may be difficult trade-offs between them – such as between efficiency and equity. There is a further complication in assessing performance, namely that the formal stated policy objectives often differ from unofficial objectives. Because of the difficulty of identifying such unofficial objectives (for example, discouraging the growth of squatter settlements), it was not feasible in the case studies to attempt to assess performance against them (Mills, Bennett and Russell 2001). During the past decade, there has been an upsurge in the collection and publication of comparative performance indicators for urban water supply systems (Asian Development Bank 1993; Yepes 1993; Alegre 2000; OFWAT 2001a). The approach used here draws from these sources. Indicators of efficiency, effectiveness and equity can be useful in assessing performance by enabling comparisons to be made between utilities

The Structure and Performance of Urban Water Utilities 21

operating under different organisational arrangements. However such intra-country and inter-country comparisons need to be treated with some caution. Indicators necessarily give an incomplete picture of a water utility because they exclude performance factors that are not easily quantifiable and because utilities face different hydrological and geographical constraints in their operation. Performance is also partly conditioned by the systemic interaction between different urban services. For example, the irregularity of electricity supply for pumping – a common occurrence in India – may reduce the performance of the urban water supply sector (Stren 1988). For this reason, quantitative indicators should not be interpreted in a rigid fashion but rather be combined with evaluation of a more qualitative kind. Bearing in mind these caveats, the impact of organisational arrangements in the study countries was assessed according to these three aspects of sector performance – efficiency (operational and financial), effectiveness and equity. 2.3.1

Efficiency

Efficiency measures the relationship between resource inputs and outputs, both in operational and financial terms. The two most common indicators of operational efficiency are: • The unaccounted for water (UFW) ratio: this indicator is usually expressed as the ratio of the difference between the volume of water delivered to the distribution system and the volume of water actually sold, expressed as a percentage of net water production delivered. The unaccounted for water ratio ranges between a low of 8 per cent in Singapore and a high of 58 per cent in Manila (Serageldin 1994). The level of unaccounted for water may be disaggregated into technical losses (that is, leakages) and commercial losses (that is, illegal connections). The reduction of unaccounted for water is not only important as a conservation measure but also because the volume of water thus saved may avoid or postpone the need for capital investment to develop new sources. • The staff productivity index: this indicator is usually expressed as the number of staff per thousand water connections. As a general rule for large cities, a ratio of less than ten staff per thousand connections is satisfactory and less than five per thousand is very good. Alternative measures include: the number of persons served per staff member; thousands of m3 of water sold per year per staff member; and kilometres of distribution pipe in the water supply system per staff member.


Other indicators of operational efficiency include: water consumption, which is expressed either as average daily consumption per person served (litres per capita per day – lpcd) or average monthly consumption per connection (m3 per month); water distribution, which is expressed variously as the number of people served per metre of distribution pipe, the number of connections per metre of distribution pipe, the number of breakages per 100 km of pipe per year, or the number of leaks repaired per 100 connections per year; and meter performance, which is expressed either as the number of meters read per reader per day or the percentage of meters in working order. Indicators of financial efficiency are critical for financial sustainability and the ability to sustain an adequate investment programme. They measure the degree of success of a utility in achieving organisational targets at minimum cost. It is difficult to make a clear comparative analysis of the finances of water utilities in different countries (Yepes 1993). Two major financial indicators measure the extent to which tariffs cover the cost of provision, as follows: • The working ratio (WR): this measures the ratio of operating cost to operating revenue, where operating cost excludes depreciation, interest payments and debt service payments. Operating revenue includes revenues from water tariffs, connection fees, well abstraction fees and re-connection fees. Sound financial management requires the WR to be less than 1 and well-managed utilities have a WR around 0.5. • The return on fixed assets (ROFA): this measures the overall profitability of a water utility. It is often used in the urban water sector of developing countries as a proxy for the more conventional business indicator, Return on Capital Employed (ROCE). This is because of the uncertainties of accounting for sunk capital and is a recognition of the fact that the overwhelming use of capital has been in providing fixed assets, such as reservoirs, treatment plants and pipes. However, in order to obtain an accurate figure for ROFA, the fixed assets have to be properly valued, ideally using current cost accounting. There are two other indicators of financial efficiency. Accounts receivable measures the ratio of payments outstanding to monthly billings. A high ratio (for example, more than three months) is indicative of problems in the billing and collection system. When the ratio is increasing, the cash flow of a water utility may be jeopardised. Collection efficiency measures the ratio of total annual collections to


total annual billings. Poor collection efficiency is more likely to be the fault of the water utility than that of the consumer (Asian Development Bank 1993). 2.3.2

Effectiveness

Effectiveness measures the extent to which outputs achieve original objectives. From the point of view of consumers, effectiveness is measured by the quality of the water supply that they receive, in the form of water availability, water quality and consumer satisfaction: • Water availability: which can be measured either by the average number of hours per day or by the maximum number of continuous hours per day for which water supply is available from the pipe network. To this must be added the pressure at which water is available in any particular area. These indicators are particularly important in the light of recent research suggesting that a priority need of consumers is for a reliable and constant water supply. Rich households can solve such difficulties by installing their own storage tanks and pumps, often illegally, on the water main. The poor are far less able to afford such facilities. Instead, poor household members, usually women, have to queue for the intermittent and limited supply from a standpost. In extreme cases they must queue in the middle of the night when overall demand on the system is lowest. • Water quality: which can be measured either by the proportion of the population in the service area that boils water taken from the tap before drinking or by the percentage of analyses of water quality that fall below an agreed standard. However, the use of data for comparative purposes from the first of these methods is limited by two factors – the financial limitation on fuel costs for low-income households, and the extent of public understanding of the link between drinking water quality and health. Data from the second approach, requiring sophisticated laboratories and a rigorous testing schedule, is often limited by the lack of resources available for operations and maintenance. For many of the urban poor, water quality is always below standard because intermittent supplies, with the regular absence of positive water pressure, lead to ingress of polluted ground water on a daily basis. • Consumer satisfaction: which can be measured in proxy form by the number of complaints recorded per 100 connections per year. Complaints may be disaggregated into billing complaints, complaints about water quality and complaints about interruptions to


supply. International comparability is limited by the differential proneness of consumers to complain and by different procedures used by water utilities to record complaints. Receiving water for two hours every other day on a regular basis may not give rise to complaints but this cannot be assumed to imply customer satisfaction. 2.3.3

Equity

An equitable supply of water, which can ensure that the poor also have affordable access to clean water (and sanitation), is vital to ensure the public health benefits that are a major justification for public sector involvement in the sector. However, water utilities come under greatest pressure to ensure an acceptable level of efficiency and effectiveness in supply to those households already connected to the network. This has often meant that the equity issue of widening supply to those households unconnected to the network is relegated to secondary importance. The most common indicator of equity is service coverage, which measures the proportion of the population in the service area that receives water from the network system. It is usually expressed as: [ (number of house connections ⫻ persons per household) ⫹ (number of public taps ⫻ persons per public tap) ] ÷ [total population of service area]. The service coverage may be disaggregated between house connections and public taps. Low service coverage does not necessarily imply a poor water supply situation because residents may have access to cheaper alternative water sources such as wells. In this situation, switching to a new extension of the pipe network may involve a prohibitive financial cost in the form of connection charges and higher consumption charges, though in urban areas alternative sources may well be compromised by pollution from run-off and on-site sanitation. The measurement of equity in urban water supply is bedevilled by conceptual difficulties. The first of these is the fact that the major equity consideration refers to the citizens, often the poorest, who although residing in the service area are not currently consumers of the water utility (either because they lack household connections or access to standposts) and who rely instead on supply from higher-cost private water vendors (PWVs). Studies suggest that morbidity and mortality rates among the poorest urban communities not connected to the network are higher than the rural average, precisely because of the lack of affordable and clean water (Black 1994). Two key indicators measure the degree of inequity resulting from this situation: monthly expenditure on water as a share of monthly household


expenditure, and the average price per litre of water purchased from vendors expressed as a quotient of the average price of water from the pipe network. Inequities are greatest where the water service is most heavily rationed. Under this so-called ‘hydraulic law of subsidies’, the subsidies go with the service. Consequently it will always be the better off and more influential consumers, rhetoric notwithstanding, who benefit preferentially from subsidies (Serageldin 1994). Price subsidies to urban water consumers almost always disproportionately benefit the nonpoor, with the poor typically paying to vendors ten times the price for water that more affluent consumers with household connections pay to the network utility. As was shown in Figure 1.1, in the 1990s the urban poor in cities around the world were typically paying between ten and twenty times the price per cubic metre paid by high-income consumers connected to the network, although examples of price differentials of one hundred times are not uncommon. The measurement of equity in the more restricted sense of comparisons among poorer and richer households connected to the pipe network is also beset with conceptual difficulties. A so-called ‘lifeline tariff’ may be incorporated within a system of volumetric charging in order to protect the poor. This will also maximise positive externalities through the benefits to public health of affordable and clean water for all. The lifeline tariff may take the form of a low and subsidised unit cost for the first 20m3 per household per month, accompanied by a graduated tariff structure, known as an Increasing Block Tariff (IBT), for additional ‘blocks’ of water. The extent to which an IBT that incorporates a lifeline tariff is used in preference to a pro rata tariff structure is usually viewed as an indicator of the degree to which equity considerations are incorporated in the pricing policy of a water utility through cross-subsidisation. IBTs also encourage efficient water use and water conservation by applying higher charges for consumption with low marginal utility such as filling swimming pools and lawn sprinkler systems. However in some urban areas of low-income countries the standard equity argument in favour of an increasing block tariff system is not always valid. For example, households in high-density housing areas who share a single meter connection may end up paying more per unit than households with individual connections. Also, many low-income families do not have private connections at all. Instead they purchase water from neighbours who thus become caught up in increasing block tariff rates and pass them on to the buyer (Whittington 1992).


2.4

Review of organisational performance

This section reviews the performance of the organisational arrangement for water supply in each of the four case study countries by applying the indicators of efficiency, equity and effectiveness outlined in section 2.3 of this chapter. 2.4.1

Ghana

The overall performance of the GWSC was very poor, but with a trend towards improvement in recent years. Indicators of efficiency were low. Water losses remained very high, albeit falling from 63 per cent in 1988 to 53 per cent by 1993. An estimated 50 per cent of all meters were not working and 24 per cent of all connections were not billed. There had been some improvement in staff productivity, with the number of employees per thousand connections in Accra falling from 33 in 1985 to 13 in 1993. But net losses increased significantly ever since the central government subsidy was withdrawn in 1987. Overall, the improvements in operational efficiency (water losses and the staff productivity index) appear to have been offset by the deterioration in financial efficiency. The overriding factor here was the refusal of central government to approve tariff increases in line with the rate of inflation. GWSC had such a severe shortage of working capital that at least 20 per cent of new connections in Accra involved community or household payment for the cost of pipe with the installation carried out by GWSC (Amis 1998). Official figures suggest that all residents in the cities of Accra and Kumasi had access to piped water (Ghana Statistical Service 1995). However they grossly exaggerate the level of service coverage, which was very low, with even Accra, the capital city, having only 60 per cent coverage. In fact, one-third of low-income households purchased their water from PWVs. Many low and middle-income residents purchased water by the bucket from the pipe network in nearby areas or from the owners of storage tanks. In 1996 the price per gallon was between 5 and 16 times as much as the charge for a public supply (Rakodi 1996). As a result: In Ghana most of the urban population do not have piped water in their homes. In as much as many people buy their water from those who have piped connections or have access to tanker trucks, the poorest parts cannot even afford to buy from shallow hand-dug wells that are untreated and probably unsafe. An average family uses ten buckets of water a day at a total cost of US$0.50 and the current


minimum wage is US$0.90 per day. Many people in Ghana do not even earn the minimum wage and a lot have no regular incomes. (Cobbold 2001) 2.4.2

India

Remarkably little overall management information is available about the performance of the urban water sector in India and this affected the case study findings. A survey of water utilities in 35 urban centres, representing 15 per cent of the urban population of the country, revealed dismal levels of efficiency, effectiveness and equity (Franceys and Sansom 1999). Operational and financial indicators displayed a very low level of efficiency. The unaccounted for water ratio was in the range of 40–60 per cent. Only 47 per cent of connections were metered and at least half of those were out of order. The staff productivity index was among the lowest in the world, with an average of 24.2 employees per thousand connections. The average collection efficiency was only 76 per cent and the average operating ratio was 2.53, indicating that only 40 per cent of operating costs were being covered by revenue collection. There was no semblance of an attempt to cover capital costs. Levels of effectiveness were also poor. Water was supplied on average for only seven hours per day. But this average masked enormous disparities, with supply averaging only one or two hours per day in many large cities, and only one hour every alternate day in some small towns. Water quality was also universally poor with, as an anecdotal indication, most water supply engineers always expecting their own households to boil water before drinking. The existing service arrangements were also extremely inequitable. The reported service coverage in all urban areas in India in 1993 was 84 per cent, but this greatly exaggerated service coverage for two reasons. First, the ‘coverage’ figure is defined as installed capacity to supply rather than actual distribution to consumers. Second, many peri-urban areas were excluded from this calculation. Low-income residents who depended upon public standposts received by far the poorest service. They had to fight a daily battle for water as they waited in endless queues. Inequities in water distribution were enormous. In Delhi, average daily consumption by slum dwellers was only 16 litres per capita per day (lpcd) compared with an average consumption of 313 lpcd (twenty times as much) by affluent residents. The overall performance of the municipal-owned water utility case studies in Maharasthra State was extremely poor, and with a downward


trend. In Pune, low-income families purchased water from residents with individual or group connections or from neighbouring areas. These consumers paid US$0.47–US$1.90/m3, compared to a sale price of metered water to middle- and high-income households of US$0.06–US$0.07/m3 (Rakodi 1998). Overall, the picture was of UWS systems that were overstaffed by a factor of between five and ten, supplying water through household connections to less than half of the urban population at prices that covered only one quarter of the economic cost (operating and capital), and at zero price to a further third of the urban population through standposts. However, both supplies were only available for a few hours every day, with the systems gradually breaking down through lack of maintenance (Franceys and Sansom 1999).

2.4.3

Sri Lanka

The overall performance of the NWSDB was poor, but with some improvement in efficiency as a result of an institutional development programme carried out from 1980 to 1990 when a gradual reduction in government subsidies was accompanied by modest increases in domestic tariffs. The staff productivity index improved from 38 employees per thousand connections in 1990 to 28 per thousand in 1995, although this latter figure was still very high by international standards. However, water losses remained excessive, with unaccounted for water at 45 per cent in 1995, with no improvement over the previous decade. Financial efficiency showed some improvement – the operating ratio fell from 1.30 in 1989 to 0.63 in 1995. The ‘days receivable’ ratio (the average time that it takes for customers to pay their bills) fell from 406 days in 1989 to 161 days in 1995, although this latter figure was still very high by international standards. Despite these limited improvements in operational and financial efficiency, indicators of effectiveness remained poor. Water availability was low, with only 30 per cent of households connected to the pipe network receiving a continuous 24-hour a day water supply. The growing incidence of water-borne diseases in Colombo strongly suggested that bacteriological water quality was deteriorating. Service coverage was unsatisfactory, with only 63 per cent of urban residents connected to the pipe network. A continuing concern for equity was shown by the maintenance of the lifeline tariff rates. Nevertheless, middle and highincome households in Colombo still benefited from subsidised tariffs (Franceys 1997).


2.4.4

Zimbabwe

By contrast with the other three case studies, the overall performance of the Engineering Services Department, Bulawayo was generally satisfactory, although with a slight downward trend. Indicators of operational efficiency were high. The ratio of unaccounted for water was low at around 25 per cent. The staff productivity index was extremely high at 4 employees per thousand connections. Financial efficiency indicators were also good. The operating ratio was close to target, at 0.7. Following a long period during which Bulawayo earned a high reputation in billing and collection, the accounts receivable ratio rose sharply in 1996 because of a combination of a computer breakdown and widespread consumer dissatisfaction over a tariff increase. Nevertheless, for over a decade the department generated sufficient surplus in order to cover its operating costs and the cost of servicing outstanding loans, although not the full cost of future investment. In Zimbabwe, where urban development has been strongly controlled and illegal settlement largely confined to the backyards of legally developed houses, piped supply is available to all within urban administrative boundaries. This almost universal connection to the pipe network suggests a high degree of equity and effectiveness, although the prevalence of drought meant that the volume of water available for consumption was at times restricted through rationing. Nevertheless, even during the worst periods of drought, a basic service was maintained on the basis of a continuous 24-hour supply. Water quality was also high. Rationing under conditions of drought had a positive impact on equity – through the introduction of both a universal ration on consumption per household, and, subsequently, of a lifeline tariff rate for low-income residents (Batley 1998).

2.5

Consumer perceptions of service quality

Focus group discussions were conducted in each of the case study countries that sought to determine how consumers perceived the quality of service provided by water utilities (Mutizwa-Mangiza 1997; Radoki 1996 and 1998; Silva, Russell and Radoki 1997). A total of 45 focus group discussions were carried out, with mainly low and middle-income residents (Radoki 2000). In general, consumer perceptions about service quality supported the descriptions of performance given in section 2.4 above, although there were some clear differences between the countries in some aspects of service quality. For example, in Zimbabwe there was general satisfaction


with the regularity of water supply, while high levels of dissatisfaction were expressed in Ghana and Sri Lanka. In India, where irregular supply had become a fact of urban life, overt criticism was muted by an attitude of resignation. Consumers in Zimbabwe and Sri Lanka expressed satisfaction over both the quality of water and the responsiveness of the water provider to complaints. On the contrary, consumers in Ghana and India expressed high levels of dissatisfaction on both counts. Significantly, consumers here were not averse to increases in water

Table 2.2: Quality of service provided by water utilities: consumer perceptions Ghana

Zimbabwe

India

Sri Lanka

Regularity of supply

High level of dissatisfaction with irregular supply, and serious and frequent water shortages

General satisfaction with regularity of supply

Extremely limited supply criticised but accepted as a fact of urban life

High level of dissatisfaction with irregular supply, and serious and frequent water shortages

Water quality

Water quality considered poor (bad taste, containing sediments and discoloured)

High level of satisfaction (no need to boil)

High level of dissatisfaction (turbidity, contamination, need to filter/boil all drinking water)

General satisfaction

Responsi- Dissatisfaction veness of as complaints provider to ignored complaints


Dissatisfaction as complaints ignored


Level and structure of water tariff

Complaints over tariff structure (drought levy, regressive)

Not opposed to tariff increase but only after visible service improvement

Opposed to tariff increase, especially for poorest

Very negative – local government should retain control

Negative

Very negative – especially among poorest

Not opposed to tariff increase but only after visible service improvement

Attitude to Negative private sector participation

Source: Rakodi 2000.


tariff, but so long as they were preceded by visible improvement in water quality and regularity of supply. Meanwhile, consumers in Zimbabwe and Sri Lanka were hostile to tariff increases on equity considerations. There was a general hostility in all four case study countries to the introduction of private sector participation in the reform process for fear that their limited access to existing services would be further restricted (Table 2.2).

2.6

Conclusions

In all four case study countries there was broad similarity in the organisational arrangements for urban water supply. Services were publicly financed and provided with only a limited degree of contracting of

Table 2.3: Country case studies: summary of performance Ghana Operational efficiency Staff product- 13 per 1,000 ivity index Unaccounted for water Financial efficiency Operating ratio

India

Sri Lanka

Zimbabwe

24 per 1,000 28 per 1,000

4 per 1,000

53%

40–60%

45%

25%

0.88

2.53

0.63

0.7

Collection efficiency

24% connections 76% not billed

Days receivable N/a ratio – 161 days

Effectiveness Water availability

N/a

1–2 hours per day

Only 30% have 24 hr service

24 hours, but rationed

34% of lowincome households

N/a

N/a

Minimal

60% (87%)

N/a (92%)

63% (91%)

100% (100%)

Equity % dependent on vendors Estimated urban service coverage (government figures in italics)


operations to the private sector. Yet despite some differences, the overall performance of water utilities in three of the four countries was poor when measured against the template of internationally-agreed indicators of efficiency, effectiveness and equity for urban water utilities (Table 2.3). Individual country performance may be summarised as follows: Ghana (very poor, with upward trend), India (very poor, with downward trend), Sri Lanka (poor, with slight upward trend), and Zimbabwe (satisfactory, with slight downward trend). Collectively, they present a sombre picture of performance of the urban water sector in those low-income countries where the public sector is dominant in the institutional arrangement for service provision. With the exception of Bulawayo, Zimbabwe, the performance data show that in these countries the stated overarching policy objective for the sector – the delivery of clean and affordable water to all its urban citizens – is not being met under the existing institutional arrangements. Accurate quantitative data on water availability were not available for the case study cities, but it is clear than even in areas where piped water was theoretically available, interruptions to supply and low pressure were prevalent, with the exception of Zimbabwe (Rakodi 2000).

3 Explanations of Performance and Reform Responses

3.1

Introduction

In Chapter 2 we identified the many failings in the performance of urban water utilities in the country cases, as measured by indicators of efficiency, effectiveness and equity. Here we attempt to explain the reasons for this poor performance. We address this core question by examining the capacity or otherwise of government in the respective countries to implement the arrangements for provision. In so doing, we seek to identify the factors that influence government capacity to undertake its roles, particularly the ‘indirect provider’ roles of regulation and enabling. We follow the contemporary approach to capacity-building that views it not merely in terms of staff training and organisational reform but widens the remit to include the range of institutional factors outside the organisation that impact on the mobilisation of internal capacity (Hilderbrand and Grindle 1995). Hence, within the broad framework of capacity-building, we make a basic distinction here between organisational capacity and institutional capacity. In the light of these capacity constraints, we then critically evaluate the reform efforts towards corporatisation in the four country cases. From the outset we recognise that one peculiar characteristic of urban water supply – its ‘capital intensity’ – has long concealed underperformance in the sector. The ratio of capital invested to operating revenue is variously quoted as double or triple that of the capital intensity of other network utilities such as electricity, telecom or gas. Coupled with the difficulty for the consumer to determine product quality (that is, potability), this means that once the initial capital investment has been made it is possible for an apparently functioning system to degrade over a very long time without that failure becoming 33


too obvious. The fact that the world is now beginning to address this challenge might indicate that we are a long way down that path of slow and hidden failure.

3.2

Organisational capacity

Three major internal factors have been identified that influence the capacity of organisations such as urban water utilities to perform well – the skills and professionalism of personnel, managerial autonomy, and availability of finance (Batley 1997). Each of these is now discussed in the light of the case study findings. 3.2.1

The skills and professionalism of personnel

The capacity of an urban water utility to perform well is obviously closely related to the quality of its personnel. Most countries have invested significantly in the professional training of water personnel. This has led to an abundance of excellent water scientists and engineers. But the vast majority of these do not understand how to manage a customer-oriented service provider. An internal review of World Bank-funded projects for the reform of state-owned water supply and sanitation companies from 1979 to 1989 concluded that successful implementation had happened in only a minority of countries where the quality of public administration was unusually good (World Bank 1995). Clearly, organisational performance is partly a function of the pay and conditions enjoyed by its personnel. The GWSC in Ghana provides a most striking case. Salaries were so low that there was a serious shortage of senior personnel. Poor morale was the norm. However, a relatively high salary level is no automatic guarantee of better performance and vice versa. This is evidenced by the very different experiences of water utilities in India and Zimbabwe. In Maharashtra State, despite widespread perks and a superabundance of highly qualified water engineers, the absence of a strong professional ethos – in particular the lack of a customer-oriented approach – was a major factor explaining low performance. Personnel continued to pursue the personal goals that were appropriate to the traditional career systems. This encouraged them to operate with typical ‘survival strategies’ within public works departments that were riddled with patronage networks. By contrast, performance remained relatively high in Bulawayo despite a severe shortage of senior and middle-level technical personnel that was occasioned by unattractive terms of employment. A strong

Explanations of Performance and Reform Responses 35

professional ethos, involving delegation of authority and intolerance of corruption, was in evidence, as well as a public service tradition involving commercial and customer orientation. The professional ethos and public service tradition seemed to have operated as compensatory factors in maintaining the level of performance in spite of low pay. 3.2.2

Managerial autonomy

Evidence from the case study countries strongly suggests that managerial autonomy is a crucial factor in promoting good performance. Without exception, the best performing water utilities were those with a high degree of autonomy and vice versa. The reference case study of the SAGUAPAC water co-operative in Santa Cruz, Bolivia is a striking example (see Box 4.7). By contrast, the five water boards in Maharashtra State, India that scored badly on performance indicators were all characterised by an extremely low level of managerial autonomy. Interference was rife by municipal, state and central government bodies in the day-to-day decision-making of these utilities. None of the four core country case studies had experience of the enhanced managerial autonomy that is a major feature of private sector participation in the operations and maintenance of water utilities. Nevertheless, the case studies confirm that it is the relationship between performance and actual, rather than formal (that is, legal) autonomy that real counts. In Bulawayo, Zimbabwe, the Water Branch of the ESD performed well despite the fact that it is fully integrated within the wider municipal administration and is consequently almost completely lacking in formal autonomy. In practice, however, as shown in section 3.5 below, it is not so lacking in autonomy as at first appears. By contrast, the formal autonomy granted to the NWSDB in Sri Lanka and the GWSC in Ghana is largely fictitious and so does not promote high performance. Although the NWSDB was converted from a government department to a public corporation in 1975, central government continues to impose stringent limitations on its managerial autonomy through the Ministry of Housing, Construction and Public Utilities. The GWSC was established as a separate public corporation in 1965, responsible to the Ministry of Works and Housing. However, its managerial autonomy has been hamstrung throughout its existence by the requirement until very recently to obtain ministerial approval for tariff increases. The good performance of SAGUAPAC in Santa Cruz, Bolivia is closely related to the high degree of managerial autonomy that is a feature of its institutional arrangement in the form of a co-operative. First, the


co-operative structure shields management from undue political interference, especially with regard to personnel management and the awarding of contracts. The general manager has been in post since 1986, in sharp contrast to the norm in Latin America where managers of state or municipal water companies are regularly removed when a new political leadership takes office. Second, the co-operative structure also means that SAGUAPAC is not bogged down with legal delays in tendering procedures and in the administration of external loan finance that bedevil water companies belonging to the public sector. This means that it can implement investment projects much faster and more efficiently than other companies (Nickson 2000). 3.2.3

Availability of finance

In such a capital-intensive business as urban water supply, adequate investment finance is critical, whether for pipes to extend services to peri-urban areas or for additional treatment capacity. In such a low risk business, which involves the monopoly provision of a basic need that households must access every day, shortage of finance should be the exception, not the rule. Yet in practice, the degree of managerial autonomy, to the extent that it enables or not the setting of viable tariffs, has had a significant effect on the availability of such finance. Without adequate tariffs there can never be the necessary internal cash generation for investment, let alone any assurance of repayment for commercial lenders. The traditional practice of reliance upon occasional, often haphazard, bursts of investment finance from bi-lateral or multi-lateral development agencies does little to promote organisational capacity. The availability of sufficient finance is also a crucial factor affecting the capacity of publicly-funded bodies to carry out the indirect roles of regulation and enablement of water utilities. Where the organisational arrangement for service delivery involves a public private partnership, there is a formal separation between the direct and indirect provider. In this case the earmarking of finance is a common solution to this problem. For example, the water regulatory body, Tripartite Entity of Sanitation Works and Services (Ente Tripartito de Obras y Servicios Sanitarios – ETOSS) that oversees the concession contract in Buenos Aires, Argentina is financed by a 2.67 per cent cess on the proceeds from all water bills. However, in the four case study countries, where no such formal separation yet exists, the financing of the regulatory and enabling roles by central government is problematic, especially at times of fiscal austerity. The exigencies of IMF-imposed structural adjustment programmes can


so restrict finance that key regulatory functions such as pollution control and dam safety can be jeopardised. This is the situation in Zimbabwe where the Pollution Control Unit (PCU) of the central government Department of Water Resources (DWR) had only four members of staff and was dependent on external aid financing for its laboratory unit (Batley 1998).

3.3

Institutional capacity

Four extra-organisational conditions in the surrounding institutional environment have been identified that impact on the mobilisation of internal capacity, either releasing or constraining it. These are: financial and economic conditions, political practices, the legal and administrative framework, and public sector interaction with the private sector (Batley 1997). Each of these is now discussed in the light of the case study findings. 3.3.1

Financial and economic conditions

Sound macro-economic policies are essential if water is to be treated as an economic good. Macro-economic stability, by reducing uncertainty, lessens the risk premium associated with foreign investment and thus indirectly increases the viability of foreign private sector participation in urban water supply. More specifically, stable foreign trade and exchange rate policies, including a commitment to currency convertibility and profit repatriation, lessen the risk premium associated with the foreign borrowing and equity finance required for network expansion. Price stability is also important because a high inflation rate renders virtually impossible the indexation of utility prices, itself a vital component of sound financial management. There were considerable differences between the case study countries with regard to the macro-economic environment. Ghana displayed sound macro-economic management, including strict fiscal discipline and liberalisation of foreign exchange. This was the product of its adherence to an IMF and World Bank structural adjustment programme since 1983 (Amis 1998). By contrast, Zimbabwe displayed a deteriorating macro-economic environment, characterised by rising inflation, devaluation, and a growing budget deficit. The reluctance of the government to reduce its extensive state intervention in the economy led to worsening relations with the IMF (Batley 1998). Macro-economic management in both India and Sri Lanka remained based on the twin pillars of central planning and welfarism. The long practice of strict


foreign exchange controls protected both countries from external imbalance. Although this shielded them from IMF pressures, the associated heavy state intervention and chronic fiscal imbalance remained major factors dissuading foreign direct investment. 3.3.2

Political practices

The actions of politicians can be a major constraint on capacity in the public sector, as shown to varying degrees in the case study countries. In all cases the major form of interference by politicians in the urban water sector was their opposition to proposed prices increases designed to introduce a cost-reflective tariff structure. Direct interference by politicians in the hiring, transfer, promotion and firing of utility personnel, especially at the highest level, was also still common in Ghana, India, and Sri Lanka, although not so in Zimbabwe. Despite strict adherence to an IMF structural adjustment programme, the reform of the state owned enterprises (SOEs) in Ghana has proceeded slowly because of opposition from leading politicians who fear a loss of patronage. Indeed, according to one writer ‘the current donor emphasis on multi party democracy is only likely to increase this need for the use of state organizations for patronage purposes’ (Amis 1998). In India, politicians seek to demonstrate their worth by active involvement in issues surrounding water because of its strong cultural significance. For more mundane vote-catching reasons, they also encourage the view that water is a public good for which zero or only nominal payment is justified. Ironically, the false rhetoric of egalitarianism, voiced in the name of the urban poor, inhibits effective management to such an extent that the most disadvantaged groups usually fail to receive any improvement in their meagre allocation from the resulting limited supply of water. In most Indian states political interference is also widespread in human resource management. In several states the ‘transfer industry’ is especially prevalent whereby water engineers are obliged to pay large bribes to politicians in order to ensure their transfer to a desired posting (Franceys and Sansom 1999). In Sri Lanka senior politicians still see the need to restrict tariff increases to a minimum. They perceive that there is more to be gained politically from a combination of new projects and low existing tariffs rather than from allowing the direct provider to attain increased financial efficiency and hence lower tariffs in the long run. Although politicians still exercise patronage over these new projects, they have now foregone the need to impose staff unnecessarily on the NWSDB (Franceys 1997).


In Zimbabwe, direct interference by politicians in the management of urban water utilities was less pronounced. At the local level, municipal councillors in Bulawayo have sometimes gone beyond a role of representing constituents’ complaints about the water situation to one of promising moratoriums on payment arrears and waivers of penalties that have stood in the way of efficient user charging. Central government water bodies were becoming more exposed to disruptive political interference than was the case in Bulawayo. At the most general level, much of the under-investment in the development of water resources has been attributed to the conflicts between parties and ethnic groups that led to hostilities in the 1980s, and which led to tension between the central government and the province of Matabeleland, of which Bulawayo is the capital (Batley 1998). 3.3.3

The legal and administrative framework

Constitutions, laws, norms and established practices shape the ‘room for manoeuvre’ of public and private providers by determining their powers and financial self-sufficiency. In three of the case study countries (Ghana, India and Sri Lanka) new laws provided positive incentives to operational and financial efficiency. But invariably these were countermanded by established practices that worked in the opposite direction. For example, in India prevarication in government policy towards reform of the urban water sector is reflected in the yawning gap between the rhetoric of official reform statements and the reality of minimal change on the ground. The 74th constitutional amendment, passed in 1992, envisaged the transfer of responsibility for urban water supply to the 3,500 municipalities in the country. In 1997 the Ministry of Urban Affairs and Employment (MOUAE) commissioned a study that advocated greater commercial autonomy for state-level urban water boards. The study proposed to restrict the role of the state government to the approval of annual action plans and the provision of budgetary support. However, to date there has been little real change on either front. State water supply and sewerage boards remain under strict political control and many urban water supply systems are still operated by state-level rather than municipal bodies. Sri Lanka is another case in point where, according to an official report, water-related legislation is ‘incoherent, inconsistent and unenforced’ (Government of Sri Lanka 1995). The references to environmental management in the constitution are very general and do not refer specifically to water. A wide range of water-related laws was enacted many years ago. However the scope of this legislation is severely


restricted and their objectives do not meet modern needs. There are now too many laws, resulting in agency responsibilities that are fragmented, overlapping and conflicting. At the same time there are huge gaps in their provisions. Many laws lack implementation capacity, particularly in terms of provision for monitoring and enforcement authority. The penalties that can be imposed are frequently inadequate. Changes in the structure of government associated with decentralisation have further confused responsibilities. New agencies that were created at the subnational level have not been equipped to assume the new responsibilities. Laws do not always apply to all parts of the country. There is no provision and little encouragement for citizens and NGOs to take civil action against lawbreakers or against government agencies that fail to enforce the law. As a result, NWSDB has faced major difficulties in securing legal rights to essential water sources (Franceys 1997). 3.3.4

Public sector interaction with the private sector

In three of the core case study countries (India, Sri Lanka and Ghana) there is a tradition of mistrust and lack of understanding between the public and private sectors. The construction industry is the branch of the private sector with which senior water utility staff has most contact. In many countries it is normal practice for private construction companies to win contracts through corrupt practices. Consequently, in these countries, water utility staff cannot conceive of the possibility that a large-scale concession contract could be awarded to private operators without involving a further extension of corruption. Hence they are often bewildered by the enthusiasm of foreign consultants who describe this as ‘reform’. This tradition of mistrust represents an important constraint on the capacity of the public sector to develop new ‘indirect provision’ roles of regulation and enablement. This problem is particularly evident in India where the ‘supply-driven’ pre-Independence public works/construction model and the post-Independence dirigiste political ideology are both deeply-rooted in the organisational culture of the engineering profession. Their professional ethos attributes high status to the public sector, where the vast majority of engineers work. In contrast, there are very few private contractors with experience in managing urban water utilities. There are only the construction contractors to be mistrusted.

3.4

Reform policies and plans

In most countries around the world urban water supply started off as one of the various functions of a municipal public works department,


sharing its scarce engineering expertise with roads, street-lighting, public buildings and waste disposal. The realisation that, unlike roads and street-lighting, water supply had the potential to be revenue generating, started a long-running trend towards commercialisation and its institutional counterpart – corporatisation. These attempts at separating off the water supply function were necessary to protect its revenue stream from the claims of other parts of the often under-funded municipal or state-level body. It also enabled the water supply function to become more focused both in regard to its mission and to its professional expertise. Consequently in many countries there has been a noticeable trend towards improving the performance of state-owned water utilities through corporatisation. Under this institutional arrangement, the state retains direct control over the provision and supply of water. However, the state water utility is granted a degree of legal, financial and administrative autonomy, broadly encapsulated in the concept of the ‘state-owned enterprise’. This greater autonomy is evidenced by measures such as the removal of statutory restrictions on its range of activities, the elimination of budgetary subsidies, a switch in revenuegeneration from a tax-based system to a more commercial charging regime, and the managerial freedom to recruit and dismiss staff. Although the above-mentioned reforms are aimed at making these public-owned utilities operate in a manner more akin to a private company, they are often incorrectly referred to as a form of privatisation. The corporatisation of state water utilities can take place where urban water supply is the responsibility of either local, regional or central government. In Germany and France, it has long been a responsibility of local government. Under the German Stadtwerke model and the French Régie personnalisée model, municipal-owned water utilities have considerable managerial and financial autonomy. Water utility staff is not included in the municipal payroll and the water account is separate from the general municipal budget (Briscoe 1995). Where urban water supply is the responsibility of central government, the performance of urban water utilities has been improved in some countries by converting them from government departments into quasi-independent public enterprises and subjecting them to the same legal requirements as private firms – standard commercial and tax law, accounting criteria, competition rules and labour law. In several East Asian countries, there is an explicit separation within the public sector between the role of ensuring water provision and the role of implementing the delivery of water. This is achieved by performance contracts, negotiated between the government


and the managers of such water utilities (Estache 1994). A striking example is the Singapore Public Utilities Board, which is the most efficient water utility in Asia and one of the best performing water utilities in the world (Asian Development Bank 1993). Box 3.1: The state-owned enterprise – an example from Botswana The Botswana Water Utility Corporation (BWUC) has achieved a high level of performance under state ownership and operation. BWUC maintains a 24-hour water supply to all its service areas. The high quality of water treatment means that Botswana is one of the few countries in Sub-Saharan Africa with safe drinking water. It charges cost reflective tariffs, regularly adjusted for inflation and cost increases. There is a strict billing and collection procedure. Meters are read monthly and supply is cut off if payment is not made within 30 days. Arrears by government users are rare, thanks to a ‘one-cheque’ system whereby the Ministry of Finance settles all utility bills and deducts the corresponding amounts from the cash allocations of each ministry (World Bank 1994).

3.5

Reform processes

So far in this chapter we have examined the organisational and institutional factors that limit the performance of those urban water utilities that are owned and operated by the public sector. We have identified ‘corporatisation’ as a institutional arrangement within the framework of state control that has the potential to generate improvements in performance. We now examine the experience of the four core case study countries in their efforts to introduce corporatisation. 3.5.1

Ghana

The Ghana Water and Sewerage Corporation was established in 1965 out of the Public Works Department and was originally conceived as a selffinancing body within the public sector. Its Foundation Act No. 310 (Section 7) stated that it should be managed in such a manner ‘as to ensure that, taking one year with another, its revenues are equal to or greater than its outgoings’. Since then repeated refusals by senior politicians to approve tariff increases have led to a growing dependence on financial subsidies from central government. As part of a wider IMF-backed fiscal austerity programme, in 1987 GWSC became one of


14 priority parastatal bodies – out of a total of over 340 state-owned enterprises – selected for corporatisation. A State Enterprises Commission (SEC) was set up in 1989 to monitor and evaluate their performance against agreed targets through the introduction of corporate planning and performance contracts. But approved tariff increases continued to lag behind the rate of inflation, calling into question the political commitment to a ‘hard budget constraint’ for the corporatised state-owned enterprises. As a result, revenue generation was barely sufficient to cover operating costs. Depreciation, debt servicing and new fixed investment were still dependent on financial support from central government and foreign donors. By the mid-1990s, GWSC was hardly performing as well as a decade before. Little had actually changed and there was still no acceptance of reform within the organisation. This situation was reflected in the poor enforcement of performance contracts. The targets themselves were weak, there were no sanctions for non-performance, and a number of force majeure provisions (for example, the lack of resources) made the contracts unenforceable in practice. SEC evaluated and rewarded performance in terms of effort rather than the achievement of agreed outcomes. Despite the rhetoric, attempts at corporatisation in general and performance contracts in particular, had done little to improve the overall performance of GWSC (Amis 1998; Larbi 2001). 3.5.2

India

A review of institutional change and attempts to develop capacity in the Indian water sector displays a common trend (Franceys and Sansom 1997). Several state-level Public Health Engineering Departments (PHED) or Boards, usually headed by a civil engineer, are attempting to transfer responsibility for operations and maintenance of water supply systems that the PHEDs have designed and constructed to reluctant urban local bodies. Funding for implementation of new works has been primarily through grants and loans that are often not repaid. Tariffs remain below cost so that funding for operations and maintenance is insufficient. Municipalities generally fail to remit funds to those state agencies that are still operating water supply systems on their behalf. The shortage of finance is met by diverting funds earmarked for capital expenditure to operations and maintenance. Although there is some evidence that customers would be willing to pay the real cost of an acceptable service, this willingness to pay has rarely been tested. Although the State of Maharashtra has been making more active steps towards institutional change in urban water supply than elsewhere in


India, even here progress in introducing corporatisation has been extremely limited. A state-level water corporation, the Maharashtra State Water Board – Maharashtra Jeevan Pradhikan (MJP) – was created in 1979 in order to construct new water systems for municipal authorities. However, despite the 1992 constitutional amendment on decentralisation requiring the transfer of responsibility for water and sanitation from state government to urban municipalities, the MJP continues to operate and maintain many of these systems because of the refusal of municipalities to assume responsibility for operations and maintenance. A 1995 state-level White Paper described how most water supply systems operated at a loss. Local authorities refused to increase tariffs and often diverted revenues collected from water consumers for other purposes. The limited progress towards corporatisation can be seen from the experience of the Maharashtra case studies. Pune (population 1.5 m) is the seventh largest city in India and water supply is the responsibility of the multi-purpose Pune Municipal Corporation (PMC) established in 1949. The two key stakeholders for urban water supply in Pune are the state government and the PMC. Both organisations have multifarious responsibilities and are unable to give detailed attention to urban water supply in the city. Consequently, there is a diffusion of responsibilities in the sector and the Water Supply Department within PMC lacks autonomy to manage the city water supply. The department receives less assistance from the MJP than other municipalities in Maharashtra. It manages its own bulk water supply, it does not receive staff on secondment from the MJP and it commissions its own feasibility studies and technical designs without support from the MJP. Despite this, the Water Supply Department is far from having the necessary levels of financial and operational autonomy for effective management of water supply services. It has extremely limited control over its own income and its operational independence is restricted through the imposition of staffing levels and external political priorities. A state government committee fixes staffing levels and municipal councillors visit the department on a daily basis to demand solutions to the water supply problems in their constituencies. Although there is a separate water and sewerage account within the PMC finances, there is no commercial accounting system for water supply services. Instead, a ‘receipts and payment’ system is in operation, where there is no matching of expenditure with income for water supply. The PMC has refused to agree tariff increases in recent years, preferring instead to cover part of the financial deficit by cross-subsidising from the surpluses generated on the general municipal account.


The organisational autonomy of the water departments in the other case study municipalities in Maharashtra State is similarly restricted by the dispersal of overlapping responsibilities amongst a variety of institutions and stakeholders. In the case of the Nasik Municipal Corporation, this is compounded by fragmentation within the water department itself. Some sections report to the City Engineer or the Deputy Commissioner for Revenue Collection while other sections report to the seconded MJP Superintending Engineer. In the other two case studies – Nandgaon and Bodwad – the municipal authorities have refused to assume responsibility for water supply for fear of losing the subsidies that they obtain under the current organisational arrangement by which the MJP retains management responsibility. Although large municipalities in Maharashtra State with relatively buoyant finances such as Pune and Nasik have the potential to manage their own water and sanitation services, they have not embarked on water sector reforms. The water supply departments of both municipalities have very limited autonomy and managerial capacity. In common with other parts of India, political interference is rife in operations, staffing, human resource management and tariff setting. In response to the perceived failings of the current situation, a new State Drinking Water Supply and Sanitation Department was created in 1996 with ministerial status. It has required municipal councils to produce water supply budgets and to increase tariff levels although it has faced strong resistance in so doing. Despite such initiatives, there is little sign that any of the top level thinking, from the national or state level, is penetrating down to the many urban municipalities. The Maharashtra case studies confirm the trend found in other States in India. They emphasise the over-riding role of government in subsidising water supply through general taxation. The studies also demonstrate the absence of any pro-active management geared to meeting the water needs of all urban citizens rather than to merely promoting new engineering works (Franceys and Sansom 1999). 3.5.3

Sri Lanka

The National Water Supply and Drainage Board (NWSDB) was established in 1975 as an autonomous agency of central government, replacing the former Department of Water Supply and Drainage. Despite the change in its legal status, it continues to operate as a department of central government under the Ministry of Housing, Construction and Public Utilities. In its early years NWSDB functioned primarily as an agency for implementing capital investment projects in the water


sector. Its enabling legislation made minimal reference to its financial responsibilities and it depended heavily on central government to provide funding for new construction schemes. Reflecting its origins as an engineering design section of the Department of Works, its management structure was dominated by construction engineers. Despite the introduction of universal metering and a financial information system in the mid-1980s, NWSDB remained highly dependent on state subsidies because of political opposition to the introduction of higher tariffs based on the concept of cost recovery. From 1985 to 1990 USAID funded a major institutional development (ID) programme for NWSDB. It was one of the most significant attempts to transform a water utility in a low-income country into a modern, financially viable customer service enterprise. The ID programme began to shift the organisational focus away from a supply-driven approach that emphasised capital investment projects towards a demand-driven approach that gave greater emphasis to operations and maintenance as well as consumer service. This was implemented through the deconcentration of management responsibilities to regional and district managers. Through this process of incremental managerial improvements, NWSDB made some small steps towards toward financial sustainability. However, a decade after the termination of the ID programme, the orientation of NWSDB still remained focused on the implementation of new investment projects to the detriment of financial sustainability and customer orientation. The major factor impeding progress towards full corporatisation was resistance from two powerful stakeholders – construction engineers within NWSDB and central government politicians – to the appointment of senior managers with business training. The shift in organisational focus generated a feeling of insecurity among the many conventional engineers who lacked business training and a customer service orientation. Through subtle patronage networks they succeeded in slowing down the appointment of financial specialists to top management posts in the organisation. Central government politicians were also unwilling to relinquish control to NWSDB managers over strategic decision-making on issues such as tariff setting, capital investment, and human resource management (staff hiring, firing and remuneration). Instead, they preferred to perpetuate the prevailing domination of NWSDB by ‘technical’ managers (that is, conventional engineers without business training) who would be less likely to press for more autonomy with regard to financial decision-making. This resistance to change was reflected in the fact that the legal framework under which NWSDB operated had hardly been altered since its


creation in 1975. Consequently, despite the greater attention paid to operations and maintenance, the NWSDB remained primarily an ‘implementation agency’ whose orientation is targeted upon new capital investment projects (Franceys 1997). 3.5.4

Zimbabwe

Water supply in the case study city of Bulawayo (population 750,000) is provided by the Water Branch of the municipal Engineering Services Department (ESD). On the face of it, the organisational arrangement for service delivery appears to be an apparently traditional form of direct public administration. The ESD has no formal autonomy and is wholly part of the municipal administration. Within this municipal structure it reports administratively through its director to the town clerk and politically to the executive mayor. It is accountable to the elected council through the Environmental Management, Engineering Services and Water Committee. As part of the municipal administration, the ESD also depends on other departments for certain functions. The strongest link is with the Treasurer’s Department, which is responsible for meter reading, billing, budget reporting and financial accounting. As a subordinate component, the Water Branch also shares certain functions – particularly human resource and financial management – with the ESD as a whole. Technical staff members, including surveyors and planners, are interchanged across the three main functions of the ESD – town planning, roads and water – so as to minimise dependence on external contractors. However, the organisational arrangement is far less traditional than it seems. Although water supply is not organised as an independent operation within the Bulawayo municipality, the Water Branch is not as lacking in autonomy as at first appears. Its top management are broadly able to negotiate the setting of policy and relations with other bodies. Whilst subject to approval, organisational objectives are set largely from within the organisation, and the Treasury largely accepts its budget priorities. Within the limits of its budget, the Water Branch is free to manage and can vire expenditure between budgetary headings without external political or administrative interference. Though subject to approval by the council and the Ministry of Local Government, Rural and Urban Development, the political commitment to ensuring that the water account does not fall into deficit has ensured that tariff levels are determined principally on economic grounds. The Water Branch also displays many features that emphasise a commercial orientation. Strong management control ensures that staff


members are deployed efficiently. A separate water account is maintained and administrative costs are attributed fully to the budget of the Water Branch as a whole and to specific projects in particular. The financial strategy is aimed at the need to be self-sufficient through acceptance of the argument for moving towards pricing based on LRMC. In practice, therefore, the actual operation of the Water Branch of the ESD displays many of the core features associated with corporatisation. Nevertheless, an analysis of subjective performance and customer orientation carried out as part of this research revealed staff attitudes in ESD that were more akin to a traditional ‘engineering’ approach to service delivery. For example, senior staff members were not strongly commercially oriented and did not see the organisation as a business. There was much less focus on public relations. Instead staff tended to think more in terms of what consumers should have rather than what they wanted. The Bulawayo case demonstrates the practical virtues of an organisational structure built along professional lines with a tradition of service and commitment, and a sense of its own importance and collegiality. The case for moving towards corporatisation – clarifying managerial responsibilities and allowing more access to private finance – is widely discussed by ESD staff. The evidence from performance indicators suggest that the ‘old professionalism’ already in place seems to compensate for the absence of this ‘new management’ approach. However, the threat of greater political interference in recent years has increased the attractiveness to staff of corporatisation (Batley 1998).

3.6

Conclusions

In this chapter we have focused on the performance of urban water utilities that are owned and operated directly by the state. The key reason for poor performance here is that the existing institutional arrangements fail to protect these utilities from capture by powerful stakeholders (politicians, public sector unions and the ‘professional hobbyism’ of water engineers) whose objectives (low tariffs, job creation and large-scale capital investment respectively) are opposed to the water needs of its citizens, especially the poorest. Corporatisation appeared a possible solution to these problems that, by granting greater managerial autonomy, could achieve better performance while retaining direct public provision. But our examination of the experience of the four core case study countries shows that, with the exception of Bulawayo, Zimbabwe, the


existing institutional and organisational arrangements, in particular the continuation of political interference in tariff-setting, have placed severe limitations on the actual implementation of corporatisation. These limitations are the main reasons why, despite considerable external support for re-structuring and capacity-building, these water utilities have been unable to break though the so-called ‘performance ceiling’. This restricts them to a ‘low-level’ performance equilibrium, as measured by indicators of efficiency, equity and effectiveness. Consequently, in these and many other countries alike, corporatisation has proved to be an unworkable strategy for radically improving the performance of urban water utilities. Partly in response to this failure to introduce corporatisation, policy makers in the four case study countries have investigated the possibilities of public private partnerships (PPPs) as an alternative route in order to achieve improved performance in the urban water sector. None has yet introduced a major PPP although at the time of writing two (Ghana and Sri Lanka) are still actively considering this option for institutional reform. In the following chapter, we examine in more detail the case for PPPs in the urban water supply sector and the various forms that it may take.

4 The Spectrum of Public Private Partnerships

4.1

Introduction

As we saw in Chapter 1, the argument in favour of the direct public provision of UWS was based on the false assumption that it is a ‘public good’. In fact urban water supply is characterised neither by non-excludability nor by non-rivalry and hence it is feasible both to charge users and to exclude non-payers. Almost nowhere in the world is urban water supplied at zero direct cost to the consumer and financed totally out of general taxation, as one would expect for a public good. Conceptually, therefore, UWS is a private good, albeit one with several features (natural monopoly, strong externalities, and merit) that give rise to the likelihood of market failure. Chapter 2 described the poor performance of state-run urban water utilities in some of the case study countries, while Chapter 3 revealed the failure of efforts to improve utility performance through corporatisation. This failure of institutional reform within the public sector provides the background to the growing introduction of private sector participation in urban water supply around the world. The factors responsible for the growing interest in private sector participation may be divided into two broad groups – factors internal to the provider and to the interests of external stakeholders.

4.2

Factors internal to the provider

There are four main factors internal to the provider that have encouraged the growing interest in private sector participation in urban water supply – the shortage of new investment resources, the wish to depoliticise payment for water, the pressure to avoid patronage, and the need to reduce personnel costs. 50

The Spectrum of Public Private Partnerships 51

4.2.1

The shortage of finance for new investment

One of the major factors driving private sector participation worldwide has been the shortage of public sector investment resources needed in order to expand and upgrade existing water networks. In the United States and United Kingdom the major pressure for new investment has come from tighter environmental controls. The 1986 amendments to the Safe Drinking Water Act in the USA dramatically increased projections of capital expenditure to comply with new legal requirements such as limits of contaminants, new rules for filtration of surface water supplies and disinfection of all public water supplies (Haarmeyer 1994). This heavy demand for new investment led water utilities to seek private sector participation because of the difficulty in issuing new municipal bonds and the unavailability of federal grants (Coyaud 1988). Similarly, in the United Kingdom capital expenditure of US$50,000 m was required over the period 1990–2000, in order to meet new EU drinking water standards and compliance standards for wastewater treatment plants. The size of the funding needs, combined with the government commitment to hold down the public sector borrowing requirement, were major factors encouraging privatisation of the English and Welsh water supply system in 1989 (Kinnersley 1994). Such investments in quality are unaffordable in low and middle-income countries. In these countries there is an even more urgent need for investment finance in order to rehabilitate systems that have been allowed to deteriorate over many years whilst expanding service coverage, particularly to the periurban areas. 4.2.2

The wish to depoliticise payment for water

The wish to depoliticise unpopular decisions is another powerful pressure encouraging private sector participation. It can be politically expedient as a means to delegate politically sensitive actions such as water tariff increases that are required to achieve cost recovery. In the extreme case of South Africa the refusal to pay water bills became a powerful tool in the hands of residents of black townships opposed to the apartheid regime. Although water charges were already heavily subsidised, they had gone unpaid for nearly a decade in most townships. This legacy of nonpayment undermined attempts to phase out subsidies. In the aftermath of the transition to majority rule, as long as the state was perceived as the provider of urban services, this problem of non-payment was likely to prevail. Through ‘communitisation’, a euphemism for private sector


participation, this problem could be resolved more quickly because the withholding of payment by residents would no longer serve any political purpose (Tandy 1997). 4.2.3

The pressure to avoid patronage

The pressure to avoid political favouritism and introduce greater rationality in decision-making over the allocation of resources for new investment is another factor responsible for the promotion of private sector participation. The situation in the State of Bahía, Brazil is a classic example. Here the elected state government appoints the board of directors of the state-owned water company, Embasa. Following each election, there is a major change in the investment priorities of Embasa. Even when the new state governor is a member of the same political party as his predecessor, he will appoint people of his own group in key positions in the company. In many cases investment priority is granted to the home region of the state governor, or that of the secretary of state, or of a director of the company (Carteado and Franceys 1994). 4.2.4

The need to reduce personnel costs

The desire to rationalise personnel costs through the elimination of clientelism in the recruitment and promotion practices of water utilities is another powerful pressure for private sector participation. Personnel costs absorb a surprisingly high share of total operating costs in many water utilities in low-income countries. By contrast, water utilities in high-income countries generally display much lower ratios of personnel costs to total operating costs, despite relatively higher unit labour costs. This difference can only partly be explained by the choice of a more labour-intensive technology in lower wage economies and the greater opportunity for economies of scale in the larger utilities found in highincome countries (Kemper et al. 1994). Reduction in personnel costs can release funds for improved operations and maintenance, as well as generating a surplus for new investment.

4.3

The pressure from external stakeholders

In addition to factors internal to the water utility providers themselves, pressures from three major external stakeholders – central government, international financial institutions and international water companies – have encouraged the growing interest in private sector participation in urban water supply.


4.3.1

Central government

In many developing countries water utilities have not applied tariff policies based either on cost recovery or LRMC. Instead they have traditionally received substantial general subsidies from central government, especially to finance the local cost contributions to capital expenditure. But following the debt crisis of the early 1980s and the imposition of IMF structural adjustment programmes, governments have increasingly sought to limit the level of these subsidies in order to reduce the size of their overall fiscal deficit. In this context governments often view private sector participation, by involving off-budget financing of capital investment, as a ‘quick fix’ through which water utilities may achieve financial self-sufficiency without sacrificing investment programmes. 4.3.2

International financial institutions

Pressure from the World Bank and other multilateral development agencies (for example, Inter-American Development Bank, African Development Bank and Asian Development Bank) is a major factor explaining the trend towards private sector participation in most developing countries. This pressure is often exerted through the leverage of lending for structural adjustment, a series of policy reforms that promote an enhanced role for the private sector and a reduced role for the public sector in the overall development process. The pressure from the World Bank also reflects self-criticism of its own previous lending policy to the sector. An internal review of Bank-supported projects found that the effective price per unit of water supplied was, on average, only onethird of the full economic cost of supplying that increment (Winpenny 1994). The Bank believed that its years of multi-million dollar investments in capacity building as well as in new assets was not delivering anything like the required performance improvement in state-run water utilities. 4.3.3

International water companies

Pressure from powerful diversified conglomerates operating on a global scale was also a significant factor in the move towards greater private sector participation. Two French companies dominate the emerging global market in urban water supply. Veolia Environnement (formerly Compagnie Générale des Eaux and later, Vivendi) was founded in 1853. By 2002 with over 85,700 employees, it supplied water to 110m consumers worldwide. Ondeo (formerly Société Suez–Lyonnaise des Eaux) was founded in 1880 and in 2002 supplied water to 125m consumers in


30 countries with over 48,000 employees and more than 3,000 water management contracts. Market penetration by these two companies, together with another French company, SAUR, has been greatly assisted by the fact that the World Bank strongly endorses the Francophone model of private sector participation for urban water supply in developing countries (Triche 1992a; Triche 1992b). The anticipated competition in the 1990s from the newly privatised English and Welsh water companies emerged only sporadically and with haphazard changes of strategy by all ten major companies involved. By 2002, of these, only Thames Water remained a significant player in the water market of low and middle-income countries, having been absorbed into the German utility conglomerate RWE along the way. But one effect of this process of new entrants looking for ways to challenge the long established market leaders has been to promote private sector involvement in water all over the world.

4.4 The argument for private sector participation in urban water supply The argument for private sector participation in the direct provision of urban water supply can be examined through its contribution towards meeting the three major public policy concerns – efficiency, effectiveness and equity – outlined in Chapter 2: • The efficiency argument states that private sector involvement can potentially improve operational and financial efficiency by introducing tariff systems that are based on volumetric and cost-reflective charging or by reducing costs through a more flexible personnel policy that avoids overstaffing. The related fiscal argument states that it can also improve the overall fiscal balance of the public sector in one or more of the following ways: by reducing subsidies to loss-making water utilities; by increasing tax revenue through expanding the role of the private sector; and by reducing the public sector borrowing requirement through private sector financing of capital expenditure. • The effectiveness argument states that private sector participation can improve the effectiveness of urban water systems by improving water availability, water quality and consumer satisfaction in general. First, the more cost-conscious management approach of the private sector will give greater priority to network maintenance, generating effectiveness dividends in the form of reduced leakage rates and better filtration systems. Second, the more consumer-oriented approach


of the private sector will give greater priority to consumer standards and customer care, generating effectiveness dividends in the form of a reduced number of complaints over billing, cut-offs and turbidity. • The equity argument states that private sector participation can improve the equity of urban water systems by introducing full costrecovery pricing to existing high-income households that are already linked to the network. The removal of such subsidies can then generate revenue for network expansion to low-income households in peri-urban areas. This expansion of the distribution network leads to lower absolute water costs for the urban poor who were previously dependent on high-cost supply from private water vendors.

4.5

Vertical unbundling

However, private sector participation in urban water supply has long been opposed on the grounds that it may lead to the abuse of monopoly power. Vertical unbundling has been promoted by the World Bank as a way of promoting private sector participation that gets round this objection and yet achieves efficiency gains. As we saw in Chapter 1, urban water supply is indeed a natural monopoly sector, in which large economies of scale dictate that production by two competing companies is more costly than by one. But on closer scrutiny natural monopoly conditions in one activity within the sector (that is, the pipe network) have been wrongly assumed to extend to all the other activities in the sector. Vertical unbundling involves breaking up a chain of activities that were previously performed by a single entity and separating the monopolistic from the non-monopolistic activities of the sector. This provides the basis for private sector participation in those non-monopolistic activities that are amenable to competition. Unbundling involves a basic separation between water production, which is more amenable to competition ‘within the market’, and water carriage and distribution, which are monopolistic in nature. In these latter cases the Bank advocates contract competition ‘for the market’. However there are reasons why the efficiency gains from vertical unbundling in urban water supply may prove to be more limited than the World Bank suggests. First, there are considerable economies of scale in water production as well as in water distribution. These give rise to monopolistic characteristics that militate against increased productive efficiency through competition (Gledhill 1993). Second, where competing private suppliers provide water to a single distributor, there is a significant increase in transaction costs in the form of both ‘hold-up’ costs


and quality control costs. The ‘hold-up’ costs result specifically from the breakdown of co-ordination previously maintained within a vertically integrated organisation where the production system is fully integrated with the distribution network by means of automatic valves. This enables the implementation of least-cost solutions to variations in demand by means of a central control unit and a computer simulation model. Where unbundling takes place, both the supplier and distributor are in a position to engage in ‘hold-up’ activity. They may do this by opportunistically preventing their partner in the market from selling their service in an attempt to force up the price of water (if the supplier) or down (if the distributor). While both producer and distributor are susceptible to ‘hold-up’ activity, a state-owned distributor is particularly vulnerable because of the more direct relationship with the final user in the case of such an essential service as water. Transaction costs increase because complicated and inflexible contractual arrangements are needed in an attempt to make ‘hold-up’ impossible. Expensive monitoring mechanisms must be put in place in order to ensure that they are rigidly enforced. Another transaction cost arising from vertical unbundling is in the form of quality control costs placed on the distributor. Because the water emerging from the distribution network cannot be traced back to individual producers, what goes into the pipe network from one supplier affects what comes out on the other side from all suppliers. The potential cost savings that one supplier may gain from riding very close to the edge of quality standards are incurred as costs by the distributor in relation to all water supplied. Hence, there is a need to incur higher costs of monitoring water quality in general.

4.6

The range of institutional arrangements

There are eight major institutional arrangements that involve private sector participation to a lesser or greater degree in urban water supply – the service contract, the management contract, the lease contract, the build-operate-transfer contract, the concession contract, the joint venture, the co-operative arrangement and divestiture. 4.6.1

The service contract

The service contract, known in Francophone countries as prestation partielle, is an institutional arrangement whereby a private company is contracted to provide a clearly defined technical task (for example, a mains rehabilitation exercise, emergency repairs, the hire of specialised equipment, design engineering) or administrative task (for example, meter billing, payment collection) for the public sector water utility. The service


contract specifies the task to be carried out and payment is made on a ‘feefor-task’ basis (that is, a lump sum, cost-plus, time-based or fixed fee basis). The corresponding payment is entered as a cost in the operating account of the water utility. Such contracts are subject to frequent competition and the contract period is usually not longer than one year. In large urban areas, separate contracts may be awarded to different companies to carry out the same task in different parts of the city, thus enabling comparative competition to take place. Under the service contract, the private contractor assumes no risk with regard to the commercial supply of water. Hence it is the preferred institutional arrangement when private sector participation is first introduced in a situation where regulatory mechanisms are weak or non-existent.

Box 4.1: The service contract – an example from Santiago, Chile There is a long tradition of contracting-out water services in Chile. EMOS, the public water company of Santiago encouraged its staff to take early retirement and compete for contracts ever since 1977. Prior to its privatisation in 1999, it had one of the highest levels of labour productivity among Latin American water companies, even when the labour content of service contracts is included in the calculation (Triche 1992a). EMOS retained three kinds of operations: i) those which it carried out more efficiently than outside contractors, ii) strategic functions with a high risk attached to them in terms of quality assurance and plant maintenance, and iii) those in which the private sector could only be attracted through subsidies (for example, artesian well exploration). Virtually all other operations were contracted out. These included: •

•

•

Long-term planning: EMOS was required to present a 25-year plan to the national water regulator. Although tariff planning was carried out internally, the studies to determine the cost of capital were contracted out to private specialists. Feasibility studies for new projects: EMOS contracted outside consultants for most of its new project work and companies pre-selected from an approved list of contractors were invited to tender for the work. Construction contracts: EMOS contracted out all of its new infrastructure works as well as improvements and repairs to existing works. This was normally done by international competitive bidding (ICB).


Box 4.1 (continued ) • Maintenance contracts: Permanent contracts were used for maintenance and renovation of the network and pumping-stations. Temporary contracts were used for rehabilitation of infrastructure, maintenance of electrical and mechanical equipment, civil works and site maintenance. Three contractors were awarded the 2–3 year contracts under ICB for maintenance of the distribution network, each with responsibility for a geographical section of the EMOS jurisdiction. Each contractor supplied the equipment necessary to carry out a wide range of up to 700 tasks, for each of which there was a fixed price. EMOS inspectors supervised the performance of these contractors. • Quality control contracts: Laboratory analysis of water samples was carried out by contractors using the laboratories of EMOS. They analysed 2,500 samples per month and payment was made per sample. • Information technology contracts: The computerised billing system was fully integrated with a system of automatic meter reading. The operations and maintenance of this system was contracted out on an annual basis. • Financial contracts: Most billing, transfer of cash, and payment to staff and contractors was contracted out. • Administration contracts: Three-quarters of the vehicle fleet was contracted out through an open register of approved drivers. Cleaning, photocopying, and office maintenance services for all EMOS installations was contracted out as well as its catering, training and fire safety services. • Commercial contracts: The following commercial services were contracted out: household meter reading, household distribution of bills and receipts, repair of water meters, installation and replacement of water meters, disconnection and re-installation of water supply, calibration of water meters, inspection and collection from business premises, and debt-collection. EMOS required commercial contractors to guarantee minimum rates of pay and conditions for their staff. It also enforced quality standards on its contractors, requiring that all meter repairers should hold a relevant technical qualification. • Industrial relations contracts: EMOS contracted consultants to introduce the following innovations: performance evaluation, incentive systems, study of future management needs, and quality circles (Alfaro 1995).


4.6.2

The management contract

The management contract, known in Francophone countries as gérance, is an institutional arrangement whereby a private company is contracted to take over core operations and maintenance responsibilities within a production unit. The customers remain legally clients of the public sector water utility and the private contractor collects bills on behalf of the public body. The contractor is paid for the work in accordance with a clearly defined contract price structure. Payment to the contractor is made on a ‘fee per unit’ basis (for example, per number of connections, per volume of water sold, or per volume of water produced). This form of payment can encourage productive efficiency. For example, payment on the basis of a fixed fee per household acts as an incentive to explore least-cost technical solutions in order to maximise profitability (for example, septic tanks in low-density areas). Payment on the basis of the volume of water sold acts as an incentive to minimise unaccounted-for-water from leakages and illegal connections. The contract period is usually for 3–5 years. Because of the difficulty in isolating policy functions from operational functions, a sharp delineation of their respective roles and responsibilities is critical to an effective relationship between the public water utility and the private contractor. It is often stated that the management contract involves no financial risk for the private contractor (Triche 1992a). Indeed, most World Bankfunded management contracts in urban water supply are more like technical assistance projects, in that they lack performance indicators and hence any assumption of risk by the contractor. However, if a provision is built into the contract for non-payment in the event of breach of duty, this means that, in practice, some risk is transferred to the contractor. Furthermore, in a variation of the management contract, known in Francophone countries as régie intéressée, the private contractor receives a fee that is calculated as a percentage of gross turnover. In addition, the public utility shares any profit with the contractor through a productivity bonus. Hence, in practice, the private contractor may bear part of the risk to the extent that its remuneration varies with the profitability of the overall operation (Cordier 1993). The largest ever management contract, worth US$4,000 million over ten years, was awarded in May 2002 by the government of Puerto Rico to Ondeo. Under the terms of the contract, United Water, a US subsidiary of Ondeo, will be responsible for the production and distribution of drinking water for all four million of Puerto Rico’s inhabitants. Ondeo is responsible for operations and maintenance, and renovation of the infrastructure, client service, and human resources management.


It also includes the collection and treatment of wastewater for the entire island. The Puerto Rico Aqueduct and Sewer Authority (PRASA) remains in charge of the investment programme of the water supply system in the country.

Box 4.2: The management contract – an example from Trinidad and Tobago Water and wastewater services in Trinidad and Tobago (population 1.3m) are provided by the state-owned Water and Sewerage Authority (WASA). Although 90 per cent of the population had access to water supply by the mid-1990s, public standposts and tankers remained significant elements in service provision. Because of the unwillingness to raise tariffs – the public utilities commission had only granted two price increases in 32 years – revenues could not even cover operating expenses and funding for capital investment evaporated. The level of customer service deteriorated as a consequence. Water was typically available for less than 12 hours per day, about half the water produced was unaccounted for, and 70 per cent of the population had no sewerage facilities. Having obtained political support for private sector participation, the government chose a management contract in order to reduce the delay to reform and to avoid any requirement to amend the company’s authorisation act prior to a general election. With little accurate information available on the condition of the system it would have been difficult in any case for bidders for a concession contract to develop reasonable estimates of the long-term risk and probable rate of return. In April 1996 the government and WASA signed a first stage management contract, the Interim Operating Arrangement (IOA), for a three-year period (1996–99) with Trinidad and Tobago Water Services (TTWS), a joint venture company formed by Severn Trent Water International and Tarmac Construction Caribbean Limited. The contract included a preferential right, subject to performance on expiry of the IOA, to negotiate a second stage Long Term Arrangement (LTA). The responsibility of the operator under the IOA was to supply personnel to undertake the management of WASA to an agreed Business Plan that sought to improve service to an expanded customer base and to achieve financial and operational self-sufficiency. The contract also involved US$83m funding to cover the operational


shortfall during the three-year contract as well as multilateral funding for capital investment. As part of the preparations, government approved a 35 per cent tariff increase and WASA began to reduce staff through voluntary redundancies. The management contract included a performance related incentive payment where the operator put a major part of their fee at risk against achievement, measured against a basket of performance indicators: continuity of supply of water; operating debt to income ratio; operating sales; and treated water production capacity. A comprehensive training programme for WASA staff was a major tool for ensuring the transformation of the organisation. By the third year of the contract, and in the absence of the longterm capital improvement programme originally envisaged, WASA achieved an operating surplus for the first time in its 34 year history. Significantly more water was being produced (30 per cent), plant breakdowns had reduced considerably, and significant improvements were achieved in effluent discharges, with a 30 per cent reduction in manpower. However, political reluctance to raise water tariffs continued to be a major constraint, with pressure from other stakeholders such as trade unions. At the end of the contract period in 1999 the government deferred any decision to move forward to the second phase LTA and instead took back control of managing WASA operations (Nankani 1997; Weatherdon and Sansom 2002).

4.6.3

The lease contract

The lease contract, known in Francophone countries as affermage, is an institutional arrangement whereby, as in the case of the management contract, a private company is awarded a contract to undertake the core operations and maintenance responsibilities of the public water utility. But unlike in the case of the management contract, the leaseholder assumes the legal responsibility for operating the service in exchange for payments for the use of the fixed assets. Customers become clients of the private company, and bills are usually paid to that company and not to the public utility that retains ownership of the assets. As a result of this legal responsibility, the leaseholder bears a much greater share of the commercial risk than under a management contract. It must provide working capital for ongoing operations and the replacement of basic components (for example, connections and pipes below a certain diameter). However, it is does not have


responsibility for debt servicing and financing new investment. In return for assuming this greater risk, the contract stipulates that the leaseholder receives a part share or the total revenue stream. The proposed water tariff and the share of the revenue stream retained by the leaseholder are key elements in the negotiation of lease contracts. The lease contract has long been the most common institutional arrangement for urban water supply in France and its use has spread rapidly throughout the world since the 1980s. The contract period is usually 10–12 years, although private companies have lobbied strongly for an extension to 20 years in order to reduce their risk. A growing number of United States municipalities have signed lease contracts for urban water supply. As a consequence of the shorter contract period, usually only five years, the degree of responsibility assigned to the leaseholder is more limited in these cases (Haarmeyer 1994).

Box 4.3: The lease contract – an example from Conakry, Guinea Reforms in the organisational arrangements for urban water supply in Guinea stemmed from the failure of a World Bank Water Supply and Sanitation Project for Conakry from 1977 to 1985. Political interference and an unfavourable economic environment led to poor financial performance and weak institutional development. Efforts to graft foreign technical assistance teams on to extremely weak organisations failed. A key problem was that the national water company operated as a department of the Ministry of Natural Resources and so lacked autonomy. Hence institutional reform was given priority. A new state enterprise, the Société Nationale des Eaux de Guinée (SONEG), was established to own all urban water supply facilities in Conakry and secondary cities. SONEG signed a ten-year lease contract for operations and maintenance, including billing and collection, with a new water management company, the Société d’Exploitation des Eaux de Guinée (SEEG). SEEG is jointly owned by the State (49 per cent) and a foreign consortium (51 per cent) that consists of two French companies, Compagnie Générale des Eaux (CGE) and the Société d’Amenagement Urbain et Rural (SAUR). Under the contract, SEEG retains a fixed portion of the revenues that it collects on behalf of SONEG, known as the lease contract rate (LCR). The foreign consortium also receives a 2 per cent share of the revenues as a management fee. The foreign investor within SEEG was selected on basis of the lowest lease contract rate offered and the


price that SEEG would charge for new connections. There was no stipulation that procurement by the contractor should be put out to international competitive bidding (ICB). This decision was based on the assumption that the contractor would strive for efficiency in order to maximise its own return from the LCR. Three potential problems have been identified in the new organisational arrangement. First, the abandonment of ICT runs the risk that the purchase of inputs from parent companies would enable excess profits to be siphoned off through transfer pricing. Second, SONEG’s armslength relationship to SEEG may become eroded over time, endangering its own ability to re-negotiate the LCR. Third, SEEG has no voice in investment decision-making taken by SONEG, yet it retains the responsibility to operate and maintain new facilities. If SEEG feels that an investment was poorly planned and cannot be operated efficiently, its ability to re-negotiate the LCR may be constrained (Triche 1990). 4.6.4

The build-operate transfer contract

The build-operate-transfer (BOT) contract is an increasingly common institutional arrangement used to finance infrastructure projects. Under this arrangement the private contractor is required to design and finance the investment project, to construct and commission the asset, to operate and maintain it to an agreed standard for the concession period (typically 25–30 years), and then to hand over the asset to the provider in good working order at the end of the concession term. Where the legislative framework permits, an alternative buildown-operate-transfer (BOOT) contract may be used. The growing use of BOT contracts reflects the increasing sophistication of global capital markets that enable contractors to explore new avenues for raising finance at a time of intensified competition in the global construction market. Similarly, at a time of growing fiscal stringency in many countries, the BOT arrangement has the advantage, from the viewpoint of the client government as provider, that it does not incur debt since the asset is constructed without the need for a direct sovereign loan guarantee. Several key principles are involved in the BOT arrangement in the urban water sector. First, the provider makes a long-term commitment to purchase water from the facility. Second, long-term capital for construction is provided by the private investor and is secured by the non-revocable revenue stream generated by the completed project. Third, timely


construction is guaranteed by tying the construction loan to requirements that the project is constructed and commissioned within budget and on time. Fourth, performance guarantees ensure that the new facilities will be operated efficiently. A major advantage of the BOT arrangement is that, by combining the design, construction, operations and maintenance functions in one package, the contractor has an incentive not only to design for rapid and economic construction but also for effective and economic operation and maintenance (McCarthy and Perry 1989). Yet BOT contracts in urban water supply are still relatively rare. The concept is project-specific and projects have been used almost exclusively to finance new investment in water production (for example, pumping stations and water treatment plants) rather than for water distribution (for example, network expansion). Several factors have hindered the growth of BOT arrangements. First, risk guarantees have been a major concern because of the foreign exchange risks involved in projects in which revenues accrue almost exclusively in local currency, many of which are neither stable nor fully convertible. Second, the financing package is often very large, as well as complex and lengthy to negotiate, and involves a mix of share and loan capital from many different sources. Third, in many countries potential private investors must undergo lengthy negotiations to ensure that the appropriate legislation is in place in order to allow BOT projects to come into existence. Fourth, there is concern over the extent to which the revenue stream for the service is guaranteed, given the difficulty of forecasting demand for water over the medium term. Consequently, the cost of BOT projects is often greater than the cost of projects financed through more traditional mechanisms from international official lending agencies. This is because of the higher risk perceived by the private sector and the higher transaction costs associated with complex negotiations.

Box 4.4: The BOT contract – an example from Kota Kinabulu, Malaysia The Water Department of the Malaysian Ministry of Infrastructure Development undertook a water supply BOT project in Kota Kinabalu (population 210,000) in 1993. A private operator, Jetama Sdn. Bhd., took over the operation of existing water production and transmission facilities for Kota Kinabalu, including its 120 water department staff, from the State Water Department. Under the terms of the 20-year BOT agreement the private operator, in which the


State retained a 20 per cent stake, is responsible for constructing Babagon Dam and the Moyog Water Treatment Plant to deliver an additional 110 million litres per day of water, as well as the refurbishment of five treatment works. The government reimburses the private operator for construction works through a monthly fee, comprising a fixed component and a variable component, related to the volume of treated water supplied. By 2000 Jetama Sdn. Bhd. and its partner, Corporate Dynamics, had constructed the dam, refurbished the treatment plants and delivered the additional water supply. They had also raised water quality in Kota Kinabalu to WHO standards, as monitored by the Department of Environment. The increase in water production, by increasing water pressure, had the positive effect that squatter areas are now able to obtain an adequate supply of water piped directly to their households, thereby ending the practice of collection from standposts. Although most of these connections in squatter areas are illegal, the State Water Department has been reluctant to enforce disconnection because of a longstanding government policy to ensure that, as a basic necessity, water is available to all sectors of society. This reluctance of the State Water Department to disconnect is mirrored in its reluctance to ensure adequate revenue collection from legal users. As a result, the State found itself in the position of only collecting US$10.5 million per year whilst having to pay US$21 million per year to Jetamu Sdn. Bhd. and the other two private water suppliers in the State. The State has sought to cover the annual deficit of US$10.5 million by soft loan finance from the Federal Government (Iskandar 2002; Knode 1999).

4.6.5

The concession contract

The concession contract, which derives from its Francophone origin as the contrat de concession, is an institutional arrangement that has all the characteristics of the lease contract, but with the significant addition that the concessionaire also finances a detailed investment programme for expansion and/or rehabilitation of the urban water supply system. Because of the large amounts of finance involved, concession contracts are usually awarded on the basis of international competitive bidding (ICB). Customers are billed directly by the concessionaire, which normally retains the whole revenue stream in order to finance depreciation


of new investment, as well as operating costs and debt service payments. The proposed consumer tariff levels and royalty payments to the public body for water abstraction and transmission are key variables in the competitive bidding process. The contract period is long, ranging between 20–35 years. At the expiry of the contract, the installations are handed over to the state, except in the event that the contract is renewed. The concession contract arrangement is less common in France than the lease contract, but has been the norm in the Municipality of Barcelona in Spain since 1867. As in the case of the lease contract, its use has expanded rapidly throughout the world since the 1990s.

Box 4.5: The concession contract – an example from Córdoba, Argentina In 1997 the Provincial Government of Córdoba, Argentina signed a 30-year concession contract with Aguas Cordobesas for the delivery of water supply within the jurisdiction of the Municipality of Córdoba (population 1,300,000). Aguas Cordobesas is a private sector consortium, headed by the French utility multinational, Ondeo, which also acts as manager of the concession on behalf of the consortium. The public sector objectives were to rid itself of the fiscal burden of an inefficient in-house operation by delegating the service delivery function, to improve efficiency by attracting the necessary technical skills from the private sector, and to ensure the investment financing needed in order to upgrade and expand the system. System efficiency has improved since 1997 as measured by labour productivity, leakage rates, service reliability, water quality, and customer care. However, little attention was devoted to the water needs of the urban poor during the drawing up of the new institutional arrangement. Progress in extending the coverage of water supply has been relatively slow to date. In particular, the issue of the linkage between home ownership and the legal responsibility of the concessionaire to supply services, and issues surrounding cost recovery relating to the financing of household connections and willingness to pay, were not considered. Unusually, the responsibility for water and sanitation in the city is split between the provincial government and the municipality respectively. Hence, the Municipality of Córdoba has no formal responsibility for urban water supply in its own city and it has no


formal involvement in the regulatory mechanism for overseeing the implementation of the water concession contract. Both of these are the exclusive preserve of the provincial government. Nevertheless, the municipality does exert informal influence over contract implementation, given the important role of water supply in urban planning and the specific need to co-ordinate network expansion and upgrading with its own sanitation department. There is no citizen watchdog committee to monitor the implementation of the water contract and the performance targets to be met by the concessionaire are not in the public domain. In response to growing concern at weak regulation of public services, in 2000 the provincial government created a new multi-sectoral regulatory body, which includes water within its remit. The Córdoba case study demonstrates that, even where it is has no formal involvement in the institutional arrangement of the water sector, the municipality still has an important role to play in promoting the water needs of the urban poor. The main lesson of the case study focuses on the drawbacks of a split in institutional responsibility for water and sanitation for promoting the interests of the urban poor (Nickson 2001b). 4.6.6

The joint venture arrangement

The joint venture is an institutional arrangement under which a special purpose company is created, owned jointly by the state (either central or local government) and the private sector, and is awarded the lease or concession contract. Under this public private partnership (PPP) arrangement, the private sector usually owns a majority of the shares in the joint venture company, although the public sector sometimes retains a final say through a ‘golden share’ option. Remuneration to the shareholders is made through annual dividend payments. The private sector partner usually also signs a management contract with the joint venture company. This arrangement is found where a wholly private sector control of the lease or concession contract is considered politically unacceptable to the government or, conversely, where political risk makes this option unattractive to the private sector. Given the political sensitivity surrounding urban water supply, joint ventures offer attractive possibilities for marrying local political input with improved operations. However, the joint venture model can lead to conflict of interest for the public sector partner. As owner of the asset base it has the regulatory responsibility to defend water consumers while as a company shareholder, it has a vested interest in maximising the rate of return on the asset base.


Box 4.6: The joint venture – an example from Cartagena, Colombia In 1995 the Municipality of Cartagena (population 850,000) formed a joint venture with Aguas de Barcelona (AGBAR), a Spanish company, to provide water and sanitation services in the city. The new company, known as Aguas de Cartagena (AGUACAR) is jointly owned by the municipality (50 per cent), AGBAR (46 per cent) and local capital (4 per cent). ACUACAR signed a 26-year contract with the municipality to operate and maintain these services. In turn AGUACAR signed a management contract with AGBAR. The shortterm municipal objective was to rid itself of the fiscal burden of an inefficient in-house operation by delegating the management function and to improve efficiency by attracting the necessary technical skills from the private sector. A longer-term objective was to secure access to soft loan finance from international financial institutions in order to upgrade and expand the network. Under the terms of the 1995 contract, AGBAR is only responsible for the management of the system. Its remuneration comes in two forms – its 46 per cent share of the profits as a shareholder in ACUACAR and its 4.25 per cent management fee from the gross income of ACUACAR. However, in 1998 the municipality awarded it a separate contract to manage a major investment programme financed by the World Bank and Inter-American Development Bank. Consequently, under this complex arrangement the private sector partner will carry out the functions normally found in a French-style concession contract, but with protection from the financial risks inherent in such an arrangement. The municipality and citizens of Cartagena are generally satisfied with the service provided by AGUACAR. Performance has improved markedly since 1995 as measured by labour productivity, leakage rates, service reliability, water quality, and customer care. However, progress in extending the coverage of water and sanitation has been slow to date. The role of the municipality in the partnership has been extremely limited, and can best be described as that of a ‘sleeping partner’ (Nickson 2001a).

4.6.7

The co-operative arrangement

The co-operative is an institutional arrangement under which the householders connected to the pipe network are the exclusive shareholders of the water utility. They elect a management board that appoints a management team to operate the utility. The co-operative arrangement for


urban water supply is found almost exclusively in Bolivia and Argentina. In Argentina, in 1988 there were 683 water co-operatives, equivalent to 35 per cent of the national total and serving 9 per cent of the population. Although most were small-scale systems, they included larger cities such as Comodoro Rivadavia and Trelew. Several co-operatives also operated in neighbourhoods in Greater Buenos Aires, of which the Cooperativa Martín Coronel, founded in 1971, with 5,000 connections, was the most successful (Brunstein 1993).

Box 4.7: The co-operative arrangement – an example from Santa Cruz, Bolivia The Cooperativa de Servicios Públicos ‘Santa Cruz’ Ltda (SAGUAPAC) is the only major urban water supply and sewerage co-operative in the world. Since 1979 SAGUAPAC has provided water to the people of Santa Cruz (population 1,000,000), the largest city in Bolivia. All 96,000 of its domestic customers are automatically members of the co-operative. The city is divided into nine water districts, where customers elect members to the administrative board of SAGUAPAC. This board appoints the general manager and approves tariffs. Customers also elect a separate supervisory board that monitors the performance of the administrative board. SAGUAPAC has the best performance of any water utility in Latin America, as measured by criteria of efficiency, equity and effectiveness: • • • • • •

a a a a a a

relatively low level of unaccounted for water (23 per cent) low ratio of 4.02 employees per 1000 water connections 100 per cent record for metering of all connections 96 per cent bill collection efficiency rate water coverage of 80 per cent, despite rapid population growth 24 hour supply of clean water.

Source: Nickson 2000.

4.6.8

Divestiture

Divestiture is an organisational arrangement by which the entire infrastructure and assets of a publicly-owned water utility are sold to the private sector, which then becomes the exclusive provider of urban water supply. England and Wales provide the major example of this institutional


arrangement in the world. Prior to divestiture, 25 per cent of water in England and Wales was already supplied by private companies. In 1989, the remaining 75 per cent was sold off to ten new private water companies that were created out of the former regional water authorities. These new ‘geographical’ monopolies were then subject to strong statutory regulation by a regulatory body, the Office of Water Services (OFWAT). Despite their complete ownership of the assets, the legal power of the companies to operate depends on the granting of a licence by OFWAT. The major motivation for divestiture in England and Wales was similar to that for concession contracts in developing countries, namely the need to obtain large-scale finance for new investment. In England and Wales, this was for network rehabilitation and compliance with new European Union environmental directives, particularly the urban wastewater treatment directive (Kinnersley 1994). Divestiture has not become the preferred option for private sector participation in low and middle-income countries and only Chile has followed the example of England and Wales. According to the World Bank, this is for several reasons: the lack of private sector interest, the complex regulatory implications, and the lack of local investment resources and underdeveloped capital markets (Triche 1992b). 4.6.9

Flexible arrangements

The above classification of organisational arrangements for private sector participation in urban water supply is not meant to suggest that each is a discrete category. The form that private sector participation takes must necessarily adapt to the political, cultural, legal and financial traditions of each country. As a result, in the actual practice of private sector participation there is a great deal of flexibility and overlapping between the eight arrangements. For example, the management contract is often perceived as an interim organisational arrangement to test the water before a lease or concession contract is introduced, providing a kind of ‘half-way house’ mechanism by which the private operator may achieve greater understanding of the operational and financial problems before committing itself to a more comprehensive involvement.

Box 4.8: Flexible arrangements – an example from Mexico City The service contract was chosen as the initial institutional arrangement for introducing private sector participation for urban water supply in the metropolitan area of Mexico City (population 16m).


This arrangement enabled the government to maintain control over the implementation of a new billing system linked to the introduction of universal metering. Because of the insufficient level of financial and operational data, it also reduced private sector risk. The government decided that the benefits of introducing comparative competition outweighed the incremental costs arising from decreased economies of scale. Hence, in 1993 it divided the city into four similar-sized service zones and in each zone it awarded ten-year contracts to different consortia. The contract was structured in three phases so that the companies could gradually assume greater responsibility as they gathered more information about the asset base. In the first two phases, the companies were paid on a ‘fee-per-task’ basis (for example, for installing meters, billing and measuring unaccounted for water). In the third phase, the companies would purchase bulk water from the state and take full responsibility for maintenance of the network and direct sale to consumers. Negotiations between the government and the companies over the difference between the price at which water was sold to the companies and to consumers were facilitated by the observation of operating costs, leakage levels and revenue streams during the first two phases. By the end of the third phase, the companies would retain a portion of the tariff collected from consumers as their sole remuneration. At this point, the contracts would become lease contracts (Casasús 1994). In fact, as a result of the democratisation process in Mexico, the phase three contracts were renegotiated such that it is ‘highly unlikely that the contractors will be given full control of operations and maintenance of the secondary network as originally envisioned. Accordingly relatively few of the expected benefits will also be captured’ (Haggarty 2002).

4.7

Conclusions

Economists have identified a major underlying cause of the structural imbalance between the supply and demand for urban water in many countries – namely that water is often perceived as a ‘public good’ that makes it difficult to extract an economic price from users. As a result, for long water has been under-priced compared to its real cost of provision and environmental externalities in the use of water are not reflected in its price. In turn, this structural imbalance between demand


and supply has resulted in a serious problem of ‘water stress’ for urban water systems worldwide – a structural crisis in provision that is caused by the failure to recognise the economic value of water. The symptoms of this crisis are extreme financial constraints, hydrological limits and soaring environmental costs (Winpenny 1994). The underlying argument in favour of private sector participation in urban water supply is based on the implicit assumption that such a major shift in the organisational arrangements for provision will help to resolve this structural imbalance between the supply and demand for urban water. By treating water as a private good and extracting an economic price for its use, the stated performance gains in terms of efficiency, effectiveness and equity will be achieved. But the act of converting a public water distribution monopoly into one that is privately managed may not necessarily produce such gains in performance. In a natural monopoly such as urban water supply, even with vertical unbundling, continued and effective public regulation will always be necessary and greater participation by the private sector inevitably creates extra regulatory problems. Transaction costs (the costs of arranging a contract ex ante and monitoring and enforcing it ex post) will necessarily increase. Hence private sector participation changes the form but not the fact of regulation and raises the question of whether the public sector is likely to be any better as regulator than it was as direct provider (Batley 1994). In the following chapters we examine the challenge to public sector regulatory performance posed by the most comprehensive form of private sector participation in the urban water sector – the concession model of public private partnership.

5 The Challenge of the Concession Model

5.1

Introduction

The objective of a public private partnership (PPP) is to transfer responsibility for the direct provision of urban water supply to the private sector, recognising that it is usually not necessary to have civil servants operating pumps and reading meters. From the range of PPPs described in Chapter 4, the presumed ideal has been the comprehensive concession model, which achieves the benefits of divestiture without incurring the social cost of transferring stateowned assets to private ownership. The term ‘concession’ in the urban water sector therefore is generally used to describe a city-wide contract with a private operator for the commercial management of abstraction, treatment, distribution and sale of water, including the financing and construction of new assets where required. Many variations are possible (for example, where government agencies continue to supply bulk water or where water supply is combined with sewerage responsibilities). In some cities, the geographical area is split between two concessionaires to promote comparative competition or to provide security in case of contract failure. The private operator assumes the full risk of operating the existing assets in exchange for a fee paid to the ‘asset holding authority’, the continuing owner of the assets, generally a state-owned company or government department. The fee may be in the form of an initial lump sum or annual payments. Alternatively, the private operator either pays for the use of the assets through amortisation of existing loans, or pays no fees as part of an agreement to direct additional funds into new investment. The concessionaire is expected to invest in rehabilitation and new assets in order to meet the demand for enhanced quantity, 73


quality and service coverage. At the end of the contract period the concessionaire hands back all assets, both original and new, in good order, to the state. To earn profits commensurate with the risk involved, the concessionaire offsets the expenses incurred by undertaking the critical task of ensuring an adequate flow of revenue, accurate billing and collection from all customers, at tariff levels agreed with the indirect provider, namely the state. The goal of this form of public private partnership is that consumers of a public service become customers of the private operator, receiving a significantly better quality service than previously and often at a lower price. The goal is also to include in service provision those who were previously unconnected, namely to achieve the universal service obligation of potable water to all. This latter group, after receiving a household connection, is likely to be paying a significantly lower price than their previous payments to private water vendors (PWVs). The reduction in the price of piped water can be used as a means of placating consumers who are deeply sceptical about ‘privatisation’. Asking private operators to bid for the contract according to their ability to reduce prices appears to be a powerful tool to achieve early efficiency gains, which is one of the prime advantages of involving the private sector. However, reducing prices in a system that will almost certainly require significant investment for many years to come can delay quality improvements and can send the wrong message to customers about the need for conservation of a scarce resource. Therefore an alternative approach to bidding relies on maintaining existing prices and requiring operators to compete on the number of new connections or the amount of new investment that they would promise to deliver within a specified time. Concessions can be seen as attractive to governments as they promise to deliver an all-embracing solution to what has apparently been an insoluble problem. They appear to transfer all responsibility for direct provision of water (and perhaps sanitation by sewerage) to the private operator through an institutional arrangement that delivers an efficient, least cost, supply along with the necessary finance to achieve effective service delivery, whilst ensuring a valid tariff. These are objectives that, as described in earlier chapters, have been beyond the capacity of most governments to deliver as direct provider. Governments have generally been unable to limit staffing levels and to motivate staff, thus failing to ensure efficiency; they have been unable to provide adequate investment funds to provide universal service of potable water; and they have failed to maintain tariffs at a level that, whatever the intricacies of crosssubsidies, cover capital and operating costs.

The Challenge of the Concession Model 75

However, the attractiveness of the ‘one-stop’ concession solution to government has to be balanced with the concomitant requirement for a massive cultural change among both consumers and water staff. Water consumers have to become used to their new role of customer, paying a fair amount in exchange for a reasonable service. The staff in the water utility, usually much reduced in number, have to become used to a new performance oriented and incentive-based work culture. The government has an important role to play in preparing both consumers and workers to accept this cultural shift, particularly when previously there has been little demand from the public for change. The goal of private companies that operate concession contracts is to maximise the financial return to their shareholders by providing what customers want at a price that they are willing to pay. However, in the monopoly provision of a basic good such as water, companies may be tempted to increase their profit margin unreasonably. Concession contracts therefore contain detailed specifications for determining water price and water quality. Yet no written agreement can foresee everything that might happen over the long 20–30 year lifetime of a contract. Concession arrangements therefore require strong regulation of prices, quality of services, drinking water quality, environmental quality and customer care. Through this regulatory function, discussed in more detail in Chapter 8, governments retain significant power over the private operator, perhaps more power after ‘privatisation’ than it had when trying to control its own direct provider. The concession model of public private partnership therefore represents a massive qualitative change in the role of government. The annual haggling over investment budgets is replaced by the need to proactively lead public opinion whilst developing considerable economic and contractual expertise in negotiating with concessionaires, as well as monitoring and regulating outputs. This challenge to governance skills can be reduced by setting the pre-qualification hurdle sufficiently high so that only international operators with long experience of delivering water in the political environment of low-income countries become involved. These companies also have the credibility to be able to borrow much of their investment requirements from the multilateral banks. Comprehensive concessions also pose a significant threat to government, with the public perception that water has been ‘privatised’. This is generally regarded as an unpopular concept when so many people resent the idea of companies earning a ‘profit’ from the supply of such a ‘heartfelt’ basic need. The tendering and awarding of contracts usually has to be undertaken in the full glare of publicity. Contract preparation requires


a multitude of responses to complex legal and institutional challenges within a relatively short time. Consequently governments, or rather individual government departments, have to take a considerable risk that such a dramatic change will in practice deliver the promised benefits without too many unexpected political costs. The requirement for experienced international operators to be involved is one way of minimising that risk but there is a danger for any government to use up scarce ‘political capital’ on the introduction of a new organisational arrangement whose benefits are necessarily unproven. The generally positive outcomes from introducing concessions in several major metropolitan cities around the world have to be contrasted with the widely reported failures in a few other cities. There is therefore a strong temptation for governments to choose one of the alternative PPP approaches described in the previous chapter, such as for example a BOT contract for bulk water supply. A BOT contract is apparently self-contained. It involves no direct interface with customers who therefore remain relatively unaware of any private sector involvement, yet it delivers the level of investment that is often the priority concern of government. But for most government direct providers the problem of water supply is not fixed asset construction, apart from their habit of over-payment for construction activities in order to fund wealth transfers to politicians and engineers. The main difficulty that most governments have is to act as product retailer, which involves face-to-face relations with customers through providing a quality product with good service at a fair price. Separating out the heavy engineering and handing it to the private sector through BOTs to meet short term financing problems rarely provides a solution to this problem. In any case, private sector consulting design engineers and construction companies are already fully involved in these activities. Governments can borrow for such straightforward tasks more cheaply than private companies. Turnkey contracts are the solution to public sector design and construction risk, with performance guarantees and operating contracts available for ongoing operations. The overwhelming danger of the BOT approach, as shown in various PPP power projects, is that the guaranteed cash flow promised by government to pay for bulk supply or treatment cannot be delivered to the private sector producer and wholesaler by government acting as retailer. As retailer, government agencies may allow too much of their product to be wasted en route to the customer through leakage and illegal connections. For political reasons, they may fail to charge customers adequately. They may also fail to adequately collect those bills that are delivered – through incompetence or ignorance as to who their


customers are and who has paid what, or through corrupt practices whereby staff allow reduced payments in exchange for personal benefits. If a concession is too great a step and a BOT has so many limitations, a lease contract can perhaps appear more acceptable. But almost all water supply systems need large-scale investment to overcome decades of under-investment. Hence even lease contracts are tending towards ‘enhanced leases’ whereby the private operator is responsible for some level of investment in rehabilitation or extension of the distribution system to peri-urban areas. There will still be the need to invest in new water production facilities as demand increases due to a more universal coverage and as household demand increases due to economic development. Matching the cost of that increased capacity with an affordable price that a private lessee is able to recover from customers is a difficult balancing act for a new government ‘asset holding authority’ that may well be staffed by ‘old school’ engineering professionals left over from the previous government utility. One possible option is for the government to negotiate BOTs for treatment processes, lease contracts for distribution, and separate service contracts for customer operations such as metering, billing and collection. However, particularly in low and middle-income countries, the possible benefits to be obtained from trying to optimise each element of the process to specialist companies is likely to be outweighed by the higher transaction costs of vertical disintegration. The technical, economic and administrative capacity that government would need to manage the various contracts would be considerable. Similarly, the transaction costs, through political interference and corruption, or, looking in a more positive light, through the additional costs of trying to ensure transparency and equity in bidding, particularly with international companies, could well be excessive. There is therefore a powerful argument in favour of combining operating and capital investment responsibilities in the form of a comprehensive concession contract. Water supply and sanitation systems require large-scale capital investment in fixed assets with very long lives. As a result, fixed costs constitute a very high share of overall costs. The efficient operation of these systems depends upon optimising the balance between expenditure on fixed assets and expenditure on operating costs such as fuel, chemicals and labour. Some level of integration is necessary to deliver the most effective balance between the two in order to achieve the lowest prices. Transferring the responsibility and risk to a single entity in order to achieve that optimisation is likely to produce better results.


The argument in favour of a comprehensive concession leads on logically to the most radical privatisation of all, namely divestiture. In a concession the existing assets remain the property of the state whilst passing into the possession of (but without ‘title to’) the concessionaire for the length of the contract. Depending upon the design of the particular concession, the private company may pay a fee for the use of the existing assets, in effect paying the depreciation charges so that government can amortise its loans. In the divestiture approach, the private company buys all the assets of the existing government provider, in effect paying the capital depreciation charges in advance. Typically though, the divested water company will also be operating under a time-limited licence at the end of which, theoretically, those assets could become useless unless sold on to another contractor or handed back to government. In both cases the principle is that private operators are given the right to take over and manage the entire business, charging customers the full cost of service provision (that is, operating costs plus capital costs) as well as a return on the capital employed. Governments can reduce the tariffs paid by customers by not charging a concession fee, as in Buenos Aires, or by selling the assets below cost, as in the England and Wales divestiture. Both approaches have the common advantage of limiting customer frustration at exceptional price rises and hence minimising the political risk of ‘privatisation’. Although in practice there is little significant difference between a comprehensive concession and divestiture with a time-limited licence, the political implications of selling government water assets are immense. For this reason, it is hardly a feasible choice for low-income countries.

5.2

Drivers for performance

Ideally it is the pressures of a competitive market that ultimately deliver the benefits of private sector involvement. ‘Franchising’ is the term used to describe this auctioning-off of the monopoly rights to serve customers in any particular location. Therefore, as a form of franchising, the concession model has to be seen ‘as a means of introducing the rigors of competitive markets without having to inefficiently divide up the network at the heart of the industry’ (Cave 1995). This results in competition for the market rather than competition in the market. Competition for the market might deliver the most attractive bid but says little about the quality of the resulting outputs. This is because the complex nature of service provision means that contract agreements


are often revised within months of signing. Government therefore has to be particularly attentive to the drivers for performance within the concession model if it is to achieve its long-term objectives within an ever-changing environment. The aim of government in any such franchise arrangement is to harness market forces in order to deliver ‘best value’ for consumers. The latter comprises a basket of simultaneous objectives – an increase in effectiveness, equity, sustainability, efficiency and transparency in the simultaneous delivery of a ‘private’ convenience good and a ‘public’ merit good. One study of public private partnerships identified six key drivers for ‘best value’ in the process of contracting out to the private sector: output based specifications; the long-term nature of contracts; competition; performance measurement and incentives; private sector management skills; and risk (HM Treasury 1999). Output based specifications demand an agreed level of performance rather than specifying inputs such as levels of investment. The most common approach is to specify the quality of water service to be supplied – including water quality, pressure at tap and hours of service – linked to service coverage. Bidding for contracts is simplified if competitors can be judged by a single output measure. This measure has often been the price per cubic metre of water supplied. However, in many low-income cities, the most critical performance indicator is service coverage, particularly in poorly served cities with significant low-income populations. Hence, service coverage rather than the price of water was the criterion for awarding the contract in La Paz–El Alto, Bolivia (Vargas 2002). Output based specifications are a considerable improvement over the past practice of government agencies paying the private sector to build a new waterworks with little guarantee that the water produced is of adequate quality, let alone that it reaches the poor. It is one of the roles of government to be proactive in finding ways to serve the poor, particularly with a ‘merit good’ such as water. In line with this, the global private operator, Ondeo, has suggested that the idea of objective oriented specifications could be developed further. Under its proposal for ‘output-based aid’, government would pay private operators at an agreed rate for the number of working household connections installed in defined low-income areas (Marin 2002). The long-term nature of the contracts delivers value to governments by forcing partners to look to the long-term outputs, avoiding shortterm ‘quick fixes’. In an asset-based industry such as water supply it enables private companies to make the necessarily large investments with sufficient time to recover those costs without charging


unaffordable tariffs. It also encourages private operators to invest in staff development and training. Such long-term contracts demand commitment and a degree of partnership and trust between the franchiser and the private operator that should reduce overall transaction costs. On the other hand, the competitive drive can be reduced when an operator knows that it has the contract for decades to come. Competition is vital to obtain maximum benefits for the consumer from private sector involvement. Competition for the market in these long-term contracts is presently limited to a handful of international water companies that can meet the common pre-qualification criterion of experience in operating commercially in cities with millions of customers. Even this level of competition is limited by the common practice of private operators to form joint ventures between themselves when bidding for large concession contracts (Hall 2001). Clearly, countries wanting to appoint private operators would benefit from having more competitors. However, there does seem to have been genuine competition for the water market in many large cities, judging by the reported high cost of bid preparations and the content of the bids themselves. The fact that bid winners accepted a commitment to achieve 100 per cent service coverage within five years for La Paz–El Alto and a 73 per cent tariff reduction for one of the Manila contracts demonstrates the level of competition (Vargas 2002; Inocencio 2002). It is less clear whether this competition has been replicated in smaller cities. Beyond the glare of international publicity there have been several examples of international private operators making unsolicited bids to inexperienced municipalities. The proposed benefits on offer have encouraged some municipalities to accept these bids without any formal tendering process. Without the check of possible competitors it is uncertain whether such municipalities have achieved best value in these new contracts. Reducing competition to a single variable, whether price or service coverage, at the time of contract awarding ensures transparency and some level of acceptance by stakeholders that the award has been fair. Contracts have been awarded on the basis of the lowest tariff proposed (for example, Buenos Aires and Manila), on the lowest average tariff proposed over the life of the contract (for example, Bucharest), on the size of royalty payment for use of fixed assets (for example, Province of Buenos Aires) and on the number of connections to be delivered by a certain deadline (for example, La Paz–El Alto). Where two (or even more) such target indicators are required from each bidder, as in the negotiations for the Johannesburg contract, there is almost always a dispute as to the correct weighting between the two.


But the almost arbitrary nature of the single numbers that are then bid, whether it is the miniscule difference between price reductions in Buenos Aires or the extremely large differences in Manila, has led many observers to question their validity. Governments have to be wary that private operators may be simply pitching their bids at a level low enough to ensure that they are awarded the contract on the tacit understanding that they can begin the real negotiation later. Such an approach immediately calls into question the basis of ‘partnership’ with the regulator or contract monitor. Simplistic competition for the market has other side effects. Awarding contracts on the basis of the lowest tariff bid, although politically attractive, does not encourage water conservation and may delay the investments needed to achieve the target of universal service coverage for sanitation as well as water. Awarding contracts on the basis of size of payment for use of fixed assets may appear an attractive source of funds for government but could well lead to an excessive increase in the tariff charged to customers, poor and rich alike. This is because the operator must necessarily recover that payment from the only source available to it, namely its customers. Competition for the market also delivers value by providing freedom for the private operator to choose its own subcontractors or procurement deals. The World Bank reasonably demands competitive procurement bids for the use of its loans with an exemption where the concessionaire has been appointed competitively. Performance measurement, whether to mimic competition or to ensure that the outputs are being achieved, is a critical issue that is increasingly recognised by public water providers as well as by regulatory bodies in contract negotiation with the private sector. Once a long-term concession contract has been awarded there is the risk that competitive pressures are removed. In order to combat this, governments have sought to promote efficiency during the contract period through the application of comparative competition. This was first introduced by dividing a city into separate zones, with contracts awarded to different contractors in each (for example, Mexico City, Jakarta and Manila). There is also increasing use of benchmarking of performance between cities as in initiatives by the Asian Development Bank and the World Bank (McIntosh and Ygiñuez 1997; Kingdom and Jagannathan 2001). These are similar to the comparative data published by OFWAT, the water regulator for England and Wales, in its annual comparisons between the 25 water only and water and sewerage companies. This approach to measuring performance has now been taken up by two Australian water utilities, following the same OFWAT


methodology to aid comparisons (OFWAT 2002a). With the increasing ease of access to global information any such data, particularly where it has been verified by external auditors (a development yet to be seen in low-income countries), can be quickly used to make comparisons between operators to promote ongoing competitive pressures. Private sector management skills deliver a change in objectives as well as a powerful motivation to achieve those objectives. Rather than attempting to satisfy a multitude of public policy goals that are often in conflict whilst delivering unwarranted benefits to the powerful stakeholders, private management has a more focused task combined with transparent reward mechanisms. Linked to outputs that require creativity and innovation in order to attain them, and knowing that failure to achieve that level of performance should lead to termination of the contract, the private sector has a more effective framework in which to deliver services. Such private sector skills are powerful levers for improvement. They involve computerised management and customer information systems linked to the introduction of quality assurance and total quality management style initiatives. These are supported by focused human resources development programmes linked to incentive payments for staff, all topped off with managerial motivation.

5.3

Risk transfer

The incentives to deliver best performance using private sector skills are linked to the opportunity to earn profits above the cost of capital. To earn such profits the private sector has to carry a higher degree of risk, the sixth driver for ‘value for money’ in the process of involving the private sector. As the direct provider of water supply, the government has traditionally assumed the risk of failure although experience suggests that it is consumers who have actually borne the cost through a deteriorating level of service. Private operators naturally prefer to maximise profits for their shareholders whilst minimising risk. When inviting the private sector to become involved, it is critical that government ensures that the stakeholder that carries the risk element is the one that can best manage that risk. If government tries to transfer too much risk or does not recognise the unreasonableness of expecting a private operator to act more like an insurance company than a water provider, the result will be either excess tariffs to be borne by customers or failure in the indirect provider. A study by the UK government that has most actively pursued the drive for privatisation describes six generic types of


risk to be borne by the private sector: construction cost risk; demand risk; operating risk; regulatory risk; obsolescence risk; and resale risk (HM Treasury 1995). In the context of this study of water supply in low and middle-income countries two further risks must be included: foreign exchange risk and political risk. Construction cost risk has traditionally been a problem for governments. They have had difficulty in minimising and effectively transferring those risks to contractors. Contracts invariably take longer than expected and tend to incur claims from the private contractors for the apparently inevitable special situations that develop, leading to higher costs than expected. Studies from the UK reveal average outturn costs from government managed projects as ranging from 15 per cent higher than initially estimated in local government projects to an overspend of as much as 30 per cent in major public sector road schemes (HM Treasury 1999; Tiffin and Veazey 1998). In contrast, the privatised UK water companies, taking complete control and therefore having to carry the risk themselves, have been delivering completed fixed assets at 15 per cent below the estimated costs in the first ten years of privatisation and 7 per cent in the succeeding five year period, even when the original estimates had already been already squeezed by the regulator. Transferring construction risks to the private sector is therefore a valuable benefit arising from BOT or concession contracts. But this is not to suggest that it is simple issue. Real unknown risks remain that the private sector cannot anticipate, particularly when working in an unfamiliar setting. The experience of United Utilities in its attempt to construct sewers in Bangkok is a reminder that ‘permissions to dig’ from an unwilling municipal authority are a part of construction risk that might not necessarily be controllable by the private sector. The £83m in provisions made by the company in its 1998 accounts demonstrates that these risks are very real (United Utilities 1998). Demand risk is linked to water use, metering, billing and collection efficiency. Together with tariff determination it makes up the overall risk to adequate revenue and hence cash flow. It might be supposed that demand for a basic need such as water would change only slowly and that there is little risk involved. However, when existing production of water bears such little relationship to metered use private operators face many unknowns when bidding for a contract. For example, the apparently high existing daily consumption in Bucharest, at 825 litres per capita per day (lpcd), is significantly above the European average of 120 lpcd (IFC 2000). In order to propose a change in the tariff level, any private operator bidding for a concession has to make some assumption


about the resultant change in the level of demand. The more that government can do to resolve such uncertainties before awarding a concession, the more the likelihood that they will achieve best value for their customers. Demand risk is of similar concern when assumptions about the rate of decline of unaccounted for water have to be made. The two private operators in Manila had to assume a certain level of demand in order to win the concession according to a ‘lowest price’ bid. Measured demand multiplied by this price equalled the potential revenue that they then had to balance against assumptions about the cost of delivery. But the 66 per cent unaccounted for water in the ‘western’ concession remained obstinately high. As a result the production of so much water that is never billed has been a substantial cost to the private operator – a cost that the previous government direct producer was able to ignore (Global Water Report 2001a). Demand risk also results from the change from an intermittent to a 24-hour supply. Under intermittent supply, consumers became used to flushing unused water when fresh water returned to their taps. This wastage, an apparent demand for water, disappears with an effective supply. Apparent demand is similarly distorted by the coping strategies of the rich, as well as PWVs, through the use of their own private boreholes, which they may or may not choose to continue to use when the piped supply is upgraded. Operators have to make assumptions as to how long these inherited coping strategies will persist. This is a significant demand risk in itself, particularly as the use of private boreholes allows the rich free use of sewers, the charges for which are almost always a (too small) proportion of water charges. The private operator then has to pay for sewers and wastewater treatment for which it is receiving no revenue. To overcome this problem contracts can give concessionaires exclusive rights over supply and therefore over use of groundwater, even from small wells and boreholes. However it can be a long struggle to enforce such a right when private abstraction, with small pumps unnoticeable in private compounds, is so hard to detect. Households that are used to obtaining water from vendors and tankers are usually very willing to switch to a cheaper, higher quality and more convenient piped supply. But resistance from tanker driver unions as well as those reasonably trying to minimise any loss of jobs in the informal sector can delay new connections and so affect demand calculations. Finally, there are the more conventional demand risks when anticipated increases in demand from industry and households do not


materialise due to changes in business patterns or incorrect assumptions about household growth. Both may lead to a reduced revenue stream as happened in Dolphin Coast, South Africa, where development of middle-income and mass housing did not match projections. Having provided the pipe network to meet that demand, the private operator had to renegotiate a 15 per cent increase in tariffs alongside other changes in order to survive (Business Day 2001). Governments and other stakeholders have to accept that although there can be significant transfer of demand risk to the operator there may also come a time for renegotiation. The alternative would be for all stakeholders to lose significant benefits through adherence to contract expectations that prove to be incorrect or unworkable. Operating risk is related to the skill of the private operator in taking on an unknown system where the likelihood is that the assets will be in a worse condition than anybody expected and also that these assets will initially be hard to locate, let alone operate productively. Operating risk may be associated with difficulties as obvious as the availability of electric power or the level of trade union resistance to changes in staffing levels. It can be associated with issues such as: minimising operating costs whilst introducing massive fixed asset investment programmes; providing new vehicles and equipment in the expectation that this will make staff more productive; increasing salaries in the expectation that it will motivate the retained staff; expectations of increased productivity following training in new ways of working; and introducing new computer systems for management information and billing. These are all massive challenges that carry significant risk of cost overrun and reduction of profits. Part of the wider operating risk is that related to billing and collection, a risk that has traditionally taken second place to engineering operations when government has acted as direct provider. State-run utilities often do not know who their customers are, let alone how much water they are using. Even when a metering system and regular billings are in place the number of reported consumers may be inaccurate because of the falsification of meter readings by meter readers. Another operating risk is the time lag between the operator taking on a system and being able to deliver upgraded assets that produce at an acceptable standard of service. This time period is crucial in terms of raising public recognition of positive change in order to justify ‘privatisation’. In turn this affects the willingness of customers to pay their bills. Regulatory risk is another risk faced by the private sector. The level of profitability that the operator achieves ultimately depends upon the regulatory system that determines tariff levels. Perhaps regulation


should not be viewed as a risk so much as a reasonable safety net such that private operators might continue to be able to finance their operations to the benefit of all customers. The reinvigorated role of government through regulation is discussed further in Chapter 7. However, the sometimes apparently arbitrary decisions of regulators can make or break a concession. This is a real, albeit unquantifiable, risk. The risk that the regulator may be neither competent nor committed to the principle of partnership is considerable. This is particularly so when the regulator and regulatory office have not been established in advance of the award of a contract. The risk is compounded in those cases where the regulatory team is staffed from the remains of the less than successful government direct provider, as happened in the case of Buenos Aires and Manila. The power of foreign private operators (that is, ‘calling in the Ambassador’) sometimes acts as a counterbalance to regulatory risk but even that is limited when the president of a country overrules a tariff increase made by the regulatory body, as occurred in Manila in 2001. Foreign exchange risk arises automatically from the involvement of experienced international private operators. Sudden devaluations create risk in the cost of importing specialised equipment for investment programmes and for servicing existing debts, some of which might have been taken over from government as part of the concession arrangement. Devaluation also leads to a foreign exchange risk for the repatriation of profits to shareholders. Arrangements have been made to overcome foreign exchange risk, such as the ‘dollarisation’ of tariffs in Buenos Aires, which was reportedly introduced after the concession agreement had been signed. By contrast, the failure to introduce dollarisation of tariffs in Manila cost the same international operator substantial amounts when the local currency devalued by around 50 per cent only one year after the contract had been signed. This arrangement was often described as a ‘minor issue’ when the Argentine currency was pegged to the dollar. Although it appears to have been at least a sensible precaution, the Argentine government nevertheless ended the dollarisation of tariffs following the 2001 debt default and subsequent massive devaluation. The concessionaire had to make provisions of $700m to write off consolidated equity in Aguas Argentinas and to eliminate foreign exchange risk on debt (Suez 2002). The expectation that the private sector will absorb risks that are totally beyond its direct control, such as currency devaluation, can only add unnecessary costs to the provision of water. Governments cannot expect water customers to pay the insurance costs of foreign operators to protect themselves against the risk of devaluation. Similarly, unless


private operators can be reasonably sure of recouping their cost of capital even when unexpected shocks occur, whether it be a military coup or dramatically abnormal weather, the ‘insurance factor’ which then has to be built into the contract through higher prices may well outweigh the benefits of private sector efficiency. If the foreign private operators cannot be sure of being able to manage reasonable risks and to share the burden of sudden shocks, then the poorer countries will lose the benefits of those drivers for improved performance. Political risk is the greatest risk of all to private operators of concession contracts, as illustrated by the experience of Aguas Argentinas. This is a risk not only for the private operator but also for the government. There are the risks, described above, borne by the private provider as to whether they will succeed in earning a satisfactory return on their capital invested. There is the political risk that governments will fail dramatically or that economies will implode and any investment in immovable fixed assets will be lost. One international operator published a map of the world showing their areas of interest, omitting Africa, perhaps reflecting their perception of risk in that continent (Anglian Water 1997). Other international operators deliberately target only high-income countries, reflecting their perception of the risk and reward balance. One of the roles of government is to create an environment where there is a reasonable level of risk involved for foreign operators as they demonstrate the potential of private operations, hopefully to the coming generation of national private operators. However there is also the risk borne by government and politicians in using up scarce political capital in new approaches to service provision. Having overcome the risk of doing nothing, the indirect providers are faced with two options. The first is to promote a limited public private partnership in the hope that this incremental approach will not frighten too many people. But this runs the risk that such an approach might never deliver the comprehensive benefits that consumers expect from such a radical change. The alternative option is to risk that political capital in an all-embracing concession, handing full responsibility to an operator that is new and untested in that particular environment. Transferring responsibility to a new operator is a particular risk that governments face when water consumers in the large cities of low and middle-income countries have become used to poor performance from their state-run water utilities – unsafe drinking water delivered at unpredictable times in exchange for a minimal tariff that may not always have to be paid. This style of supply has become a fact of life in many cities where both rich and poor have developed coping strategies to


overcome its worst effects – namely, household storage and treatment, with various forms of informal carrying for those outside the existing service area. When there is no public demand for reform it is a brave government that takes on the challenge to introduce a change as significant as a public private partnership. There is also a significant risk to government promoting reform when existing managers, staff and suppliers have become accustomed to the status quo and only see these new developments as threats to their own way of working. Government officials with responsibility in the metropolitan areas have often wanted to reverse the downward trend in investment and service provision. Given the failure of past efforts at commercialisation, the allure of the new, fashionable public private partnerships has been strong. It does appear that the way to achieve a commercialised, customer oriented water service with cost-reflective tariffs whilst making a return on capital to support a viable investment programme is through ‘tapping the market’ in a PPP concession. But it takes considerable political and government courage ‘to go for broke’ in a concession. There is a major role here for government to play in leading such a change. And when that decision for change has been made, planning and monitoring a PPP concession does not mean that government withdraws from the sector. Rather it demands a new and even more challenging involvement as increasing customer awareness and expectations raise the political stakes, with the added pressure of growing international concern from NGOs and trade unions. Resale risk and obsolescence risk are not significant in the water sector. The resale risk of individual fixed assets at the end of such extended lives is insignificant. Concessions generally specify that fixed assets are returned to the government in good order without any element of resale. However the resale risk related to the forced sale of the fixed assets of a divested water company that has lost its licence, as is theoretically possible in the case of the private operators with 25-year licences in England and Wales, is so high that it has generally been ignored. The obsolescence risk is equally insignificant because fixed assets such as treatment works and pipes have long design lives of 30–50 years and in practice often operate for over 100 years.

5.4

Buenos Aires: the concession model in operation

In order to understand how the concession model can work in practice the research included a study of the water concession in Buenos Aires,


the capital of Argentina. The 1993 contract in Buenos Aires was the first of a new global wave of concessions and the aim was to investigate whether the public private partnership has achieved any significant improvement in water supply and to compare the drivers for change in Buenos Aires with the focus countries. Water supply in Buenos Aires developed in the second half of the nineteenth century as a public private partnership. By the 1930s, when the government had long since taken over direct supplier responsibilities from the foreign concessionaire through a federal body, Obras Sanitarias de la Nación (OSN), the entire population of 2.4 million was supplied through a network extending over more than 4,000 km. By 1940 Argentina boasted the highest urban water supply coverage in Latin America and the specialised training school of OSN attracted professionals from the rest of the sub-continent. Despite these successes, OSN suffered from three deep-rooted problems. First, although payment for gas and electricity was the norm, from 1920 to 1940 political parties had actively discouraged voters from paying for water. Citizens soon believed strongly that the financing of water provision was exclusively a government responsibility. As a result, it was impossible to introduce a proper tariff structure until the 1950s. Revenues did not even cover operating costs and central government transfers covered a growing financial deficit. Technical factors predominated over economic considerations in decisions made concerning capital expenditure. Safe in the knowledge that the cost of new investment would be covered by federal subsidy, studies for new projects were not based on any financial feasibility study. Project design was carried out exclusively by engineers who had little concern for economic viability. This led to the construction of grossly over dimensioned and under-utilised infrastructure projects, of which the Palermo water treatment plant, one of the largest in the world, was a classic example. Third, investment decisions were determined primarily as a result of political pressure from the major parties, each of which had different priorities. The absence of strategic investment planning within OSN, itself a consequence of domination by engineers, meant that the organisation was unable to insulate itself from such political pressure. By the early 1990s the Greater Buenos Aires water system was generally agreed to be on the brink of collapse because of lack of investment. In 1954 investment in water had represented 1.8 per cent of GDP but this share had fallen to only 0.5 per cent by 1993. The fall in investment had been so severe over the previous decade that water treatment


technology was obsolete and preventive maintenance had been abandoned. In turn, this had led to a sharp decline in service standards and water quality had fallen sharply. There was an increasing risk of major breakdown. Two-thirds of the pipe network had exceeded their useful life and the lack of replacement and repair of deteriorating assets led to spiralling water losses. Productivity and morale within OSN was very low. As owner and operator of the water system, the government was not able to invest sufficiently to match urban population growth. By the early 1990s, OSN was spending more than 80 per cent of its budget on operations and less than 5 per cent on new investment (Mazzucchelli, Rodriguez Pardinas and González Tossi 2001). As a result, less than 70 per cent of the population of 9.1 million had water connections and the majority were receiving water that was not up to drinking water standards. Only 15 per cent of the service area received water at an acceptable pressure. Nevertheless, the average consumption was 500 litres per capita per day (lpcd), 300 lpcd after losses, which is double the European average. The close proximity of the River Plate and the generally flat topography that delivers low cost water supply also meant a high cost of sewage disposal. The sewerage system was serving just 58 per cent of the population and the level of wastewater treatment was extremely low at 4 per cent. The result was highly polluted groundwater and surface water. The service provided by OSN was also very inefficient: unaccounted for water was high at 44 per cent, only 2 per cent of residents were metered, and billing was erratic with a reported bill collection efficiency of only 80 per cent. OSN was overstaffed, employing some 7,450 people. Operating revenues were reportedly US$230m, leading to an operating deficit of US$8m. Attention to the needs of consumers was minimal. Most important of all, service coverage was highly inadequate, with 40 per cent of the population living in the poorer areas within Greater Buenos Aires lacking direct access to drinking water. To provide a quality service of water and sanitation to all residents of the city, the government turned once again to the private sector, inviting bids from international water companies to operate a 30-year concession. Significantly, privatisation of water took place in the context of a nationwide privatisation programme that itself was the result of a financial crisis. Following the overthrow of the military government in the wake of its defeat in the Falklands War, the first democraticallyelected government had postponed any fiscal adjustment, leading to hyperinflation. In 1989, the incoming Peronist government of Carlos Menem announced a new strategy, consisting of: foreign trade


liberalisation; financial and economic deregulation (transport, ports and postal service); reform of the state; and the convertibility plan establishing parity between the Argentine peso and the US dollar. The breadth and depth of the reforms took place at a time when the opposition of civil society to radical measures of financial adjustment had been considerably lessened by the experience of hyper-inflation. The far-reaching privatisation programme, which was a key component of the state reform process, had two distinct stages. The first stage (1989–91) took place during a period of continuing high inflation. Telecommunications and civil aviation were the key sectors privatised during this stage and in both cases the overriding objective was to ensure new investment in order to overcome declining level of service. However, the state negotiated badly, failing to ensure competition, failing to ensure compliance with the terms of the contract, and also failing to establish an adequate regulatory mechanism prior to sell-off. The second stage occurred during a period of low inflation (from 1992) and saw a marked improvement in the negotiating capacity of the state, as evidenced by the establishment of regulatory frameworks prior to sell-off in the case of gas, electricity and water. The state reform law spelled out the form that privatisation would take in each sector. In the case of water supply, it stated that privatisation would be in the form of a concession whereby the government remained owner of the assets but the concessionaire was responsible for operations, maintenance, management and enlargement of the system. The government announced its intention to arrange a 30-year concession for drinking water supply and sewerage services in Greater Buenos Aires. The concession area was exactly the same as that operated by the former OSN. The granting of the licence was completed in record time. The process from bid preparation to award took about two years, including a year to prepare bidding documents and draft legal documents. Following a twophase process, separate technical and financial bids were placed. One of the main problems for bidders was the inadequate quality of existing operational and commercial data. Revenues could not be audited. Little historical data was available about the volume of water produced, of unaccounted for water, and of the volume of water actually consumed. As maintenance had been inadequate, little was known about the condition of the system and the detailed requirements for rehabilitation. The government responded to these shortcomings by making all records available for review by bidders and OSN personnel were available to answer questions. A large number of external consultants were


engaged to develop background documentation, to promote the concession and to identify potential investors. The cost of this preparatory work was estimated at US$4m. Specifically, officials were able to provide a reasonable historical record of tariff payments. This revealed that the percentage of consumers who were billed was low, although the collection rate among those billed was as high as 80 per cent. This record, together with evidence of consumer willingness to pay for other services (for example, the collection record in the power sector) and a clear authorisation for the contractor to disconnect non-payers, gave prospective operators the confidence that they would be able to collect bills and would be protected in the event of non-payment (ECLAC 1995). For the technical phase, service quality and coverage targets were established and bidders were invited to present technical solutions to meet the target goals. They were also required to submit detailed proposals of their intentions over the life of the contract, including an investment plan for the rehabilitation and expansion of the system. The financial selection criterion was based on the proposed consumer tariff. Since the pre-concession average charge of about US$0.40 per cubic metre already covered the operating and maintenance costs of the system and it was assumed that the private operator would be more efficient, bidders were expected to offer initial rates lower than the existing tariff. A baseline tariff was specified and the bidders were asked to submit a price bid expressed as a percentage with reference to the baseline tariff. Four consortia submitted proposals and three final offers were made, after one bidder that had proposed to employ innovative water treatment technology was eliminated because the technology was judged too uncertain. In an extremely close competition, the contract was awarded to the consortium Aguas Argentinas, led by Lyonnaise des Eaux (now Ondeo), which bid a tariff reduction of around 27 per cent below the current water rate. This was only marginally lower (0.8 per cent) than its nearest rival. One of the requirements of the bid was that the operator should retain a 25 per cent stake and that the original consortium should retain a 51 per cent stake for the 30-year duration of the concession. The operator also had to deposit a US$150m guarantee with the government. This would be forfeited in the event of noncompliance with the contract. The performance-oriented contract, which focused on outputs such as service coverage rather than inputs such as levels of investment, called for 100 per cent coverage of water supply and 95 per cent

The Challenge of the Concession Model 93 Table 5.1: Aguas Argentinas: contractual objectives for service coverage Year 0

Percentage Population (mn)

Year 5

Year 15

Year 30

Water

Sanitation

Water

Sanitation

Water

Sanitation

Water

Sanitation

70% 6.0

58% 4.95

82% 7.7

66% 5.9

95% 9.1

84% 8.0

100% 10.25

95% 9.75

Source: Mazzucchelli, Rodriguez Pardinas and González Tossi, 2001.

coverage of sewerage by year 30. It was anticipated that this would require investments of approximately US$4,000m with a requirement of US$1,200m in the first five years. The concession did not include any fee to be paid by the concessionaire for the use of the existing assets, but required all assets to be returned to government in good condition at the end of the 30-year period, with government paying for any non-depreciated assets. The concession started on 1 May 1993 with Aguas Argentinas as concessionaire and Lyonnaise des Eaux as operator. The government established a regulatory body specifically for this contract, the Ente Tripartito de Obras y Servicios Sanitarios (ETOSS), which is discussed in detail in Chapter 7. The regulator is necessarily concerned with the financial status as well as the service quality. Analysis of the published financial statements of the operator shows that revenues rose from US$305m in 1994 to US$514m in 2000, a 69 per cent increase (Aguas Argentinas 2000). Meanwhile operating expenses increased by only 3 per cent, a significant achievement. Staff numbers were reduced to 4,300 in 2000, by which date bill collection efficiency had risen to 98 per cent. The expectation of US$1,200m investment by the end of year five (1998) can be confirmed by the figure of US$1,031 million reported for ‘Property, Plant and Equipment’ at year-end 1999 (Year 6). These fixed asset numbers are slightly less than anticipated but do not necessarily represent a problem in an output-oriented contract. By the end of 2000, service coverage had increased to approximately 85 per cent for water and 63 per cent for sanitation, representing 100 per cent of the water coverage target and 92 per cent of the sewerage target for that year. The regulator predicted that in a joint effort with customers and local governments by Year 10 (2003) the company would have delivered water services to an additional 2.3m inhabitants and sewerage services to an


additional 1.7m (ETOSS 2001). This apparently excellent progress, confirmed by the regulator, is challenged by some who calculate that extensions of service as a percentage of targets was only 54 per cent for water and 43 per cent for sewerage if the effect of regularisation of illegal users is excluded (Azpiazu and Forcinito 2002). The company was clearly successful in controlling operating costs whilst achieving much of the anticipated investment. This resulted in an impressive level of profitability. At the end of FY2000 the company was achieving a 13.4 per cent return on fixed assets and a 43.7 per cent return on equity, according to Aguas Argentinas methodology. This apparently high figure is explained by the relatively low level of equity involved, as shown by the high debt to equity ratio of 154 per cent. Taking the regulator’s estimate of an asset replacement value of US$10,700 million, the return on fixed assets is a more modest 1.4 per cent. However, in cash terms in 1997 Aguas Argentinas paid its first dividend to shareholders who had initially contributed US$120m in equity funding. The US$12.6m provisional dividend payment recorded for 1996 rose to US$21m by 2000, by which time total equity had risen to US$398m. The company had also ‘executed a management control and technology and know-how transfer contract with Suez Lyonnaise des Eaux, service operator and shareholder of the Company’ (Aguas Argentinas 1997). For this the company pays the operator 6 per cent of the gross operating margin, resulting in payments of US$15.6m in 1996 rising to US$19.3 m by 2000. It is not clear to what extent this ‘management control contract’ represents a valid charge for services rendered or is simply an alternative means of extracting additional, though disguised, dividends. The financial information illustrates that it is possible to operate a viable water utility whilst investing heavily in quality and service improvements. By 2001, the broad objectives of the Argentine privatisation programme had been achieved in the case of the Buenos Aires water supply. Financial subsidies from central government had been eliminated and service provision had been vastly improved. Although the level of investment in the first years of the concession was less than ETOSS had anticipated, the company succeeded in transforming Aguas Argentinas into a modern water and sanitation provider. Water quality now meets international standards and is delivered at an appropriate pressure. Customers can contact the company when they wish and problems are solved when reported. But the acceptability of international operators extracting dividends and management fees of US$40m per year from a middle-income country


concession that is generating annual gross revenue of $514m has to be judged by the customers themselves. Are most consumers prepared to pay that US$5.2 per person per year charge (that is, Aguas Argentinas dividend and management contract fee per person served) in addition to the US$1.8 per person per year charge for the regulator in exchange for a 24-hour potable water supply? The Buenos Aires case suggests that a large-scale concession, managed by a major international operator in a relatively rich city where water is plentiful, is indeed capable of delivering the benefits associated with the principles of PPP, albeit at a considerable price. Ironically, the resurgence in late 2001 of severe macro-economic difficulties that had acted as the main driver for government to introduce the concession in the first place will severely test the sustainability of this organisational arrangement.

5.5

Choosing public private partnerships

The four case study countries investigated in this study have yet to introduce any comprehensive water supply concession. Considering the drivers for change that appeared to be significant in Buenos Aires, two of the countries have experienced very similar levels of failure in water supply. Although there have been economic difficulties in all four countries these have not reached the level of hyperinflation that was experienced in Argentina. Similarly these pressures do not seem to have coincided with any change of government that saw political advantage in introducing major institutional reform. Yet at the time of writing (December 2002) the government in each country is reconsidering its role and has been planning some form of major public private partnership. Ghana and Sri Lanka are closest to completion, with consultants and transaction advisers in place and external support agencies fully involved. India has the potential to benefit most from private sector involvement, but continues to be on the point of announcing its first significant concession, as it has been now for several years. As described earlier, Zimbabwe, although successful in the direct provider role by municipal government, has also begun to consider PPPs to consolidate and extend service improvements. However, its current desperate economic and political situation looks likely to delay any major change for the time being. One of the suggested explanations for change in Buenos Aires was the lack of any significant opposition from civil society, blunted by the economic crisis at the time. Yet it is not clear why there should be such apparently instinctive reaction from civil society against the involvement


of the private sector when so many people purchase their everyday needs from private retailers. Perhaps it is explained rather by the underlying suspicion of ‘privatisation’ that is generated by many revelations of corrupt contracts between government and private companies. There is also the fear of job losses in low-income societies where many urban households are struggling for survival. Here apparently trivial changes in water tariffs are achieved at the cost of hundreds of jobs. Whatever the reasons, civil society organisations are actively campaigning against PPPs around the world, often confusing, sometimes deliberately, the difference between privatising water resources and privatising water supply services. 5.5.1

Ghana

Following reports by various consultants, Ghana decided to replicate the approach of its neighbour, Cote d’Ivoire, which has had a longstanding lease contract for all its major urban areas with significant national shareholdings in the single private operator. The approach in Ghana was to plan for two major lease contracts to cover the urban areas of the country. There were to be ten-year contracts for ‘Business Unit A’ (Accra plus with a number of smaller towns) and ‘Business Unit B’ (Kumasi plus a similar number of smaller towns). The hope was that the major urban areas would generate sufficient revenue to subsidise the smaller towns that the previous Ghana Water and Sewerage Corporation (GWSC) had found so difficult to serve. It was envisaged that the two contracts would facilitate the role of government regulation by promoting comparative competition. Multilateral agencies promised investment support and a bilateral donor paid for initial asset management planning and a public relations campaign. However the process was disturbed when a major international private operator made an alternative proposal that appeared to guarantee much higher levels of investment, particularly in new treatment capacity. This had been a concern of government since it would have been responsible for financing this under the original proposals. But uncertainty over the implications of the proposal, particularly with regard to dramatically increased future tariff levels to finance the additional investments, led to confusion. The offer was reportedly linked to an inducement to politicians, a factor that has delayed the reform process by several years as the multi-lateral and bilateral donors reconsider their involvement. Invitations to bid were rescheduled to April 2002, seven years after moves first began to restructure GWSC (Global Water Report 2001b). However, no contract has been agreed at the time of writing.


One illustration of the strength of stakeholder opposition to the reform of the sector is the formation of the Ghana National Coalition Against the Privatisation of Water. This was established by various NGOs and individuals to lobby specifically against: • The view that privatisation (the participation of foreign transnational corporations) is the appropriate solution to the problems bedevilling our water sector. • The view that ‘to be private is to be efficient, and to be public is to be inefficient’. • The view that the public sector, in this case the GWC Ltd, is incapable of being reformed to deliver water services efficiently and effectively to all. • The commodification of water (ISC 2001). International NGOs have also declared their opposition to any ‘privatisation’ in Ghana. Yet in so doing they ignore the desperate plight of the many households that cannot obtain a household connection or that do not receive sufficient water through their existing connection. The opposition illustrates the challenges facing any government as it moves towards public private partnerships. The Ghana government appears to be hoping that the limited nature of the proposed leases, by downplaying the private aspect, will be sufficiently ‘weak’ to allow it to overcome the political opposition, whilst being sufficiently ‘strong’ to deliver the necessary improvements. Indeed, as the Ghana case demonstrates, choosing PPPs often requires a delicate balancing act. 5.5.2

India

Private sector participation in the Indian water sector has so far taken the form of successful service contracts. No major concession contract has been awarded to date. In 1996 the Pune Municipal Corporation (PMC) announced plans for a $185m water supply and sewerage project that involved construction, billing and maintenance contracts with the private sector in order to achieve universal water and sewerage coverage by 2025. Following a change of local political leadership, the project was abruptly cancelled in October 1998, two weeks before tenders were due to be opened (Zérah 2000). Recent attempts to develop concessions in Hyderabad, Bangalore, and Goa have also ended in failure. Renewed efforts are being made in Hyderabad and Bangalore but they may well be limited to enhanced management contracts for water distribution only.


A step towards PPP was taken in Rajasthan with the award of service contracts in June 1995 for the operations and maintenance of a newly constructed 112km water transmission main and a major treatment plant. The decision to award the contracts was driven by a ban on further recruitment of government staff. The rates initially tendered by four existing contractors were twice as high as expected. They appeared to be operating a cartel arrangement that would not have delivered the necessary efficiency gains, so confirming the fear of many observers regarding private sector involvement. There were also bureaucratic difficulties in approving other firms of sufficient experience to be placed on the tender list. These difficulties were eventually overcome by selecting a cooperative of retired engineers with the requisite technical expertise. After a court challenge the contracts were awarded to the co-operative at a price that was 40 per cent less than the original offers from the cartel contractors, albeit for a reduced period of time. In the succeeding two years the work was reported to be satisfactory with the state government considering a move towards wider management contracts (Franceys and Sansom 2002). The Hyderabad Metropolitan Water Supply and Sewerage Board in Andhra Pradesh requires large investments to maintain and upgrade its system. It is experimenting with private public partnerships for the sewage treatment plant maintained on contract basis since its rehabilitation in 1995. The Board is also experimenting with a variety of pilot projects in contracting services to the private sector, including bill delivery and cash collection from area offices. However, the attempt to fund the multimillion dollar Krishna water project, designed to bring over 400mld to the city from a distance of 130km through a BOOT, failed when the international bidders demanded too much in the way of government guarantees. As the then managing director commented, ‘The proposed Krishna BOOT contractors wanted to be paid next day – or next week. How could we agree to that when some people in the city have not received a bill in years?’ (personal communication to authors, 2000). The international contractors knew that pumping water into a ‘leaking bucket’ could not ensure sufficient revenue to meet their costs and hence looked to government guarantees to minimise their risk. Hyderabad Metro wanted to know what they were obtaining from expensive foreign operators if the risk was not transferred. The Krishna project is urgently needed in Hyderabad where water supply currently averages only two hours every other day. Finance has now been obtained from a government lender, HUDCO, with state guarantees for public sector delivery.


The most developed proposal for a concession – in Tirupur, Tamil Nadu State – has been announced as ‘achieving closure’ on a number of occasions but has yet to deliver any new investment, let alone an improved water supply. The Tirupur Area Development Project is being developed as a comprehensive project, envisaging the provision of 185 mld water in addition to sewerage and drainage facilities, industrial effluent collection and treatment, and improvement and expansion of intra-city roads. The total cost of the project, with an ever-delayed completion date, is US$170 million, of which the water supply component is estimated to cost US$72 million. In the context of the Indian water sector, the project has a unique financing mechanism and institutional arrangement for implementation. The project will be financed by both debt and equity with a debt–equity ratio of 2.6:1. A Special Purpose Entity called the New Tirupur Area Development Corporation Limited (NTADCL) has been set up to implement the project and to raise funds from institutional investors and capital markets. The NTADCL will have equity participation from local institutions, state government, central government, a financial institution (Infrastructure Leasing and Financial Services), and the BOT Operator. It was initially planned to raise US$47 million through equity with US$122 million in debt raised through water bonds. These would be revenue bonds with variable redemption periods. ‘The project will thus set a precedent for involving the private sector to develop a source and convey water to the distribution system. This will reduce the financial burden of government entities and will enable them to improve the quantity of water supplied as well as increase the coverage’ (Raghupathi 1996). After persistent delays, by 2003 the largest and most detailed PPP in India was ready to start. However, the acquisition of state guarantees for the anticipated borrowing requirements makes the proposal much less unique than originally envisaged. Another example of public private partnership in India can be found in Chennai (formerly Madras), the major metropolitan city in Tamil Nadu. Chennai Metropolitan Water Supply and Sewerage Board (Chennai Metro) has particular problems because the city lies under a rain shadow with no major river systems supplying surface water. Unusually, it receives only loans and no grants from government. In 1993 there was no piped water for six months and at one time it appeared that the city might have to be evacuated when the existing rain-fed reservoirs dried up. Approximately 6,500 deep boreholes and water tanks for each street were provided as emergency measures. State government assisted in bringing water to the city by the rail.


Unusually in India, Chennai Metropolitan Water Board has long attempted to act in a commercial manner. Despite the recurrent droughts, it achieved an operating ratio of 0.46 in 2000–01 with a return on capital employed of over 5 per cent (Chennai Metro 2001). Part of the reason for these results was that it had begun to experiment in PPPs through contracting-out of various services. For example, a taxi firm supplied many of the staff cars. The water tanker service was contracted out after it was discovered that vehicle repairs were 3 per cent of total operations and maintenance costs and that vehicles were off the road for 50 per cent of the time. Chennai Metro disposed of 59 vehicles and changed to hiring vehicles, particularly tankers. It used to cost US$6 for 6m3 delivery by a utility truck but this was halved to US$3 for a 12m3 delivery by a private truck. Maintaining and operating pumping stations had traditionally been problematic for Chennai Metro. In particular, poor performance and absenteeism by station workers jeopardised the conduct of these duties and the trade unions reportedly rejected any attempts at imposing discipline. Policing and monitoring the work was difficult and expensive. In response, from 1992 Chennai Metro invited tenders from contractors to undertake operations and maintenance of sewage pumping stations. The great advantage to the contractors is the minimal capital outlay required to win and manage a contract. This allows them to gradually build up their skills and experience. They also receive cash up front, before they have to pay out. They trust Chennai Metro not to abuse the contract conditions, which although appearing onerous, are in fact standard for the government of India. The utility reports that 14 sewage pumping plants were contracted out for a year in 1993 at an average cost that was 20 per cent less than the estimate for Metro Water to carry out the work. Only in one case had a contractor failed to fulfil adequately the contract and in this case Metro Water resorted to the damages clause in the contract (Franceys 1995). It may well be that such small scale contracting-out can be used as the ‘Trojan horse’ of institutional development by forcing water sector managers to see the level of efficiency that can be achieved in a part of their business and hence generate the potential to replicate it in other parts. But until a consensus grows amongst primary stakeholders that the existing situation is unsustainable, attempts to deliver an model of institutional development ‘from outside’ will fail. As one perceptive critic has noted: In theory, the abysmally inefficient public enterprises could be transformed without a change of ownership, by giving the companies greater autonomy and by encouraging competition. In practice,


given India’s political and bureaucratic culture, this is little more than a pious hope, with long-drawn-out delay and a waste of resources being the likely outcome. Privatisation is therefore urgently needed. ( Joshi 1997) Whatever the need, there is little sign yet in India of the benefits of significant public private partnerships such as concessions being realised in the near future. 5.5.3

Sri Lanka

Following detailed consideration over many years about introducing PPPs in various aspects of water and sewerage in Colombo, the capital, the government is now in the process of making the initial step of establishing a regulatory commission. The reform process is driven by the recognition by government that it is only able to provide half of the US$2,250m investment required to achieve national water supply and sanitation goals up to 2010 (Gunasekera 2001). The government has stressed that ‘there will not be any privatization of assets in the proposed reforms, and that private sector participation would be in the form of short-term and long-term management contracts’ (Ameer 2000). As in Ghana, the government of Sri Lanka is attempting to minimise political opposition by down-playing the extent of any private sector involvement. This political risk management has led to the abandonment of any plans for a PPP in Colombo. Initial concessions are now planned for Greater Negomobo to the north of the capital which includes a tourist area and a freeport industrial area (potentially a more secure source of revenue) as well as along the south west coast, including the tourist area between Kalutara and Galle (Bureau of Infrastructure Investment 2001). Yet consultants involved in these concession proposals have expressed doubt as to whether concessions can be viable in such limited areas. 5.5.4

Zimbabwe

Although the private financing of new investment through bond issues is a long-established practice in the urban water sector of Zimbabwe, there has only been limited interest in public private partnerships. In part, this is due to its earlier success with the public sector model and more recently to the absence of any significant external pressure because of donor withdrawal from active involvement in the country. There has been discussion of private sector involvement in a bulk water transfer scheme designed to bring water to Bulawayo from the Zambezi, several hundred


kilometres away. Gweru City Council has investigated the range of options and had been planning to introduce a 30-year ‘partial concession’ agreement with SAUR UK. However, political and economic instability in the country has led to concern as to the viability of any concession. SAUR UK is reported as having stated that it would be difficult to obtain acceptance from a board sitting in Europe for any significant actions in Zimbabwe (Plummer and Nhemachena 2001).

5.6

Conclusions

It may well be asked why these governments are considering radical changes in the management of urban water supply when so many of the key stakeholders appear to be so reluctant. There appears to be an element of fashion, driven by international conferences and consultants selling their new skills. But there is also growing recognition in government that something needs to be done about the poor performance of their existing direct providers. This is perhaps coupled with a natural bureaucratic affinity for the idea of regulation of a private operator. Most significantly, there has been substantial pressure from the multi-lateral donors led by the World Bank. It has publicly declared its refusal to make any more loans to the water sector of several countries unless they implement public private partnerships. The Bank appears to believe that there is no alternative, having seen its investments in the public water suppliers produce such limited benefits over so many years. But for government the political risk remains. Is it is possible to move from a second rate public provider to a world class international operator in a private concession delivering dramatically improved service, albeit paying an economic price for water? And how can that change be achieved whilst avoiding the nightmare of ending up with a third-rate, rent-seeking contractor that is unable to deliver service improvements whilst still charging at a high price and causing untold damage to relations with voters, civil society in general, and trades unions in particular? Governments, including elected politicians and civil servants, face major decisions for which they feel unprepared, particularly when confronted with the ever increasing range of PPP models that consultants develop for them. One of the apparently credible reasons for not taking up the challenge of a concession is the assumption that the private sector will not bear the additional risk of addressing the needs of the poorer segments of the urban population. We now investigate the relationship between public private partnerships and the poor in the following chapter.

6 Addressing the Water Needs of the Urban Poor

6.1

Introduction

The historical justification for public sector involvement in the ‘private good’ supply of water has been to ensure public health benefits, particularly for the poorest. This was based on the assumption that the private sector would be uninterested in serving those who are less able to pay. However, the public water and sanitation sector in low and middle-income countries is failing to meet the needs of the urban poor. The figures for service coverage, the main indicator of reasonable access to this basic need, show an increase of 50 per cent over the past decade in those not served with urban water supply (WHO 2000). Very often, the public sector has failed to achieve the goal of public health provision for the poor and has ended up subsidising the convenience interests of the rich. This poor performance of the public sector has been made worse by the rapid growth in urban areas that would have stretched even the most efficient water utilities. Average urban growth rates of 3.7 per cent means that the urban populations in low and middle-income countries have been doubling in less than twenty years. India reached a peak of urban growth of 3.9 per cent per year (Census Board of India 1991), Africa 4.4 per cent between 1950 and 2000 with individual cities such as Lagos, Nigeria (5.6 per cent, 1975–2000) and Dhaka, Bangladesh (6.9 per cent, 1975–2000) achieving ‘doubling times’ of 12 years and 10 years respectively (POPIN 2001). The expansion of the necessary infrastructure in line with this population growth rate, particularly without any reasonable cash flow to finance investment, would severely test the capabilities of many planners and engineers, even in highincome countries. 103


These population growth rates may be contrasted with that of the ‘successfully privatised’ Greater London, at 0.7 per cent per annum from 1990–2000, a growth rate that implies a doubling of the population over 100 years. Even at the peak of its demographic growth during the nineteenth century, the population of London only doubled once every 50 years. If the population that emigrated from England during that time had moved to the cities instead then the resulting urban growth rate would have been more than 5 per cent per year, similar to the growth experienced in Africa since 1950 (UNPFA 1996). In addition to escaping the high levels of population growth characteristic of metropolitan cities in developing countries, London has long been a highincome city with good access to water resources. Without such advantages, the provision of water to the urban poor in low and middleincome countries is a particularly difficult challenge. It is not only in the large metropolitan areas of low and middleincome countries that population growth rates are a major challenge. It is estimated that secondary cities and towns of fewer than 500,000 people will continue to account for more than half of the urban population at least until 2015. These secondary cities will contain more than twice as many people in 2015 as they did in 1990 (1,640 million compared to 812 million) (ibid). This 3 per cent average annual population growth rate will be especially hard to cope with because these secondary cities have more limited access to human, financial and political resources to solve their water needs. Providers of water and sanitation also face the challenge of addressing the poverty that characterises these rapidly growing urban areas. Between one-quarter and one-third of all urban households in the world live in absolute poverty (UNCHS 2001). In some of the world’s poorest countries half of the urban population are living below official poverty levels (UNFPA 1996). Of the one billion urban dwellers in Asia excluding the People’s Republic of China, an average of one-quarter are believed to be poor, rising to over 30 per cent in India and nearly 50 per cent in Bangladesh (ADB 2000). As the process of rural to urban migration speeds up – a process that is occurring later in Asia than in the rest of the developing world – the absolute numbers of people living in urban poverty does not appear to be falling even though the percentage rates may decrease. Serving the poor is therefore a primary, not a secondary concern. It lies at the heart of the challenge of providing water and sanitation in urban areas. Definitions of poverty and the poor are both quantitative and qualitative. Quantitative measures define those living ‘below the poverty

Addressing the Water Needs of the Urban Poor 105

line’. They are often defined as individuals living on less than US$1 per day (usually adjusted for Purchasing Power Parity) or households earning less than US$100 per month. Quantitative measures also include households that have a dwelling space of less than 40m2 (or as low as 25m2 in one example) so as to incorporate those who have an earning capacity in the urban areas (and therefore a spending capacity to buy water for example) but who are unable to access formal housing. Qualitative definitions include ‘poor quality of life combining low income, poor health and education, deprivation in knowledge and communications, and the inability to exercise human and political rights’ (ADB 1999). Both the qualitative and the quantitative approach to poverty are necessary for addressing the water needs of the urban poor. The qualitative descriptions are necessary to understand what it means to be poor and to recognise the participatory and empowering style of intervention that is required to achieve public health and developmental goals. These approaches are critical in order to overcome issues of bad social relations and powerlessness, without which environmental health improvements will not be achieved, however many kilometres of pipe is constructed. The quantitative definitions are also necessary to enable regulatory bodies to determine appropriate tariffs and to monitor the performance of water utilities against measurable goals. Serving the poor is also difficult because, in general, they live in so-called informal housing areas – the slums, shanties and unplanned areas that typically accommodate 25–50 per cent of the urban population. This proportion can reach as high as 70 per cent in Tanzania (Msimbe 1999), Ghana (ISODEC 2001) and Uganda (Kayaga 2002a). Here residents are living ‘without basic facilities and services nor security of tenure and permanently confronted with insecurity and instability’ (IFUP 1999). The unplanned nature of such settlements makes it harder to supply water by conventional means. There are usually no clear access routes under which a utility can bury its conventional pipes in convenient straight runs. Roads and footpaths inside the settlements tend to be narrow, twisting and unpaved. Many houses have no identifier or address and householders often have no legal title to the land. This makes it difficult to record consumption and to deliver bills in the normal way. Governments have often tried to stem the tide of urban growth by refusing to allow official water providers to service ‘illegal areas’. In response residents of such areas find alternative means to access water services, usually with poorer quality access, through illegal connections or through ‘informal suppliers’ – tanker and cart carrier intermediaries – who


provide poorer quality access to water, at the same time driving up leakage rates through their own illegal tapping of mains water and reducing the revenue potential for the conventional water supplier. In the light of such factors – rapid growth, urban poverty and illegal dwellings – the limited service coverage figures, although unacceptable, are perhaps understandable. The combination of up to 50 per cent in poverty, up to 50 per cent living in unplanned areas and up to 5 per cent annual population growth together represent a massive challenge to conventional service providers. As a consequence of official policies to limit unplanned, unserved areas by refusing to ‘reward’ squatters with easy access to services, governments are failing to meet their public health objectives, as tragically shown by the continuing outbreaks of cholera in many such countries.

6.2

Serving the urban poor

It was argued in Chapter 1 that the role of government is to ensure adequate water (and sanitation) to all because water is a merit good with considerable positive externalities, namely a service that brings wider benefits to society as a whole. It is feared that in a pure market situation individuals would only purchase what they believe they need for convenience (rarely for health) and would not purchase enough to achieve health benefits and that they would then be tempted to dispose of the waste in a manner that fails to benefit society as a whole. Consequently, the merit good argument emphasises that it is the role of government to ensure the adequate provision of public health services to all, with a particular focus on the needs of the poor where the benefits to wider society of ensuring basic provision will be greatest. Traditionally, government providers have sought to fulfil their public health obligations for water in poor urban areas through the provision of public standposts, usually designed to serve between 200 and 500 people. To serve so many with water at a time that is convenient for collection relative to other household tasks requires suitably sized pipes with adequate delivery pressures. Constructing standposts on existing systems means that they are rarely supported by an adequate pipe distribution system and are also often located at the end of the pipeline in peripheral areas of the city. Hence they are at the back of the queue in both hydraulic and geographical terms as well as in terms of political influence. Low pressures at standposts during the peak collecting hours (early morning and early evening) are particularly disadvantageous to the


poor who cannot benefit from conventional household storage. Women, who usually have the responsibility to collect water, may end up queuing at three in the morning for their turn at the standpost when it begins to deliver small amounts of water (Sharma 2002). The problem of low pressure is often exacerbated by a common coping strategy used by rich consumers who install their own pumps to suck what water is available from the mains into their storage tanks, thus reducing pressure at the standposts still further. Where they are not allowed to supply illegal housing areas – a common restraint on government direct providers – engineers may try to meet their social and health obligations by providing standposts along major adjoining roads. This brings the water supply as close as possible without breaking government regulations. But as the size of such unplanned areas continues to grow many households are established at a significant distance from the roads and therefore from the standposts, limiting the effectiveness of the utility supply. As a result a significant proportion of the 25 to 50 per cent who live in informal areas might not be receiving any formal water service at all. Public utilities generally offer standpost water supplies as a free service. However, the combination of a free service with poor quality (in terms of hours of supply as well as water quality) destroys any sense of ownership or responsibility by the users for ‘their’ standpost. This often leads to vandalism and a tap that, if it has not been stolen, is left permanently open. In turn, this results in higher unaccounted for water and even less concern by the provider to maintain the service. In Sri Lanka the water utility has tried to improve this approach in some areas through metering standposts with the bill shared among the members of the local community. This approach can work where the community is sufficiently motivated to maintain some oversight over who is using the tap. In Ghana, slum improvement projects have similarly tried to promote revenue collection and improve quality. A community member, usually a woman, has a key to the padlock that locks a can over the tap. At agreed times of day the tap is opened for use by the designated members. In Uganda the National Water and Sewerage Corporation also provides standposts that are metered to ensure some cost recovery. However, there is a specified minimum monthly usage of 75m3 per standpost. In addition there are high connection fees and six months deposit of minimum monthly fees required in advance. This may represent sensible commercial practice but it also constitutes an unnecessary barrier to extending clean and affordable water to all (Kayaga 2002a).


An alternative to standpost provision, particularly where there are water shortages, is the provision of water tanks on the street that are filled by government-managed tankers. But these have two drawbacks. First, by the time that it eventually reaches the household the quality of the water is often less than desirable because it has passed through so many transfer stages. Second, such services for the poor are often erratic because tankers can easily be diverted to more lucrative residential areas where customers have more influence to complain when their service fails. Nevertheless, this approach is common in India and does achieve a basic level of supply. An interesting variation of the ‘public–private’ debate in this context is whether it is the role of government to own tankers and employ tanker drivers or whether this is an activity that could be contracted out to the private sector. Chennai in India has dramatically reduced costs and improved quality by contracting-out this service to private operators. But it would be better not to need the tankers in the first place, recognising tankering only as a temporary solution. Authorities in Hyderabad, India, promoted street tanks with tanker supply in slums but found that it reduces the effectiveness of earlier attempts to support the poor through the provision of standpost supplies. As the tanks are normally situated close to the standposts that deliver water for two hours every alternate day, the piped water is then used for drinking water whilst the much more expensive tanker water is used primarily for washing. This system of dual supply – with the more expensive water being used for convenience – is not an economic way of realising public health goals (Personal communication from Chary, 2001). These examples show that some government direct providers are attempting to meet the needs of the poor but often only by marginally upgrading a failed approach that does not deliver what the urban poor want and are willing to pay for – a convenient and affordable piped supply.

6.3

Private water vendors and the urban poor

Whatever the weaknesses of government, the poor still have to obtain water from somewhere, every day. The failure of the formal, government agency providers has been resolved in several ways – by neighbours on-selling water from their household taps, by vendors carrying water from distant standposts or illegal connections, and by tanker drivers sourcing from private boreholes or by illegally tapping the water mains.


In these ways, the private sector has long been involved in meeting the water needs of the urban poor – although it has often been ignored because of its informal nature. Private water vendors play a critical role in supplying 20 per cent or more of the urban population of developing countries (World Bank 1998), with some studies quoting cases of up to 80 per cent, thus demonstrating the extent of informal private sector involvement (Collignon and Vezina 2000). Because PWVs do not have access to economies of scale, let alone government subsidies (except perhaps where they steal the water), the price that the poor are paying is always significantly higher than that of formal government providers, even where the price charged by the latter has been increased to an economically viable level. In addition, vendors often provide poorer quality water. Furthermore, such water requires household storage facilities – another source of contamination – and this carries an additional cost where space is at a premium in very high-density informal housing areas. However, there is a range of quality and price among different PWVs in the same way as there is among government providers. A study on the role of small-scale entrepreneurs in Latin America found that competition amongst PWVs in Guatemala and Paraguay held prices down to ‘a maximum of 2.5 times and 1.4 times the official utility price, far from the exorbitant rates commonly attributed to PWVs’ (Solo 1998). Using pipe distribution networks from private boreholes, vendors in Guatemala had investment costs between 20 per cent and 60 per cent lower than for the government direct provider, with operating costs an average of 75 per cent lower, administrative costs 94 per cent lower, and with a lower level of profitability (ibid). However other studies, quoted in Chapter 1, find that in many parts of the world PWVs are charging ten to twenty times more than public service providers. In an attempt to limit these costs and prevent exploitation some governments prohibit the re-selling of water. But in the absence of any alternative source of supply, the resulting illegality may drive the price even higher. A ban on re-selling also prevents the establishment of vendors at each standpost to collect some revenue and to limit damage, waste and vandalism. The Uganda government recently removed its previous ban on re-selling so that the National Water and Sewerage Corporation can now encourage the construction of private ‘water kiosks’. These are small shops built over the standpost to serve the poor that not only generate necessary revenue but also employment. The key advantage of the service provided by PWVs is the facility for customers to pay small amounts of money for small amounts of water


at times that are convenient to them. The poor cannot afford the high connection fees and monthly or quarterly bills charged by government providers, particularly when those utilities demand payment at a centralised office, requiring an expensive journey from home. The connection fee has long been a barrier to new connections to the pipe network. The fee, usually in addition to the actual connection costs of pipes, ferrules and taps, has operated as a way of reducing demand on a system characterised by gross under-investment that consequently cannot meet normal demand. The connection fee is usually justified in economic terms as a contribution by the newly connected consumer to the, admittedly high, fixed capital costs of the distribution system. But if the capital costs of the water treatment process, for example, are (or should be) paid for through the depreciation element included in the regular tariff, then the costs of the distribution system should similarly be included. There may be a role for a deposit to guarantee future payments when connecting a new customer but it is the responsibility of a customer-oriented service provider to make that connection affordable, and not to use it as a barrier to connection. Connection fees may not always appear to be very significant. But when the private sector can provide and install household handpumps for water supply in urban areas at a price lower than the official charge for connection to the pipe network (for example, Vijayawada, India), the issue of connection fees needs to be addressed. This alternative source becomes even more attractive to householders because of the absence of any consumption charges arising from handpump use. However there are increased health risks from accessing potentially polluted shallow groundwater – this is one of the reasons for providing piped supplies of treated water in the first place. It is the task of the direct provider to facilitate connections to the mains supply to ensure public health. Overall, PWVs are currently fulfilling a vital need. They are also generating local employment, itself a critical factor for development. The ideal for government is to identify and recognise best practice in existing private water provision and to incorporate this into new forms of public private partnership. However the problem is that in the absence of the economies of scale that are available to piped suppliers and in the absence of any oversight mechanism, those informal providers who have responded to the challenge of serving the poor are usually charging a high price for a relatively poor service in terms of water quality. And in some cases vendors may well be controlled by criminals in the slums who take advantage of the desperate need of the poor for daily water supply.


The enormous tariff divide between vendors and public providers gives a clue as to one possible solution. If the subsidies for consumption that currently go to the rich could be redirected into extending connections to the poor, perhaps through focused subsidies on new connections, with a rebalanced cost-reflective tariff structure that allows for recovery of capital costs, then the sector would generate the necessary funds to cope with population growth. Furthermore, the poor would see their water bills fall dramatically. Setting appropriate tariffs for water is as important to the poor as developing new institutional forms of public private partnership.

6.4

Non-government organisations and the urban poor

In addition to the small-scale PWVs, poverty oriented non-governmental organisations (NGOs) have begun to look for ways to solve the water needs of the urban poor. In the first instance, NGOs can use the techniques that have proved effective through their experience in rural areas. For example, in some cities the topography means that groundwater is available through springs and hand-dug wells that can be protected with sanitary aprons to ensure proper drainage of spilled water and therefore clean collection of drinking water. In Kampala, Uganda, a project to support basic health care initiatives in Kawempe, a suburb with a population of 390,000 that was not being served by the government direct provider, responded to the requests of the community to assist in protecting springs. Local Water Source Management Committees achieved this with community contributions of labour and finance, thereby ensuring a clean water supply without the need for connection fees or consumption charges (Kayaga 2002a). However, there are dangers in promoting the use of groundwater in many cities where on-plot and on-site sanitation is necessarily the appropriate solution to disposal of wastewater. Recognising that it is usually cheaper to pipe in clean water than to pipe out wastewater, NGOs have turned towards devising innovative ways to access the pipe network. In most of these pilot projects, they have played the role of intermediary between the government utility and the urban poor. The Kawempe project in Kampala also found that householders recognised the problem of potential contamination and constructed standposts in areas chosen by the committees on land donated by residents. The water committees supervised construction and took responsibility for collecting the daily proceeds from water sales. Furthermore, ‘bookkeeping of the water sales transactions is emphasized and is a prerequisite for


continued support by the project. NGO staff inspect the cashbooks on a periodic basis. With the assistance of the local council, households who are considered poorest in the community are provided with 40 litres of water daily free of charge from the public standposts in the project area’ (ibid). In Dhaka, Bangladesh, an NGO (Dusthya Shasthya Kendra–DSK), in partnership with the government utility and the municipality, has been enabling communities to form water committees to take responsibility for a shared connection. The eight members of these committees are all women with a five-member male advisory board to limit social intimidation of the women. The NGO finances the initial construction of a water point that comprises a ground tank with a handpump fitted for abstraction. The handpump also acts as a natural limiter to the amount taken. The depth of the tank ensures that it fills whenever water flows, even at characteristically low pressures. Water is paid for according to consumption or, if the community so chooses, per household. The water committee delivers payment, with NGO assistance, to a bank account jointly held with the NGO. From this account the metered water bill is paid to the utility that is prepared to accept the NGO as the guarantor. After a year or two, when confidence in the system has been established, the NGO passes all responsibility for the account to the water committee whilst maintaining a limited monitoring role. Payments made to the committee also include payment to the NGO for its investment in the water point – revenue that it then recycles to invest in new water points. The utility is pleased to have paying customers rather than a free standpost. The municipality is pleased to supply the land for the tank at the edge of one of their roads in order to ensure that water is available to at least some poor residents. This approach emphasises again the two key aspects of services for the poor – facilitating connections and allowing small, frequent payments (Enayetullah 2002). A similar approach can also be seen in the case of sanitation in India. Although sanitation is not the focus of this study, it is worth noting the case of Sulabh, an NGO provider of sanitary services. Ensuring that the poor are served with convenient and safe sanitation is perhaps an even greater problem than serving with water, resulting in much lower figures for sanitation coverage. Sulabh, in partnership with municipalities who often pay capital costs as well as power and water tariffs, provides sanitary blocks with an average of ten seats per block. A full-time caretaker ensures cleanliness and users also have access to soap and in some units to showers and storage lockers. For this service users pay a small


fee – though children and the destitute are admitted free of charge. Use of urinals is also free. In one survey customers were content to pay the Rs 1 (US$0.02) user charge and valued the facilities, particularly the accessibility, cleanliness, water and soap which went with the toilet use (Chary 2002). Using this approach, Sulabh, a not-for-profit NGO, but in practice operating in a very similar way to a private company, has been able to establish 4,000 such sanitation units, serving upwards of 600 people each day. Any surplus is reinvested in a variety of social welfare programmes. The examples in this section show that the poor are indeed able and willing to pay for water services that are made available at the right time in the right way, usually with convenience and ease of use in mind, rather than public health. They also show that some NGOs have demonstrated the creativity and flexibility necessary to find these new ways to serve the poor.

6.5

Government providers and the urban poor

The challenge to policy-makers in the urban water sector is to meet the expressed needs of the poor for the convenience of household connections in the most efficient manner, by harnessing wherever possible the ideas, the expertise and the development potential of the small scale independent providers and NGOs. But this challenge appears to be easily ignored by government direct providers, even though, according to the merit good argument, it is the reason for their being established in the first place. One study of incentives for utilities to serve the urban poor found that there were almost no such incentives, but rather that there were significant disincentives (Franceys 2002a). Government utilities, under the influence of what was described in Chapter 1 as the New Public Management (NPM) are now under great pressure to commercialise – to cover their costs and to declare a surplus at the end of the financial year. In order to achieve this, they are striving to reduce costs and to limit their number of staff. They are obliged to follow an approach that demands higher connection fees, in order to cover their long-run marginal costs. However there is the danger that the priority granted to commercialisation may smother the concern to ensure universal service coverage if there is inadequate understanding of how these two goals might be combined. For example, the National Water and Sewerage Corporation in Uganda, which has responsibility to serve urban areas, has no stated policy for serving residents living in informal settlements


despite the fact that the majority of potential customers of the utility live in such areas (Kayaga 2002a). Commercialisation should therefore be a major driver for serving the poor who represent such a significant segment of the market for water. It is not good management practice to ignore the high proportion of the population who do not have connections by assuming that standpost provision is effective. Public direct providers attempt to meet the social welfare needs of those who have connections through the use of increasing block tariffs (IBTs). Although the economics of water provision show that, for a given capacity, cost per unit of water supplied declines as water use at any connection rises, increasing block tariffs invert this relationship for prices. The price charged per unit of water supplied therefore increases in a series of blocks. An increase in the levels of consumption means that total household demand per month moves into a higher tariff range, attracting a higher price for that consumption above the upper limit of the previous range. The argument is that IBTs allow for a ‘lifeline block’, below the cost of supply, to ensure that basic water needs for life and health are affordable. The subsidy inherent in the lifeline block is paid for by the higher tariff rates imposed on larger users. These are designed not to be a form of taxation but rather requiring payment of long run marginal cost (LRMC). The lifeline block is set at a price based on the presumed ability to pay. This technique assumes that the poor already have a connection through which they can receive the lifeline block. It presumes that meters are working and are read periodically and accurately. It also presumes that richer consumers are not able to benefit from the subsidy themselves through an excessively large volumetric allowance in the lowest, lifeline, tariff band. For example, the 20m3 per month lifeline block that is used in some countries quoted in Chapter 1 can easily meet all the water needs of an average-sized middle-income household. But a 20m3 per month lifeline block does not allow for the situation where poorer households, often in tenement or multi-occupancy housing, receive water through a single connection. Perversely, here the poor end up paying more per unit of water than the higher-income groups. In some countries, attempts to meter standposts have fallen into the same trap. Suggestions that multi-occupancy households could be registered in such a way that the lifeline allowance is increased to match the number of households have generally been regarded as too complex to introduce. The argument is that there are already too many problems of meter readers accepting payments to record false readings to allow them the discretion to count the number of households as well.


The South African government has recognised the need to limit the size of the lifeline block by reducing it to 6m3 per month – approximately 30 litres per person per day for an average household size, and sufficient for drinking, cooking and bathing. However the government has also reduced the price of water in the lifeline block to zero – which removes the concept of being a paying customer from the transaction. It is harder to demand customer rights and, for example, complain about inadequate service when no payment is made for the service. It is also hard for a water utility to cross-subsidise a zero lifeline tariff when such a high proportion of the service area is utilising that block alone. When up to half the population in a typical city in a low-income country does not have their own household water connection, consideration of the complexities of IBTs may be missing the point. Through their existing high payments to PWVs, the poor have demonstrated their willingness to pay consumption charges. The priority has to be to deliver those connections to all by focusing any subsidies on the cost of connection. Reducing the cost of connections and altering the fees associated with new connections is critical. Water distribution systems for the poor do not have to follow the high cost, high technical standard approach to individual connections. For example, the city of Durban, South Africa, has pioneered the use of non-conventional piped supplies to the poor. Recognising that the poor desire the convenience and quality of a household connection, Durban Metro Water, the government provider, sought to deliver this service at a reduced price. First they minimised investment costs by providing a ground level water tank outside the dwelling with a small diameter pipe connection, linked to a relatively small-size distribution system. Smaller pipe sizes reduce the investment costs but also mean that peak demand cannot be delivered at a reasonable pressure. The ground tank solves this problem by storing water so that supplies can trickle through over a longer period at reduced pressure, whilst ensuring immediate availability at a time convenient to the householder. The requirement that the householder carries out the final pipe connection from the mains take-off point, negotiating their own best route through the unplanned area, also reduces costs. Delivering water through a pipe to the household tank has the additional public health benefit of minimising the contamination that otherwise can occur through mobile tankering or carrying of water. Costs in the Durban system are also reduced by removing the need for water meters. A lockable valve box is installed at the point where the main supply pipe enters and to which the household tank connections


are made. At first this valve box was managed by the utility ‘water bailiff’ who collected the standard US$1.7 per month in advance from householders (Kayaga 2002b). If the household had paid their monthly tariff in advance then each morning their valve was opened to allow the 200-litre tank to be filled. This approach removed the need for meterreading, billing systems, addresses to deliver bills to, debt collection systems and debt write-offs. However, it did put pressure on the water bailiff, a member of the local community, to leave valves open for longer than specified and to allow water supply even where payments had not been made. Since the introduction of the free lifeline block of 6m3 per family per month payment is no longer required, electronic systems are now used to control the daily valve opening (McLeod 2001). The Durban approach demonstrates that it is possible for government suppliers to find a way to meet the needs of the poor in nonconventional ways. A study on pricing and service differentiation to serve the urban poor explored this approach further (Sansom and Franceys 2002). It demonstrated that the poor are quite capable of choosing their preferred style of provision at a price that suits their needs. It also showed that the provider could make a realistic return on this service when accepting that serving the poor is a market like any other. The Mayor of Guntur, India, used such ideas to reduce connection fees and to enable households to have their own connections. Within one day he was able to sign up 700 households wanting individual connections in a slum that were apparently already well supplied with standposts. Ramagundam, India, offers a 50 per cent connection subsidy to the poorest household in every group of ten poor households in a slum. This approach is based on the view that the marketing potential of the poorest household having a connection would ‘encourage the wives in the other nine households in the group to demand that they too should have their own connection’ (personal communication from Somarapu Satyanarayana, Chairperson of the Ramagundam Municipal Council, 2002). An alternative approach to meeting the needs of the lowest-income groups is found in Chile where the poor receive financial support towards the cost of their water bill directly from local government. The water utility (initially government direct providers, now privately owned) helps to administer this programme but is not responsible for any cross-subsidisation. Hence it can concentrate on its core task of providing good quality water at low cost with a simple tariff structure that customers can understand. But the success of the Chilean programme depends upon two factors that are not always present in many low and


middle-income countries. These are properly functioning municipalities with up-to-date registers of all poor households and sufficient funds with which to subsidise low-income consumers. These examples show that it is possible for government direct providers to meet the water needs of the urban poor. But the pressure on governments to do so is often sadly lacking. In fact it is the newly involved private sector, in the form of public private partnerships, which now comes under most pressure to address the needs of the poor. This is ironic because in most countries it was the presumption that the private sector would not serve the poor that justified government involvement in direct water provision in the first place.

6.6

Public private partnerships and the urban poor

The new public private partnerships in the water sector of metropolitan cities face a major challenge to ensure that, as well as delivering the required investments and overall improvements in service delivery, they also meet the specific needs of the poor. There is evidence from around the world that this is happening. This comes from the studies described below and from various reports from the World Bank’s Water and Sanitation Programme and Business Partners in Development programme, as well as other research programmes such as the Asian Development Bank’s ‘Beyond Boundaries’ study (Weitz and Franceys 2002). The assumption that private companies will not address the water needs of the poor has proved incorrect for several reasons. First, governments have developed mechanisms through contract design and regulation to require private operators to serve the poor. Second, private operators have realised that in order to operate successfully in the highly politicised environment of large cities in low and middle-income countries, they must address the water needs of the poor. Third, private operators have found that water sales to the poor can become a significant market share. Constituting as much as 50 per cent of the total potential market, the poor cannot be ignored, politically or financially. For these reasons, the challenge for the private operator in low-income countries to address the water needs of the low-income groups is an integral part of its overall objective to generate an adequate profit from producing good quality water. International private operators have adopted a range of approaches in order to meet this challenge. A common key characteristic of these approaches has been to address the needs of the poor in a flexible and


creative manner – being prepared to ignore the conventional rules for water connections. In effect, the large private operators have had to learn to emulate the small-scale independent providers by becoming aware of the needs of their customers at the local level and to emulate the NGOs through techniques of participatory development. The end result, as described in the following examples from Buenos Aires, La Paz and Manila, has been to focus on ways to minimise connection costs and connection fees and then to facilitate small but regular payments by the poor – but all within the context of a reformed supplier of potable water benefiting from the economies of scale of a pipe network. 6.6.1

Buenos Aires, Argentina

The general features of the Buenos Aires concession were described in Chapter 5. However, as well as delivering an improved quality of water at a reasonable price, the private operator, Aguas Argentinas, has also been involved in serving the low-income population. Although the relatively rich capital of a middle-income country, in the mid-1990s 10 per cent of households in Buenos Aires were below the poverty line (35 per cent by an alternative measure). Some of the poor live in squatter settlements in the midst of richer communities. Some live in what were initially unplanned areas that were subsequently recognised by the municipal authorities although without significant infrastructure services ever having been supplied. The concession contract specified challenging connection targets that the private operator had to achieve. As Aguas Argentinas strove to meet these targets, extending the water distribution system beyond the centre of the city that was already almost fully served, it found that consumers were not prepared to pay the high connection fees. These fees, which households were legally obliged to pay when the mains pipes reached their area, were typically around US$500 for a water connection and US$1,000 for sewerage connection. The fees varied according to property land surface, type of soil and percentages of road and pavement work, with formulas too complex for most households to understand. At this price, connections were unaffordable for lower middle-income households, let alone the poor, even when the private operator provided loans for connection fees, repayable over two years. Given the high investment of US$1,200 million anticipated in the first five years of the concession, the operator needed a steady cash flow from new connection fees as well as the subsequent increase in revenue from new water sales in order to pay for service extensions. When the concession began in 1993, poor consumers were served by truckers who


were re-selling water at 15–50 times its bulk price. Although there were local reports of annual family expenditure on water and sanitation in peri-urban areas at less than US$150, the reports of the vendors’ high rates prevailed – right up until the low-income families refused to hook up to the network (Solo 1998). Planners had misinterpreted the information. Potential consumers were reluctant to pay the substantial oneoff connection fees so long as they could obtain tankered water, albeit at a higher price per cubic metre. Aguas Argentinas reportedly halted service expansion whilst it looked for a new approach and renegotiated the contract. The company began a concerted effort to meet the needs of the poor at the same time as finding new ways to enable lower middle-income groups to connect to the network. Coincidentally, as early as 1996 it had begun to work with NGOs to serve poor communities. The demanding contract targets agreed in 1993 would have meant that services for the poor would have been achieved only in the final years of the 30-year concession – a very long time for the poor to wait. Instead, Aguas Argentinas ignored its own technical standards and developed new ways to ensure early connections for the poor through a variety of experimental pilot projects. Both the government and the regulatory body recognised the potential of this process and agreed to finance it through a small additional charge for all water consumers – the Universal Service and Improvement Charge (SUMA). This was fixed at US$2 for each service (water and sewerage) every two months and enabled a reduction in connection charges for lower middle-income and poor households to only US$120 (significantly lower than the previous US$1,500), to be repaid bimonthly at US$4 per service over five years. With this agreement in place, Aguas Argentinas moved ahead with its ‘Low Income Areas Department’ action plan. It hired an NGO to undertake a socioeconomic census – or ‘social mapping’ – to learn where the various income groups were located. The NGO was also paid to provide social awareness training for the staff of the private operator. In order to address the scale of the task, Aguas Argentinas recognised that it was necessary to differentiate its approach to the various levels of income and housing conditions within the low-income groups. This initially involved acting as a partner to some NGOs in small programmes that involved innovations such as voluntary labour to dig trenches, cost-saving by omitting water meters, and accepting pipes donated by an NGO and a municipality. Subsequently, a range of approaches was used. This is the type of experimentation that public direct providers find especially difficult when there are few rewards for


individuals who dare to innovate but many personal risks involved wherever there is the potential for accusations of failure. For example, the ‘Participative Water Service’ projects were based on direct links between the residents of the area (via an association or ‘leader’) and Aguas Argentinas. This mode of operation, in which the community provided voluntary labour for construction, was only conceivable in those areas where community work was accepted. It proved problematic in larger areas with more than 3,000 residents (Lyonnaise des Eaux 1999). The Employment Generating Unit (UGE) was applied to large-scale projects where the use of voluntary labour was impossible. Here a contractor, financed by the provincial government, carried out the network extension under the supervision of the private operator. The Provincial Bank paid for materials and labour through a soft loan, with the residents reimbursing the connection charges to the Province over five years. Another approach is the Tax Credit Agreement, which is based on a direct agreement between Aguas Argentinas and local municipalities. The company normally has to pay a fee to the municipality each time that it digs a hole in a public road. This agreement provides Aguas Argentinas with a tax credit equivalent to that amount, which may be used to carry out work in disadvantaged sectors. This system actually means that the connection costs are subsidised by the municipality in question. Aguas Argentinas has to advance the cash, but deducts the cost of the work from its tax credit (Lyonnaise des Eaux 1999). These examples demonstrate the range of approaches used. Those involved commented that all were necessary: They are all important, we have to have participation of the population; a water project should carry much more than water, involving those who were historically excluded; participation has a great impact on collection efficiency in ‘bad/conflictual’ neighbourhoods; even though it costs, a level of participation is always needed; but it can be graded according to the type of neighbourhood. (Personal communication from Patrick Dupoux, Head of Low-income Areas Department, Aguas Argentinas 1999) From 1996–2000, what was described as the ‘Low-income Areas’ programme (subsequently the Community Development Department) delivered services to an additional 260,000 low-income inhabitants (Dahan 2001). Overall figures indicate that ‘water services have been extended to 1.2 million poor people and sewerage services to 0.3 million


poor people. The majority of these connections have been funded by the expansion programme of the private operator’ (Zérah 2001). It is most unlikely that this could have been achieved by a government utility on the same time scale. Nor would it have been achieved if the private operator or government utility had strictly followed the contract. The freedom granted to the private operator enabled it to innovate. This is a critical benefit of public private partnerships. 6.6.2

La Paz and El Alto, Bolivia

Creative approaches towards addressing the water needs of the poor have also been undertaken in the 30-year concession for La Paz and El Alto in Bolivia. Unusually, the bidding for this concession was not on the basis of reductions in tariffs or size of investment but on the number of connections to be achieved within the first five years. The winning operator, Aguas del Illimani (Ondeo), won the contract in 1997 by promising to provide 100 per cent water connections by 2001 (up from 90 per cent in La Paz, and 80 per cent in El Alto) together with significant increases in sewerage connections. Aguas del Illimani targeted service expansion in low-income areas through a programme called the Peri-urban Initiative for Water and Sanitation (IPAS). The project tested innovative approaches for sustained provision of water and sanitation through the use of appropriate technologies, social marketing and micro-credit for the construction of wetcores (that is, household water and toilet facilities) (Vargas 2002). Foreign donors such as the World Bank’s Water and Sanitation Programme (WSP) and the Swedish International Development Cooperation Agency (SIDA) supported the programme. The private operator sought commitment from local communities before beginning to work. It responded to the expressed needs of households by using the so-called ‘condominial’ approach. This allowed for a relaxation of technical standards through the use of smaller diameter pipes and shallower and shorter pipe runs through back yards. These innovations led to financial savings of 40 per cent for the water service. Community involvement led to an additional 10 per cent saving in the water service but required an additional US$8 per connection for social intermediation (the participatory community development aspects of providing sustainable water supply to the poor) by the water company for both services (Foster 2001). The La Paz–El Alto experience shows how an approach that enables the community itself to realise the need for improved services and to act as an agent – rather than an object – of its own development can be


effective in poverty alleviation (Vargas 2002). However, the private operator did not undertake these developments in isolation. The government, as indirect provider, assumed the responsibility of establishing the contract with clear service coverage goals. Its regulatory body, Superintendencia de Saneamiento Básico, has approved the adaptation of technical standards and is now monitoring progress. 6.6.3

Metro Manila, the Philippines

Innovative approaches to addressing the water needs of the poor are also a feature of the largest water privatisation to date – the Metro Manila (11 million population) concession contract signed in 1997, which envisages US$7,000m investment over the 25-year term of the contract. Two private operators won contracts – Manila Water in the East Zone concession area (Ayala/International Water/United Utilities) with a price reduction of 74 per cent, and Maynilad in the West Zone (Benpres/Ondeo) with a 43 per cent price reduction (MacLeod, Clamp and Dejonckhere 1997). Hitherto, criminal gangs and profiteers operated a distribution system in the squatter areas that took advantage of the lack of access of households to the formal network. These gangs provided lower quality water that was several times more expensive than that of the state utility. It was supplied from water tankers, vendors sourcing legally or illegally from the water mains, or from private wells. The poorest households spent up to 12 per cent of their income on buying water from vendors (David and Inocencio 1996). The concession contract specified a more rapid attainment of universal coverage than the Buenos Aires concession. Furthermore private operators had to demonstrate a work schedule that would ensure that service improvements were not unfairly delayed, especially in poor areas. They were required to move from the 67 per cent water coverage in 1997 to 100 per cent coverage within ten years, provision of 24-hour water supply to all connections by mid-2000 and a guaranteed pressure for all connections by 2007. Under the terms of the contract the private operators were able to claim ‘service coverage’ to the poor by providing one standpost per 475 people, a very low level of service. They could charge for the water delivered from standposts, whether these were operated by individuals, officials or community associations. However, problems arose of nonpayment by the assigned association or local government officials as well as abuses in the management of standpoints, such as charging exorbitant prices and irregular operating hours that limited access (Inocencio 2002).


In response, one of the operators, Maynilad, experimented with the individual household connections that most customers prefer. This programme waives the land title requirement previously required by the government water provider and enables payment for connection fees by instalments over 12–24 months. These instalments are added to the regular monthly water bills so that payment begins only upon receipt of the first bill and not before installation. As part of the agreement between the private operator and the community to reduce the connection fee, communities provide voluntary labour for carrying pipes and digging trenches. Each connection is metered separately in order to ensure fair cost recovery but the operator provides a group of conveniently located meters on the water main. This reduces both investment costs (for example, only one tapping on the main and not having to provide spurs into narrow alleyways) and operation costs (for example, easier meter reading and reduced leakage). Each household then makes its own connection, generally using plastic pipes above the ground to further minimise costs. These innovations have led to an 80–90 per cent reduction in water costs for a family using 10m3 of water per month, compared with previous water purchased from PWVs, then at lower volumes because of the cost. Household members, who had been used to walking some distance or queuing for hours, appreciate the benefits and convenience of a direct connection by which they only have to open their taps when they need water. Also households no longer need to invest in containers to store water that had become a source of contamination as well as a waste of valuable space Manila Water, the private operator responsible for supplying the other half of the city, has also experimented with serving the poor. It uses group taps for between two and five households, whereby users form groups, register connections and share the cost of usage. Community managed water connections as well as some privately managed water distribution connections have also been used, whereby a community or private company takes on the role of water retailer. However, these distributors do not always benefit from a bulk water tariff and so may be caught by the effects of increasing block tariffs on a single meter with multiple users. Although the householders using this system may pay 80 per cent less than previously, this is still more than twice the average payment of a household with a similar consumption but with an individual connection (Inocencio 2002). There is also a considerable administrative burden on a few members of the community who must collect the payments and pass them on to the operator.


As a result of these initiatives, major changes have been observed in the physical appearance of those areas where individual household connections have been made. Houses that used to be made of temporary materials are now made of more permanent materials such as hollow blocks and cement. Before the connection, containers or drums were a common sight outside the houses because residents had to store water. Now they are hardly ever seen as storing water is no longer needed. Other indirect benefits of the introduction of individual connections come from the time that is freed up from collecting water. These give mothers more time to care for their children. Some low-income residents, describing their experience in an independent focus group, report that they now have more time for leisure, even that they can now go ‘malling’ – visiting the shopping malls – while others have found productive ways of spending their time through income earning activities. Residents in poor communities have also benefited from employment because the private operators require their contractors to hire local workers for construction work (Inocencio 2002). The Metro Manila partnership between the public and private sector has resulted in significant improvements in service delivery. Maynilad increased household connections by 23 per cent in the first three years and Manila Water by 14 per cent. The private operators considerably improved the quality of service although the target of 24-hour supply for all connections by mid-2000 was not achieved. The operators complain of delays in the bulk water supply projects, which are still the responsibility of a government agency. Although never perfect, partnerships are delivering benefits for the poor. With continuing investment of effort and resources by all partners, water for all is achievable.

6.7

Conclusions

It is clear from this review of the innovations introduced by some private operators that no sophisticated technology is involved, and that there is nothing that a government utility could not achieve. Indeed the example of Durban, South Africa, shows that at least one government utility is finding ways to serve the poor. But that example seems to be the exception at a time when it is fast becoming normal practice for private operators to address the water needs of the poor. It appears to be the combination of ‘competition for the market’ plus good contract design and effective regulation that is delivering these social benefits. One private operator, Ondeo, believes that its success in winning a new


management contract in Johannesburg, South Africa was partly the result of its demonstrable expertise from previous contracts in serving the poor. A high degree of creativity and adaptability is needed to address the water needs of the poor who have to exist in the world of ‘insecurity and vulnerability, bad social relations, low self-confidence and powerlessness’ (World Bank 1999) as well as minimal incomes whilst living in illegal squatter areas. A clear advantage that private operators have in this respect is their motivation and willingness to be innovative and flexible in searching for ways to address the special delivery problems that arise in this context. When such a way can be found to serve the poor the results can be dramatic. A study in Argentina reported that: Using the variation in ownership of water provision across time and space generated by the privatization process, it was found that child mortality fell 5 to 7 percent in areas that privatized their water services overall; and that the effect was largest in the poorest areas. It is estimated that child mortality fell by 24 percent in the poorest municipalities. (Galiani et al. 2002) In their attempt to ensure the delivery of adequate services, publicly owned utilities have had to become ever more prescriptive in the standards that they expect, partly in an attempt to limit the temptations for officials to extract personal gain. As a result, middle managers know that they have to follow the rules and that obedience and submission to technical standards is valued more highly than creativity and flexibility, particularly with regard to serving illegal squatter areas. Using the bureaucratic skills of contract preparation and regulation may therefore be a more appropriate task for government than trying to run a customer services business. Government still has a clear duty to establish a regulatory system with a prime responsibility to ensure adequate service provision to the poor. It needs to hire transaction advisors who are mandated to ensure early service coverage extension to the poor in any public private partnership contract. Furthermore it must consider the use of multilateral and bilateral funds not only to finance large capital investments by the private operator but also to fund ‘output-based aid’ through which, for example, the private operator is paid according to the number of functioning individual connections provided in designated poor areas. The new understanding is that it is more effective to subsidise connections than it is to subsidise consumption.


It is also clear that the poor can only be served effectively through a participatory approach. Private operators are already recognising this but governments also need to accept the principle. In this way the benefits of a participatory approach can be harvested not only in the metropolitan cities served by foreign private operators but also in the secondary towns, perhaps by national private operators. Half the urban population of low and middle-income countries reside in these smaller towns and 95 per cent are served (formally at least) only by government providers. Serving the poor is the overwhelming imperative in the urban water sector. The cases described in this chapter show that the task is achievable by public or private providers. Both need incentives to deliver these benefits and both need the pressure and the protection of a competent regulator. This is the subject of the following chapter.

7 Regulating and Enabling the Direct Providers

7.1

Introduction

Government has the responsibility to ensure that citizens, particularly the poor, can access potable water in order to ensure that the merit good benefits of this vital service are available to all. This is known as the Universal Service Obligation (USO) or Community Service Obligation, whereby monopoly suppliers have a specified duty to deliver equitable access to services. However, for the reasons described in earlier chapters, many governments have not been able to deliver this USO through their own direct providers. The New Public Management (NPM) approach of splitting the indirect provider responsibilities – that is, ‘ensuring access’ – from that of the direct provider – ‘delivering access’ – provides government with the opportunity to take a longer-term view. Government can then focus upon overall objectives in a way that has the potential to limit short-term political and producer interests. This move to a renewed focus on policy follows an earlier move over previous decades to separate out aspects of environmental monitoring, including aspects of water resources management. Perhaps because these activities have tended to be carried out by like-minded professionals, predominantly water scientists and engineers, this degree of separation of responsibilities was not perceived as such a significant change to the role of government. By contrast, the introduction of economic regulation, usually but not necessarily in conjunction with privatisation, is the driver for a significant change in that role. Because piped water supply to domestic consumers is close to a natural monopoly there is little possibility that competition can regulate economic behaviour. With public private partnerships, as described earlier, there can be competition for the market, namely competitive bidding for 127


the right to be awarded the contract for a specified period. But there is only limited possibility for competition in the market. Giving any entity responsibility for the monopoly supply of a daily basic need for which there is no alternative opens up the possibility of that provider abusing its position in order to maximise its own benefits. Economic regulation is therefore a necessity. A private operator has to achieve a profit level that provides an adequate return on its cost of capital. In low and middle-income countries private operators have to make higher profits to convince shareholders to invest in very long-term assets in a higher-risk setting. Private operators should also benefit from the opportunity to make an additional level of profits, which acts as an incentive to managers to become more efficient and more creative in achieving the universal service obligation. But such private companies may be tempted to go beyond these reasonable levels of benefits and abuse their monopoly position. However, it is worth recalling that public direct providers also commonly abuse their monopolistic position over piped supplies through over-investment in treatment processes as well as through corruption and inefficiency. Public providers also fail their customers by maintaining tariffs that are so far below any reasonable level that they rarely generate sufficient funds for the professionally less satisfying tasks of routine operations and maintenance. The failure of government providers to set adequate tariffs is the root cause of many of the ills of the urban water supply sector. Public providers equally need to be regulated. In fact in low-income countries there is already a level of competition in the market through PWVs competing to supply slums and shanties and peri-urban areas. However, in many instances such competition has been limited due to the power of local cartels, often influenced by criminal elements. Given the resulting high prices as well as the poorer quality of water supplied, any benefits gained through competition are usually outweighed by the costs. Therefore, whether the direct provider is public or private, a separation of responsibilities allows the indirect provider, through some form of regulatory body, to monitor the performance of the direct provider with regard to water quality, service quality and coverage. This separation of responsibilities also provides the critical opportunity to monitor price levels in order to limit monopoly abuse and to ensure equitable use of any subsidies. Such regulation should ensure that water prices are high enough to finance an appropriate level of investment at a reasonable level of efficiency. The word ‘appropriate’ has to be used in conjunction with ‘investment’ to emphasise that it

Regulating and Enabling the Direct Providers 129

is the task of the regulator to monitor and control the tendency for gold-plating (over-investment in higher than necessary quality of plant and equipment) and hobbyism in new works (the tendency for professional interests to take precedence over costs and benefits to consumers). The word ‘reasonable’ has to be viewed in relation to efficiency levels in low-income countries to indicate that the target is not best-practice efficiency by international standards. Such a level of optimisation would significantly increase the risk of failure as bestpractice efficiency requires ever increasing complexity of systems with ever reducing redundancy in those systems, whether in labour or plant and equipment or information technology. Interpreting these words accurately in each particular socio-economic context is a challenge for the regulator. The establishment and monitoring of performance agreements between indirect and direct government providers or the monitoring of contracts with private operators is therefore the critical new role of government in the water sector. It is a task that requires expertise in finance, economics, management and technology. It needs a relatively independent entity staffed by a team of professionals that is given the freedom to develop its expertise over a number of years. Having blamed political interference by governments for much of the failure of the urban water supply sector in the past, the NPM approach faces a major challenge. Is it realistic to expect governments not to abuse their power over their own regulatory bodies? One solution advocated to avoid such potential abuse is to use the contract as the basis for all adjudication of disputes. For this reason, some see a clear distinction between contract monitoring and regulation. Such an understanding may be appropriate for simple PPPs such as service contracts. However, no major contract with the private sector, nor performance agreements with the public sector direct provider, can make provision for every eventuality – particularly in the context of long-term 30-year concessions in large cities involving major foreign investment. Private operators around the world have already made compensation claims on the grounds of unexpected devaluations, droughts and political interference as well as ‘revolutionary’ changes of government. In order for such adjustments to be both fair to the operators as well as just for customers, so as to avoid giving away excessive profits or making unacceptable allowances for poor performance, the regulatory body must be transparent and sophisticated in its decisionmaking. A government department responsible for conventional contract monitoring cannot undertake that role.


As a major text on the subject has stated: A complete contract would be immensely complex and extremely difficult to write, monitor and enforce . . . Indeed it would be very hard for the government to commit not to vary some contract terms as events unfold. Much more likely, then, is some kind of incomplete contract that leaves a number of aspects to be resolved. But this is effectively just what regulation involves – a continuing task of contract monitoring, enforcement and renegotiation. Thus in circumstances of any complexity, franchising does not do away with the need for regulation. (Armstrong, Cowan and Vickers 1994) Two major types of regulation exist – by specialised agencies and by contract enforcement. Regulation by contract is found wanting when judged against a series of key regulatory attributes: independence, information, control and monitoring, sanctions, degree of freedom, quality and relations (Defeuilley 1999). For the new form of arms-length water provision there appears to be no alternative but independent regulation as opposed to contract enforcement. ‘Regulation by contract still needs a regulator – to monitor, interpret and adjudicate on the effects of changes in circumstances – through a contract that promotes common goals for the third party, rather than protection for the contracting parties’ (Schoon 2001). As we have seen, the purpose of separating the indirect provider role from that of the direct provider role was to introduce clarity of objectives into the role of government. Experience has shown that this clarity can best be achieved by ensuring the further separation of the regulatory role from that of the major government roles of negotiating public private partnerships (that is, contract preparation) and developing overall policy for the water sector. The regulatory process needs an independent view on the economic cost of achieving political goals of service coverage and environmental protection. It needs independent monitoring of performance indicators to judge success or failure that is not overly tied to the interests of the policy making function of government or of any sponsoring department. However much we describe the benefits of such separation of tasks in order to promote efficiency and transparency it is rarely possible to achieve this goal. ‘It is a convenient fiction that ministers are responsible for policy, regulators for its implementation, and utilities for providing the services. The reality is a lot more complex and messy’ (Helm 1999).


All the case studies described below illustrate this ‘messiness’, with government and other politicians often becoming involved, to the frustration of the regulator. However, the debate that ensues appears to be delivering greater benefits than the previous single agency approach. In high-income countries, other forces in society such as the media, NGOs, consumer associations and academics tend to act as a buffer. Together they shield regulatory bodies from overdue interference from government. At the same time these forces act as a prod, promoting action by the regulator when it is seen to be slow in coming. This critical role of civil society has to be encouraged if the regulatory model is to adapt successfully in low and middle-income countries. The regulatory task of adjusting and adjudication in a constantly changing political and socio-economic environment is a major challenge for any government agency. If government has found it difficult to undertake satisfactorily the relatively straightforward task of providing water then it will struggle even more with the task of regulating a global private water operator. Achievement of this task will require wellpaid, independent professionals in a government agency that is endowed with a considerable degree of autonomy. Ironically, these are the same organisational characteristics that would have served government well in its role as direct water provider but which were rarely on offer. Regulation is also a challenge to the private operators. When these companies sign a concession contract they have usually been able to quantify the risks inherent in that contract and bid accordingly. But when government is granted a degree of discretion through a separate specialised agency, however necessary that flexibility may be, this introduces the element of regulatory risk. This extra risk that the private operator has to bear is an unknown quantity in many situations, particularly when, as has frequently happened, regulatory bodies are established after the contract has been signed. To limit that risk, and the additional costs that go with a higher risk, if the role of government becomes ‘steering not rowing’ governments also have to recognise that for the boat to steer a steady course it needs a ‘light hand on the tiller’ (Savas 1987). To pursue the analogy, when squalls or perhaps even storms appear, then intervention is required to ensure that the boat remains on course. But at other times, as both overseer and as regulator, government must resist the temptation to interfere constantly in day-to-day management issues. Even then, the end result of the process of separating-out responsibilities is that the power retained by government over the private sector


through the regulatory process remains significant. It is normally quite adequate to meet the anxieties of those who fear the ‘privatisation of our water’. In fact, governments exercise more effective control under privatisation than they did when management was a part of government, as confirmed by a UK government minister: ‘utilities which we intend to privatise are more easily controlled when they are in the private sector’ (Ridley 1996).

7.2

The activities of regulation

The regulator will normally be responsible for five basic activities: licensing operators (and amending licences when necessary), pricesetting to ensure adequate financing, performance monitoring, adjudication (judging between competing interpretations of contract expectations), and imposing any sanctions for non-compliance. Some of these activities require particular interpretation in the context of water supply in low and middle-income countries. Others may not necessarily have to be undertaken directly by government officials but can be outsourced. This ‘tapping the market’ was described by the director of NWASCO, the water regulator in Zambia: ‘The strategy is to outsource the more routine work of collecting detailed information as well as auditing of the providers’ (Chanda 2000). 7.2.1

Licensing operators

The provision of clean water for public health is a critical activity. Operators should have experience in treating and distributing clean water, either directly or through joint venture partners. It is therefore common to require some level of licensing of private operators to ensure that they have the scientific knowledge and skills required to deliver potable water, though without this becoming an overly bureaucratic procedure. This is of particular relevance in the event of changes in joint venture partners. This may occur if international operators, on whose skills the award of the initial contract was based, withdraw because of deteriorating economic conditions. Equally the concept of licensing is important when small-scale independent providers are incorporated into formal water provision in order to ensure that they are able to deliver potable water. 7.2.2

Price-setting

Inadequate tariffs are at the root of the failure of government to provide clean water. Consequently, price-setting is a key task of the regulator. In


order to reduce regulatory risk, it can be simplified by contracting a significant part of the work to consultants according to pre-defined models. The agreement on operating and capital expenditure targets, together with incentives for efficiency gains linked to target returns on capital, is a relatively mechanistic task when undertaken within clear policy guidelines. The Aquarius financial model that is used by OFWAT, the water regulator for England and Wales, and the price setting calculations detailed in law for the Chilean water regulator to follow, are both prepared by external consultants. They are potential models of what could be achieved in terms of minimising both discretionary elements in regulation and regulatory risk. One of the key tools of regulation for price-setting is the use of comparators. Comparators are other service providers, primarily but not exclusively other water providers, whose costs and efficiencies can be used as a benchmark against which to measure the performance of the regulated direct provider. Accessing such data is difficult for a regulator in a low-income country where only one private water operator is regulated (and that in the atypical capital city). The World Bank and Asian Development Bank are now developing bench-marking capability to share comparative data between governments and their regulators as well as between conventional public providers. Price-setting in a low-income country must also be informed by the potential to adapt technical standards in order to meet objectives. It is not possible to provide affordable water and sanitation for low-income consumers in a country with a per capita income of US$500 to the same standards as for consumers in a country with a per capita income of US$20,000. However, it is possible to achieve similar objectives by adapting the technologies and processes but, it should be emphasised, not simply by assuming that a single standpost can serve several hundred residents in a slum. Regulators need to be able to access concepts of appropriate engineering standards so that they can avoid unaffordable investments in fixed assets yet also meet expectations of service improvement. 7.2.3

Performance monitoring

In pursuit of its role of performance monitoring the regulator watches service outputs to ensure that the quality of service provision, in all aspects, meets that promised in the contract. The regulator also has to monitor the effect of the service on the environment (for example, on water resources or wastewater disposal) so as to avoid negative externalities. The regulator must also monitor financial performance to ensure


that investments can be financed, that operational efficiency is increasing, and that profit levels are appropriate. Yet before the regulator can monitor these aspects, overall policy objectives have to be determined that recognise and incorporate the trade-offs between water prices, environmental protection and longterm investment, as well as the constant concern for adequate services for the poor, particularly in low-income countries. In addition the objectives of cross-subsidisation between high and low-income consumers or between high consumption industrial users and domestic consumers have to be established. This is fundamentally a political task that is best addressed through existing government ministries and the legislature. The role of monitoring and auditing performance against these agreed objectives is then a relatively routine task that could be undertaken by a private accounting or auditing business just as well as by a government department. In particular where foreign private operators are involved there might be advantage in counterbalancing the foreign nature of private management with a team of international auditors. 7.2.4

Adjudication

The regulator has to act as adjudicator in disputes, acting as the impartial referee in the interpretation of contracts and agreements between the private operator and the government. In order to minimise the danger of yet another government department, with the potential to be captured by political or producer interests, this activity could be undertaken through the competition authorities or even through the conventional legal system. The counter-argument is that using the existing institutions may not be sufficient in countries where the legal system is bogged down with a backlog of cases. The renegotiation of contracts is part of the accepted role of the regulator where there are significant material changes. However, in practice, government departments have carried out many re-negotiations when the political issues become predominant. This suggests that the role of the regulator may be best limited to the tasks of price-setting and monitoring, with the wider policy issues settled by the relevant government departments. 7.2.5

Sanctions

Finally, at some level, the indirect provider needs the power to impose sanctions for failure to comply with undertakings agreed with the regulator, namely specific activities that the operator promises to carry out


within a specified time. Sanctions may involve fines, or in the extreme case, the loss of licence (Stanley 2001). It is unlikely that the regulator would be perceived as having the necessary degree of authority for such contentious issues, particularly where a foreign private operator is involved. The appropriate government ministry, informed by the regulator, is best placed to take responsibility for such sanctions

7.3

Models of regulation

The development of new forms of regulation in low and middle-income countries requires an understanding of the experience of high-income countries. Here water regulation is a relatively new activity that has often been an adaptation of the regulatory system for power and telecommunications. Regulation of the wave of UK privatisations in the 1980s was primarily based upon the ‘incentive based’, or ‘price cap’, model. This is often contrasted with the earlier ‘ratebase’, or ‘rate of return’ model used mainly in the USA. The rate of return approach guarantees a fixed level of profitability each year, usually from 4–5 per cent, and is based on the reported operating costs and investments of the utility. If companies achieve higher levels of profitability in some years then regulators can claw-back these profits on behalf of customers by adjusting tariffs accordingly in subsequent years. Under this system, tariffs of regulated water providers are determined at public hearings held before Regulatory Commissions. It is estimated that 8,750 of the 57,500 community water systems in the USA are regulated through 46 such state commissions (Beecher, Dreese and Stanford 1995). These authors emphasise the limited nature of water regulation in the USA. They report that ‘the bulk of privatisation activity in the United States has been in the area of operations and maintenance contracts. Unless a regulated utility is involved and the contract is substantial these agreements are largely transparent [invisible] to the commissions’ (ibid). The majority of water supply in the USA remains under direct public provision. Where private utilities are regulated, there is considerable variation in approach because commissions ‘have differing authority and inclination to provide incentives for specific utility management practices’ (ibid), even at such a basic level as the requirement to seek out leastcost practices. Beecher describes the USA regulatory approach as ‘very costly to implement; highly formalistic and legalistic; [which] does not necessarily ensure efficient utility behaviour [and] can thwart competition’ (ibid).


There are two major drawbacks of the rate of return model of regulation. First, there is the problem of ‘gold-plating’ whereby the only way for the operator to increase profits, in cash terms, is to over-invest in the fixed assets on which they can generate the agreed level of profitability. Second, is the lack of any ‘drivers for efficiency’, in operations or in capital investment, something that is at the heart of incentive-based regulation. 7.3.1

Water regulation in England and Wales

The key innovation of the incentive-based model is that private operators can retain any additional profits if they out-perform by becoming more efficient more rapidly than the regulator had envisaged when setting the prices. Periodic price reviews, carried out every five years under the English and Welsh system, enable the regulator to share part of the benefits from this out-performance with customers through an adjustment to water tariffs. This adjusted tariff, which can be an increase or decrease depending upon the extent of improved quality requirements, then forms a new target that the private companies can attempt to outperform all over again. The resulting variation in profitability has been described as ‘the saw tooth effect’. This describes the increase in profitability during the period of the price cap that is expected to be a rising trend as the private operator responds to the incentive to earn higher profits by increasing efficiency. At the following price review the regulator is expected to claw back that additional profitability to the benefit of customers by re-setting price levels to recognise this more efficient level of costs. The reduction in the rate of return on the assumed cost of capital in a single year can be seen in graphical terms to complete a single ‘saw tooth’. The continuing process of incentives for rising profitability with subsequent sharing of efficiency gains theoretically results in a series of ‘saw teeth’ pattern changes in profitability. The costs revealed in all these activities have to be reported annually to the water regulator, who then compares this data with that of other private operators. This forms the basis of the judgement by the regulator of a valid level of costs at the next price review. The combination of incentives and comparators is a remarkably powerful regulatory tool for the indirect provider. In England and Wales the economic regulator, OFWAT, forms part of a triumvirate of water regulation that includes the Environment Agency, which monitors abstraction and wastewater disposal, and the Drinking Water Inspectorate, which monitors water quality. The sponsoring government ministry, now the Department for Environment, Food and Rural Affairs, retains overall responsibility for guiding the


regulator through policy objectives with regard to water quality improvement relative to possible environmental improvements and their possible impact on prices. Government retains the right to set overall policy at each price review, and the regulator has to ensure that the companies can finance and implement that policy. This regulatory model also includes Customer Service Committees (CSCs) that have the statutory responsibility to advise the regulator on issues of importance to customers and to support customers in their complaints to the private companies, obtaining compensation where appropriate. The ten CSCs, designed to reflect particular regional interests, have voluntary unpaid members appointed by the regulator and part-time paid chairpersons appointed by the minister. By such means government maintains an effective involvement in the process. As statutory bodies, the regulator is obliged to listen to their representations and the private operators are obliged to attend their meetings. Presently funded and staffed through the regulator, in 2000 the government announced its intention to establish an independent Consumer Council for Water, presumably to increase the power of the customer. However in practice the initial government proposals would reduce the rights of customers. In an attempt to improve recognition amongst customers and to prepare for possible greater independence in 2002 the CSCs were renamed WaterVoice. The experience of regulation in England and Wales is one of continual change with active scrutiny of the evolving process by a wide range of interested parties. For however elegant the principle of the price cap model, the England and Wales experience shows that regulation is also a learning process. The early simplicities of the ‘RPI-X’ price cap (where RPI is the retail price index, a measure of annual inflation, and X is the efficiency target to be achieved by the private operators) quickly had to be adapted to meet the particular needs of water and wastewater. Refinements to the formula were made in order to justify price increases to take account of quality improvements demanded by the government and the European Union (Q), improvements in service to customers (S), improvements in security of supply where threatened by possible drought (V) as well as price decreases to reflect past out-performance when the regulator failed to claw back the benefits sufficiently in the first price review (P0). A price adjustment formula where K = RPI ⫺ ‘P0’ ⫺ ‘X’ ⫹ ‘Q’ ⫹ ‘V’ ⫹ ‘S’ is much harder to communicate to stakeholders. Nevertheless it is producing benefits for the population both as customers (receiving excellent water supply) and as citizens (benefiting from an ever improving environment).


The expansion of the price setting formula illustrates that once the process of regulation begins it is hard to rein it back to its initial more modest formulation because every extension to the price cap principle demands ever more information to justify any decision on price. For example, in such a capital-intensive business as water, capital expenditure plays a critical role in price determination. Hence the regulator has to question whether the assets are really necessary in order to deliver the required outputs, or whether some change could have been made to operating procedures and costs in order to achieve the same outputs. This involves examining the trade-off between operating expenditure and capital expenditure to ensure that profits are not enhanced by minimising operating expenditure. For example, the private operator could theoretically reduce spending on leakage reduction – an operating cost – with the knock-on requirement, as water demand increases, for additional future capital expenditure on development of new water resources in the form of a dam, which can be funded on a cost passthrough basis. Having determined the validity of the proposals for capital expenditure on new assets, the regulator must investigate whether they have been priced correctly together with the necessary judgement as to possible efficiency gains that might be achieved during implementation. Such determinants have to be gauged to deliver maximum benefits without making any incentive for additional profits appear beyond reach. The regulator must then monitor the implementation of asset management plans to ensure that assets have been constructed when stated, because any delay might have given the operator a bonus of unused cash. The regulator must also question whether new assets have been built to the required standard to provide the necessary sustainability, such that they actually deliver the outputs as promised, that they are being maintained adequately to ensure no decline in performance and to ensure that they could theoretically be handed over in good order at the end of the licence period. In practice price cap regulation still has to retain an element of rate of return regulation. In other words, in order to set prices the regulator has to have assumed a level of profitability on the investments undertaken. In England and Wales the implicit rate of return that the regulator should assume for accepted capital expenditure became a matter for debate, particularly as each of the utility regulators (for example, gas, electricity, and water) came up with their own interpretations. Each regulator had the right to set its own view as to the cost of capital but as that view is always open to appeal to the Competition Commission it


has to be sufficiently reasoned to pass further scrutiny. During the 1999 water price review there was debate concerning risk-free returns to capital, the equity premium appropriate to reward private providers of shareholder capital, as well as the Beta factor, which measures the particular volatility of utility shares relative to the rest of the stock market. The debate concerning the value of regulatory capital value itself (that is, the regulatory asset base or the value of investments in the business for which the private shareholders have to be compensated) has become extremely complex. This was a significant issue when so many assets were fully depreciated at the commencement of privatisation but have to be maintained at an adequate level. A judgement was therefore made as to the value of the business in the English and Welsh case. This was done by taking the average share price for the first hundred days of trading, with the addition of all new investment in fixed assets, revalued each year through the use of current cost accounting but also depreciated at current costs to reduce the risk of ‘inter-generational transfers’. The many regulatory questions touched upon here can be addressed at an ever-increasing level of detail, a fact that calls into question the extent to which the regulatory body moves from being a monitor to becoming a manager – setting prices, fixing investment levels, and determining targets. There are serious dangers if government assumes such an intrusive regulatory role, particularly where a different interpretation of some of these complex issues can mean a significant difference in profitability for the private operator. Ideally, therefore, the demand for ever-increasing amounts of information to inform decisionmaking could be limited by some level of trust in the relationship. The very use of the word ‘partnership’ in the concept of public private partnerships implies some degree of working together, of sharing and trust. Yet as soon as a private operator appeals against a tariff decision by the regulator, then every detail in the regulatory decision has to be justifiable. Hence the search for detail and justification continues, with the regulator in England and Wales making good use of comparative competition, under which he compares the performance of each of the private companies according to a wide range of indicators. This not only enables the monitoring of performance against a benchmark but also uses the most efficient companies as targets against which to judge the less efficient companies. This approach has been developed to such an extent that companies now have to declare their prices for standard activities (for example, to relay a length of standard water main). In the price review the regulator then allows for costs only at the level of the most efficient companies. This delivers a powerful incentive for improvement.


Clearly there is not much scope for partnership here because in order for such data to be acceptable and verifiable there must be an auditing system in place to ensure that companies are reporting correctly. The regulator has the right to choose technical reporters, which the companies have to pay for themselves, as well as the more usual financial auditors to prove accuracy of the financial data submitted. The comparative information that is obtained is such a powerful tool for effective regulation that the UK government has found it necessary to restrict possible take-overs or mergers between water companies to ensure the continuing availability of a wide range of comparators. And on the occasions when takeovers have been allowed, the relevant companies have had to promise a reduction in water prices to compensate customers for the possible loss of future efficiency gains through the loss of the comparator. This overview of water regulation in England and Wales indicates the complexity and level of sophistication that is the inevitable outcome of the task. For all the attraction of separating regulation from a politically managed government department, regulation is necessarily a political process that has to adapt continually to the evolving local environment, as the following three examples show. First, the regulator for England and Wales was challenged in Parliament and in the media because the results of the initial price setting gave rise to excessive profits. The regulator had to respond by finding a politically acceptable way of reducing those profits to something like the cost of capital, a process referred to as ‘the glide path’. Second, in 1995 a drought threatened the security of water supply in one region, leading to a new concern over levels of leakage. The regulator had to respond by setting leakage targets for each company with progress reported at regular intervals. Third, the new private companies were believed to be abusing their power by disconnecting non-payers. This created a political storm, with accusations that the poor and sick were being disconnected. The regulator had to begin monitoring these activities and eventually in 1999 the government passed legislation to ban domestic disconnections altogether. Yet despite the difficulties that this complexity involves, regulation does bring into the open those decisions that had previously either been made behind closed doors or that had been taken by default. This is a major benefit for governance. The experience of England and Wales shows how water regulation has evolved significantly over a relatively short period. The process continues with the government announcing its intention to introduce a regulatory board to replace the individual regulator. The regulatory system


is also under pressure to promote competition in the water sector, reflecting the successes in the telecoms, power and gas sectors, where the respective regulators have declared that part of their task is completed now that a competitive market has been achieved. Inset appointment and common carriage are two reforms designed to promote competition in water supply. Inset appointments allow a competitor to set up a separate supply agreement with a major water user located within the area of another company. Common carriage grants a competitor the right to use the pipe network of another company (at a price) in order to convey its water to customers. However, these reforms are unlikely to do away with the need for regulation in the water sector in the near future. The water companies strongly support the conclusions of an official study into the electricity sector that regulation has been more effective than competition in driving down prices. According to this study, all customers have gained an 8 per cent average reduction in power bills through regulation but just one quarter of customers have saved an additional 7 per cent by changing their suppliers (that is, through competition). But all customers have had to pay an additional 1.5 per cent to pay for the £850m cost of introducing competition (National Audit Office 2001). Nobody knows how far competition will extend in the water industry. The British government has recently fulfilled its role in setting objectives by announcing an extension in competition through inset appointments and common carriage to those commercial users in England and Wales that consume more than 50 million litres per year. The Customer Service Committees would like to see this limit reduced to 10 million litres per year but are opposed to the opening up of the residential market to competition. As in the cases of other countries described below, the reform process has been ‘policy-making by experiment’. If competition does not become a reality, the end result of price cap regulation appears to be rate of return regulation. This is because the scope for further operating and capital expenditure efficiencies must presumably be exhausted after a number of price reviews whilst governments become ever more tempted to directly involve themselves in the process on an annual basis. The challenge then will be to maintain incentives to promote creativity and innovation for further efficiencies as well as avoiding the costly to implement, highly formalistic and legalistic rate of return model of regulation in the USA. If rate of return regulation is considered costly, it is interesting to consider the cost of incentive-based regulation. At present OFWAT costs the English and Welsh customers US$19m per year – approximately


US$0.36 per person per year (OFWAT 2002b). On top of that are the costs to private operators of managing regulation. One water company has reported costs of at least US$5.10 per person per year, which also have to be recovered through the water tariff (Skellet 1999). As well as attempting to limit the costs, the proclaimed ideal of ‘light handed regulation’ for all water companies began with 177 pages of annual reports published in 1990/91. This had increased to 452 pages by 1999, together with a CD ROM of company data plus 312 pages of Periodic Price Review reports in the same year – a mountain of information for stakeholders to absorb and make sense of (author’s estimates). This description of the system of regulation in England and Wales provides a framework for investigating this important new role of government as indirect provider in low and middle-income countries. The incentive-based model of regulation has been promoted strongly around the world and several regulators have told the authors that they are following the ‘OFWAT model’. Yet to date there is still only limited experience of water regulation in low and middle-income countries. We therefore now examine our benchmark case of Buenos Aires, which constitutes one of the longest experiences of regulating a private water company. It should be noted that the examination was carried out prior to the economic crisis that overwhelmed Argentina in December 2001. 7.3.2

Water regulation in Buenos Aires, Argentina

The regulator for the Buenos Aires water concession is the Tripartite Entity of Sanitation Works and Services (Ente Tripartito de Obras y Servicios Sanitarios–ETOSS). It was established at the beginning of the concession period in 1993 and is managed and administered by a sixmember Board of Directors representing the Federal Government, the Provincial Government of Buenos Aires and the Municipal Government of Buenos Aires, each with two directors. The tasks of ETOSS are: to review the tariff structure; to oversee contract compliance; to control and maintain service compliance; to protect customers; to approve and supervise the execution of expansion plans and investments according to contract specifications; and to control the quality of drinking water (Bories 2001). The six directors are political appointees. Although their six-year contracts (renewable once) were designed to minimise external pressure, membership has changed according to the political fortunes of the particular party or faction to which they belong. The personnel of ETOSS were drawn mainly from the previous government direct water provider, OSN. Because most had a professional background in engineering rather


than in economics or accounting, staff underwent a steep learning curve in the art of regulation in general, and of setting viable tariffs in particular (Alcazar, Abdala and Shirley 2000). The absence of accurate information about the water supply system that they were trying to regulate was also a major problem for them, as it was for the private operator. However ETOSS complained that the information provided by Aguas Argentinas during the first two years of the concession was poor, incomplete and biased (Mazzucchelli, Rodriguez Pardinas and González Tossi 2001). According to some observers, the concession contract was drafted in a manner that allowed undue intervention by ETOSS in the operational activities of the concessionaire. Although the contract was described in Chapter 5 as output oriented, in addition to specifying the targets that the operator must meet, the contract also provided that the regulated firm ‘must maintain and renovate all pumping materials, valves, hydrants, connections and other elements that are needed for the optimal provision of the service, regardless of their life span’ (Alcazar, Abdala and Shirley 2000). This level of detail enabled the regulatory staff to ‘micro-manage’ to such an extent that in the first five years of the concession the regulator was sending two letters a day to the company. Perhaps this was a conscious effort to compensate for the widespread belief that the ‘independent regulator’ had little political clout. The degree of freedom that the operator should be allowed in order to meet the goals established in the contract became a substantive area of dispute between Aguas Argentinas and ETOSS and relations between the two became confrontational (Defeuilley 1999). There was a fundamental lack of clarity regarding the nature of the regulatory task to be carried out by ETOSS. Was its role indeed ‘outputoriented’, namely to monitor the extent to which outputs met objectives? Or was its role ‘investment-oriented’, namely to investigate complaints that the operator was failing to meet the anticipated investment schedule? The operator clearly believed that it was the former, which would be usual for a regulated public private partnership. However ETOSS appeared to behave as if its prime task was to ensure that the investment targets were met. It soon became apparent that the government was interfering in the regulatory process. A major contract revision took place in less than a year when in 1994 the national government requested Aguas Argentinas to accelerate expansion of the water system into an area with severe groundwater contamination and further increase production capacity. In response, Aguas Argentinas requested and received a 13.5 per cent tariff


increase (Haarmeyer and Mody 1998). A large part of this price rise reflected an adjustment for inflation under a complicated formula included in the contract that was not adequately explained to the general consumer (Alcazar, Abdala and Shirley 2000). When the company subsequently failed to achieve the promised accelerated expansion the regulator levied substantial fines as a penalty. A second major tariff increase took place as a consequence of the inability of Aguas Argentinas to collect the high connection fees mandated under the contract. These had been increased by 40 per cent in the 1994 renegotiation to the levels described earlier, around US$500 for water and US$1,000 for sewerage. Those households not yet connected to the network who would have to foot the bill for connections did not have a sufficient ‘voice’ to prevent the scale of the increase yet by law would be liable to pay the fees when the network reached their homes. The high cost of connection became a controversial issue when the company pursued the expansion programme into unserved areas, which, not surprisingly, tended to be lower income areas. As the accumulated arrears of the operator in connection charges rose to around US$25m, to which had to be added the associated loss of anticipated revenue from water consumption, the company sought a further revision of the contract. Negotiations over the issue between Aguas Argentinas and ETOSS reportedly soon broke down. Political pressure was brought to bear on members of the regulatory board and in the end ETOSS was bypassed. Two federal agencies, the Public Works Secretariat and the Natural Resources and Human Development Secretariat, then reached an agreement with the operator in 1997 (Zérah 2001). As described in Chapter 6, a universal service charge (SUMA) of $2 bimonthly per service was levied on all customers to subsidise the revised connection charge for new customers. In addition, the fines levied earlier against the operator were set aside (Alcazar, Abdala and Shirley 2000). This agreement itself was questioned in a successful court case brought by consumers’ associations who said that the universal service charge, designed to share the costs of new connections between all customers, was in fact an illegal tax. However, the government won the case on appeal. The effect of the additional standing charge was to increase average customer bills by 13 per cent. In 1998, the operator requested a further 11.7 per cent price increase to which the regulator countered with an offer of a 1.6 per cent increase. The government again became involved in negotiations for a final 5.3 per cent agreement (Aguas Argentinas 1999). Subsequently, a further


4.9 per cent price rise was agreed for 2000, with increases of 1 per cent and 0.5 per cent scheduled for succeeding years. But these soon became irrelevant in the light of the December 2001 ending of parity between the local currency and the dollar, the subsequent 70 per cent devaluation of the peso, and the conversion of the water tariff back into pesos. This review of price revisions since 1993 indicates that the regulatory process in Buenos Aires was not ideal. The regulator appeared to be bypassed on a regular basis: More alarming, however, is the lack of respect the government has had for ETOSS. Decisions made by the regulator that appear to threaten the dominance of private capital are frequently overridden by the state, to the extent that government rewrote the contract in 1997 considerably softening many of Aguas Argentinas’ contractual commitments. Significantly, ETOSS was not a part of this renegotiation. (Loftus and McDonald 2001) Even so, this was a more transparent and effective process of governance than when the government acted as direct provider. Even in the midst of these negotiations Gustavo Criscuolo, one of the ETOSS directors, could explain that ‘the regulator is independent, in the centre of a triangle, not overlapping with either the politicians, the users or the concessionaire’, emphasising that ‘we want transparency of regulation – no free services to users, no high profits to the concessionaire’ (Criscuolo 1999). The Buenos Aires regulatory system has at least achieved financial independence – financing is exclusively from users and there is no financial support from the government. ETOSS is funded by a 2.67 per cent levy on revenues, equivalent to US$5.2 per customer per annum for each of the 2.6 million customers in 2000. However, this is significantly higher than the $0.84 cost per customer in 2002 of OFWAT, which regulates 25 separate companies, not just one as in the case of ETOSS. Questions have been asked about a regulator with a staff of 110 (1998) that produces a remarkably limited number of reports yet costs over US$10 million per year. This demonstrates that new policy initiatives that create government departments or agencies run the risk of themselves becoming mere employment providers. But irrespective of those costs, regulation of the private sector does give governments an excellent opportunity to set targets and monitor progress. Before privatisation the public water provider suffered from a lack of resources and finance associated with poor efficiency in


operations and bill collection. The cash flow was so low that maintenance was not possible, and the company was heavily dependent on loans from the federal government to meet basic operational expenses. The basic aim of the public private partnership was to overcome this situation and move quickly towards universal service coverage. As the regulator portrayed it: ‘The concession is expansion. If we don’t achieve that, there is no success. Quality is not so important. The only measure of success is the attainment of universal service coverage – the top objective is urban access to services’ (Criscuolo 1999). Despite the imperfections of the regulatory process, the public private partnership has delivered a reasonable result for consumers and the government. There has been a 29 per cent increase in water customers, and a 17 per cent increase in sewerage customers as well as a significant increase in service to low-income households, as described in Chapter 6. Another benefit of regulation is that this information is now available for debate in the public domain, and explanations must be given for any shortcomings. As indirect provider, the government has a powerful negotiating tool over the concessionaire as direct provider and there is the possibility to apply sanctions when failures cannot be justified. Customers also now have the opportunity to monitor progress and to raise issues of concern. Although formal customer representation was initially minimal, users have now been incorporated into the regulatory body, not as officials or Board members but through a Users Commission established in preparation for the major review of the investment plan for the second five-year period. ETOSS eventually held public hearings in 2000 after delays caused by the need for consumer groups and NGOs to make sense of the mass of detailed technical information that was suddenly thrust upon them (ETOSS 2000). One commentator concludes that water regulation in Buenos Aires has been ‘weak and ineffective’ (Zérah 2001). Yet, judging by the end result, namely that far more people are receiving a reasonable quality of water and sanitation service than was likely under government direct provision, the regulatory system in Buenos Aires is achieving many of its goals. All regulators, in high and low-income countries alike, are buffeted by events, whether climatic or political. In 2002 ETOSS, not to mention Aguas Argentinas, faced its stiffest test ever following the breakdown of the ‘dollarisation’ of tariffs, the massive devaluation of the local currency, and the subsequent appeal for reparations by the operator through an arbitration tribunal.


7.4

Regulation in the case study countries

At the time that the initial case study fieldwork was carried out there was no government economic regulation of the water sector in Sri Lanka, India or Ghana. However, in the past five years there appears to have been more progress in regulation than in privatisation within the sector of these countries, though detailed information on results is limited. 7.4.1

Ghana

The Ghanaian government established an independent Public Utilities Regulatory Commission (PURC) in November 1997 to regulate tariffs and customer service standards in the new public private partnerships that are being developed in the electricity and water sectors. Attempts to introduce private sector participation in the water sector have suffered from several false starts although the basic plan remains to create two ‘enhanced leases’, Accra–Tema and Kumasi, both of which include a hinterland of smaller towns. While the government develops its plans for the PPPs with the help of transaction advisors, PURC is already undertaking its regulatory role of setting tariffs. In 2001 it granted permission to Ghana Water Company Ltd, the successor to the Ghana Water and Sewerage Corporation, to raise tariffs by 96 per cent. The large increase is an indication of the extent to which the real tariff had fallen as nominal tariff rises lagged behind the high rate of domestic inflation. The regulator has stated that tariffs need to continue to rise significantly, at sixmonthly intervals, to ensure that the revenue stream is sufficient to cover costs prior to the invitation to the private sector to bid for future concession contracts. PURC is also demanding improvements in service quality in exchange for tariff increases. It has called upon GWC to undertake a comprehensive rationing programme aimed at achieving water supply at least twice a week to all areas or localities that are currently severely deprived of supply; to reduce its high level of unaccounted for water, currently at 51 per cent, which continues to affect its operational efficiency as well as its cash flow position; and to reduce commercial losses caused by lapses in billing, metering and illegal connections from the current 20 per cent to 16 per cent (PURC 2001). Both the tariff increases and the service improvements are necessary measures that government had failed to achieve as direct provider. The separation of some powers to an indirect provider, the regulator, is proving to be beneficial in its initial stages.


7.4.2

India

India has had a long history of institutional change, if not reform, in the water sector (Franceys and Sansom 1997). The government has been hesitant about private sector participation in urban water supply, previously seen as the prerequisite for regulation. However, it has begun to consider how to implement full cost recovery through tariff mechanisms according to the principle of ‘user pay, abuser pay, polluter pay’ so as to promote investment. To achieve this, the government is seeking to decentralise and strengthen accountabilities, commercialise service provision and promote private sector participation. The long-term goal is to establish state regulatory bodies that are ‘independent, autonomous and accountable and include consumer participation’ (Kapoor 2001). The government sees the potential for splitting the direct provider role from that of the indirect provider without necessarily involving the private sector. The first experience of regulation has been in the electricity sector. Power regulators in Orissa and other states have followed the US style of regulation with a formal ‘judicial format’ where decisions have to be justified in a court of law (Ahluwalia 2001). Although the courts have reinforced the capability of the supposedly independent regulators, the latter are not really independent of government and tend to reflect governmental capacity. Where this is good, the regulator can also do a good job but where it is weak, the regulator is similarly weak. From personal experience as a regulator, Ahluwalia suggests that it is a waste of resources to establish regulatory bodies where governance is weak, particularly as they are regulating public utilities that remain under the direction of the state minister. The few private operators do not find that the regulator can support their cause, which is to ensure the viability of their access to finance, ‘even though it was the private supplier who initially made the case for regulation’ (ibid). In describing the balance of power between regulator and government at state level Ahluwalia states that ‘no regulator would go out on a limb for a private supplier and come away unharmed’ (ibid). Private businesses have long experience of working directly with government ministries as contractors to achieve mutual benefits. They now complain that the introduction of a separate regulatory body within government is simply confusing these contractual (and non-contractual) relations. According to G. P. Rao, Chairman of the Andhra Pradesh Electricity Regulatory Commission, an important reason for creating an independent regulatory framework was to raise the confidence of private and foreign investors who were concerned about the slow pace of


government decision-making, its opacity and its possible bias towards state-owned enterprises. He appears to agree with Ahluwalia that if regulators function as part of the same ministry they cannot remain distant and will be interfered with. As another commentator noted: ‘Differences will not be made public and the best public interest will not be served’ (Rao 2001). The first state-level regulatory body for water supply was scheduled for Andhra Pradesh in 2002. It would be independent of the state power regulator (who had hoped to absorb the additional sector responsibility) and would be established in advance of any public private partnerships in water. Yet there is little optimism that the regulator will have either the necessary independence or authority required to undertake its role effectively in the short term: It is a charade, an image of reform only. Government is still not willing to let go, it is confused, particularly as all interests are represented in one political party or another. Independent regulation cannot be as efficient as it needs to be – the time is not right yet for such a sophisticated tool – we need a blunter tool to get government out of this. (Ahluwalia 2001) 7.4.3

Sri Lanka

The establishment of a Regulatory Commission for Water Supply and Sanitation is a crucial first step in the reform process that the Sri Lanka government hopes will lead to private sector investment to achieve 24-hour water supply for the entire urban population by 2010. The regulatory framework is designed to overcome market failures, promote efficiency, encourage competition and attract private sector participation (Gunasekera 2001). Legislation to set up the regulatory body is well advanced (De Silva 2001). In addition to achieving universal service coverage, it is expected that reform will promote the financial viability of the sector through full cost recovery by providing services that meet appropriate standards of quality whilst protecting the rights of consumers. The role of the proposed regulator is to: • advise government on policy with a view to improving services and promoting efficiency; • licence service providers; • approve contracts of private sector service providers;


• • • • • •

review and approve tariff and other charges; prescribe and monitor service quality and performance indicators; promote consumer rights and obligations; facilitate public education, consultation and awareness; undertake dispute resolution; conduct or commission surveys and research studies (ibid).

It is planned to establish a small, streamlined regulatory organisation consisting of three full-time members, independent from the service providers and from political influences. An Asian Development Bank study has recommended that the regulator should make extensive use of out-sourcing for activities such as water and wastewater quality monitoring, legal matters, financial management, information collection and data analysis, and public awareness in order to curtail recurrent costs (De Silva). Although little of the plan has yet been implemented, it is striking how quickly ideas of regulation have become acceptable to governments as they recognise a means to escape from earlier failed attempts to reform. 7.4.4

Zimbabwe

Plans for the first major public private partnership in the water sector in Zimbabwe did not include any proposals for a separate water regulator. Instead they assume that the municipality in question, Gweru City Council, would maintain responsibility for deciding tariffs after the contract is signed (Plummer and Nhemachena 2001). One possible reason is that Zimbabwean municipalities in general have been seen to be acting responsibly towards their water supply departments and therefore could be trusted to continue that oversight role. There is no reported expectation of a water regulator in Zimbabwe, neither in any other city nor nationally.

7.5 The regulatory experience of low and middle-income countries The development of public private partnerships has led to the introduction of regulatory bodies in a number of other low and middleincome countries apart from the case study countries. Some of the earliest concessions, for example Macau and Port Vila, followed the French model and eschewed regulation in favour of negotiation through contract. In contrast, Chile established its water regulator, Superintendencia de Servicios Sanitarios (SISS) in 1990, well in advance


of the divestiture of the majority of its urban water supply systems. It now reports on a range of performance indicators from its regulated companies in a manner similar to OFWAT, the English and Welsh regulator. The large public private partnerships that followed Buenos Aires (for example, La Paz–El Alto in Bolivia, Manila in the Philippines and Jakarta in Indonesia) have all developed independent regulators, although in the case of Jakarta this occurred after three years into the concession. Both Manila and Jakarta have been buffeted by devaluations and droughts and government has taken an active role in setting tariffs over the head of the regulator. The regulatory process continues to evolve, but meanwhile there has been a significant improvement in water supply and in the number of households connected to that supply in those countries. Many other countries are now demonstrating an interest in regulation, also irrespective of their progress towards implementing public private partnerships (MacIntosh 2002). For example, in 1997 Zambia established a water regulator in advance of any significant privatisation ‘to regulate the service providers [public or private] for improved performance and service to the consumers’ (Chanda 2000).

7.6

Conclusions

The economic regulation of water supply, one of the new roles of government, is here to stay. It is needed in the case of both public direct providers and private providers. However it is not an easy task. It requires significant political insight as well as capacity building in terms of human resources. This chapter described two main case studies of water regulation. In England and Wales the regulator has access to 25 comparators whereas each of those 25 companies has very little experience of other incentive based regulators. By contrast, in Buenos Aires it is the private operator that has considerable access to regulatory experience around the world whereas the regulatory body has limited experience of only one company to monitor and facilitate. This imbalance in access to information and the consequences that it poses for the capacity of government are considered in the next chapter. One suggested solution to the capacity problem would be to give responsibility for regulation to an international private company, but somewhere in government there would still remain the need for capacity to regulate that regulator. The key criteria for successful regulation have been described by one researcher as: a clear mandate with specified duties and powers; the


autonomy to take decisions; accountability with mechanisms for arbitration; transparency and openness to scrutiny; stability and consistency; professionalism with status and respect; and objectivity that is focused and non-partisan (Stanley 2001). These are general characteristics of governance that are often severely lacking in low and middle-income countries. Hence the development of effective regulation is a challenge to the behaviour of government in a wider sense than that of the water sector alone.

8 Taking Account of Capacity

8.1

Introduction

The New Public Management (NPM), by focusing upon the separation of the direct provider role from that of the indirect provider, is making a difference to service provision around the world. Both pre-existing consumers and the urban poor, many of whom were previously unserved, are benefiting from this change in the urban water sector. However, the introduction of these reforms in low-income countries is still extremely limited. There is therefore concern over the capacity of government to extend NPM to the vast majority of the urban population who are still not receiving these benefits (namely whether the direct providers – public or private, national or foreign – will expand effectively beyond the major metropolitan areas). There is also concern over the capacity of government to maintain this separation of powers and its effectiveness in the long term. There is concern over the capacity of operators to finance the large-scale investment programmes that are required. There is concern over the capacity of governments to deliver the macro-economic conditions that will facilitate the financing of those programmes under conditions of manageable risk. There is concern that the first generation of water sector reforms associated with the NPM is now passing and that, as a result, the desired acceleration of service coverage to meet the millennium development goals (MDGs) of potable water for all will not be achieved. Perhaps this above-mentioned list of key capacity requirements is becoming perilously close to the much broader notion of capacity referred to in Chapter 1, which was almost synonymous with development. Yet this is a major issue here because ‘the water problem’ itself will not be solved without good governance and effective government 153


at the highest level. However, in this chapter we try to remain ‘wet’ and focus on those specific elements of capacity that are particularly related to the urban water sector. We may define capacity as ‘the ability of individuals within their institutional framework to perform appropriate tasks effectively, efficiently and sustainably.’ The contribution of individuals, organisations and institutions is well recognised by Alaerts et al. He describes capacity building as ‘human resources development and strengthening of managerial systems’ within the context of ‘institutional development’, in turn within the broader framework of ‘creating an enabling environment with appropriate policy and legal frameworks’ (Alaerts, Hartvelt and Patorni 1999). According to this definition, the capacity of even such a specific task as the delivery of water out of a tap cannot be viewed in isolation since it is partly a function of wider governance capability. Alaerts et al. define the goal of capacity building as ‘that the [water] sector as an aggregate can perform optimally, now as well as in the future’ (ibid). Yet the research carried out for this study suggests that the present goal of many water utilities is not so much to perform optimally but rather to perform at a ‘good enough’ level. The challenge is to develop the capacity to deliver services in a way that breaches the ‘performance ceiling’ characteristic of the water utilities described in Ghana, India and Sri Lanka, and to reach a level of service performance that is at the top of the range of comparator services providers (not necessarily in the water sector) in those countries, whether public or private. It is unrealistic to believe that the overall performance of water supply service can be significantly better than that of other services or utility organisations in any country. In many administrative systems it is dangerous for any individual or organisation to ‘put their head above the parapet’ and strive to demonstrate too much competence because it exposes those individuals in leadership positions to political and personal attacks. But a ‘good enough’ performance that evolves in line with societal expectations is an achievable objective. We recognise the limitations of such a goal. It might not deliver 24-hour water supply, 95 per cent bill collection efficiency nor world-class levels of staffing efficiency. However, attainment of the ‘good enough’ goal would at least mean that the majority, including a significant proportion of the low-income households, could gain ‘reasonable’ access to a ‘reasonable’ level of service most of the time. But even to achieve that ‘good enough’ goal still requires a ‘good enough’ level of capacity within both indirect and direct providers. As

Taking Account of Capacity 155

part of our investigations of capacity we have used a set of subjective descriptions of the necessary qualities required in a water utility, as developed by the Water and Sanitation for Health Programme (WASH). When LMIC utilities are judged against such desired standards of leadership, commercial orientation, customer orientation, management and administrative systems, and organisational and staff culture, we find that most of these are lacking to some degree (WASH 1986). To a large extent, these capacity shortfalls may be remedied through the conventional approaches of training, education and investment in facilities, particularly information technology. Similarly, although no indirect provider bodies existed in the case study countries at the time of our research, the particular competencies required by a regulatory body can be taught. However, experience suggests that it is the wider aspects of the institutional framework (that is, the so-called ‘enabling environment’) that ultimately define ‘the ability to deliver’, not the individual and organisational capacity of knowledge, skills and attitudes. WASH also uses the concept of ‘organisational autonomy’, referred to in Chapter 2, namely the capacity of an organisation to manage its own affairs. For a direct provider this would include the ability to manage investment planning and human resources and to introduce appropriate viable and timely tariff increases, all without undue interference from politicians and other government departments. This is the key capacity that was lacking in all case study countries except Zimbabwe and that best explains the ‘low level equilibrium trap’ that characterises service provision in the utilities examined in these countries.

8.2

Developing the capacity to change

The long-term goal of capacity building in the urban water sector is to enable organisations and individuals to develop in step with economic growth and consumer expectations, after an initial period of accelerated improvement to overcome present weaknesses. However, the mechanisms to escape out of the equilibrium trap and achieve this ‘breakthrough’ in terms of sustained improvement, based on real autonomy, are often absent. The question here is whether the act of separating out the direct and indirect provider roles is in itself sufficient to deliver the necessary enabling framework for sustained institutional change. When considering the necessary capacity to change, it is useful to make the distinction between those reforms that become matters of wide public debate and citizen mobilisation and those that generate responses


largely from within the bureaucratic arena (Batley 1998). The establishment of a formal regulator, located between public policy makers in government and the direct provider, falls firmly into the latter category. The addition of another layer of government, however technically competent or politically useful in its role of tariff-setting, will not per se deliver significant capacity for change in urban water supply. In order to provoke a public response and generate a wide public debate, the institutional framework requires a much more significant challenge than the mere establishment of a regulatory body. It is this capacity to mount such a challenge, often in response to what is seen as a threat, which is critical to delivering change and achieving a breakthrough. In recent years, this ‘capacity to change’ has invariably come from the introduction of a private direct provider, especially an international private operator, into the urban water supply system. If the first wave of private sector involvement is drawing to a close, there may now be a need for an alternative but equally powerful new challenge. The reason for desiring this high level of public response can be found in the organisational behaviour literature relating to change management. One writer describes the need to ‘unfreeze’ the existing situation, making it then possible to undertake the required change before deliberately ‘re-freezing’ the new patterns (through training or incentives) in order to be assured of the permanence of that change (Lewin 1997). This approach also uses the concepts of ‘promoting forces’ for change and ‘restraining forces’ (ibid). Not surprisingly, in urban water supply the restraining forces, namely the vested interests of the existing producer system, can very easily outweigh the more limited forces of the proponents of change, whether they be national ‘change champions’ or external donors and financiers. A crucial impact of the introduction of an international private operator is this capacity to stir up public debate about the quality of service, unfreezing the existing situation, whilst at the same time limiting the impact of the restraining forces. In the few cases where the restraining forces appeared to triumph there has been such an intense public debate that the system was forced to change regardless. In Cochabamba, Bolivia, the debate became so intense that it led to a public uprising and the overturning of a major concession contract. After the so-called ‘popular victory’ the reinstated public utility cannot raise tariffs and so is unable to finance any expansion to the peri-urban areas. Sadly, this has left the poor still paying many time times more than the rich for their water. Meanwhile, venal politicians are planning to reclaim control from the ‘water warriors’ (Nickson and Vargas 2002).


The ability to deliver affordable water to all does not depend so much upon the existence of an ideal organisational model, public or private, but on the willingness to use any means to challenge the existing pattern, particularly of pricing and subsidies. Indeed, the inherent or potential capacity of individuals working in an appropriate organisational framework in any country to deliver improved services is assured and relatively constant. We have seen ‘failing’ staff in the water sector liberated and re-enabled with a change of management. The real question concerns the capacity to successfully promote change by challenging and defeating the ‘restraining forces’. This is not simply an argument in favour of privatisation. In previous generations this capacity to challenge and defeat the ‘restraining forces’ was delivered through nationalisation, an option not currently available in most of the water sector but one that policy-makers may well return to in future generations. Releasing the capacity to change in this institutional context appears to require a ‘trigger’ or driver, something that goes beyond the vague desire of top government officials or politicians to reform and improve services. The World Bank has taken one route to releasing this capacity by publicly suggesting that there will be no future water sector loans to some countries unless those governments introduce significant private sector involvement. This forthright external stance then provides a strong lever that national change champions may use in order to unfreeze the prevailing ‘low level equilibrium trap’. There have been other triggers. The revolutionary change introduced by the Manila concession came about because the Philippine president declared a Water Crisis Seminar. As a government official who acted as a ‘change agent’ as Chief of Staff to the Secretary of the Department of Public Works and Highways explained, ‘We didn’t know we had a crisis until the president told us’ (Dumol 2000). By ‘creating’ the crisis the president created the mindset that could overcome the early resisters to change and enable the reform process to build up momentum. Similarly, the Buenos Aires concession was achieved partly as a result of the threat of a cholera outbreak reaching the city in the midst of economic crisis. By contrast, without such capacity for promoting change, and despite many years of discussion, the implementation of the proposed reforms in Ghana, India and Sri Lanka, described in this research, are making very slow progress. The capacity to change has, on occasions, been limited by resistance from trade unions – stakeholders who have a legitimate interest on behalf of their members, especially given the desperate shortage of jobs


in many low and middle-income countries. However, water utilities undergoing a reform programme cannot even move towards a ‘good enough’ level of efficiency when they are overstaffed by a factor of two or more. Major PPP reform programmes have therefore included significant support for retraining and early retirement where appropriate. For example, in preparation for the Manila concession, union leaders visited Buenos Aires where they met their counterparts for discussions on how to minimise the social cost of ‘downsizing’. Yet however strong is the trade union resistance to change, formal sector workers employed in water utilities remain the ‘privileged few’, in comparison to the poor consumers who stand to benefit most from the merit-good nature of water. The latter are the primary stakeholders in a government supported urban water supply reform programme and, for this reason alone, producer interests should not be allowed to act in detriment to their urgent needs. If some sort of crisis is necessary in order to deliver radical change, then there also needs to be the ongoing capacity to keep the ‘restraining forces’ at bay thereafter. Ongoing opposition does have a valuable role to play in the reform process because all organisations benefit from healthy criticism, particularly where there is an absence of competition. Nevertheless, the private sector, as a form of competition to the public sector model, must be allowed to make a reasonable start to the process of management reform in order to demonstrate whether or not it can really deliver sustainable benefits in urban water supply. In the present wave of reform the fact that many of the private operators are international has been an important capacity strength. Such multinational companies do pose the danger of exploitation through their enormous financial and human resources that are far in excess of those of most governments. Despite this, it is important to recognise the potential to appeal to wider powers that such an international company possesses when short-term national political considerations threaten to derail the reform process – considerations that, however valid, tend to prioritise producer interests rather than the interests of the urban poor as potential customers. International private operators have a major advantage in terms of capacity building because they can access additional promoters of change to challenge these restraining forces. Whether through ambassadorial meetings with heads of state or through their contacts with international financial institutions such as the World Bank, this access to wider networks that can promote and enable capacity building may be a more significant benefit of privatisation than the oft-quoted supply of private finance.


Once this capacity to drive through and maintain change has been recognised by the stakeholders, it is necessary to consider the capacity implications of the specific tasks of the New Public Management: regulation, running an efficient customer oriented water supply utility and ensuring that adequate services are delivered to the urban poor.

8.3

Capacity within the public sector

As indirect provider, the public sector requires the capacity to determine policy, to legislate to the extent needed to implement that policy, to establish contracts with private operators and/or performance contracts with any continuing public direct providers, and to regulate the implementation of those contracts. Governments have found little difficulty in developing capacity in the traditional areas of policy and legislation. In order to negotiate reasonable contracts, they have found it relatively straightforward to augment their capacity, when required, by hiring consultants. By contrast, governments have found it much harder to develop capacity in economic regulation. Regulation necessarily means coping with rapidly changing situations where there are many variables and few clear rules. The ability to make the appropriate regulatory decision therefore requires considerable autonomy from ministerial control in order to act with the necessary flexibility and discretion. The multi-faceted nature of the regulatory process requires professionals with the mindset of an economist or accountant who also understand the role of management, the market for private services, the engineering foundation of the water business, the legal framework, and the politics and sociology of development, together with communication and inter-personal skills. Unfortunately, in many developing countries this sort of person with an independent frame of mind will usually have the potential to earn far more in the private sector or in an international organisation. A common alternative to overcoming this scarcity is to appoint a senior civil servant, supposedly imbued with most of these skills, but in practice often lacking appreciation of the role of the market and with a tendency, based on career experience, to defer to the ministerial view. The following sober view of regulatory capacity from India is an indication of the challenges ahead: The fixation of the salaries of top regulators on government parities means that the job is only attractive to those who have already revealed their preference for government employment. Nobody with any


market skills, which would command a premium in the private sector, would be attracted by these terms. And when it comes to autonomy, nobody in government has apparently accepted the fact that these regulatory agencies are not supposed to be an extension of government. In this rather depressing context, the top regulatory jobs are really an extension of government service, in which serving or retired bureaucrats get to play their traditional games without the checks or balances (for what they are worth) of direct control by the Minister. (Business Standard 2001) This challenge is emphasised by another commentator: ‘If regulation is difficult for rich countries, it will be desperately hard for poor ones. Part of the problem is cultural: not many developing countries have good antitrust regulation, or are used to the idea of regulating to promote competition rather than to restrain it’ (The Economist 1997). With regard to the task of regulating national contractors, one cynical view suggests that these private contractors have a deep understanding of government power and have long learnt how to access and share the resources needed to survive and prosper without any particular focus on customer needs. According to this view, national contractors know that they have to ‘play the game’ as government sees it and are accustomed to adapting in order to meet those demands. By contrast, international private operators have to meet the expectations of international stakeholders, particularly with respect to international public opinion. Transparency is growing as a result of globalisation and it is far less easy for international companies, rather than national contractors, to continue with past practices of rent-seeking and corruption. However, there is still a tendency for regulatory capacity to be absorbed into ‘government as usual’ (that is, a bureaucratic approach overly influenced by political demands). In order to counter this tendency, it is necessary to establish the degree of autonomy (that is, the extent of responsibility and authority) that is granted to the regulator. This decision on how much autonomy to grant to the regulatory body is closely linked to the question of whether there should be an individual regulator with the impressive list of personal attributes described above or a multi-member regulatory board that can spread the required skills over a number of individuals. For reasons of practicality and transparency, the broad consensus around the world today favours the latter of these two options. The personification of regulation in a single individual who can be held accountable has been a characteristic of the UK style of utility


regulation. However, the latter is also now moving towards a multimember approach. In 2002 the individual water regulator for England and Wales appointed non-executive advisory directors, in effect a regulatory board, whose views he promised to ‘take full account of’ in reaching conclusions. Subsequently the government announced its intention to create a formal regulatory board. By contrast, the Argentine regulatory system adopted a multi-member approach since its creation. However, there is strong evidence that the basis for selection has prioritised the need for ‘political balance’ rather than achievement of the necessary mix of skills. Government faces three major strategic decisions regarding the regulatory format. First, it must decide whether to have a single national water regulator or to decentralise this responsibility to state, province or even municipal level. Second, it must decide whether to have separate regulatory bodies for each sector, each one focused upon a single utility service such as water, or whether to have a multi-sector regulatory body with a remit that includes, for example, electricity and gas as well as water. Third, it must decide whether to have separate regulatory bodies for economic regulation and environmental and quality regulation, or to fuse these concerns in a single regulatory institution. A key concern when making these decisions is to limit the imbalances that can arise when a single regulator ‘takes on’ a single utility. This is particularly relevant when the utility is managed by an international private operator with global experience of negotiating with national regulators to its own advantage. In this case, the regulator faces the classic principal–agent problem – the tendency for the principal (that is, government) never to be sure whether their agent (that is, contractor), is performing at optimal efficiency and effectiveness. In order to counter the dangers implicit in such a principal–agent relationship the regulator needs ‘comparators’ – data from other utilities with which to compare operating efficiency, construction costs and cost of capital across companies. Without access to such comparators, a water regulator with oversight responsibility for just one or two contracts can rarely hope to develop the necessary confidence that it is delivering just and fair decisions. It would be able to carry out the basic regulatory tasks of price setting and monitoring service provision, but would always be unsure whether the price was reasonable or whether the private operator was benefiting unduly. This very uncertainty can tempt regulators to become overly restrictive in areas where they would have served customer interests better by being flexible. One such uncertainty relates to transfer pricing,


namely the excess profit that an international private operator might be reaping through overcharging for trading items within its own group, without the external control of any tendering process. Another uncertainty refers to how to respond to a complaint by the operator that devaluation of the local currency is making it impossible to finance further investment. In both examples, the regulator must decide whether its decision rests exclusively upon the contractual rules or whether to share the risk in such a manner that does not then deliver excessive profits to the operator. Ideally, any regulator should have a portfolio of contracts and operators to referee, either regulating a range of differently tasked utilities at state or municipal level or having a national regulator for several single task utilities. Initiatives to address this capacity constraint with regard to comparators were described in Chapter 7. Another approach to developing regulatory capacity is the World Bank’s ‘International Network of Utility Regulators’. This acts as a forum for discussion and information exchange with regional networks such as the South Asia Forum on Infrastructure Regulation (SAFIR). One proposal to resolve the decision as to whether the regulator should be national, provincial or municipal-based is the establishment of a ‘Coordinating Regulatory Agency’. This would be a central body from which local regulators could access expertise and advice, information flows, a discussion forum, research services, support and consultancy, and training. It would not have an executive role but would be a source of support to all regulatory agencies in the country (Stanley 2001). An alternative, albeit more expensive, way to strengthen regulatory capacity is to employ international accounting consultants to deliver the comparator experience and to audit the regulatory analysis. International consultants can also be used to audit the accounts of private operators, but using international auditing standards rather than the less stringent locally adapted standards that have tended to be used in the past. However, it should be acknowledged that even international auditing standards may not necessarily have been of an acceptable standard, as shown by the 2002 accounting scandals in the United States. Another way to ‘level the playing field’ by reducing the asymmetry in information between principal and agent is to use ‘open-book accounting’ under which the private operator not only has to supply regular financial statements to the regulator but where these accounts are open at any time for inspection and investigation, to determine the ‘true’ level of costs. This approach has already become best practice in ‘partnering


agreements’ between private companies as well as for some government contracts in high-income countries. However, in order to succeed, there must be mutual understanding that this high degree of openness is operating in the context of a strong partnership. It should not be seen as an opportunity for an inexperienced government regulator to micromanage, by questioning the appropriateness of each and every invoice. Regulators, whether individual or multi-member, need strong support staff. In several countries the regulatory body has been staffed with engineers transferred from the former state water provider. They often lacked the necessary skills in accounting and economics and experience of the new tasks of regulation. Furthermore, they often resented the new private management taking over their former institution. This presents a major challenge to capacity building in regulation, a challenge that has been recognised in other utilities. A further problem is the sheer demand for skilled manpower. ‘If you need to create a body with autonomy and expertise, you are quickly talking about 50 professionals, says a telecommunications adviser at the World Bank. That is a big problem for countries with limited human and institutional resources’ (The Economist 1997). In order to meet all these capacity demands on the indirect provider we need to recognise that regulation is both a science and an art. The science of regulation involves the task of collecting and analysing data on services, costs and the environment in order to determine the approximation to the best answer, whether tariff levels or acceptable service standards. Statutory authority is essential in order to obtain this information from private operators and it is for this reason that the regulator has to be in some way a part of government. But there is also the art – or the politics – of regulation. This requires a certain distancing from the government of the day in order to avoid becoming absorbed in its political objectives at the expense of the private operator and the customer. So regulation involves the near impossible task of ‘holding the ring’ between government on one side and the private sector (or the government direct provider) on the other. To make matters worse, this is often tantamount to holding the ring between the forces promoting change and those forces restraining change. The indirect provider – the regulator – has to become the ‘impartial referee’, without, of course, becoming a ‘punch bag’ in the middle, pummelled by all sides. Whether there is the capacity in low and middle-income countries to sustain these tasks over the long term – tasks that are more sophisticated than operating a direct water provider efficiently – is generally unproven, given the limited and short-term experience of regulation to date in most of these countries.


8.4

Capacity within the other partners

The question of customer representation is an important capacity issue within the regulatory process. A forum for customers to have a voice in the management process is critical, both to improve that process and to allow the inevitable discontents and frustrations to be expressed in the most productive manner. Customer representation may function as part of the regulatory body or as independent entities, albeit funded through the regulatory system. Customer representative organisations may function at the national level, at regional level and at municipal level. In high-income countries the task of customer representation has become ever more sophisticated, as described by one consumer representative: A lot of discussion has become more technical, especially when working in sub-groups. This makes it more difficult for a customer representative – because you deal with things that are outside most customers’ experience. It is hard to assess whether you truly represent customer views. But to represent customers’ interests properly, you just have to keep digging deeply into those affairs, and challenging the companies’ assumptions. (OFWAT 2001b) Customer committees in England and Wales have the comprehensive tasks of representing the customers’ views to government and to the regulator on all aspects of service provision and policy, of auditing the complaints procedures of private operators and of arbitrating on behalf of the customer in cases of unresolved complaints, often in order to achieve a higher level of compensation. The availability of early retirement on good pensions has helped to deliver the necessary capacity in England and Wales to staff these voluntary (that is, unpaid) customer committees. In the very different economic situation of low-income countries, such sources of capacity are much more limited. Instead, the NGO sector can play an important role, both acting independently as quasi-consumer association bodies and by seconding staff with the appropriate personal capacities to serve on any such customer committees. In all countries customer representation faces the general challenge of avoiding politicisation. There is the additional challenge in low-income countries of ensuring the representation of the poor on customer committees. This is a critical capacity issue where a large proportion of the urban population lives in slums and unplanned housing areas. An effective way has to be found to access the views of the poor at the stage


when many of them may still be waiting to be connected to the pipe network. In order for this to happen, community based organisations and NGOs working in such areas need to be incorporated into the regulatory process. There are other aspects of capacity relating particularly to serving the poor. Contingency theory suggests that the most effective organisations are those designed to be contingent upon their socio-economic environment, with particular reference to the size of market and type of technology required. Urban water supply, which involves the provision of a ‘simple’ technology to a ‘mass market’ may be described as requiring a ‘mechanistic’ style of organisation and management, namely one with agreed procedures and relatively fixed rules for all tasks. By contrast, the regulation of that service provision, because it requires significant and skilled adaptation to meet changing circumstances, can be described as requiring an ‘organic’ style of organisation, namely one requiring the capacity to be flexible and adaptive. This apparent mismatch between organisations that have to work so closely together is a particular challenge for capacity building (Burns and Stalker 1994). A similar mismatch is found in services for the poor in slums and unplanned areas. These has tended to follow a ‘craft’ approach, namely one-off initiatives by small-scale independent providers and NGOs, working independently from (though often benefiting) from the direct provider. On equity grounds the poor should also benefit from the economies of scale in the form of the enhanced quality and quantity of water that a municipality-wide, ‘mechanistic’ provider can deliver. They should also benefit from the financial subsidies, explicit or by default, which the rich have long been receiving through under-priced tariffs. However, serving the needs of the poor living in informal, unplanned, illegal housing areas cannot be undertaken in a ‘mechanistic’ style because every low-income settlement has different characteristics in terms of income and organisation as well as differing physical characteristics relating to housing density and access lanes. Because of the significant size of this segment of the market, delivery to the poor needs to move beyond the ‘craft’ approach and benefit from an ‘organic’ style of thinking that is both adaptive and flexible. In particular this requires an awareness of social development issues that are critical to enable the poor to benefit from any infrastructure development. Hence in terms of contingency theory what is required is a hybrid organisational style, known as ‘mechanical–organic’ – one that is capable of delivering good quality bulk water as cheaply as possible to poor households but that can then be locally distributed through an ‘organic’, flexible approach.


The particular human skills and attitudes that such an organisational style needs are not normally found within the capacity of an engineering-led, ‘mechanistic’ water utility. But some NGOs have developed these skills. So public-private-NGO-community partnerships are needed that can deliver the required ‘mechanical–organic’ style. Such partnerships include not only private operators but also NGOs, or their social development consultant equivalents. Together they view the beneficiary community as partners, acting and deciding together in the provision of clean water and sanitation. This approach requires private operators to demonstrate capacity in a range of activities that they have not previously performed.

8.5

The capacity of international private operators

International private operators have the proven capacity to efficiently manage water companies serving major metropolitan areas. It is this skill that ensures their place on the list of pre-qualified bidders. However, the need for this capability necessarily limits the pool of potential operators that can demonstrate that aptitude because so many countries have followed the public sector model. The three main French companies – Veolia, Ondeo and SAUR – have built up a substantial portfolio of international PPPs through their long domestic history and their early opportunity to work abroad in French colonies and overseas departments. These three companies alone now account for four-fifths of the people served by international water PPPs in low and middle-income countries as well as approximately two-thirds of the total investment involved. One company alone, Ondeo, although occupying a smaller position in the French market, appears to have about one-third of this market in low and middle-income countries, as measured by the population served (Figure 8.1). This concentration of power in just three major companies has given rise to fears of anti-competitive behaviour in some markets, particularly when the two largest companies occasionally combine in joint venture bids. Such collusion raises doubts about the capacity of a single municipality, even a large metropolitan authority, to regulate such a powerful international combination. It was initially thought that the privatised English water companies would take up the challenge to broaden private operator capacity worldwide. However, thanks to a combination of high domestic profit margins and some early losses overseas, this has not happened. The main English contender, Thames Water, was taken over in 2000 by the


Private Operators LMIC Operational Water PPPs by reported population served

Ondeo, 32%

National Contractors, 18%

Veolia, 17% Other international, 3% Biwater Nuon, 3% Anglian, 3%

SAUR, 7%

IWL, 3%

Canal Energia, 3%

RWE–Thames, 9%

United Utilities, 2% Figure 8.1: The share of international private operators in the market for public private partnerships in urban water supply in middle and low-income countries (by reported population served) Source: Franceys 2003a (updated)

German multi-utility, RWE. An earlier 1998 takeover of the English regional company, Wessex Water, by the US company, Enron, proved a failure. Enron used Wessex to form the core of its new water subsidiary, Azurix, which then made extravagant bids around the world to secure lease contracts. As a result, Azurix was foundering before the collapse of Enron in 2002, and many of its operations were sold to other companies. The subsequent sale of Wessex Water in 2002 to a Malaysian company, YTL Power International Berhad, is a promising pointer towards the development of international capacity. This unique combination of international experience and a low wage domestic base might help to solve one of the main challenges facing PPPs in the urban water sector, namely how to serve secondary towns in low and middle-income countries.


Major international private operators view contracts in secondary cities of less than 500,000 population as unprofitable because of the high costs of employing expatriates, even at the level of 1 per cent expatriate staff that some companies have been able to achieve. A certain minimum size city is necessary in order to be able to absorb the fixed costs of an expatriate, estimated as US$250,000 per year. The failure to employ an expatriate jeopardises the ‘international’ element in the contract that plays such a vital role in both overcoming the restraining forces described above as well as assuring the financiers that the system is being managed in such a way that minimises the risk of loan default. In this sense, with its much lower average cost per expatriate, YTL Power International Berhad could be well suited to extend the benefits of private direct providers to smaller towns. Despite the poor record of the English water companies, some international operators, particularly Spanish companies, are beginning to compete in their own right rather than as subsidiaries of the major French companies, as has been the case until recently. Elsewhere, domestic partners are beginning to take a lead role within consortia. For example, Manila Water now regards itself as a Philippine company, notwithstanding its partnership with International Water, thanks to a government requirement of 60 per cent local participation in the consortium. Less encouragingly, Benpres, the national partner within Maynilad, the other consortium operating in Manila, now wants to sell its share of the business in order to raise money to support its other activities (Global Water Report 2002b). Cross-cultural managerial behaviour is another aspect of capacity that is relevant to international private operators. Writers on management styles often refer to the cultural distinction between ‘individualism’ and ‘collectivism’ and between ‘uncertainty avoidance’ and ‘risk-taking’. Of particular relevance to the urban water sector is the difference between a ‘rules-based’ approach to management and the more traditional ‘relationship-based’ approach that is common in the public administration systems of low-and middle-income countries. The organisational culture of international private operators, with their individual performancerelated incentives for staff, functions primarily according to ‘rules’. This approach is particularly appropriate in a ‘mechanistic’ type of organisation and is one of the core aspects of capacity that an international private operator can deliver. Cross-cultural managerial behaviour also has an effect on how contracts with international private operators are managed at the level of government and regulatory bodies. Government officials describe their


perception that British water companies have tended to regard the signing of a contract as the endpoint of negotiation and the green light for making financial claims based on unforeseen situations that had not been covered under the contract. This adversarial behaviour reflects the British experience of contracting in the construction industry. By contrast, French water companies are perceived as regarding the signing of a contract as the beginning of negotiations that will continue over the whole life of the contract. This more consensual behaviour, itself a critical capacity, is most likely based on their long experience of working alongside municipal mayors and councillors. International private operators have begun to develop many new facets of capacity in order to operate as direct water providers in low and middle-income countries. Serving the poor in illegal unplanned areas has never had to be a core competence of international private operators in their domestic markets. Yet as described in Chapter 6, one French company, Ondeo, has displayed the competence for flexible and lateral thinking. It is developing the necessary ‘mechanical–organic’ capacity by investing in pilot projects and partnerships with NGOs in order to find a way to serve the poor. It is to be hoped that other private operators, international and national, will develop similar skills in order to deliver effective water services in the slums that are a feature of all major cities in low and middle-income countries.

8.6

The capacity to act as partners

Inherent in the terminology of public private partnerships is a final crucial competence, namely the capacity to behave as a ‘partner’. A cynical interpretation might suggest that the inclusion of ‘partnership’ in the PPP concept is simply a public relations device designed to make ‘privatisation’ more acceptable. Yet, as described in Chapter 6, there is an urgent need for genuine partnership – ‘acting together and deciding together’ according to one definition – in order to ensure the trust and participation on which depends effective service provision to the urban poor. To ensure services to all also requires a degree of trust and an extension of participatory development to government as well as to customers. If there is little trust, as in the early stages of the Buenos Aires concession (Chapter 7), then the potential benefits of PPP and the NPM are significantly reduced. Already the private sector in high-income countries has deepened the concept of partnership. In an approach known as ‘partnering’, parties to a contract agree to maintain an active search for ‘mutually beneficial exchange relationships’, popularly known as ‘win-win solutions’.


The partners consciously commit themselves to avoid falling into the trap of an adversarial relationship that often characterises construction contracts. The concept of ‘partnering’ features ‘teamwork, continuous improvement, openness, acceptance of new ideas, trust and mutual benefit’ (Hitchings 2001). This capacity of partnering in the form of a relationship between government, private operators, and the community is essential if creative and effective ways are to be found to serve all customers, and particularly the urban poor.

8.7

Capacity within the case study countries

In the light of the above discussion the issue of the capacity to reform urban water supply is now considered for each of the four case study countries 8.7.1

Ghana

The water sector in Ghana has long experience of the challenges of institutional restructuring. Having started in 1928 with a system managed by the hydraulics branch of the Public Works Department (PWD), the Water Supply Division (WSD) of PWD was established in 1958 as an autonomous entity directly responsible to the Ministry of Works and Housing. To introduce commercial principles, the Ghana Water and Sewerage Corporation (GWSC) was established in 1965. In 1985, the government decided to restructure GWSC to upgrade its commercial operations, improve conditions of service, withdraw subsidies, increase tariffs, eliminate redundant staff and recruit key personnel. With only limited improvements in service following that restructuring, urban and rural water supplies were separated in 1994, after which the Ministry of Works and Housing and the World Bank commissioned the Ghana Water Sector Restructuring Study to evaluate options for increased private sector participation (PSP) in urban water supply. The rural water division of GWSC was transformed into the Community Water and Sanitation Division (CSWD) as a semi-autonomous division, subsequently being transformed into a new entity, the Community Water and Sanitation Agency (CWSA) with the responsibility for facilitating water and sanitation services in rural areas and small towns under community ownership and management (COM). Given that the earlier attempts at capacity building have delivered so little, it may well be asked whether a move to NPM can succeed where others have failed. As part of the process of preparing for private sector involvement, GWSC was converted into a limited liability company,


Ghana Water Company Limited (GWCL) in July 1999 with responsibility for urban water supply, in the expectation that it would become the asset holder and manager with private companies responsible for operations. But as described in Chapter 5, the planned public private partnership is much delayed. However there has been a significant development in the capacity of the indirect provider with the successfully establishment of the Public Utilities Regulatory Commission (PURC), as described in Chapter 7. PURC has the tasks of tariff setting, economic regulation and customer protection of urban water supplies. It has received significant capacity building inputs from external consultants to enable it to begin the process of regulation. When fieldwork for this research was first carried out in 1996 few in Ghana were thinking of performing as complex a regulatory role as OFWAT in the UK. Instead the regulation being considered ‘was primarily that of monitoring and contracting, that is ensuring that things got done and that agreements are adhered to, similar to the role of monitoring international aid projects of which they had substantial experience’ (Amis 1998). The study concluded by questioning whether the political will to bring about the reform process existed, despite the local capacity to fulfil these regulatory functions. In fact Ghana has followed the OFWAT regulatory model to a considerable degree. There has been the capacity and the will to deliver a fully functioning regulator that is now setting tariffs for the public direct providers and is even establishing customer committees. But by mid-2002 there was still no political will to deliver a functioning public private partnership. As the Ghanaian experience demonstrates, without significant triggers, change in the urban water sector can be a protracted process. 8.7.2

India

The experiences of attempted institutional reform in the Indian urban water sector are often delayed for years or cancelled altogether. The engineer administrators usually blame their political overseers for these setbacks. Only in some metropolitan cities such as Hyderabad, Chennai, and Bangalore are there any real attempts to introduce NPM techniques in order to deliver improved service to customers. Interestingly, in each of these cases the change process was not initiated by officers trained in public health engineering but rather by senior civil servants belonging to the Indian Administrative Service (IAS) who are trained with a commercial orientation within the public service and who are allowed at least three years in post before the inevitable transfer to a different function.


This is evolutionary change of the most limited kind. There has been remarkably little strengthening of individual or institutional capacity. Nor has there been any significant change in the way that these organisations relate to local municipalities. In practice, they still function as Public Works Departments and are headed by statelevel engineers who regard the completion of new investment projects rather than attainment of the universal service obligation as their key objective. Such engineers have displayed neither the personal inclination nor the management understanding to challenge the present system. They have derived sufficient personal and career satisfaction from their present way of working to obviate the need for change. The challenge of developing a commercially viable water utility, generating sufficient funds to become largely self-financing has never been a goal worth striving for, especially when the other major stakeholders (that is, politicians) also derive satisfaction from their role as distributors of state funds. The Indian urban water sector may be described as a system that has evolved the capacity to serve four distinct groups of stakeholders – two primary ones (engineers and politicians) and two secondary ones (the urban high-income groups and the work-force). The engineers have achieved secure jobs that allow them to indulge their desire to construct new works. They are poorly paid in relation to the private sector although in some states they may enhance earnings through corruption associated with the awarding of contracts for new works. Engineers have little incentive to manage effectively because the promotion criterion is exclusively based on seniority. These engineer administrators sometimes become frustrated at the performance of their organisations and by the daily ‘fire-fighting’ role that they are forced into by local politicians and officials. Nonetheless they are able to avoid any challenge to their view of the world and their role in it. They find personal fulfilment in the knowledge that they have performed well by completing a new construction project (Franceys and Sansom 1999). Politicians, the other primary stakeholders, have the benefit of considerable powers of patronage. They are able to distribute largesse through granting (or withholding) new works in areas that are poorly served. They also have particular influence over the employment and posting of staff. They have the power to restrict tariff increases in order to gain voter support. In some cities they even have the right to demand their own personal water connection to the transmission main, thus bypassing the frustrations of receiving an intermittent supply through the distribution system.


The higher-income groups in urban areas and the staff of the water utilities are secondary stakeholders in the water supply system. The rich receive a poor quality product but they pay virtually nothing for it, relative to their household income. They receive most of the benefits of the limited water supply and sanitation system. Unlike the poor, they can afford to purchase household water tanks to store the intermittently supplied water, or their own pumps to suck water illegally out of the distribution pipes. In some cities they can afford to install their own boreholes to supplement the intermittent piped supply. The higherincome groups are also more likely to have access to sewerage because they tend to live in those parts of cities that are served first. In exchange for this sewerage service they only have to pay an additional charge equivalent to around 20 per cent of their already minimal water bill. This represents an extremely inequitable subsidy. The cost of full sewerage and sewage treatment worldwide is typically equivalent to 120 per cent of the cost of a properly priced water supply. Given that the latter is at least three times the current tariff levels in much of India, then higher-income groups are paying for sewerage at one-eighteenth of its real cost. As ever, it is the rich who are receiving the subsidies. The other secondary stakeholders are the majority of the staff of the water utilities. They benefit from life-long job security with limited work effort and the support of trade unions to ensure that institutional reform does not challenge this situation. We have described these stakeholder interests in some detail in order to illustrate that a ‘revolutionary’ change in capacity is needed if the sector is to even begin to meet the needs of consumers. However, the system does have one particular capacity, namely a proven competence in crisis management. Whenever the system appears to be on the brink of collapse, this capacity for crisis management comes to the fore. Yet when the crisis is averted, as in the case of Chennai in July 2001 when trains were used to transport water to the drought-stricken city, the system settles back into its traditional behavioural pattern. In this manner the Indian urban water system manages to avoid the kind of institutional challenges that led to radical improvement in Buenos Aires and Manila. The most important driver for change in India is the 74th Amendment to the Constitution, which was promulgated in 1992. This laid the foundation for democratic decentralisation by granting major constitutional status and powers to urban local government, including for water supply. Potentially, the 74th Amendment has major implications for governance of the urban water sector, and is of far more


immediate significance than any consideration of private sector participation. In theory, urban local bodies could use these new powers to assume the role of promoter or lead client in the provision of drinking water, converting the state water boards into a supportive role as consulting engineer or project manager. Unfortunately, most specialist observers believe that the urban municipalities do not have the necessary capacity to act as ‘intelligent clients’, let alone as direct providers. The provisions of the 74th amendment for water supply appear to be receiving little attention, beyond the requirement that municipalities introduce conventional, commercial style accounting for fixed assets. Consequently, the state water boards and/or departments seem likely to continue with their present predominant role. Nevertheless, institutional stakeholders do have a growing sense that the world is changing around them and that they might have to engage in some form of real reform. However, they behave as if any such change must not challenge the basic premise that their job is basically about building water works and that the introduction of change should be delayed until after they have completed their own careers. ‘Neither politicians nor bureaucrats have been willing to surrender the vast pools of patronage that lie in the public sector. Nor have they been ready to contemplate the job cuts which might be involved in raising efficiency to private sector standards’ (Wagstyl 1997). Without the introduction of viable tariffs, private sector participation can never be introduced because there are no funds available to pay the real costs of effective supply. But without the revolutionary driver of privatisation it seems that viable tariffs cannot be introduced. The challenge is to generate the capacity to break out of this vicious circle. With the involvement of the World Bank there has recently been a significant effort by central government ministries to understand the potential benefits of private sector contracts and the parallel requirements for price-setting through regulation. The Ministry of Urban Development and Poverty Alleviation believes that state governments should encourage and provide autonomy to water sector institutions ‘particularly in selection of projects, administrative approval, construction of capital works, personnel policies, determination of tariff and methodology for effective recovery of dues. The State Governments’ role should be limited to approval of annual action plans and provision of budgetary support’ (Minhas 1997). Meanwhile attempts to involve the private sector in a radical manner continue to


run into problems. Over the past decade public private partnerships with international private operators have been promoted in a number of cities, as described in detail in Chapter 5. All promised much but have delivered little. Most recently the Ministry of Urban Development and Poverty Alleviation has established a Change Management Forum (CMF), supported by external donors, with the goal of promoting institutional and organisational development and supporting reform of the urban water and sanitation sector. CMF aims at commercial and customer orientation, capacity building and knowledge sharing through dialogue and partnership. The CMF initiative is trying to take capacity building beyond individual training programmes, whilst recognising that such programmes are still a critical component of change. It is trying to go beyond ‘re-badging’, namely the simplistic redefinition of the respective boundaries of government direct provider organisations. It brings together politicians and senior municipal administrators as well as the engineer administrators in a forum to consider best practices, national and international, and to commit as partners to individual and institutional change, up to and including private sector involvement. When viewed from the perspective of a member of the Advisory Board, CMF is a promising development whose long-term effects are yet to be seen (Franceys 2002b). Water consumers have great potential as catalysts for institutional development through the ‘bottom up’ demand for change. Water consumers in India, who have rarely been treated as customers, have been ‘taught’ over many generations to be content with whatever they receive so long as it costs them almost nothing. They have learnt to lobby and agitate for a basic supply when this is threatened by drought, low pressure or delayed extension to their area. But there is little overt demand for an acceptable level of service in exchange for a modest tariff increase. Evidence from interviews with consumers suggest that water consumers do realise that the present price of water is extremely low and that they would be prepared to pay more for a better quality service (Rakodi 1998). But this sentiment is not yet expressed at the political level. This limited effective capacity of consumers to lobby for a ‘new’ water supply service is a major constraint on the development of the sector. Without that effective demand, the existing professionals presume that they are performing adequately and that they may justifiably resist pressures for reform of their ‘supply-driven’ institutions. The brightest hope for ‘bottom-up’ demand for reform comes from NGOs. These have


proliferated because of the failure of Indian government institutions to respond to the changing needs and demands of consumers. They serve an important role as proponents of change, particularly on behalf of the poor and at times have even taken on the role of direct provider. There is a clear role for NGOs to generate genuine customer capacity for demanding better services. The major international private operators have all attempted to develop capacity for their services in the Indian market. The usual pattern is to go through cycles of establishing country offices, making links with politicians and administrators, developing private direct provider contracts, and then waiting whilst the system absorbs and neutralises the proposal. At this point in the cycle the country office is closed down and the operator moves on to more promising parts of the world. In fact, the major ‘capacity’ in the Indian water sector is the capacity to neutralise radical change. But of course India has the capacity to deliver whatever it desires – there are many small changes being implemented, often too small to be noticed. Perhaps capacity for reform in India really does come in the form of the small, slow steps of an elephant rather than any leaps of a tiger. As one writer has put it: ‘It will never have speed, but it will always have stamina’ (Das 2002). 8.7.3

Sri Lanka

The National Water Supply and Drainage Board (NWSDB) has been providing an ‘almost good enough’ service – adequate but not outstanding – following significant investment in capacity-building. In the process, NWSDB has been pushed as far as the existing resources and systems of government have allowed. Perhaps inspired by an admirable attempt to limit bureaucracy, central government has maintained a very ‘lean’ staffing level to oversee the board. It could be argued that government has delegated the responsibility of management of the sector to NWSDB and therefore did not see the need to develop any capacity for oversight. Competent government personnel have staffed the relevant departments in the Ministry of Housing, Construction and Public Utilities, but given their extensive responsibilities it has not been possible for them to carry out all their oversight functions with respect to water supply and sanitation. Government appoints NWSDB board members. It has tended to use these appointments as a reward for political support or as a means of ensuring ministry representation rather than on consideration of the need to direct a commercial enterprise, albeit one with social welfare


concerns. The management of NWSDB has also been politicised by the involvement of senior politicians in strategic decision-making. There have been many proposals for reform over the years. The 1996 proposal for institutional reform of NWSDB encapsulates the choices available to the urban water supply sector in Sri Lanka. The first option was to commercialise under government ownership by using contracting-out and BOOTs wherever possible, focusing more clearly on core competences while retaining the variety of cross subsidies. The second option was to privatise the financially viable areas, such as the capital city and tourist resorts, and to transfer government subsidies directly to the managing authorities, presumably municipalities, for those parts of the organisation that could not become economically self-sufficient. As described in Chapter 5, the government initially considered the second option of private sector involvement in Colombo. Subsequently, it explored the possibility of concession contracts in smaller tourist and industrial areas on the coastal strip to the north and south of the capital. Economic regulation seems to be ‘the acceptable face’ of NPM and the government has pressed forward with plans to establish a water regulator, with advice from international consultants. But the continuing delays in the reform process suggest that there is little desire for, or capacity, to change the organisational arrangements for urban water supply. 8.7.4

Zimbabwe

Fieldwork carried out in Bulawayo as part of the research found considerable strength in the professional and technical capacity of the municipal system of water distribution (Batley 1998). The Municipality of Bulawayo was supported by a central government agency, the Department of Water Resources (DWR), which is responsible for abstraction and delivery of bulk water. The resulting universal service coverage is an excellent achievement, although poorer customers were finding it difficult to afford the relatively high cost of water. Two significant drivers for change were identified – the deteriorating economic conditions in the country as a whole and the acute shortage of water in the region. However, there was a widespread view that the effective administrative systems in place would not necessarily translate into good management capacity to cope with change. ‘There is a lack of good managers to deal with matters that don’t fall within the procedures, to deal with change, to develop new sources of finance and to


be more entrepreneurial’ (Deputy Director, Water, Municipality of Bulawayo, quoted in Batley 1998). At the time of the fieldwork, it was proposed to convert the national government’s Department of Water Resources into a parastatal body. This would enable it to move from an environment in which it was in the controlling position, maintaining a continually expanding water sector (although with little regard to efficiency and sustainability) to one where it would have to work with other stakeholders and adopt a more entrepreneurial, and cost-effective management style. However, there was a perceived risk that the informal political intervention would continue under the new institutional arrangement and that policy, regulatory, water resource management and supply functions would continue to be confused under one organisation. Changing the DWR into a parastatal, in itself would be unlikely to generate the managerial capacity to handle a more complex environment. There have been recent attempts to involve the private sector in order to develop capacity. The Municipality of Bulawayo explored the possibility of signing a contract with a private company to transport water from the Zambezi river, 480 km away – the so-called Matabeleland Zambezi Water Project. However the political and economic situation in the country has delayed this US$560m project and prospective Italian and Malaysian bidders have withdrawn, citing irregularities in their dealings with government officials (Global Water Report 2002a). By 2002 the overall governance capacity in Zimbabwe had reached such a low level that major international private operators were unlikely to consider investment in the water sector. SAUR UK decided not to proceed with negotiations for a concession contract in Gweru, a city with a population one-third that of Bulawayo, stating that ‘it would be difficult to obtain acceptance from a Board sitting in Europe for any significant actions in Zimbabwe’ (Plummer and Nhemachena 2001).

8.8

Conclusions

In two of the case study countries – Ghana and India – the current institutional arrangement under which the public sector acts as both direct and indirect provider is failing to deliver a ‘good enough’ service. In another of the countries – Sri Lanka – it is just about providing that


level of service thanks to substantial and sustained investment in capacity building. In the remaining study country – Zimbabwe – the public sector had been delivering a ‘better than average’ service – but with the prospect of impending decline due to the deteriorating political situation. Ironically the capacity for indirect provision, through regulation and policy-making, appears to be present in all of the four case study countries, as exemplified by the establishment of a regulatory body in Ghana and the preparations for such a body in Sri Lanka and in one state in India (Andra Pradesh). But even with the best of intentions, regulation alone can never achieve a viable water supply. The experience of the case study countries strongly suggests that the mere separation of the indirect role from the direct role is not in itself a strong enough driver to bring about change in the form of sustained improvement in performance. The capacity to change is only likely to be revealed through the involvement of a ‘change promoting force’ as strong as the private sector. In the light of the merit good nature of urban water supply, significant private sector involvement in its direct provision should not be automatically necessary. However, it may be the only way to provide a good level of service to all, given the insufficient public sector capacity to do so in many low and middle-income countries. International private operators have the capacity to create efficient water companies as well as the capacity to serve the poor. This is because of their particular capacity in introducing a rules-based, mechanistic approach to service delivery whilst at the same time being able to limit the restraining forces against reform that are ever present. Some national companies, with international partners, are now also demonstrating that same capacity. A reasonable rate of return in the form of profits above the cost of capital is a price worth paying, it may be argued, in order to attract international private operators that can overcome the lack of capacity found in government providers. Civil society has also demonstrated its capacity to play a positive role, although at present it often lobbies against the reform process because of its understandable mistrust of government intentions. There is a need for sharing of ideas with civil society organisations about reform in order to explore the potential benefits of ‘tapping the market’, particularly with regard to improving services for the poor. Notwithstanding the weaknesses identified above, the public sector does have the capacity to deliver the New Public Management. In fact


it has the capacity to deliver whatever it is asked to deliver, once it has received the necessary preparation and ongoing support (namely ‘capacity building’). The public sector has ‘the ability to deliver’ when so enabled. But the ‘capacity to change’ – the willingness to make the move to a reformed water sector – is a capricious quality that appears to depend upon individual political impulse as much as it does upon reasoned public policy.

9 Reforming Urban Water Sector Reform

9.1

Introduction

Earlier chapters have addressed both the capacity problems faced by the case study countries that are considering the introduction of specific reforms and how that capacity may be best increased. However they did not address the crucial question of the extent to which the reforms themselves are relevant to particular countries. This is an important question because these reforms usually form part of a package that is widely perceived as an agenda for the international water sector based on the principles of the New Public Management (NPM). Although the evidence that capacity constraints are a major barrier to the implementation of reforms provides a strong case for questioning those reforms, it is also necessary to directly address the relevance of the reforms themselves. This final chapter, therefore, questions the overall reform agenda, and the value of the specific reforms that are the focus of this book, as well as drawing conclusions on the difficulties of implementing reform policies in the urban water sector. The initial sections summarise and draw together the contents of earlier chapters, giving an overview of the extent of reform in the case study countries, and of the performance of governments overall as well as in relation to the specific policies examined. The chapter then proceeds to question the relevance and current viability of the NPM and its associated policies to the circumstances of low and middle-income countries. The chapter concludes by identifying the financial and political price to be paid by consumers and governments respectively in order to introduce the organisational and institutional reforms that will be necessary if the millennium development goals (MDGs) of improved water for all are to be attained in urban areas by 2025. 181


9.2 The international reform agenda for the urban water supply sector This book has examined the extent to which the state in adjusting economies has the capacity to respond adequately to the new demands placed upon it as a result of the introduction of a raft of public policies, collectively known as the New Public Management (NPM), in the urban water supply (UWS) sector. According to economic theory, the consumption characteristics of UWS place it firmly in the category of a private good. It does not fulfil the two key conditions of a pure public ‘common-pool’ good – non-excludability and non-rivalry. In the absence of public good characteristics, there is no strong technical argument from the side of consumption in favour of the direct state provision of UWS. However, its production features – natural monopoly, externalities and merit good – do provide a strong technical case for state intervention in order to counter possible divergences between private and social costs and benefits, divergences that can have important social welfare and equity considerations. Consequently, the consumption and production characteristics of UWS suggest that a combination of private provision with strong regulation by the state is the most appropriate service arrangement. Hence the sector lends itself to the introduction of NPM reforms. Chapter 1 referred to the growing global concern for changing the organisational arrangements for the urban water sector as a response to the poor performance of water utilities, especially in low and middleincome countries. Although reform policies vary considerably from one country to another, there is now a clearly defined international agenda for sector reform. This embodies two key principles – the institutional principle and the instrument principle – that are expressed in major policy statements by the OECD and World Bank. The second, instrument principle – that water should be viewed as an economic good and consequently that water companies should be treated as commercial enterprises – lies at the heart of this international reform agenda. As we argued in Chapter 1, the main components of this international reform agenda for the urban water sector are closely related to the NPM paradigm. They may be categorised within the framework of the key functions of an urban water system: regulation and enabling; financing; purchasing; and providing. Table 9.1 summarises the main areas of urban water sector reform within each of these. It also associates them with the underlying NPM rationales. In those cases where the reforms were under consideration in the case study countries, it also identifies the stated rationale for adopting these policies.

Reforming Urban Water Sector Reform 183 Table 9.1: The main areas of urban water sector reform, their NPM rationale and their adoption in the reform agendas of case study countries Key functions of urban water systems and main areas of sector reform

NPM rationale

Whether part of case study country reform agenda, and if so, the stated rationale

Enabling: liberalising laws on private sector participation and for introducing PPPs

To encourage pluralism in provision, and efficiency enhancing competition for the market

Liberal policies under consideration

Regulation: establishing regulatory structure with autonomy

Not emphasised: greater emphasis on incentives rather than control

Structure in place in Ghana, under development in Sri Lanka; initial consideration of regulation in India

Financing: volumetric charging and cost reflective tariffs

To encourage efficient resource allocation/To reduce need for subsidy/ To ensure funds for maintenance and infrastructure renewals

Operating costs funded in Zimbabwe; moves towards cost reflective tariffs in Ghana and Sri Lanka

Provision: decentralisation of water sector management/Increased autonomy to water utilities/ Improved accountability to water users

To give managers greater responsibility/To allow consumers to have greater voice as customers

India and Sri Lanka: managerial responsibility still limited despite decentralisation/Ghana: limited autonomy despite corporatisation/Little attention to giving users a voice, Ghana now developing customer committees

Four key points emerge from Table 9.1. First, in none of the countries were the adoption or consideration of NPM-type policies part of a comprehensive reform agenda for the public sector as a whole. Second, even in the very limited cases where countries had adopted NPM-type policies, the reasons for doing so differed considerably from the NPM rationale. This was particularly the case with respect to the gradual introduction of commercial charging, where the main concern was to raise revenue rather than to improve efficiency or to conserve water. Similarly, the attitude towards private sector participation was one of reluctant acceptance rather than active enabling.


Third, none of the countries have managed to implement a wideranging reform agenda for the urban water sector. Three countries – India, Sri Lanka and Ghana – have stated plans for sector reform but have made only slow progress in translating them into reality. The fact that these countries have experienced considerable difficulties in implementing even a limited set of reform policies suggests that a broad sector reform programme is not likely to be feasible. Fourth, and most significantly, in all four case study countries early reforms were focused almost exclusively on restructuring the institutional arrangements for service delivery within the public sector itself, through formal decentralisation and corporatisation, rather than fundamentally changing the role of the public sector in the overall institutional arrangement for urban water supply. The basic structure of the sector, dominated by public utilities and with minimal private sector participation, has until recently remained largely unaffected by the reform policies undertaken in the four countries. However, adapting to the flow of international policy advice, Ghana in particular is now actively trying to adopt the full package of NPM whilst Sri Lanka is undertaking the necessary preparatory work.

9.3

The need for reform

The very limited extent to which the NPM reform agenda has been implemented cannot be explained by the generally adequate performance of the traditional institutional arrangement for urban water supply in the case study countries. On the contrary, as shown in Chapter 2, these countries displayed many of the problems that NPM reforms are precisely designed to address. In many respects, they provided clear examples of the low level of government performance in its traditional role as direct provider. Ghana, India and Sri Lanka all displayed poor or very poor outcomes in terms of the efficiency, effectiveness and equity of their urban water supply systems. The only exception was Zimbabwe, where significant improvements had been made in performance under the traditional institutional arrangement of direct state provision. However, this research provided evidence that it would not be possible to sustain this record. The catalogue of problems associated with government performance was strikingly similar in the four case study countries. In Ghana very high water losses, broken meters, and non-billing of connections were all major problems. Effective service coverage in major cities was also low. In India water losses were also very high, and staff productivity was extremely low. The effectiveness of service coverage was dismal, with

Reforming Urban Water Sector Reform 185

supply typically restricted to several hours a day at the most. Water quality was also poor. In Sri Lanka water losses were very high and staff productivity was also low. Service coverage was limited by frequent cutoffs and water quality was poor. The poor in particular had to pay a high price for the public provider failure. By contrast, in Zimbabwe performance was much better when the fieldwork was carried out. Financial and operational efficiency was good, and service coverage was almost universal. However, the situation has deteriorated sharply since then. The depth and breadth of these problems meant that important domestic stakeholders and foreign agencies alike perceived a clear need for reform in all the case study countries. But even though there was no adoption of a comprehensive reform agenda in any of the countries, to what extent had progress been made with specific reforms?

9.4

Specific policy reforms

The field research presented in this book includes four tracer policies that enable an overview of the policy and implementation of NPMtype reforms: 1) cost reflective tariffs; 2) corporatisation with performance contracting; 3) public private partnerships; 4) economic regulation of direct providers. As is clear from previous chapters, the research found that progress in the implementation of these policies was extremely limited in the case study countries. Table 9.2 summarises the extent of policy implementation in the case study countries and visually indicates its degree through the use of shading. Only Ghana had in place the basic components of an NPM-type reform agenda, but the extent to which this had been implemented was very limited. By contrast, India displayed none of the basic components of such an agenda. Zimbabwe was the only country to display partial implementation of any of the three NPM-type policies, namely cost reflective tariffs. Overall, the extremely limited implementation of reforms meant that, in practice, it was impossible to evaluate the performance of the new role of the state that is premised on the introduction of such NPM-type reforms.

9.5 Relevance of the NPM agenda and related water sector reforms As we have seen, when the rhetoric of reform is put to one side, the impact of NPM on the urban water sector of the case study countries has

186 Tapping the Market Table 9.2: The extent and pace of policy implementation in the case study countries Selected policies from the NPM agenda

Ghana

Cost-reflective tariffs

Moving towards implementation Corporatisation Legislation with performance passed but contracting very weak implementation Public private Attempting partnerships to implement

Economic regulation

Achieved

India

Sri Lanka

Zimbabwe

Not on state policy agenda Not on national policy agenda

Under consideration

Successfully implemented for operating costs

Under consideration for national policy agenda Under discussion

On national policy agenda

Not on national policy agenda

On national policy agenda

Not on national policy agenda

Partial Not on national implementation policy agenda

been extremely limited. Rather than inertia and complacency, this reality is more a reflection of conviction on behalf of consumers and vested interests of major stakeholders. Urban water is still perceived by urban residents in these countries primarily as a public good that should be subsidised to some extent out of general taxation. The water engineers who still dominate the management of urban water utilities broadly share this perception. There is no major domestic constituency in favour of NPM-type reforms in the sector. Most stakeholders (senior managers, politicians and trade union leaders) favour either the status quo or a very gradual move towards the introduction of cost-recovery pricing (but to cover operating costs only). The poor who pay most, to vendors and through disease, as always do not have a voice. Interestingly, the experience of Zimbabwe suggests that it is possible to achieve significant improvement in performance without recourse to PSP, through the granting of greater financial and managerial autonomy whilst retaining direct public sector involvement. Contracting-out of specific tasks to the private sector (e.g. billing, collection and vehicle maintenance) does not seem to have played a significant part in this approach.


Hence, by default the multilateral lending agencies have become the major stakeholders pressing for the introduction of the NPM approach. Their overriding motivation has been a concern for overall macroeconomic management. What was originally a secondary consideration – a concern for equity – has become more prominent as the poverty agenda has grown in importance, at least in the mission statements of the multilateral and bi-lateral agencies. Their tacit support for global water corporations has been borne of a desperate effort to find a workable solution. Where some private sector participation has taken place, it has usually been introduced as a result of extreme external pressure by these international stakeholders and accepted with great reluctance by government and the general public. As we have seen in Chapter 5, by far the most common form that this private sector participation (PSP) takes is the French model of affermage (lease) or concession contract. Today, some 274 million people, equivalent to about 13 per cent of the 2,091 million urban population of low and middle-income countries, are already served through such public private partnerships and about 80 per cent of those contracts (by population served) are managed by international private operators (Franceys 2003a). Differentiating that service coverage by private operators between low-income countries (45m, or 6 per cent of the LIC urban population), lower-middle income (95m, or 10 per cent of the LMIC urban) and upper-middle income countries (135m, or 35 per cent of the UMIC urban), illustrates the extent to which the poor are again being sidetracked in this reform process (Table 9.3). A massive increase in capacity will be needed in order to widen the benefits to the other 1,817 million by splitting the direct provider from the indirect provider role. However, there is now growing doubt regarding the capacity of international private operators to continue with the concession model – the most comprehensive and hence most effective form of PPP. The foreign exchange losses suffered by Ondeo in the two largest PPPs – Buenos Aires and Manila – are causing a significant re-appraisal of acceptable levels of risk and reward in emerging economies. The fourth largest international water company, SAUR, has suggested that as a result of ‘a marked increase in risk in developing countries there is a need for financial solutions including substantial grants and soft funding [which] are unavoidable to meet required investment levels’ (Talbot 2002). One writer has suggested that if solutions cannot be found ‘the international water companies will end up being forced to stay at home’ (Ibid 2002). SAUR demonstrated that point in 2002 by withdrawing from its PPP contract for several cities in Mozambique. Private operators can manage

Total Operational

14.9

Lower Middle Income Countries

Source: Franceys 2003a

2.7

20.5

Upper Middle Income Countries

Low Income Countries

84.5

High Income Countries

Operational by Income Level

202.35 122.5

Total Reported/Planned

Proposed capital expenditure ($billion)

44.6

88.8

118.6

218.0

469.9

607.6

Population served– Water & Water & Sanitation ($million)

0.0

6.0

16.5

34.6

57.1

82.5

2%

4%

27%

26%

9%

11%

Population Served– Percentage Sewerage & Waste water Total Population Treatment alone served by PPP ($million)

Table 9.3: Global coverage of public private partnerships in water and sanitation in 2001

6%

10%

35%

35%

19%

25%

Percentage Urban Population served by PPP

188


construction risk, operations and revenue collection risk and a reasonable level of governance risk. But it is unreasonable to expect them also to take on foreign exchange risk when devaluations can be so massive and unpredictable. Water tariffs, particularly for the poor, cannot be priced to include insurance against a possible 300 per cent devaluation, as happened in Buenos Aires in December 2001. Unless there is a change in approach it will not be possible for the private operators to take on commercial risk in unsupported concessions. If governments want to continue to reform their water utilities by involving a private sector operator then a model must be in place that offers the same features that regulated concessions have been delivering, namely the best available skills and a commitment to service for all. This must then be combined with the kind of protection for the private operator that the growing popularity of a more limited management contract delivers. In short, the spectrum of PPPs has to be extended again, to some kind of ‘enhanced management partnership contract’. The introduction of the PPP model also places enormous strain on governmental capacity. As we saw in Chapter 8, the contractual nature of the relationship between government as ‘indirect provider’ and the operator as ‘direct provider’ is essentially confidential (that is, nontransparent) and prone to perpetual renegotiation throughout the lifetime of the contract. In this process, formal regulatory bodies can easily be marginalised or neutralised. Yet as we have seen in the case study countries, the alternative strategy to improve performance via corporatisation and greater autonomy for state-owned water utilities seems to pose an almost insuperable challenge to governmental capacity for change, both within the utilities themselves and within those ministerial bodies to which they report. Although the lack of finance, shortage of technically qualified personnel and legal impediments are sometimes obstacles, especially in the field of environmental protection, these are not the major problems that government capacity must address. Of far greater importance are: the enduring legacy of a supply-driven organisational culture among water engineers for whom consumer orientation is of very limited consideration; the continuing politicisation of the sector, as manifested through decision-making and personnel management; and the resignation of residents who have ‘given up’ on their water utilities and in their despair fail to demand their rights as citizens and customers, actual or potential. The overriding goal for policy-makers in the urban water sector is to provide affordable clean water for all, particularly the poor, given that the rich can afford the necessary coping strategies. We have argued


throughout this book that the crucial policy objective in order to meet that challenge is to bring about the organisational strengthening of water utilities towards a position where they may become largely selffinancing, regardless of who owns or operates them. The attraction of PSP is that it has a far better track record than corporatisation in ‘delivering the goods’ in terms of achieving this greater degree of selffinancing. Hence PSP is only a means to an end and so it should be evaluated in terms of the contribution that it makes towards meeting the goal of affordable clean water for all. Clearly this potential advantage of PSP is usually greatest where governments are weakest and have failed to meet basic water needs through direct provision. Where strong governments are able to provide water services effectively and equitably, the attraction of PSP is substantially reduced. However, it is precisely where governments are weakest – where they are unable to provide the oversight and management functions necessary to protect the public interest – that the risk from PSP is greatest. The irony is that PSP is usually most successful where the public sector has better capacity (Gleick et al. 2002). So PSP requires governmental capacity as a pre-condition for success. Public private partnerships have been an important demonstration of the possibility of change, but even PPPs involving major international companies are themselves not powerful enough to overcome poor governance. This paradox poses a major challenge for those who believe that the private sector can make an important contribution towards meeting the millennium development goals (MDGs) for water and sanitation.

9.6

Conclusions

The 2002 World Summit on Sustainable Development (WSSD) held in Johannesburg set the ambitious target of halving by 2015 the 1,200 million people in the world who currently lack access to clean water and the 2,400 million people who lack improved sanitation, and to achieve improved water and sanitation for all by 2025. In fact, these targets simply re-affirmed one of the MDGs already substantially agreed in 2000. A new Global Task Force for Water and Sanitation is being set up to monitor progress. It joins a plethora of global bodies already entrusted with the task of promoting ‘water for all’ – the World Water Council and its World Water Forum, the Global Water Partnership, and the Water Supply and Sanitation Collaborative Council. But it is questionable what Johannesburg can deliver that has not been achieved by previous international water conferences in Dublin


(1992), Rio (1992), The Hague (2000), Bonn (2001) and Kyoto (2003). Those conferences have already instilled in policy-makers the overarching message that water is a finite and vulnerable resource that has an economic value in all its competing uses, that participatory management and the involvement of women is crucial, that integrated water resources management is critical for sustainability, and that water is also a human right that the poor in particular must be able to access. The estimated 375 deaths of young children averted every year in those Argentine municipalities that privatised their water utilities dramatically highlight the importance of that right of the poor to clean water (Galiani et al. 2002). Media coverage of the WSSD highlighted the commitment of more aid money in the form of a series of donor-funded initiatives as the key factor in achieving these and other global development targets. Yet the amount of new finance that is made available to the sector is not the key factor that will determine success. The financial and technical challenges are quite straightforward and uncomplicated. The crucial factor determining success in meeting the global water and sanitation targets relates to the governance of the sector, namely the institutional arrangements for service delivery. In the words of Willem-Alexander, Prince of Orange (2002), ‘The water crisis that is affecting so many people is mainly a crisis of governance – not of water scarcity.’ But there is a price to be paid by consumers and governments alike in order to meet the challenge of improved governance in the urban water sector. There is the financial cost to be borne by consumers through the introduction of cost-reflective tariffs for efficient water supply. There is overwhelming evidence that customers in general, and the poor in particular, are very willing to pay that price. This is particularly so when, as in Manila, as a result of the private concessions, the amount that the urban poor pay for water falls by up to 90 per cent whilst the quality and convenience increases dramatically. There is also the political cost to be borne by governments, both politicians and administrators, from challenging vested interests, by increasing tariffs and initiating sustainable reform in the urban water sector. To ensure that these costs to be paid are reasonable, reform is likely to involve a significant increase in private sector participation in the delivery of water and sanitation services together with the parallel introduction of incentive-based price regulation supported by comparative competition. The urgent task is to challenge and convince governments that it is a price worth paying.

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References 201 Franceys, R., Morales-Reyes, J. and Njiru, C. WEDC, Loughborough University, Loughborough. Weitz, A. and Franceys, R. (eds) (2002) Beyond Boundaries: Extending Services to the Urban Poor. Asian Development Bank, Manila. Whittington, D. et al. (1991) A study of water vending and willingness to pay for water in Onitsha, Nigeria. World Development 19(2–3): 179–98. Whittington, D. (1992) Possible adverse effects of increasing block tariffs in developing countries. Economic Development and Cultural Change 41(1): 75–87. WHO (World Health Organisation) (2000) Global Water Supply and Sanitation Assessment Report 2000. World Health Organisation and United Nations Children’s Fund, Geneva. Willem-Alexander, Prince of Orange (2002) No Water No Future: a Water Focus for Johannesburg, Contribution to the Panel of the UN Secretary General, in preparation for the Johannesburg Summit, World Summit on Sustainable Development. Winpenny, J. (1994) Managing Water as an Economic Resource. Routledge, London. World Bank (1993) Potential Private Sector Participation in Lima’s Water Services: Report of a Workshop. Water and Sanitation Utilities Partnership Report No. 2, World Bank, Washington DC. World Bank (1994) World Development Report. Oxford University Press, New York. World Bank (1995) Sectoral and Project Performance Indicators in Bank Financed Water and Waste-water Operations. Operations and Evaluation Department, Transport, Water and Urban Development Division, World Bank, Washington DC. World Bank (1998) World Development Report 1988. Oxford University Press, New York. World Bank (1999) Consultations with the Poor. World Bank, Washington DC. Yepes, G. (1993) Performance Indicators: Water and Sanitation Utilities. TWUWS – The Water and Sanitation Division of the Transportation, Water and Urban Development Department, World Bank, Washington DC. Zérah, M.-H. (2000) The Cancellation of the Pune Water Supply and Sewerage Project. Water and Sanitation Program – South Asia, World Bank, New Delhi. Zérah, M.-H. (2001) The Buenos Aires Concession: the Private Sector Serving the Poor. Water and Sanitation Program – South Asia, World Bank, New Delhi.

Index accounts receivable measures, 22 adjudication, 134 administrative contracts, 58 ‘affordability limit’, 6 African Development Bank (ADB), 53 Ahluwalia, S., 148, 149 Alaerts, G. J., Hartvelt, F. J. A. and Patorni, F. M., 154 Alcazar, L., Abdala, M. and Shirley, M., 143, 144 Alegre, H., 20 Alfaro, R., 58 Ameer, A., 101 Amis, P., 13, 19, 26, 37, 38, 43, 171 Anglian Water, 87 Anglophone countries, 13 Aquarius financial model, 133 Argentina, 15, 125 Aguas Argentinas, 86–7, 93, 94, 118, 119–20, 143, 144 Buenos Aires concession model, 88–95, 118–21 concession contract, 66–7 co-operatives, 69 ETOSS (Ente Tripartito de Obras y Servicios Sanitarios), 142, 143, 145, 146 ‘Low Income Areas Department’ action plan, 119, 120 Obras Sanitarias de la Nación (OSN), 89, 90, 91 ‘Participative Water Service’ projects, 120 privatisation programme, 91 regulation, 142–6, 161 tariffs, 92 Tax Credit Agreement, 120 Tripartite Entity of Sanitation Works and Services see ETOSS Universal Service and Improvement Charge (SUMA), 119, 144

Armstrong, M. Cowan, S. and Vickers, J., 130 Asian Development Bank (ADB), 6, 20, 23, 42, 53, 81, 104, 133, 150 ‘Beyond Boundaries’ study, 117 ‘asset holding authority’, 73 auditing systems, 140 Azpiazu, D. and Forcinito, K., 94 Azurix, 167 Bangladesh, Dusthya Shasthya Kendra (DSK), 112 Barker, P. J., 2 Batley, R. A., 12, 13, 14, 19, 29, 34, 37, 39, 48, 72, 156, 177 Batley, R. A. and Larbi, G. A., 15 Beecher, J., Dreese, G. and Stanford, J., 135 Black, M., 24 Bolivia, 15, 35, 156 co-operatives, 69 La Paz and El Alto concession, 121–2 Ondeo, 53, 79, 121, 124 Peri-urban Initiative for Water and Sanitation (IPAS), 121 Bonn summit, 191 Bories, Y., 142 Botswana Water Utility Corporation (BWUC), 42 Brazil, 52 Brinkerhoff, D. W., 12 Briscoe, J., 41 Brunstein, F., 69 build-operate-transfer (BOT) contract, 63–5, 76–7 Malaysia, 64–5 build-own-operate-transfer (BOOT) contract, 63 bureaucracies, 9 Burns, T. and Stalker, G., 165 Business Day, 85 Business Standard, 160 202

Index 203 Cairncross, S., 3 capacity, 153–80 concepts of, 12–13 defined, 164 Ghana, 170–1 India, 171–6 international private operators, 166–9 Sri Lanka, 176–7 within the public sector, 159–63 Zimbabwe, 177–8 capacity to change, 155–9 Carteado, F. and Franceys, R., 52 Casasús, C., 71 Cave, M., 78 Census Board of India, 103 central government, 53 Chanda, M., 132, 151 change, 155–9 change management, 156 Chary, S., 108, 113 Chile EMOS, 57–8 regulation, 150–1 service contracts, 57–8 urban poor, 116–17 civil society, 179–80 and regulation, 131 Cobbold, F., 27 Cohen, J. M., 12 Collignon, B. and Vezina, V., 109 Colombia, joint ventures, 68 commercial contracts, 58 common carriage, 141 Community Service Obligation, 127 comparative performance indicators, 20–1 comparators, 133 competition, 78, 80, 81, 128, 141 concession contracts, 65–7, 187 Argentina, 66–7 concession model, 73–102 Argentina, 88–95 performance drivers in, 79 connection fees, pipe networks, 110 construction contracts, 57 construction cost risk, 83 consumer perceptions of service quality, 29–31

consumer satisfaction, 23–4 consumer surveys, 14 consumption, 3 contingency theory, 165 contracts, long-term nature, 79–80 co-operatives, 68–9 Argentina, 69 Bolivia, 69 Cordier, M., 59 corporatisation, state owned water utilities, 41–2, 44, 48–9 Coyaud, D., 18, 51 ‘craft’ approach, 165 Criscuolo, G., 145, 146 cross-cultural managerial behaviour, 168 customer orientation, 10 customer representation, 164 Dahan, S., 120 Das, G., 176 David, C. and Inocencio, A., 122 decentralisation, 8, 9 Defeuilley, C., 130, 143 demand management, 6 demand risk, 83, 83–4 De Silva, J., 149, 150 direct providers, 127–52 ‘direct’ provision, 18, 19 divestiture, 69–70, 73, 78 England and Wales, 70 downsizing, 8 Dumol, M., 157 East Asia, 41 ECLAC (Economic Commission for Latin America and the Caribbean), 92 The Economist, 160, 163 economies of scale, 4 effectiveness measures of, 23–4 private sector participation, 54–5 efficiency, 21–3 private sector participation, 54 employment relations, 10 enabling, 103 ‘enabling environment’, 155 Enayetullah, I., 112

204 Index engineering (‘supply-led’) approach, 3, 5 England and Wales Customer Service Committees (CSCs) (WaterVoice), 137 divestiture, 70 regulation, 136–42 Enron, 167 environmental controls, 51 environmental monitoring, 127 equity, 24–5 and private sector participation, 55 Estache, A., 42 ETOSS (Ente Tripartito de Obras y Servicios Sanitarios), 94, 142, 143, 145, 146 externalities, 4–5 external stakeholders, pressure from, 52 Feachem, R. et al., 17 Ferlie, E. et al., 8 finance availability, 36–7 for new investment, 51 financial contracts, 58 financial efficiency indicators, 22 flexible arrangements, Mexico City, 70–1 foreign exchange risk, 86 Foster, V., 121 ‘four Es’ (efficiency, effectiveness, equity and enabling) of reform, 8 France, 41 Ondeo, 166, 169 private sector participation, 53–4 SAUR, 166 Franceys, R., 13, 19, 28, 38, 40, 47, 100, 113, 175, 187 Franceys, R. and Sansom, K., 13, 20, 27, 28, 38, 43, 44, 98, 148, 172 ‘franchising’, 78 Francophone model, 54, 56, 59, 65

macro-economic management, 37 National Coalition Against the Privatisation of Water, 97 organisational performance, 26–7 public private partnerships (PPPs), 96–7 Public Utilities Regulatory Commission (PURC), 147, 171 reform processes, 42–3 regulation, 147 slum improvement projects, 107 State Enterprises Commission (SEC), 43 state owned enterprises (SOEs), 38 tariffs, 147 User Supply Division of the Pubic Works Department, 170 Ghana Statistical Service, 26 Ghana Water Company Ltd (previously GWSC), 147, 170, 171 Ghana Water and Sewerage Corporation (GWSC), 19, 26–7, 43, 96, 170 establishment, 42 Gledhill, R., 55 Gleick, P. et al., 190 globalisation, 7 Global Task Force for Water and Sanitation, 190 Global Water Report, 84, 96, 168, 178 ‘good enough’ performance, 154, 178–9 government, role in reform of urban water sector, 1 governmental capacity, 13–14 and public private partnerships (PPPs), 189 groundwater, 111 Guinea lease contract, 62–3 World Bank Water Supply and Sanitation Project, 62 Gunasekera, A., 101, 149

Galiani, S. et al., 125, 191 Germany, 41 RWE (multi-utility), 167 Ghana, 3, 13, 14, 37, 184–5, 185 capacity, 170–1

Haarmeyer, D., 51, 62 Haarmeyer, D. and Mody, A., 144 Haggarty, L. et al., 71 Hague summit, 191 Hall, D., 80

Index 205 Helm, D., 130 hierarchies, 9 Hilderband, M. E. and Grindle, M. S., 33 HM Treasury, 79, 83 ‘hold-up’ costs, 55–6 Hood, C., 8 Hubbard, M., 15 ‘incentive based’ model, 135 increasing block tariffs (IBTs), 25, 114 India, 13, 14, 20, 116 capacity, 171–6 Change Management Forum (CMF), 175 Chennai Metropolitan Water Supply and Sewerage Board, 99–100 electricity sector regulation, 148 higher income groups, 173 Hyderabed Metropolitan Water Supply and Sewerage Board, 98 institutional reform, 171 legislation, 39 Maharashta Jeevan Pradhikan (MJP), 44 Ministry of Urban Affairs and Employment, 39 Ministry of Urban Development and Poverty Alleviation, 175 organisational performance, 27–8 political practices, 38 private sector participation, 97 Public Health Engineering Departments (PHED), 43 public private partnerships, 97–101 Pune Municipal Corporation (PMC), 44, 97 reform processes, 43–5 regulation, 148–9 regulatory capacity, 159–60 sanitation, 112–13 service coverage, 27 Tirupur Area Development Project, 99 Waste Water Supply and Sanitation Department, 45 water quality, 27 ‘indirect’ provision, 18, 19, 33

Indonesia, regulation, 151 industrial relations contracts, 58 ‘informal suppliers’, 105 information technology contracts, 58 Inocencio, A., 80, 122, 124 inset appointment, 141 institutional arrangements, 56–71 build-operate-transfer (BOT) contract, 63–5 concession contracts, 65–7 co-operatives, 68–9 divestiture, 69–70 flexible arrangements, 70–1 joint ventures, 67–8 lease contracts, 61–3 management contracts, 59–61 service contracts, 56–8 institutional capacity, 37–40 financial and economic conditions, 37–8 legal and administrative framework, 39–40 political practices, 38–9 public sector interaction with the private sector, 40 institutional principle, 5 instrumental principle, 5 Inter-American Development Bank (IADB), 53, 68 ‘inter-generational transfers’, 139 international competitive bidding (ICB), 57, 63, 65 International Conference on Water and the Environment (Dublin), 5 International Finance Corporation (IFC), 83 international financial institutions, 53 International Monetary Fund (IMF), 7, 37, 53 international private operators, 156, 176, 187 capacity, 166–9 international reform agenda, 182–4 International Solidarity Committee (ISC), 97 international water companies, 53–4 Iskandar, M., 65

206 Index Jackson, P., 15 joint ventures, 60, 67–8 Colombia, 68 Joshi, V., 101 Kapoor, V., 148 Kayaga, S., 105, 107, 113, 114 Kemper et al., 52 Kingdom, B. and Jagannathan, V., 81 Kinnersley, D., 51, 70 Knode, S., 65 Larbi, G., 43 Latin America, private water vendors, 109 lease contracts, 61–3 Guinea, 62–3 Lewin, K., 156 Lewis, M. and Miller, T., 18 licensing, operators, 132 Littlechild, S., 4 Loftus, A. and McDonald, D., 145 long-run marginal cost (LRMC), 6, 7, 114 long-term nature of contracts, 79–80 low-income countries, 13 low and middle income countries, regulation, 150–1 Lyonnaise des Eaux, 120 McCarthy, S. C. and Perry, J. G., 64 McIntosh, A., 151 McIntosh, A. and Yñiguez, C., 81 McLeod, N., 116 MacLeod, S., Clamp, T. and Dejonkhere, L., 122 McPhail, A., 6 maintenance contracts, 5 Malaysia, build-operate-transfer (BOT) contract, 64–5 management contracts, 59–61 Trinidad and Tobago, 60–1 managerial autonomy, 35–6 Marin, P., 79 market forces, 6, 9 market institutions, weakness, 13 Mazzucchelli, S., Rodriguez Pardinas, M. and González Tossi, 90, 143

Menem, Carlos, 90 merit good, urban water supply as, 5, 79 metering, 3, 6, 46 meter performance, 22 Mexico City, flexible arrangements, 70–1 millennium development goals (MDG), 181, 190 Mills, A., Bennett, S. and Russell, S., 11, 12, 14, 15, 20 Minhas, B. S., 175 models of regulation, 135–46 monitoring of performance agreements, 129 Msimbe, 105 Mudege, N., 19 Mutizwa-Mangiza, D., 14, 29 Nankani, H., 61 National Audit Office, 141 New Institutional Economics, 9, 10, 12 new investment resources, 50, 51 New Public Management (NPM), 7–11, 17–18, 127, 129, 153, 181, 182, 183 impact of reforms, 10 organisational reforms, 11 New Public Management reform agenda, 184 and related water sector reforms, 185–90 Nickson, R. A., 18, 36, 67, 68, 69 Nickson, R. A. and Vargas, C., 156 non-governmental organisations (NGOs), 166, 176 and the urban poor, 111–13 North, D. C., 12 obsolescence risk, 88 OECD, 5, 182 Office of Water Services (OFWAT), 20, 70, 81, 82, 133, 141, 142, 164, 171 and regulation, 136–42 operating risk, 85 operators, licensing, 132 ‘organic’ approach, 165

Index 207 organisational capacity, 34–7 availability of finance, 36–7 managerial autonomy, 35–6 personnel, 34–5 organisational performance Ghana, 26–7 India, 27–8 Sri Lanka, 288 Zimbabwe, 29 output based specifications, 79 output-orientation, 9 participatory approach, 5 partnerships, 169–70 patronage, 50, 52 payment for water, depoliticisation, 50, 51–2 performance drivers, 78–82 in the concession model, 79 performance measurement, 20–5, 81 performance monitoring, 133–4 personnel, skills and professionalism, 34–5 personnel costs, 50, 52 personnel development, 12 Philippines, 15, 80, 81 Metro Manila concession, 122–4 Water Crisis Seminar, 157 pipe networks, 4, 6, 55 connection fees, 110 Plummer, J. and Nhemachena, G., 102, 150, 178 policy reforms, 185–90 Polidano, C. and Hulme, D., 10 political risk, 102 poor, 165, 185 see also urban poor POPIN (United Nations Population Information Network), 103 population growth rates, 103–4 poverty, 104 definitions, 104–5 ‘price cap’ model, 135, 137, 138 price-setting, 132–3, 138 price stability, 37 price of water, 2 private operators, regulation, 131 private ownership, 18

private sector, 17, 53 interaction with the public sector, 40 management skills, 82 private sector participation (PSP), 54–5, 72 effectiveness, 54, 54–5 efficiency, 54 and equity, 55 France, 53–4 India, 97 private water companies, and the urban poor, 117 private water vendors (PWV), 1, 24, 74 and the urban poor, 108–11 privatisation, 8, 75 providers internal factors, 50 separation of roles, 155 public direct providers, 128 ‘public good’, water as a, 3–4, 50, 71, 186 public ownership, 18 public private partnerships (PPPs), 49, 50–72, 67, 95–102, 187–9 Ghana, 96–7 and governmental capacity, 189 India, 97–101 objective, 73 and regulation, 150–1 Sri Lanka, 101 and the urban poor, 117–24 Zimbabwe, 101–2 public sector capacity, 159–63 interaction with the private sector, 40 Puerto Rico, Ondeo, 59–60 quality control contracts, 58 quality control costs, 56 Radoki, C., 14, 26, 28, 29, 32, 176 Raghupathi, U., 99 Rao, G. P., 148, 149 ‘rate base’ model, 135 ‘rate of return’ model, 135, 136, 141 rationing, 25

208 Index reform, 181–91 international agenda, 182–4 urban water supply (UWS), 5–7 reform policies and plans, 40–2 reform processes Ghana, 42–3 India, 43 Sri Lanka, 45–7 Zimbawe, 47–8 reform programmes, 7–8 regulation, 75, 128 adjudication, 134 Argentina, 142–6 by contract enforcement, 130 by specialised agencies, 130 Chile, 150–51 and civil society, 131 England and Wales, 136–42 Ghana, 147 India, 148–9 Indonesia, 151 of licensing operators, 132 low and middle income countries, 150–1 performance monitoring, 133–4 price setting, 132–3 and private operators, 131 and public private partnerships (PPPs), 150–1 sanctions, 134–5 Sri Lanka, 149–50 Zambia, 151 Zimbabwe, 150 regulation models, 135–46 regulatory capital, 139 regulatory risk, 85–6, 131 resale risk, 88 ‘restraining forces’, 157, 158 return on capital employed (ROCE), 22 return on fixed assets (ROFA), 22 Ridley, N., 132 Rio summit, 191 risk transfer, 82–8 Roth, G., 17 RWE (German multi-utility), 167 Safe Drinking Water Act, USA, 51 sanctions, 134–5

Sansom, K. and Franceys, R., 116 SAUR, 54, 62 Savas, E., 131 Schoon, C., 130 ‘second generation’ reform process, 8 Serageldin, I., 21, 25 service contracts, 56–8 Chile, 57–8 service coverage, 24 India, 27 Sri Lanka, 28 service delivery, reassignment of roles, 10 service provision, 17–32 consumer perceptions of quality, 29–31 organisational forms, 18 organisational arrangements, 17–32 Sharma, S., 107 Silva, T., 29 Silva, T., Russell, S. and Radoki, C., 14, 29 Singapore Public Utilities Board, 42 Skellett, C., 142 Solo, M., 109, 119 South Africa, 15 Durban Metro Water, 115 non-conventional piped supplies, 115–16 South Asia, 13 South Asia Forum on Infrastructure Regulation (SAFIR), 162 Spain, concession contracts, 66 squatter settlements, 3, 20, 105, 106, 125 Sri Lanka, 13, 14 Bureau of Infrastructure and Investment, 101 capacity, 176–7 Institutional Development (ID) programme, 46 legislation, 39–40 National Water Supply and Drainage Board (NWSDB), 19, 28, 46–7, 176–7; establishment, 45 organisational performance, 28 public private partnership, 101 reform processes, 45–7

Index 209 regulation, 149–50 Regulatory Commission for Water Supply and Sanitation, 149 role of proposed regulator, 149–50 service coverage, 28 standposts, 107 water availability, 28 staff productivity index, 21–2 standposts, 106–7, 122 Stanley, W., 135, 152, 162 state owned enterprises (SOEs), Ghana, 38 state owned water utilities, 41 corporatisation, 41–2 state-run water utilities, 7 Stren, R. E., 21 structural adjustment, 14 structure and performance, urban water utilities, 17–32 Sub-Saharan Africa, 13 Suez, 86 Swedish International Development Cooperation Agency (SIDA), 121 Talbot, J., 187 Tandy, P., 52 tankers, government-managed, 108 tariffs, 25, 43, 53, 78, 80, 83, 85, 111, 128, 132–3 Argentina, 92 Ghana, 147 USA, 135 Thames Water, 54, 166 Tiffin, M. and Veazey, P., 83 trade unions, 157–8 training, 12 transaction costs, 56 transparency, 160 Triche, T., 18, 54, 59, 63, 70 Trinidad and Tobago Interim Operating Arrangement (IOA), 60 management contract, 60–1 Water and Sewerage Authority, 60–1 Trinidad and Tobago Water Services (TTWS), 60 turnkey contracts, 76

Uganda, 109 Local Water Source Management Committees, 111 National Water and Sewerage Corporation, 113 standposts, 107 UK, 51, 83 unaccounted for water ratio, 21, 27 unaccounted for water (UAW), 6 UNCED, 3 United Nations, 7 United Nations Centre for Human Settlements (UNCHS), 104 United Nations Conference on Environment and Development (Rio Conference), 5 United Nations Population Fund (UNFPA), 104 United Nations Population Information Network (POPIN), 103 United Utilities, 83 Universal Service Obligation (USO), 127 urban poor and government providers, 113–17 housing, 105 and non-governmental organisations, 111–13 and private water companies, 117 and private water vendors, 108–11 and public private partnerships, 117–24 services to, 106–8 water needs, 1, 103–26 urban water supply (UWS) direct public provision, 3–4 international reform agenda, 182–4 as a ‘merit good’, 5 reform, 5–7 urban water utilities, structure and performance, 17–32 USA, 51 Safe Drinking Water Act, 51 tariffs, 135 USAID (United States Agency for International Development), 46

210

Index

Vargas, M., 79, 80, 121, 122 vertical unbundling, 55–6 Veolia, 53, 166 Wagstyl, S., 174 Walsh, K., 8 water, price, 2 water availability, 23 Zimbabwe, 29 water consumption, 22 water distribution, 22 water production, economies of scale, 55 water quality, 23 India, 27 Water and Sanitation for Health Programme (WASH), 155 water sector loans, 157 Weatherdon, G. and Sansom, K., 61 Weitz, A. and Franceys, R., 117 Wessex Water, 167 Whittington, D. et al., 6, 25 World Health Organisation (WHO), 103 WHO/UNICEF, 1 Willem-Alexander, Prince of Orange, 191 ‘willingness to pay’ (WTP), 6 Winpenny, J., 53, 72 working ratio (WR), 22 World Bank, 5, 7, 37, 42, 53, 54, 55, 68, 81, 102, 125, 133, 157, 174, 182

Business Partners in Development programme, 117 ‘International Network of Utility Regulators’, 162 Water and Sanitation Programme, 117, 121 World Bank Water Supply and Sanitation Project, Guinea, 62 World Summit on Sustainable Development (WSSD), 190–1 Yepes, G., 20, 22 Zambia, 132 regulation, 151 Zérah, M.-H., 97, 121, 144, 146 Zimbabwe, 13, 14, 19, 37, 184, 185, 186 capacity, 177–8 consumer satisfaction, 29–30 drivers for change, 179 Engineering Services Department, Water Branch, Bulawayo, 47–8 Matabeleland Zimbabwe Water project, 179 organisational performance, 29 political practices, 39 public private partnerships (PPPs), 101–2 reform processes, 47–8 regulation, 150 water availability, 29

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