World Bank Documentdocuments.worldbank.org/curated/en/587431468313789774/pdf/452… · Technology advances are increasing competition and market contestability. Previ- ously nontraded

December 1994

5

fience of Latin America 9

13 Cash-Starved SOEs in Bolivia

Jobn Nellk and Ira Lzeberman

Privatization in Estonia 21 Jobn Nellzs

RlsK AND LONG-TERM FINANCE Risk and Prhae Pow- Role fbr the World Bank 25

James Bond

Inkstructure Investment Funds 29 Andrea Anaytotos

"Backstop" Lending for Capital Market Development in Argentina 33 Odo Habeck

Sbyam Khemani 1

Michael Klein and Neil Roger \

ResrcucturlngthePBwerSector:TheCaq Robert Bacon

The Global Information Economy and the Robert Schware and Susan Hume -

The World Bank Group = Vice Presidencv for Finance and Private Sector Develo~ment

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Private Seutoris an open forum intended to encourage dissemination

of and debate on ideas, innovations, and best practices for expanding

the private sector. The views published are those of the authors

and should not be attributed to the Worid Bank or any of its affiliated

organizations. Nor do any of the conclusions represent official policy

of the World Bank or of its Executive Directors or the countries

they represent.

Introduction

The Responsiveness Revolution

We have entered an era of rapid and continuous change, sometimes referred to as the "

Revolution." New technologies in telecommunications, informatics, advanced materials,

portation are changing the patterns of comparative advantage for entire regions, countries, and sectors. -? . t.

Production is becoming ubiquitous and highly flexible. Information is moving sw~ftly from the point

of sale to the production line. Services like clerical processing can be located anywhere. Relationships

with suppliers are now global. ~e lephones and televfsions as we know them will soon be replaced by

universal digital networks that will completely change the nature of interactions between people and

businesses alike. Technological change, too, is altering the nature of markets a n d competition. In this

new world, the goods and services we produce embody more knowledge content than before, and

this knowledge is a key source of productivity growth and competitive advantage.

The name of the game for business ancl government alike is ag~lity, responsiveness, and information.

The World Bank can play an important global connector role in promoting these characteristics-by

disseminating successful policies and strategies and spreading knon1ledge about emerging economies,

innovation, and adaptation to rapidly changing economic trends. To do this, we are developing easily

readable p u b l i c a t i o n ~ f which Private Sector is one. Thls quarterly publication is an open forum on

issues to do with expanding the private sector.

Jean-Fran~ois Rschard Vice President Finance and Private Sector Development

In This Issue

- Is Pl-.T

hn Nellis ai vatization is

want public enteq take precedence c

. '9 The -ti of Latin .$ .en 198

rt ent

owned firms usually outperform public enterprises, but y against political interference. W h ~ l e governments may

)rises to be profitable and productive, they often are unwilling to allow commercial aims to ver noncommercial alms.

17 B u s s f a n ~ n zerica John lYellFs aad Ira tiabetman

and 1992, governments m Latin show how Russla's voucher-led k d more than 2,000 publlcly mass privatization program is

rises What dlstingulshes th~s prlva- impressive for both its size and from that in most other reglons, the speed with which it was Mateen Thobani, IS its success m implemented. But so far, results

rating large revenues from sales. This Note have been tentative and partial rveys privatization strategies m the reglon The important next steps are selling the remairwng

shares and firms for cash through auctions and 13 Privatization by Capitalization- tenders, developing capital and securities markets,

A Popular Participation Recipe for and making business real estate wadable The Cash-Stanred SOEs in Bolivia Note also introduces a compendium of papers,

Andrsw Ewing and Susan Russia. Creating Private Enterpmes and E$iczent GoIdRZMk desgibe auniqudy Markets, presented at a recent World Bank- Bolivian brand of pr~vatiza- sponsored conference on Russian privatizat~on

wui 19s 1sstJE tion that comb~nes the appeal of popular participation with 21 Privatization in Estonia

Broad-bwsd the new feature of retalnlng h h a Nellis says that Estonia,

erhrstiutim the buyer's payment ~n the with one of the best oveiall business. Rather than d~strlbuting shares to the economc reform and privati-

mtegies people, the government has decided to endow zatlon records of any part of

~ ~ d ~ b l ~ ~ ~ ~ ~ ~ - - pension accounts for each adult citizen These the former Soviet Union, is a

rightsmwatm ' accounts will be managed by competing private good role model for transition

? A w l o n funds. While ~t 1s early days yet with this economies. Its privauzation

finawlaj odel, when and if its success has been clearly process does not emphasize payoffs to ~nsiders . L & ~ ~ the model could be adaptable for And it has adopted a range of divestiture methods

wnglomemter - 3L,,, -

W! r e s . a~rned at putting assets in the hands of those with \ the incentives and skills to use them wisely. The

Note looks at some of the remaining issues to be grappled with-including control of contracts negotiated as terms of tender sales, dealing w ~ t h leases, and administration of the bankruptcy law

o c o n o ~

And more. . .

RISK AND LONG-TERM FINANCE

25 Risk and Private Power-A Role for the World Bank Independent power projects typically are structured on a project finance basis. Guarantees to the lenders result from the project itself rather than from the project sponsors. The problem is that lenders are reluctant to participate in projects where they are exposed to government policy failure risk. The World Bank could play an important role in promoting private investment in power by helping to overcome this risk problem. James Bond suggests how.

29 Idmmucture Investment Funds Andrea Anayiotos discusses new ways to access international and local capital markets for long-term infrastructure financing. She focuses on equity funds that pool risk and provide long-term funding to private entities. These funds mitigate some risks by investing in a diversified portfolio of infrastructure companies and projects in different countries at different stages of development and by choosing to invest with reputable sponsors.

33 "Backstop" Lending for Capital Market Development in Argentina Local capital market development is necessary to help fund medium- and long-term investment. Odo Habeck looks at an innovative World Bank loan to Argentina that should promote capital market development. The general design of the loan-contingent disbursement, disbursement against the purchase of financial assets, appraisal of local institutions to which ongoing surveillance is delegated, use of established market firms as project managers-could be applied to many countries whose financial markets are still developing. The expected result of the loan: banks should be better able to manage risk and therefore to provide longer-term fmance for local business.

COMPETITION

37 Competition law is getting a higher profile in a more integrated world economy. Good competition law helps to minimize government interference in business. A clear set of objectives for such law makes it much easier for governments to deflect special interest group lobbying. In transition economies, competition law helps to foster sound business discipline, culture, and ethics and is especially important as state monopolies are being privatized. Shyam Khemani offers a framework for designing and implementing good competition law.

41 Will the current wave of privatization lead to lasting welfare gains, or is it just part of a historical cycle? In Back to the Future, Michael Klein and Neil Roger note that in the nineteenth century railways, canals, roads, and gas, power, and water systems were privately owned. They conclude that the only way to insure against another turn in the cycle is to expand the scope for more automatic "regulation" through competition.

45 Restructuring the Power &tor: The Case of Small Systems

The pattern of power sector restructuring being applied in most countries is derived from the experience of Argentina, Chile, and the United Kingdom. This model is based on capturing the

benefits of competition in the generation sector and regulating those parts of the system that cannot be competitive and that may therefore exploit their monopoly position. Robert Bacon argues that small power systems may experience a very different balance of advantages and disadvantages from these changes. Even when it is possible to introduce limited competition in generation, the costs of vertical separation may be so large that they offset the gains from competition.

49 The Global Information Economy and the Eastern ~aribbean Technology advances are increasing competition and market contestability. Previ- ously nontraded goods such as information services are now becoming tradable. For -

example, the export of information services offers a real opportunity for new job growth in many developing countries. Telepol-ts-satellite earth stations that can bypass existing poor public telephone networks and provide companies with affordable, high-quality international telecornmu- nications services-are turning out to be a key enabling factor. Robert Schware and Susan Hume look at the opportunities in U.S. and European markets for exporters in the Caribbean.

Editor: Suzanne Smith Room 68105 The Wodd Bank 1818 H Street, NW Washington, D.C. 20433

Telephone: 202 458 7281 Fax: 202 876 9245 Email: [email protected]

The entire contents of Private Sector01 995 World Bank. You are authorized to reproduce, duplicate, and disseminate all or part of this publication so long as you include the name of the publication and the name of the respective author. You may no t however, modify, alter, or otherwise change any pan of this publicstion or sell, transfer, or otherwise disseminate any part of this publication for profit

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Is Privatization Necessary? John Nellis

The answer is a decided "yes." Privatization is necessary, and not simply to improve the performance

of public enterprises-though the evidence is striking that it can and does improve performance.

Privatization's essential contributions are to "lock in the gainsff achieved earlier in reforming public

ownership or in preparing a firm for sale, to distance the firm from the political process, and to

inoculate it against the recurrence of the common and deadly ailment of public enterprises:

interference by owners who have more than profit on their minds.

Performance and ownershiithe debate

Market forces

Neoclassical economic theory suggests that the relationship between ownership and performance is tenuous; efficiency is seen mainly as a function of market and incentive structures. In theory, it makes little difference whether a firm is privately or publicly owned as long as:

It operates in a competitive or contestable market without barriers to entry or, just as important, barriers to exit. The owner instructs management to follow the signals provided by the market and gives it the autonomy to do so. Management is rewarded and sanctioned on the basis of performance.

Evidence shows that the theory does indeed apply in practice-with two crucial quahfications. First, the full set of necessary conditions is only rarely met. And second, even when it is met, it tends to stay met for only a while; the necessary conditions cannot be made to endure.

Principal and agents

There are a number of modern amendments to neoclassical reasoning that attempt to establish

a clearer relationship between ownership and efficiency. These come mainly from public choice theory and the literature on principal and agents. Operationally, this reasoning says that private ownership will produce superior efficiency outcomes because of five factors:

Private ownership establishes a market for managers, leading to higher-quality management. Capital markets subject privately owned firms t o greater scrutiny and discipline than they do public enterprises. Public enterprises often operate on Janos Kornai's famous "soft budget constraint." Because of explicit or implicit guarantees from the state, public enterprises can borrow capital at less-than-market interest rates, and they often enjoy outright subsidies and other concessions from the state (meaning that they don't pay their taxes, their utility bills, their accounts payable to other public enterprises, customs duties, or the like). Private firms are subject to exit much more often than public enterprises. Private firms are more subject to bankruptcy, liquidation, hostile takeover, and closure than public corporations. When exit is a real possibility, there is a greater likelihood that owners and managers will take active, efficiency-enhancing measures to avoid it. Politicians interfere less in the affairs of private than public firms. Political interference is a major cause of efficiency-reducing conditions in public

enterprises; it manifests itself in overstaffing, undercapitalization, inappropriate plant location, wrong use of inputs, and many other costly acts. Private firms are supervised by self-~nterested board members a n d shareholders, rather than by disinterested bureaucrats, and are thus more ke ly than public firms to use capital efficiently and to maintain it.

Practical solutions

The problem with all five of these arguments is that one can readily conceive of mechanisms to

2%e study shows strong postsale performanc+increased real sales, greater pro3ta bility, increased investment spending, iimprvements in operating efficiency, and, most sulpriiing, a slight increase in wont! forces.

correct the perceived deficiency-without changing ownership. For example, if finding and rewarding excellent managers is the issue, enterprises could recn~it outside the public sector, or even internationally, and offer incentive packages equal to private sector scales. If the soft budget constraint is the problem, governments could eliminate all guarantees and stipulate that public enterprises must turn to commercial capital markets and act, and be treated, llke any private sector borrower. If exit is the constraint, governments could liquidate persistently poorly perfornwg public enterprises. If political interference is the difficulty, then the owner and the enterprise could sign a performance contract spec~fying the mutual obligations and responsibilities of the principal and the agent; or the owner could constitute and empower a new and more independent board of directors and give it explicit instructions to maximize commercial profitability; or the owner could name a powerful and inde-

pendent chief executive officer, and give him or her a free hand. The fifth factor-better representa- tion of the interests of capital-is more difficult to resolve without some change in ownership, or at least some privatization of managernent- through management contracts, leases, franchises, or concessions. But even here performance agreements and other mechanisms to create surrogate capitalists are imaginable: for example, establishing a holding company or companies and instructing them to act like private owners, or fragmenting ownership among several different levels of government or state agencies and making them dependent on the income generated by the enterprise. Both institutional approaches would presumably diminish the saliency of noncommercial objectives.

Tried and tested?

All of these theoretically applicable solutions have indeed been tried, or are presently being tried, around the world-with some highly positive responses. New Zealand's "corporatization" efforts of the mid-1980s achieved efficiency and financial gains in ten of eleven enterprises studied by Duncan and Bollard in Corporatzzation and Privatization: Lessons from New Zealand.' Korea's performance evaluation system for twenty- six of its government invested enterprises reduced, for a time, financial losses to zero. These financial gains were accompanied by a declining ratio of costs to sales, indicating efficiency gains. Korea's reform program relied heavily on a goal setting and review system- complete with r e w a r k a n d a massive change in the boards of directors that reduced civil servant membership to a small minority.

The most powerful recent empirical evidence to support the thesis that reform can work without ownership change comes from China. There are now about 1.3 million township and village enterprises employing 90 million people. They account for more than 20 percent of China's industrial production and are growing far more rapidly than the traditional state- owned enterprise (SOE) sector. Their financial and economic performance surpasses that of

The World Bank Group

the traditional SOEs by two or even three times. They are a stunning example of how positive performance can be achieved by firms that are not privately owned-but that are made to act as if they were.

Added to these positive cases are the findings of a fairly extensive literature, most of it dating from the early 1980s, that tried to measure public versus private performance. This was done basically on a "with and without" basis; that is, comparisons were between roughly similar public and private enterprises in operation. The conclusions reached were by no means unani- mous, but more often than not the literature suggested that, after correcting for market structure, there are no real differences between public and private ownership. The policy implication is that perceived deficiencies of public enterprise performance can be corrected by changes in policy, incentives, and institutions, and that ownership change is not necessaly.

In light of all this, how can one still reasonably contend that ownership matters?

Why ownership matters

Probability

The first strand of the case is probabilistic in nature. While private firms do not always outperform public enterprises, the evidence shows that they usually do. For example, over the years, the \Vorld Bank has noted that rates of return on equity invested in industrial or commercial public enterprises often are about a third of those in the country's industrial private sector. The overall contention is that there are two spectra of performance from good to bad-ne for public enterprises, one for private firms. There is a fair degree of overlap between the two. But the private sector performance spectrum extends somewhat to the right of the public enterprise performance spectrum-and mean performance for private enterprises is also some- where to the right. That leaves a variance to explain-and ownership is a strong candidate for a good part of the explanation.

Empirical work

The second strand of the argument is empirical. It is based on several recent and rigorous studies that have looked at firms before and after privatization. These recent studies show generally, and impressively, improved perfon~ance after sale. A Jozlrnnl of Finance ar-ticle2-by Megginson, Nash, and van Kandenborgh-compares the pre- and postprivatization financial and operating performance of s q - o n e companies from eighteen countries in tkuzy-two industrial sectors. The sh~dy shows strong postsale perfonnance-increased real sales, greater profitability, increased investment spending, improvements in operzting efficiency, and, most surprising, a slight increase in work forces. A second study, on the welfare consequences of selling public enterprises,-' was conducted by the World Bank in collaboration with Boston University economists. Trus study looked at pre- and postsale performance in profitability and productivity in twelve firms in four countries. It went on to con- struct an elaborate counterfactual, to determine what would have happened had the enterprises not been privatized. The authors then were able to say "here is what was actually happening before sale, here is what actually happened after the sale, here is what we reason would have happened under continued government ownership." In constructing this scenario, they did their best to isolate and neutralize the gains and losses due to factors other than divestiture. They then subtracted the hypothetical from the historical, and thus derived a measure of the gains due to ownership change. This study quantifies the welfare gains and losses of the various actors in the process; that is, the costs and benefits to the selling governments, purchasers4omestic and foreign-worlters, consumers, and competitors. The results are as follows: in eleven of twelve cases studied, there were positive welfare effects for society because of the sale, and improved performance at the level of the firm.'

Compromise and backsliding

The third and final strand of the argument for private ownership is political and organizational in character. The idea is twofold. First, as noted,

8 Is Privatization Necessary?

most governments fmd it difficult if not impossible to apply the entire package of qualLfying conditions that are essential for reforms short of ownership change to work. The landscape, particularly in developing countries, and now in ex-socialist countries as well, is littered with partial attempts to impose reform where the government owners hadn't the will or the fortitude or the knowledge or the capacity or the luck to impose the whole of the reform package-and the results were minimal, modest, or nonexistent.

W%en the cdsd fades, or when the regime changes, or when some major political claim arises, commitment to the priority of commercial aims and to noninterference in day-today management of the firm fades with it.

There are innumerable examples in which government owners kept prices for the products of supposedly reformed public enterprises too low to cover costs, out of fear of the political consequences of price increases. Government. may shut off direct budget flows to public enterprises, but few then go on to block conces- sionary transfers from the banking system. Governments grant operational autonomy to managers, but not with regard to hiring and firing, or plant location, or from whom to obtain inputs. Technically innocuous board of director reforms have been halted in Kenya, Morocco, and else- where because board membership is a lucrative core part of the patronage system. The list is endless, and the point is obvious: most governments have noneconomic objectives for their public enterprise systems. While they want them to be profitable and productive, they are most often unwilling or incapable of allowing these commercial aims to take clear precedence over the noncommercial. Thus, their reform efforts tend to be partial.

Second, in the few cases in which governments do establish and maintain the precedence of commercial over noncommercial aims, the results are, as we have seen in China, very good. But they tend not to k t . In most instances there is pronounced backsliding. The common story is that bad times make for good policies-in crises governments do establish the precedence of commercial objectives, they do impose a harder budget constraint, and they do give autonomy to public enterprise managers to achleve commercial aims. But again and again, when the crisis fades, or when the regime changes, or when some major political claim arises, commitment to the priority of commercial aims and to noninterference in day-to-day management of the firm fades with it. Examples of backsliding include the New Zealand Post Office, the Japanese National Railway, Pakistan public industrial enterprises, and some of the Korean government invested enterprises.

Conclusion

Based on this reasoning and evidence, it is clear that ownership mattersthat it is a significant determinant of the profitability and productivity of an enterprise. Political and organizational factors are fundamental to the reason why. Ultimately, as Oliver WdLamson is fond of saying, "politics trumps economics."

' Ian Duncan and Alan Bollard, Corporntrzntiol? nrid Pnuuliznlwn: h s o m born Neui Zenlnnd (Auckland Oxford Univ~,r\it!, Press. 1 9 2 1 2).

WLlliam L. blegginson, Roberr C Nash, and Matthias vai, Randenborgh, "The Financial and Operating Performance of Newly Privatized Finns: An International Empirical Analysis," j o u m l of Finance 49(2): 40352 (1334). Ahmed Galal. Leroy Jones, Pankaj Tandon, and Ingo Vogelsay, Weljare Consequences of Selling &rblic Enferprisa: An Empirical Analysis (New York: Oxford University Press, 1994). There is much else that is striking in this study. For example, it shows dearly that policy matters as well as ownership, that macm economic liberalization in conjunction with privatization is a powerful conlbination, and that effecrive regulation must accom- pany (preferably precede) the privatization of infrasuucture firms if divestiture is to yield its Full potential

john Nellis, Senior Manager, Private Sector Development Department

The Privatization Experience of Latin America Sell-off helps fiscal stability

~vateen nobani

Between 1985 and 1992, governments in the Latin American and Caribbean region privatized Inore than 2,000 publicly owned enterprises-including banks, ports, airlines, highways, public utilities, and insurance companies.' Chile and Mexico were among the first and most comprehensive. Their example was followed by Argentina, and soon most of the region had begun privatization programs.

In nearly all countries, the primary motivation for this sell-off was the fiscal and debt crisis. With the revenues from the sale of state enterprises, governments were able to ~ i g ~ c a n t l y reduce the hemorrhaging of public resources. In fact, what distinguishes this privatization effort from those in most other regions is its success in generating large revenues from public enterprise sales.

More recently, however, divestiture policy has been based on objectives of efficiency, productivity, and new investment. Therefore, privatization was expected to result in lower prices, improved service delivery, and better product quality. Po1icymaket.s have also seen the rapid sale of state-owned enterprises (SOEs) to a large and diverse group of new owners as a way of ensuring an irreversible reduction of the public sector.

Across the region

Chile divested more than 90 percent of its SOEs, more than 500 Firms, in two rounds, the first in the mid- and late 1970s, and the second in the rnid- ancl late 1980s. In Mexico, the privatization prognm began slowly in 1983 but accelerated after 1988, and about 90 percent of the SOEs have now been divested. Mexican government proceeds from privatv~tion have totaled about US$22 billion. The rnain remaining SOEs include the large pew- leurn company, IJEI\4FX, some communications

10 The Privatization Experience of Latin America

Bu mqpnhii privatWg, w Parinate the govmmRYs tiquidati~ SOEs under econonrp role in pradudjon oi goods and d a m minirMmi, and mtdcea in areas where - lncresre juivate sector Ua p r m m sew has

prrtrciprjso~ aoatp-- - Redoce mwcceflewr Incmam afticieney of Waa?msutyto 80b immlmmt

~E&alcestBC&w Avoid poteneial &in OR

-w-

I

Rsdirsstraleoftbesm a m h m p&ab seem campetonce: &use public debt

Expand phmthd fsm I - swwfben dunwic rupital markets i

I Riwthti4n annp1eW T h ooverrp~sld sold WEa BeMleen May lm2 Md In conpantar were bnd-1393) (Walb or parhlty) in bwmbrr l9S, tbs gnvernaenl pr*htbd, indding:

t,bcumWcab*~~~. OH and *Id M ISplhidatd mte than 30 8 in the steal sector am rs3Cwaysr Mne, mall cosnlercial enmprbsa 9 In the gmacbernieab pwochmiosl%,.nal esW&, Only h e hsellixed a- and c h ~ ~ l ~ w e a m sla&cRy g ~ l s m r a d T o v d d a more than US$9m. 4 in the fortilizat sabr.

and *, and water supply

Proumds W$Il,tbnin b.btreductim MinjeaCthb sale dths f i a US$&!ibn, m d y paid tar wilb

(miklsDa) , j - n f m l n ~ m 11 small enttqhes ( ~ a ~ t l l t r d d9scounted iwlemi domestic :Uli@Bbn h a W1, us$bR about usS1Oa p&lic Lbt iamtnunm m EBjh'1-d-

,ateom, u-mm YPF).

b d w USSl1 Ibn for klt tndmiafi Rivat&tlm law o(ilruWs hat Principally k r redrloa of

firms, including a major newspaper; an insurance company; a power company; development banks; and isolated industrial f ims that did not receive satisfactory bids when offered for sale.

Argentina's privatization program began in late 1989. By December 1993, the program had con- tributed to a debt reduction of US$11.1 billion, about 40 percent of (post-Brady) total commercial

bank debt outstanding. The cash reabed amounted to almost US$8 billion. The sale of a telecornmu- nications firm accounted for almost half the total, and the state oil company, YPF, accounted for 17 percent. Brazil's program is proceeding more cautiously but has generated sizable revenues. During 1990-93, twenty-four companies were privatized, mainly in the steel, petrochemicals, and fertilizer sectors, with proceeds totaling about

The World Bank Group 11

In first round (1974k Intpmve public sector

Maximize wwrnment tinanem

mmnuw Develop an l i c ien t Reduce size of government pruducth base

In rncond round (1981): Spread ownership

Reduce importance of gownmeat

In first r o d (1911). 470 Gevernsnnt ownership was fima. or 82?h of Sob. wsre reduced fram 1,155 parmhtal privatized, mcludinq b r n b d m in 1981 to 220 by and ntanufacturing saterprk. June 1932

I In se~olld round (1981), M finm were privatized, for a

tDtoIOfY696afSOEs.

PERU VE#EPUELA

Primthe all SOB wlaid-lgsa. Tramdm to private sector all

sdling to - e n d apemom SO& withut m widea who will quickly impme public pdiq obZectIvu perforrarmce and iajmt a w Wwa~ airline fnoln

bankntpcv Expond and improw telephonic sewice ( M n a pmnrm and priva- aits6m stalled in ?#&El,)

~ f i ~ ~ ~ n p ~ , B 1 ~ t h e g o v e m m s t includig: priratiPrd 1 boldimp, including

5 mini- enterphs 1 telephone campany (CAm 4 petroleum tuk i larkr 1 aidtne 2 banks 4 3 h o b

8 1 airline. 5 sumr refinerfea

U- in c a b plm W n easb procasdr US$715m in invwbnemt WSS1.9bn for CAM, wbwaase conwnitn~entr rsk included c#nslitsrent to

add N m IinaP-rnaghly

U-Syasn)

I Not available lnternal debt reduction Most3y for community About W% for social projam, 10% fot R&D, 1% for mainin& and 1- fhm 10% for p r t v m o a exp-

US$6.5 billion. In Venezuela, eighteen firms were privatized between 1990 and 1993, generating about US$2.5 billion in cash; US$1.9 billion was from the sale of a single telecommunications f m . By the end of 1993, Peru had privatized twenty firms, including banks, mining and petroleum enterprises, and rniscellaneous manufacturing and transport firms, generating US522 million in cash and US$715 million in investment commit-

ments. Earlier this year, it sold a 35 percent share in its two telephone companies for US$1.4 billion and received an assurance of additional new investment of about US$600 million.

In Colombia, fou r previously nationalized banks and twenty-one firms have been privatized, with operations generating US$6OO million. Although Bolivia has thus far sold or liquidated only thlrty

The Privatization Experience of L d n America

small SOEs, for US$10 million, a 1992 law allows for privatization of all SOEs other than those in mining and hydrocarbons, and the present governrnent is now privatizing seven major SOEs. Under the Nicaraguan program begun in 1991, 289 of the 351 SOEs acquired during the previous administration were sold, liquidated, or returned to their original owners. It is expected that the rest will be sold shortly. The telephone company is also being offered for sale, and steps are under way to divest the state power and oil companies. The Jamaican program is moving

STRATEGY

Debates about real and financial or macro and micro sequencing that have

occurred in some countries and among some World Bank staff have been con-

sidered largely irretevant by policymakers in Latin America. Where programs

have faltered, the main reasons are that policymakers failed to:

Establish a regulatory framework and resolve constitutional and other legal

constraints to privatization at the outset.

Find ways to reduce political opposition, particularly when divesting large,

"strategic" SOEs-for example, by distributing shares to broad segments of

the population. - Ensure that privatization is carried out in an open and transparent manner-

important for reducing political opposition.

Make the objectives of privatization clear and rank them.

Promote investor interests to generate multiple bidders, both foreign and local,

to improve the government's bargaining position, and to avoid impressions of

"giving away the store."

Spend the necessary resources on management consuftants and lawyers to

adequately prepare SOEs for divestiture.

along, with twenty-four SOEs sold and thxty-three at advanced stages of sale. In Belize, the privatization strategy has achieved the total or partial privatization of SOEs in the banana industry and in the telecommunications and power sectors. Revenues from the sale of a 51 percent share in the telecommunications enterprise alone were equivalent to 4 percent of GDP. When Trinidad and Tobago began its privatization process in 1988, it had eighty-eight SOEs. By the end of 1993, nine of these had been privatized and SLY- teen had been liquidated. Ten more are in the process of being privatized.

Privatization has moved very slowly in some countries. In Uruguay, the privatization process was halted in December 1992, when the sale of the national telecommunications company was rejected by referendum. In Guyana, the privatization process has been stalled since the change of government in 1392. In the Dominican Republic, Paraguay, and some Central American countries, there has been virtually no privatization.

Dedicated revenues

The bulk OF the proceeds from privatization have been earmarked for reducing public debt in most countries. In Mexico, all the proceeds from privatization were used to buy back internal public debt, and the annual savings from the reduced interest payments have been used to finance targeted poverty alleviation programs. Argentina has used about 60 percent of its privatization proceeds to reduce debt and has not earmarked the remainder. In Brazil, the privatization proceeds have been used principally for reducing federal public debt but also for social programs. In Colombia, more than half the proceeds have been used for external debt prepayments and overdue pension payments. Peru and Venezuela have not used sale proceeds for debt reduction, but have earmarked most for social p r e jects. In Nicaragua, it is expected that proceeds from the proposed telecommunications sale will be used to aid in resolving outstanding property claims.

Revenue expectations were usually met or exceeded. In some cases, however, as in Argentina, Brazil, and Chile, the process came to a temporary halt or proceeds were not as large as expected. \Where the privatization effort faltered, the most important causes were legal and constitutional impediments to privatization and the lack of a clear regulatory framework setting the mles of the game and establishing the institutional capacity to ensure that players adhere to the rules (see StTGlkgp above).

This Nore was llnalized in I\To\flernkl. 1994. ' Sebastlan Edwards, "Lab America and the Carihban: A Decade aher the Debt Cnsis" (World Bank, \Vashington, D.C., 1993).

Mateen 713obani, Senior Economist, Technical Department, Latin America and Caribbean Region

Privatization by Capitalization A popular participation recipe for cash-starved SOEs in Bolivia

As presidential candidate Gonzalo Sanchez de Lozacla ("Goni") was preparing his campaign for Bolivia's 1993 elections, he faced, on the one hand, popular pressure for faster tangible results after a lengthy spell of economic stabilization policies and, on the other, a popular anxiety about certain remedies. While minister of planning in the reform-minded government of the mid-1980s, he had used "shock therapy" to help bring hyperinflation under control. Now, eight years and two governments later, the economy was stable, but hardly growing. Most Bolivians were still very poor, struggling with the region's lowest literacy rates and high infant mortality. Only double-digit rates of growth could make rapid headway. Privatization was one obvious answer. The state was still very much the key player in important sectors such as mining, hydrocarbons, and public utilities. These operations were generally perceived as being inefficient and, in some cases, co1111pt. But Bolivians were suspicious of privatization. They feared it meant a loss of lobs, a loss of the nation's patrimony, and a return to (probably Yankee) imperialism.

Then the campaigning president-to-be noticed the popularity of Eastern Europe's voucher schemes for popular participation. He read about the problems eastern Germany's privatization program was having with its leveraged management buyouts. Though these buyouts gave enterprises new managers, the managers had no capital for investment. Combining the appeal of popular participation with the new feature of retaining the buyers' payment in the business, he produced the unique Bolivian model of capitalization. And thus in May 1993, he announced his campaign strategy, Plan de Todos. The Plan de Todos (loosely, plan for everyone) proposed a simple privatization model for six large state enterprises

in key sectors. The enterprises would be offered for sale by international tender. The successful bidder m~ould pay the agreed price not to the government, but into the company itself, dou- bling its net worth. The cash would be used for investment in the sector, stimulating expansion and efficiency improvements together with job creation. Initially, the strategic investor and the government would hold equal, 50% stakes in the new company. In the original Plan de Todos, the government would immediately give its share in equal parts to all adult Bolivians-about 3.2 million people. When this process was done for all six sectors in the plan (telecommunications, electricity, oil and gas, railways, aviation, and parts of mining), about US$2 billion of shares would have been distributed to Bolivian adults and about US$2 bitlion of new funds would be available for investment by the now privatized Bolivian companies. In addition, the government figured that these funds would allow the privatized companies to leverage another US$6 billion or so of debt, if necessary.

Sanchez de Lozada won the presidential election in July 1993 With the help of World Bank advisors, he has been working to make this capitalization concept a reality.

Speciai capitalization issues

While the process has been moving along fairly well since then, it has run into many of the thorny issues associated with traditional privatization scheme-sector reorganization strategies, the legal framework, and regulatory considerations (see box on page 15)--and a unique set of capitalization challenges. Aside from the general worry about how a relatively impoverished government can afford to give up the revenues from privatization, the key capitalization issues are:

How will a strategic investor with only 50% of a company's stock be assured of sufficient control over the company to warrant the investment? In the short term, what restrictions will be put on the company's use of the new investor's funds deposited in its accounts? If the longer-term purpose of these funds is to facilitate investment in the company and sector,

how wdl thus be spelled out, and what sanctions will be applied if the investments are not made? H o n ~ will "all adult Bolivians" be identified? Many Bolivians live in quite isolated areas, and there is no tradition of citizen registration. \&%at form will the distribution take? Who will safeguard Bolivian citizens' interests? In particular, what is to stop the new majority shareholder from "ripping off" the minority shareholders?

Giving up the revenues

Sanchez de Lozada believed that the privatization revenues would do more for ordinary Bolivians if these h ~ n d s were under the control of private owners of newly capitalized firms. He had two reasons. First, he thought this would lead to more investment and more new jobs and that eventually the budget would benefit from larger tax streams. Second, he had misgivings about how the government bureaucracy would use the money. He m~as afraid that large flows of privatization revenues in the hands of the bureaucracy could contribute to more inefficiency and possibly corn~ption.

Early shift: to pension fund mode

Fairly early on, the government decided that giving ordinary shares in six companies to over 3 d o n Bolivian citizens would create enormous logistical problems. So instead, it decided to use the shares to endow "pension accounts" that would be set up for each adult citizen. The penslon accounts would be managed by a number of competing private pension fc~nds. While the capitalization law passed in early 1994 specifically l~nked the citizens' participation to a pension-based model, none of the infrastructure for this scheme is yet in place.

Investor interests and obligations

A 50% stake in a company is usually enough to ensure management control. However, to avoid any uncertainty and the risk of a negative impact on the selling price, the capitalization law proposes that a management contract be given to the strategic investor for a fiived period of time. After that time, the investor would be able to buy

Privatization by Capitalization

shares in open markets to increase the share- holding beyond 50%.

When the buyer takes over the company, cash balances wlll be more or less equal to what the buyer paid for it. Potential investors have been quick to see the advantages of taking over a company with a healthy and liquid balance sheet. Assuming that an agreed investment program is part of the sales contract, and since planning for capital investment has a lead time, the new owner will, in the meantime, be able to manage these balances as for any other prudent company, with short-term, low-risk investments within or outside of Bolivia. Enforcement mechanisms or sanctions to ensure that the investor delivers on the "agreed" investment plan will be developed for each sector on a case-by-case basis. Local telephone services, for example, are so underinvested that it will be easy to follow the approach adopted in other telecommunications privatizations-numerical regional targets for new installations. The general approach will be to create a climate where investment by a company in its own sector will be a logical and profitable option, making sanctions unnecessary. Contractual obligations will be clearly spelled out at the time of the transaction.

Popular participation issues

Having decided to take the pension account route, the government must now grapple with preexist- ing financial problems in Bolivia's pension scheme. The government is hoping to solve them in parallel as new rules are developed for capitalization. Clearly, it will be important to ensure that the new pension scheme is not "contaminated" by the old problems.

A citizen registration scheme for the pension accounts based on voter registration is under way. But Bolivians-particularly those already past retirement age-still do not know when and in what form they can expect a "payout" from the scheme-for example, whether it will be in lump sum or an annuity. The first capitalization transactions will almost certainly happen before the pension scheme is fully in place. In the interim, the government needs to settle what will happen

to the citizens' shares in the period between capitalization and the establishment of a private pension industry. Who will look after the citizens' interests during this interim period? Who will be the investors' partner? And what share voting rights will this partner have? The current plan is to place these shares "in trust," with the trustee's voting rights limited to a few major categories of decision. This would seem to be a workable and equitable solution, one that would allow time to develop proper answers to the pension scheme questions while not prejudicing the success of capitalization transactions or the rights of the Bolivian people. The final decision will be made within the next few weeks, before any capitalization transactions are concluded.

Finally, with major multinationals as the likely strategic investors, and yet-to-be-established pension funds as the Bolivian people's represen- tatives in the capitalized companies, who will look after the people's interests in the longer tern7 The safeguard system is still being developed. At this stage it is proposed that even during the period when capitalized companies are being managed by strategic investors under management contracts, the articles of association will require, for certain decisions (for example, related to the disposal of assets or to major capital investments), a "super majority" of shareholders, ensuring that the pension funds represented on the boards of directors of the companies are given a meaningful voice in important strategic decisions. Second, the new pension h ~ n d law now being drafted will closely control what pension funds can do with the resources entrusted to them and give strong regulatory powers to pension fund regulators. Eventually, the pension hinds, and Bolivian citizens, will be able to trade stock in capitalized companies on the Bolivian stock market as well as in international markets. Although the local stock market is barely regulated as yet, nen7 laws and regulations should improve the situation.

This Note was finalized in November 1994.

Andrew Ewing, Managel; Private Sector Develop- ment Department, Susan Goldmark, Private Sector Deuelopment Specialist, Latin Amen'ca and the Caribbean Country Department 111

Russian Privatization John ~Vellis and ha Liebmmnn

Russia's privatization record is impressive and unique. Participants at a June 1994 World Bank

conference on the subject concluded that it was irreversible, that the next stage of privatization-

selling remaining shares and firms for cash through auctions and tendertimust be expedited, and

that developing capital and securities markets and making business real estate tradable should

get top priority. This Note reviews the privatization achievements of Russian reformers over the

past three years, discusses emerging second-tier privatization and post-privatization issues, and

summarizes the key themes in the papers presented at the World Bank-sponsored conference.

Impressive by any standard

Privatization is the one bright spot in the generally Meak Russian economic landscape. Starting from an acutely difficult position' in November 1991, a small, determined, and often beleaguered group of Russian reformers-with some important external supportz-has been able to:

Devise and implement, in the face of strong resistance, a "corporatization" program that has turned about half of Russian state-owned enterprises into joint stock companies. Persuade the most important "insider" stakeholders who might have opposed privatization -workers and rnanagers-to take part in the process by offering them shares in the firms in which they work for free or at a low price. Conceive and implement a voucher program giving 144 million participating Russians a chance to become, along with insiders, owners of enterprises.

= Create a national voucher auction system covering more than 85 regions, with 750 bid reception centers. Facilitate the creation of some 600 private investment funds that compete for vouchers and convert them to diversified shareholdings in newly privatized enterprises.

18 Russian Privatization

1. Russia's voucher-led mass privatization program, without prece-

dent in size and speed, is a major success. Why? Because the links

between the enterprises and the state have been severely frayed, if

not yet totalIy cut, and a mass of property owners--who, presum-

abb, will suppott further reform-has been created. The first and

overarching goal of the process, to make reform irreversible, seems

to have been achieved. Initial inquiries into the behavior of firms after

sale reveal that restructuring is under way. as evidenced by product

diversification, labor shedding, and change of top management.

2 The next stage of privatization will entail selling the remaining

shares and the remaining thousands of enterprises for cash, through

auctions and tenders. The government proposes that e substantial

amount of the cash so generated remain in the firm, to finance

needed restructuring. To increase the attractiveness of firms to

investors, the real estate on which the company si5s mrart be clew tradable and clearly included in the deal. This epprbech wlll

address essential needs of newly privatized firms, but wlll necessarily

be slower than transfer through voucher auctians. And it has

already provoked vehement opposition f r m reqionab gavornmonts

and municipalities, which see the new apprmch as a threat to their

lucrative control over local real estate. In mid-July 114. dw Russian Parliament rejected the proposed ~ c o n d - p h a t e program,

but it was promptly promulgated by a presidential desrer.

3. A fundamental contribution of the mess pr ivrbat im pragram h s been its capacityto reveal the need for, and to spur, rdorm In other

aspects of the economy. Legal reforms, land privatization, protection of shareholder and creditor riqhts, social safety bet

reforms and the closely related issue of haw to dispose of ancillery

or social assets of firms-the need for r e h n in al l these erers is

acute, and considerable activity is under way. H m n r , a recurrlnp

theme in the conference, on which there was unlvertal a!yeornent,

I was that the top priority was the development of ixpital and securities markets. This Is seen as critical to asalet imeatprs in

acquiring property and proteetirig savings, and ta d r e s s tke meti for improved corporate governance in the pdvatized firms.

By the end of June 1994, = Between 12,000 and 14,000 medium-size and

large enterprises had been transferred to private ownership. This set of Fims employed more than 14 million people, or about half of those employed in Russia's industrial sector. About 40 million Russian citizens owned shares in privatized firms or investment funds.

These achievements were made in the absence of consensus on the desirability, scope, and pace of liberalizing reform in general, and of privatization in particular, and without what would normally be considered the requisite administrative and financial resources to implement, monitor, and enforce a privatization program of this magnitude. Yet it was done. The only potentially comparable privatization experiences are those of the former East Germany and the former Czechoslovakia.

In Germany, the Treuhandanstalt succeeded in putting more than 10,000 enterprises into private hands between 1991 and 1994. This achievement cannot and should not be minimized. Nonethe- less, German privatization was a case of integrating a formerly socialist economy into a functioning -indeed flourishing-market economy, an

exercise that differs sharply from the total transition that Russia confronted. In Germany, an irreproducible combination of West German legal and administrative institutions, West German managers, and West German money eased many of the problems of that integration.

The mass privatization program of the former Czechoslovakia, which transferred 1,491 firms into private ownership in 1992 and 1993-with a "second wave" coming in both successor states that will touch an additional 1,300 firms--is the best, perhaps the only, comparator to the Russian privatization program. Once again, the Czech and Slovak privatization programs are remark- able achievements. Indeed, a Few Czechs have uggested that their method was the "right way" to

privatize since: in contrast to the Russian approach,


hinds-played a major ownership and governance role from the outset; and some Czech prac- titioners and external observers now criticize Russia for not having followed the same course.

Without disputing the impressive Czechoslovakian achievements, it has to be stressed that Russia embarked on privatization in circumstances very different from those of the former Czechoslovakia. First, precornmunist Russia in 1917 was markedly different from precommunist Czechoslovakia in 1948; it was less industrialized and less capitalist. Second, the length of the communist period in Russia was almost double that in Czechoslovakia, so in Russia collectivist approaches and habits had more time to take root and become deeply in- grained. Third, and paradoxically, Czechoslovakia "benefited" from an absence of reform commu- nism; that is, unlike Hungary, Poland, ancl, to some extent, Russia, Czechoslovakia maintained basically intact the central planning system until the very end. The successor governments thus have not had to debate the scope and pace of liberalizing reform with entrenched, decentralized stakeholders such as the Solidarity movement in Poland, the workers' councils in Hungary, or the relatively empowered enterprise managers, cooperative members, and leaseholders created in perestroika Russia. The Czechoslovak successor regime in 1990 was less constrained by decentralizing forces than almost all of the other successor regimes in Eastern and Central Europe-circumstances of which Vaclav Klaus and his reform team have made the most.3 In addition, Russia is a far more complex country than was Czechoslovakia, with some 150 million people spread across a vast territory of 88 regions, autonomous republics, and major municipalities. The Moscow o b h t alone is larger than the Czech Republic and Hungary combined.

AU in all, the obstacles to Russian privatization were more numerous and more daunting than those encountered in Germany and Czechoslovaltia, or indeed in any other country that has seriously embarked on the process. In Russia, because of these different initial conditions, the period of "extraordinary politics"" was both shorter-lived and less intense than in other economies in

transition. This point must be grasped, both to comprehend how truly impressive Russian privatization results have been and to understand why the Russian process has unfolded as it has, with the defining characteristic being the provision of financial rewards or equity stakes to all the actors and agencies involved. Had the Russian reformers attempted to follow the Czechoslovak route of centralized administration of the process, and had they tried to treat enterprise insiders as potential purchasers like any other, the likelihood is high that very little privatization would have taken place.

7hese achievements were made in the absence of comen.sus on the desirability, scope, and pace of liberalizing reform in general, and of privatization in particular, and without what would nomaally be considered the requisite administrative and financial resources to implement, monitol; and enforce a privatization program of this magnitude. Yet it was done.

What happens next...

The Russian privatization team thus opted for the method that it judged would yield results-and it got them. But as a consequence, the results were tentative and partial. The transfer of ownership basically to insiders was a striking step, but only a first s t e p w h i c h must now be followed by equally essential second steps opening ownership of privatized firms to external investors and owners. These steps will, it is hoped, bring needed capital, market access, managerial Itnow- how, and a bottom-line mentality to privatized companies. External investors should complete the restructuring of firms begun by the transfer of

20 Russian Privatization

ownership. A significant percentage of restructured firms would then become profitable and nationally and internationally competitive; and Russia would be well launched on the process of growth and integration into the global economy.

Such is the hope-but much stands in the way. A number of critical issues and questions emerge:

Insiders fear that the restructuring brought about by external investors will cost them their jobs; they thus do their best to prevent or limit sales of large blocks of shares to external investors. %at are the mechanism.s by which secondary share trading, leading to restmrc- tztring, will be amplified and entrenched? The voucher scheme expired on July 31, 1994; the present political configuration will not, apparently, tolerate a second voucher issue. However, between 10,000 and 12,000 enterprises remain uncorporatized, unprivatized, and lacking the voucher mechanism to spur their divestiture. W?at will happen to this important set ofjirrns? At what pace will cash sales (tenders or azrctzons) proceed, and who will ensure the transparency of the process? Small-scale privatization in Russia is impressive in absolute terms (with some 85,000 small business units divested), but lags relative to similar programs in, for example, Poland, Hungary, Estonia, and the Czech Republic, where a much larger percentage of the entire small-scale base has been divested. Small-scale privatization schools both new owners and consumers in market economics, and has proved critical in job creation, essential to the absorption of surplus labor flowing out of the large-enterprise sector. Why has Russia per- formed comparatively poorly in small-scale privatization, and what does it mean for the economic fi~tu,re of the county? Twelve to fourteen thousand medium-size and large firms are now in private hands. But few believe that their fiiture operations will be left entirely to determination by pure market forces, especially since at present the Russian variant of the market deviates so sharply from the textbook model. Privatized firms urgently require technical assistance (to help in the preparation of business plans and restructuring);

credit to finance working capital, trade, and investments; and equity injections to provide both long-term money and active governance. How can these needs be met without reintro- ducing into businesses the h e a y hand of the state? Who will fund and provide these resources? And what parallel reforms are requzred in the ,finuncial sector and capital market deuelopment to sz@port these actions? Important as privatization is, it is only a part of the transition process, alongside new entrants and greenfield investments. What does the non- priuatized private sector look like, and how, i f at all, do its activities differ from those of the privatized sector?

l l le new book based on papers presented at the World Bank conference addresses these questions and issues-in sections entitled Privatization, Capital Market Development, Corporate Gover- nance and Restructuring, and The Emerging Private Sector: Constraints and Regulations (see box on page 17 and page 53 for more information about the book).

I In the sense that the reforn~ers did not simply face the privatization of a mass of state-owncd unterprises, but also had to deal with the "quasi-private" enritia created during h e late ~ 6 r o 1 ' k a period. Scc John Nullis. Improving Ihe PerJoormance of Sm'eI Enlerprisa (World Bank Discussion Paper 118, Wash~ngron, D.C., 1991) ' From thc G-7 countries (through bilateral programs), the EBRD, the World Bank Group, and the European Union. Equally important, h e Russian privatization team knew how ro put these exernnl resources to effective use. ' Onc potentially massive set of decenvaluig factors that existed in

199&the feda-al nature of die state and rhr tensions between the Czech and Slovak retiltones--has, of courx, been resolved by the dissolution of the federation. The phrase is from Leszek Balcerowicz and Alan Gelb, "Macropolides in Transition to a Market Economy: A Three-Year Perspective." a paper presented at the World Bank's Annual Bank Conference on Development Econonucs, Washington, D.C , April 1994 The authors argue rhat a period of curraordinaly polirics" occurred in a number of W r n and Central European countries when the old communist elites were discredited, but "modem" interest groups were few, fragmented, and unorgaoized. This allowed reforming rechnocrdts to rake command, greatly raising [he "pl.obabiliry rhat d~fliculr, nonnally controversial, econormc policy measures will be accepted" (p, 11). The period lasrs, say [he authors, for one or rwo years, and then "politics as usual" tends to regain supremacy.

John Nellis and Ira Liebeman are both managen in the Private Sector Dwelopment Departm,ent.

Privatization in Estonia Major accomplishments and remaining problems

Job n l\kllis

Estonia has one of the best overall economic Other post-communist countries would do well reform and, in particular, privatization records of to examine the Estonian program. any part of the former Soviet Union. An estimated 50 percent of state-owned enterprises and business units had been transferred to private ownership or control by the end of May 1994.

Estonia has one of the best overall True, Russia has moved even faster on privatization; its divestiture over the last two years of

economic reform and, in particular, almost 70 percent of its industrial sector has been pm'vatization of any part of nearly miraculous. But since Russian privatization is m a d y a transfer of control.ling stakes of shares the fomW So&, Union to insider-workers and managers--questions remain as to whether these new owners will undertake restructuring to the extent and at the pace required. In contrast, Estonian ownership transfer is taking place in a reformed macroeconomic environment, and it does not emphasize payoffs to insiders. Instead, Estonia has adopted a range of divestiture methods aimed at putting assets into the hands of those with the incentives and skills to use them wisely. In addition, bankruptcy is operating as a parallel privatization process; this spurs the Estonian Privatization Agency (EPA), the company, and sometimes the potential purchaser, to complete preparations and close the privatization deals.

What are the factors that have made this success possible? First, good policy, including the ending of soft credits to enterprises, a currency board system that links money creation to hard cur-rency reserves and keeps Inflation at modest levels, liberalized prices, an open trade regime, and the encouragement of foreign investment. Second, good politics, with active leaders so far persuading the populace to tolerate the p a d l but (it is hoped) temporary adjustment. Third, good history, with strongly developed national and commercial tradi- tions. And fourth, good geography, with Scan- h v i a n and Finnish markets and investors close by.

Range of divestiture methods

The divestiture methods include: Restitution of homes. farms, and businesses expropriated during the cornrnunist period Auct~ons for small-scale business units A tender process for medium-size and larger firms thought to be of interest to foreign or domestic investors Lease arrangements for parts or all of a set of enterprises Joint ventures combining foreign, private management and capital with govemment-owned assets An active bankruptcy process, which liquidates insolvent, nonperforrning state firms and turns the assets over to private entrepreneurs A voucher program in which those holding vouchers will soon be able to exchange them for shares in privatized firms, for shares in investment companies that are being created, for housing, and for land.

By the end of May 1994, these efforts had led to: 125 signed contracts throc~gh the tender process Over 1,000 small business units auctioned off, representing about 85 percent of the small businesses originally designated for sale

22 Privatization in Estonia

340 leases for all or part (sometimes quite small parts) of enterprises 200 joint ventures An estimated 200 bankruptcy proceedings (most of which are thought to deal with state- owned entities).

Four tenders conducted by mid-May 1994 have generated US$63.4 million in sales proceeds (with more to come as contracts in process are signed). Buyers have conwacted to invest more than US$30 rmllion in the privatized firms and to guarantee more than 14,000 jobs. Between 30 and 50 percent of sales through tenders have gone to foreign investors or to domestic purchasers with foreign partners or foreign financial baclung. Most of the items sold are small in size; very few of the privatized companies propose to maintain more than 500 employees, and only two have contracted to maintain 1,000 or more workers. Nonetheless, in a country of 1.5 d i o n people, the tender pro- g a m is important. Bids on a fifth tender were s u b mitted in late May 1994. EPA oficials estimate that the tender process w d be completed by mid-1995.

Evolving process

A program of trade sales of up to twenty large companies, supported by the European Bank for Reconstruction and Development, is in active preparation. The idea is that some larger companies require detailed financial engineering or the hiving-off of social assets. The EBRD will become the privatization agent for a group of firms. It will undertake a minimal amount of cleanup, and sell these companies w i t h twelve to eighteen months. Yet another twenty large companies will be privatized through a plblic ofm'ng effort supported by the Phare program of the European Union. The intention is not simply to privatize but also to:

Promote the Estonian equities market = Provide the first opportunity for citizens to

trade privatization securities (vouchers) for shares of firms

= Divest the state's portion of a group of existing joint venh~res.

This will work as follows: The EPA will attempt to find a core investor to take a majority stake in

several hlgh-potential f m s . Once a core investor is in place, the rest of the shares w d be offered to the public, for vouchers, cash, or both. If these first transactions combining public offerings and vouchers go miell, this method could be used to privatize large mfrastructure enterprises, such as the port, the airhe, and utilities such as telecommunications.

A number of problems remain

Speed. E\~en the comparatively fast-moving Estonian experience underlines the importance of decisiveness and speed in the privatization process. Several companies held back from previous tenders (by sectoral ministries), on the grounds that they could be sold more advanta- geously at a later date, are now in operational trouble-and in two cases, bankn~ptcy. One can add these examples to a growing body of international experience supporting the view that delaying privatization often results in deterio- rated assets, decreased revenues for the state, and probably decreased welfare and efficiency for the economy.

Control of contracts. The tender process has resulted in 125 contracts, and more are being concluded. The contracts now need to be monitored and enforced. The EPA is presently setting up a Contracts Control Office with five or six staff.' Experience shon~s that monitoring nurn- bers of persons employed in the privatized firms is fairly straightforward; seeing that installments are paid on time is more difficult, and keeping track of promised in\~estments is much more difficult. The ultimate weapon to deal with noncompliance is repossession of the business or object. To the EPA's and the government's credit, one repossession has already been carried out.

Leases. The more than 300 leases pose problems. Many are contracted to last until 1999 or longer, and m most cases the annual payment is very small. Government policy is, rightly, to fully privatize the leases, as fast as possible. The question is how. EPA officials would prefer to simply auction off the leases to the highest bidder, but the law requires that a valuation be made before an auction-and this would be trouble-


some, given the legal and technical difficulties of sorting out the renter's improvements and investments from the state's property. A variant would be to convert the leased companies into joint stock companies, then give the leaseholder shares representing the value of improvements made during the leasehold, and allow the government to auction off the remaining shares. However, in ths case valuation is also difficult. The tender process avoids this complication, but for other reasons is still not as simple or as fast as auctions. What to do? Leases should be converted to full private ownership by whatever means the government and the EPA find most expedi- tious-through auctions if possible, but through tenders if necessary. IF no acceptable bids are received through the auction process, leaseholders might be allowed to purchase the company for a nominal sum.

Joint ventures. A June 1994 amendment to the Privatization Law states that joint ventures may continue to be contracted. Yet giving sectoral ministries complete freedom to negotiate joint ventures runs the risk that nontransparent, corrupt sales may be concluded. The proposed solution (though it too has risks) is for the EPA board of directors to review and approve joint venture contracts concluded by other ministries.

Bankruptcy. Estonia has one of the most active bankruptcy programs in the ex-socialist countries. A creditor or group of creditors with nonper- forming loans petitions a court, which assesses whether the terms of the Banluuptcy Law are met and appoints a trustee. Bankruptcy aims solely at protecting the creditors; there is nothing that resembles a "Chapter 11" provision allowing the debtor a chance to restructure.

The process does not appear to be monitored, though a register does record the liquidation of enterprises and the reason for the liquidation. As of mid-May 1994, it had received notice of the completed liquidation, clue to bankruptcy, of twenty-six enterprises. An estimated 200 bank- n~ptcies are in process. Most are liltely to be state-owned companies. The conclusion is clear: bankruptcy has emerged as an important alternate

route to formal privatization as a means of divesting state-owned property in Estonia. However, it poses some problems, the principal one being that it takes legal precedence over-and can block or even cancel-privatization. The June amendment to the Privatization Law allows delay for six months of the application of a bankruptcy action, for Firms in an active privatization process. A "grace period" of this nature is desirable. More ominously, it has been suggested that the weakness of the courts, the fact that no government agency was monitoring bankruptcies, and

Estonian ownership transfer is taking place in a refomzed macroeconomic environment, and it does not emphasize payoffs SO insidem. Instead, Estonia has adopted a range of divestiture methods aimed at putting assets into the hands of those with the incentives and skills to use them we ly .

shortcomings in the accounting system all con- tributed to the occurrence of some "dirty games." The proposed solution: a more active role for the courts, more monitoring by the Ministry of Justice, and education for creditors so that they monitor one another. These actions sound sensible, but they might slow privatization and weaken or damage this active and decisive bankruptcy regime. Before taking any action, the government should carefully consider the costs as well as the benefits of regulation and enforced coorclination.

Vouchers. There is growing concern that the total supply of assets tradable for privatization securities will be insufficient to meet the demand. Estimated total demand fo~~hcoming through vouchers is about 20.5 billion kroons, or ~ ~ $ 1 . 6

24 Privatization In Estonia

billion. As noted, vouchers are or will be exchangeable not only for shares in enterprises or investment funds, but also for the housing in which one resides and for land. On the supply side, a rough estimate is that housing will absorb about 6 billion kroons of vouchers, land a further 4.5 b~llion kroons, and enterprises 5 billion kroons, for a total of 15.5 billion-still leaving a surplus of artificial demand of over 5 billion kroons. However, many if not most of the restitution or "compensation vouchers" will not be issued until the special commissions resolve restitution claims, a process that could take a few years and result in the issuing of vouchers long after the housing and enterprise stock has been claimed.2

There is also a concern about voucher tradability. At the end of May 1994, the Estonian cabinet approved a bill allowing complete tractability of vouchers among Estonian citizens and residents. Despite the opinion of the Bank of Estonia that malung vouchers tradable would not sigmficantly or enduringly contribute to inflation, anxiety per- sists. It seems clear that as long as the vouchers are ultimately redeemable only for asse-and cannot be redeemed for cash by a government office or bank-then any trading internally for local currency would not add to the money supply and would not, in itself, have a major or enduring inflationary effect. Another concern is that making vouchers tradable defeats their prime political purpose-to transform Estonian citizens and residents into owners. When vouchers become freely tradable, some percentage of holders will choose to dispose of the gLft they have received by selling them to anyone who pays an acceptable price. The proper economic response to all this is to allow voucher trading to proceed. If a voucher holder wants to sell for cash rather than hold shares (or buy housing or land), that is his or her choice; and no claim can be made that the individual is worse off for having made this choice.

purchasers often obtain assets rather than going concerns; and even when concerns are sold, the buyer may contract to assume only a portion of the enterprise's debt. The result is a debt over- hang with which the government must deal.

The government began to deal with the debt problem by trying to clear interenterprise debt. A cross-cancellation exercise carried out for enterprises held by the Ministry of the Economy (which has one of the largest portfolios) will clear between 80 and 100 million kroons of arrears. Changes modernizing the accounting and taxation laws should allow the ministry's companies to take another 120 million kroons in write-offs. Still, these two steps account for only 40 percent of the debt held by this important group of enterprises. Other ministries presumably are in a similar situation.

Ultimately, someone will need to assume these debts. The government must decide who can and who should absorb these losses. An irnportant argument in favor of forcing creditors to absorb some or all of the losses is that it will send a strong signal that the government will not bail out creditors (including utilities and other state- owned enterprises).

Lily Chu and Paul Siegelbaum offered many helpful comments on this hotc. Jr was completed in July 1994. ' 'The German Treuhandanstal~'~ Office of Contract Control

employs j00 specialists-but they have thousands of contracts to monitor. Repoltedly, some 20 percenl of the Treuhand's conlncts are already in dispute. It is reasonable to ask whether the benefits of using such contracts outweigh ~ i i e c o s ~ of negotiattng 2nd monitoring them. If this happens, one solution beuig considered is to allow holders to exchange these vouchers lor goverlimenr interest-beal.ing bonds In effect, the government would pi~rchase the vouchers. 731s approacti has serious budge ta~ in~plic.,~tions, and the issuing of bonds withoi~t backing is definitely infl~tionary. Another Idea IS to I~nk ,'cornpensarion vouchers" to some new form of private pension fund.

John !\kllis, Senior Manager, Private Sector Development Department

Debt Last is the issue of debt. The revenues being generated by sales of enterprises are not sufficient to cover the debts and liabilities of the privatized fums because, in the tender process,

Risk and Private Power-A Role for the World Bank James Bond

NonuMsty private investors are an increasingly significant source of power sector investment in OECD

countries, especially for power generation. Thii has changed the unddying rrtruchue of the eledddty

sector, triggering efficiency gains and cost reductions that have been passed on to the consumer.

However, the trend has not yet evolved to the same extent in developing countries, despite intense

interest by project sponsors. The reason is that debt financing for independent power producers

(IPPsl in developing countries has been scarce. The crux of the problem is that lenders are reluctant

to participate in projects in which they are open to country risk. They don't like lending when

repayment of their loans could be jeopardized by arbhrary decisions by the host government. To fuc

this, as the risks associated with independent power projec& are unbundled and d i i bu ted among

participants in a deal, the lenders must be provided with appropriate cover for country risk. By

contributing to a solution to the country risk problem, the World Bank could play an important role in

promoting private investment in power. This Note, based on views expressed by private investors

during a recent roundtable on private sector power, suggests how this role could take shape.

The potential for independent power in developing countries

There is a significant appetite among IPPs to invest in the developing world. Nearly eighty memorandums of understanding have been signed between IPPs and the Indian union and state governments. More than 100 have been signed with China, PPs believe that power projects in developing countries have higher potential returns than those in the industrial world, because demand for power is growing rapidly in those countries and the potential for efficiency gains is high.

IPP interest is timely. Governments in developing countries, disappointed with the performance of their public utilities and seeking new sources of finance for power investments, are starting to

Risk and Private Power-A Role for the World Bank

court foreign investors. India, China, Malaysia, and the Philippines are the notable cases. However, when governments try to attract private investment, they often want to lay off all project risk to the investor. \Vhile IPPs are rather good at handhg most project risks, one risk they cannot manage is the unpredictable behavior of the govelnment itself.

The problem takes form in debt financing. Independent power projects generally are developed on a project finance basis, with sponsors

There is little signficant difference between developing and industrial countries in the way that agreements for plant construction and ~peration are drawn up. By contrast, the agree- nents relating to the environment of the project differ substantially. Typically, in industrial countries, the project environment belongs to the general framework in which the power sector and private investors operate: the predictability 3f government decisions and enforceability of contracts, the transparency of the regulatory environment, electricity tariffs that ensure a jmong Financial situation for the sector, and the zonvertibility and transferability of currency. But this is the area where lenders for developing- country projects perceive the greatest risk. Governments may, for political reasons, make decisions relating to tariffs that render projects insolvent, or they may devalue their currencies or expropriate foreign investment. Unless lenders feel comfortable that their loans are sheltered From this country risk, they will be unwilling to support a project.

funding part of ..., project through their ,,.~ity contribution. This contribution is typically 25-33 percent in developing countries and 10-15 percent or less in industrial countries. The rest is financed through debt, generally from banks. Project developers are unable or unwilling to

Until now, many of the private investors currently working to launch power projects in cieveloping countries have sought to mitigate country risk simply by requiring the host government to guarantee that the rules of the game will be respected through specific support or implemen-

provide corporate guarantees for the portion of the investment financed by debt, so lenders must look to the robustness of the project itself for guarantees.

To close the financing plan and actually start construction on a power installation, a sponsor therefore needs to be able to negotiate a set of agreements that satisfies not only the government and itself, but also the banks that will be financing the major part of the investment. Some of these agreements relate to the period of construction of the plant (completion guarantees, siting agree- nents); some to the period of operation (power mrchase agreements with the purchasers of the electricity, he1 purchase agreements, agreements on dispatch); and others to the environment in ~rhich the project will be undertaken.


tation agreements. Increasingly, however, the value of such government guarantees is being questioned. If, as is usually the case, the government is unwilling to ensure that its public power utility respects the terms of a power purchase agreement, what are the chances that it will respond when its guarantee is called?

Instead, cover for this country risk could be provided in the following ways:

Macroeconomic reform. The best way to address country risk is at the source of the problem: remove all the obstacles that make lenders uncomfortable. But that requires economic and power sector reforms so far-reach- ing that they would go well beyond a specific project, with a time scale measured in decades rather than months. (In fact, promoting private investment for power, even before the entire investment frameworl< has been put right, can give a significant impetus to the macroeconomic reform process.) Contractual mechanisms. A second solution is to develop contract~~al mechanisms that address each aspect of country risk. For example, if the power utility that would normally purchase the output from the IPP is uncreditworthy, electricity could be sold directly to a small number of end users (as in the Colombia power project sponsored by the firm K&M or the Hopewell projects in China). And if the currency is not convertible, the project sponsor could enter into a special agreement with the government making its foreign exchange requirements (for parts, debt senrice, and dividends) available through the central bank (as in the proposed Songo-Songo project in Tanzania). Obtaining cover from third parties. Lenders could also turn to third parties for cover. Export credit agencies could pro\/ide guarantees. And the International Finance Corporation (IFC), through its "B loan," provides banks (or their regulatory bodies) with comfort against country risk. The IFC acts as lender of record, fronting for commercial banks.

More investors are now turning to the Bank and the IFC for this kind of country risk cover.

A role for the Bank in promoting independent power projects

A fairly clear consensus has emerged from industry players that the Bank can have a useh~l role in promoting private power, though not necessarily in developing projects itself. Instead, it should find ways to encourage others to invest. The Bank should focus on developing mechanisms to provide cover for country risk, above all to project lenders, without necessarily assuming this role itself.

The following points clefme a possible role for the Bank.

Dealing with the environment

Supporting macroeconomic reform. support for macroeconomic reform by its borrowers is part of the Bank's regular stock-in-trade and is probably the most effective way to address country risk. The Bank channels significant resources, both loans and staff time, to this activity: about one-quarter of lending during the 1980s went to quick-disbursing structural adjustment operations, designated for macroeconomic reform. Supporting power sector reform. The Bank's ongoing program of support for power sector reform (described in the recent policy paper, The World Bank's Role in the Electric Power Sector) will make power sectors more attractive to private investors by removing major policy obstacles and by making power utilities creditworthy. The program encourages commercialization and corporatization of power utilities, which will make them more viable customers for power from IPPs. For example, the privatization of the CBte d'lvoire power sector, supported by an energy sector adjustment loan from the World Bank, has lifted a major obstacle to participation by IPPs. Encouraging entry of private investors. Over and above commercialization and corporatization, the Bank has an important role in promoting competition: by helping governments to remove barriers to entry for new players

28 Risk and Rhrate Power-A Role for the World Bank

(such as by eliminating statutory monopolies for public power utilities) and generally by encouraging regulation that is both transparent and open. Current World Bank support to China and India is a step in this direction.

Dealing with the players

= Educating the counterparts. The Bank could assist its borrowers in their dealings with the private sector using an approach developed in the early 1980s for its petroleum exploration

mi le PPs are rather good at handling most project risks, one risk they cannot manage is the unpredictable behavior of the

promotion projects. For example, the Bank could fund the development of a sector legal and regulatory framework. It could fund the solicitation of bids from investors, the evaluation of the bids, and the negotiation of deals, and, in the case of private-public partnerships, it could assist with financial engineering. In some cases the Bank could also act as advisor to governments, for both government-initiated projects and unsolicited bids. World Bank financing of a project itself would not be automatic or necessarily desirable. The Bank's assistance to China and India, which includes seminars and conferences to pass on negotiating skills, reflects t h s approach. Working with the private sector. The Bank will seek to work with the private sector, both as a clearinghouse for information about investment opportunities and as a source of advice and best practice on how projects might be structured. For example, much of the Bank's nonconfidential country and sector data could be made available to private investors, which would reduce their development costs. The recent roundtable, which brought together

thirty-five key industry players and Bank and IFC managers, is a beginning.

deal in^ with the projects

Praviding explicit guarantees for country risk. There clearly is a need for deal-clinching guarantees to private investors, to enable them to mobilize debt financing for their projects. The form of such guarantees would depend on country creditworthiness and the structure of the project. A case-by-case approach would be required to determine whether the Bank's expanded cofinancing operations (ECOs), the sponsorshp trusts managed by the Multilateral Investment Guarantee Agency (MIGA), or other mechanisms are the most appropriate. The private power operations proposed in C8te dlIvoire and Tanzania (Songo-Songo project): both countries perceived as having high political risk, will be interesting test cases for the Bank. Delivering wholesale finance. Private sector sponsors believe that there is little role for the Bank's standard government-guaranteed loans to finance private power projects. However, there is significant scope for the Bank to develop financing mechanisms that could tap domestic savings in developing countries to fund infrastructure proiects. These mechanisms could include domestic debenture markets, domestic investment guarantee agencies (as proposed for Mexico), and rating agencies.

James Bond, Principal Energy Specialist, Finance and Private Sector Development

Infrastructure Investment Funds Andrea Amq~zotos

Institutional investors, facing lower rates of return on investments in the mature power and

tetecommunications sectors of industrial countries, have h e n scouring emerging markets for higher

returns. To attract these institutional invastors, a growing number of equity funds are giving them

the opportunity to mitigate risk by investing in a poMolio of infrastructure entities in developing

countries. Fund managers expect the infrastructure equity funds to yield more than 20 percent

annually from long-term capital gains. These funds will help to attract additional equity and debt

capital Rows to developing countfies and may contribute to the development of local capital markets.

This Note discusses new methods for tapping international and local capital markets for long-term

infrastructure funding, and it focuses in particular on the key characteristics of the equity funds--

pooling risk and providing long-term capital to private entities. These key features are relevant to the

design and implemenMon of infrastructure debt funds being considered for World 8ank participation

in such countries as China, Colombia, India, Jamaica, Mexico, Pakistan, Sri Lank, and Thailand.

Expanding private sector participation in infrastructure

Infrastructure spending in developing countries is expected to exceed US$200 billion a year during the 1990s. Private investment now accounts for about 7 percent of the total, but its share is increasing and may double by the year 2000.' Private sector participation has occurred through the privatization of existing assets and through new investment-using mainly limited- recourse or non-recourse financing schemes, including build-operate-transfer or build- operate-own arrangements. These BOT and BOO arrangements are financed mostly by sponsors, buyers' credits, loans from export- import (EXIM) and commercial banks, and multilateral agencies. However, new methods of tapping financial markets are being developed, including the establishment of equity funds.

Local market finance has been limited in most developing countries, and significant funds are being sought from abroad in the form of direct and portfolio investments and bank loans. However, to sustain private investment in infrastructure over time, local capital market development will be necessary. To some extent this is already taking place. Tne International Finance Corporation's (IFC) Emerging Markets Database shomis that the total capitalization of stock markets in developing countries grew from US$599 billion in 1989 to US$1,399 billion in 1993, with infrastructure stocks increasing from 3 percent to 22 percent of the total capitalization. In Malaysia, for example, YTL raised funding for two independent power projects from domestic pension funds.

New ways of tapping capital markets

Some infrastlucture firms in developing countries--those with an operating track record-

Infrastructure Investment Fun&

TABLE 1 IlYlFRASTAUCTURE IlYMSTMENT FUNDS

hnrl (md & Cm mMs$n

RL6 Asian I-tun Fund Atbetican ~ n r l 6 r o u p bghn: kia-Pacific (3%D% in ebioa)

Alliance ScanEast Fund LP. E~b~WAuuraa~l-8wiepy of U.S. Rs@or batern Europe, ikItlcr. 4-m Partnsr lld3 Awricpr Intmatbnsl 6mp

l@ent#iend Finance ComntrLn EmpauIkbkler h m w n and Pwsmat

@Mom Power, Wimpon, end n l w d Mustdm

.Q i USt800million

The Asian inh..rbuctnn Fund Pemgrine lmmmmt Holding8 Uegiom Asia (40% in Chima)

Seaion: C e and Eacms#I mpe (P*d aad Hlwuql

%&c: T~IocoimmiCaSOm :8kw lH#4tnrSUioa

Global P o w I- 6F; C8pital Corporation Region: Global emwgln@ markets

C o m p a ~ ~ , LP. (6leQsl Pohw S m J t l P d M s n a ~ 86FtM:PWVBT lmertnwars Company, LPC) -W Finrnclr WgMvaibr me: billion

ScuWrr Latln Americabmt Eor I n d e p t W Power WM m, lnc. swtot: ?mnm (mddet Stevela & Chrlt, Led faSWr(l~laR. S h USIm rnillim

,.corpoiiiaAndida de blnaada

S C l l u a R P ~ - M s w d -


have gained access to international capital markets through equity and bond issues. Compania de Telefonos de Chile and Telefonos de Mexico have issued equity in the form of American depositary receipts (ADRs) on the New York Stock Ex~hange .~ Bonds issued in the United States under rule 144a3 raised US$105 million for the Subic power plant (Philippjnes), which is 50 percent owned by Enron, a major U.S. company. Revenue bonds were also issued under lule 144a to raise funds for the Mexico City-Toluca Toll Road.

The AES Corporation (United States) and Hopewell Holdings Ltd. (Hong Kong) have set up subsidiaries that have raised equity through public offerings to invest in the Asian power markets. General Electric Capital Corporation (a subsidiary of GE Corporation) issues securities on U S , and European markets and invests portions of the proceeds in projects throughout the world.

A number of equityfunds have been established with the potential to raise approximately US$5 billion for investing in a portfolio of private infrastructure entities in developing countries (table 1). Similar funds exist in industrial countries; for example, the Energy Investors Fund (United States) invests in independent power projects in the United States, and the Infratil Fund invests in the deregulated infrastructure sectors of New Zealand.

In addition, there are a number of mutual Funds that invest in the listed securities of infrastructure firms in various countries (table 2).

Key characteristics of the equity funds

The growing number of equity f ~ ~ n d s will channel equity, quasi-equity, and, in some cases, debt capital from institutional investors to power, telecommunications, and transport projects in Asia and Latin America (see box 1 for an example of such a fund). These funds allow investors, who might otherwise not invest in individual projects because of risks and costs associated with making efficiently sized investments in individual proiects, to invest in diversified port-

folios of infrastructure firms and projects. The funds will allow institutional investors to invest in the growth sectors of power and telecornrnu- nications in developing countries and to reap higher returns than through comparable investments in industrial countries.*

Reputable investment management companies and financiers are the sponsors and the driving force in the creation of these equity funcis. The IFC played a key role in the creation of five funds -as a cosponsor and as an investor. T

TABLE 2 SELECTED INFRASTRUCTURE MUTUAL FUNDS FOR $&MU INVESTORs

IIWORI al US. dollm)

Frnd

Super Asia Infrwbuctum hiad Nomm Asian I ~ n c t u r s Fund

Emerging Mark* lafrastrncture Fund Emerging Markets Telecolmnunic~ors Fmd Gabelli Global Teleeo~mnonications Fund Garbmore Globd UliWitiesr Fund GT GloQal Telecomrrruniorrtims Frmd Montgomery Global Comnwnications Fund

sors' business and government contacts have enhanced the marketability of these funds and may act as a catalyst for significant private flows of equity and debt capital to Asia and Latin America. In addition to providing capital, the Funds will mobilize debt for their portfolio investments from E X M banks and multilateral and financial institutions.

These funds typically are set up as limited partnerships or trust companies, and public information concerning their operations is limited. The AIG h~nd , which had its first closing in May 1994, raised more than US$1 billion. The Asea

Infrastructure Investment Funds

All the funds will face the risks associated with all infrastn~cture investments, including liquidity risk. The funds will mitigate some risks by investing in a diversified portfolio of infrastructure companies and projects in different countries and at different stages of development and by choosing to invest with financially sound project sponsors. The funds may seek to reduce liquidity risk by listing their own shares on developed capital markets and by assisting project entities in listing their securities on emerging capital markets once they have established an operating track record. However, for the foreseeable future, the infrastructure investments generally will remain illiquid during the life of these funds.

These equity funds are an example of new approaches to financing infrastructure development, and they should continue to grow in number and size.

' According to the World Bank's World Lk~elopnienl Report 1994 (New York: Oxford University Press, 1994).

* AD& are cenificates of deposit that enable foreign companies to raise equity o n U.S. markets without complex settlement and rransfer mechanisms. Rule 1 4 4 allon,s forcign entities to privately place secuntles in the Unired Stares with quil1ifii.d institut~onal i n v e s t o r ~ h a r is, under reduced disclosure rcrluirernents.

" A report by McKinsey & Co. suggests that annual rates of return o n investments in induswial countries average 10 p e m t for roads, 15 percent for power. and 25 percent for telecommunications; returns on such investments in emelging markets are expected to avelage 30 percent.

ndrea Anayiotos, Consultant, Private Sector )c?velobmmt Dma.rtment

Brown Boveri (ABB) fund raLJLJ US$100 million in 1993, and the Central European fund raised US$42 million in May 1994. The Scudder fund has made two investments recently, one in the 100-megawatt Mamonal power plant in Colombia and the other in the 60-megawatt Elcosa project in Honduras. The AIG and Central European funds also have made some new investments. Although most of the funds are independent, the ABB fund's investments are tied to sales of ABB equipment.

"Backstop" Lending for Capital Market Development in Odo Habeck

Argentina

This Note discusses the Argentine Capital Market Development Loan, approved by the World

Bank's executive directors in March 1994. This project addresses systemic risk and other aspects of 1

market development. The project has become known in the World Bank as the "Backstop Facility."

But that name does not do justice to the scope of the project because it does not reflect its

important development features. The Note describes the project design and explains why this

structure was chosen and how it will allow banks to provide longerterm loans to qualifying borrowen.

Proposition

Many large corporations in Argentina are now able to access international capital markets, but smaller enterprises must rely on less developed local capital markets or conventional bank products. If local banks are unable to tap the markets and must rely solely on their ability to attract deposits, they are less likely to be able to meet the needs of their client base. Well- functioning and liquid capital markets providing medium-term funds would enable the banks to better manage their risks and therefore to meet borrower demand. Furthermore, the debt securities issued by the banks would provide important market benchmarks for all borrowers.

What is the Capital Market Development Loan?

The Capital Market Development Loan (or Baclzstop Facility) differs from traditional World Bank lending. The loan's principal purpose is to develop capital markets rather than to provide direct funding for procurement of goods or services. The loan funds are not disbursed in the first instance to banks participating in the project; the banks must acquire funds by issuing securities in private markets. The World Bank

funds are instead made available to a government-owned Backstop Fund (the Fund) so that it can, if necessary and under specific future circumstances, purchase securities issued sub- sequently by banks subject to their having previously purchased backstop commitments from this Fund. Several important features dif- ferentiate this loan from traditional World Bank structures: - Disburse~nents will occur only if eligible

backstop commitments are in fact exercised. There is a static commitment charge of 0.25 percent and an incremental usage charge of 0.15 percent. The World Bank does not approve any individual loans made by the participating banks. The operation of the Backstop Fund relies on the judgment of the local fund administrator and approved domestic rating agencies.

Because the Fund is available to refinance bonds issued by commercial banks, it supports rather than supplants evolving private markets. The refinancing would take the form of a Fund purchase of a new bank debenture should market disn~ptions occur at the time of sched- uled bond redemption. Qualifying disruptions are confined to events affecting all banks, rather than those affecting only a single issuer.

34 "Backstop" Lending for Capital Market Development in Argentina

They could stem from political, economic, or international causes. If such an event occurs, the Backstop Fund would buy a new bond to refinance the bank's initial issuance and would hold the bond until i t could sell it back into the market. In essence, the government provides systemic risk insurance to qualifying banks (not directly to investors) through the issue of backstop options. This insurance should encourage banks and investors to participate in the markets.

FlOURE 1 STRUCTURE OFTHE ARGENTINE CAPITAL MARKEf

DEVELOPMENT BACKSTOP FACILITY

Republic 3 agreement 1 I Subsidiary

ban agreamnnt

agreements

Mediumerm lmns

agreement A'hi'i""n r Financial management agrsement

Partlcrgmg banks -1

Financial I

How is the Backstop Facility structured?

The World Bank provides a US$500 million loan to the Argentine Republic, which in turn has a subsidiary loan agreement with the newly created Backstop Fund (figure 1). The Fund will be established by the government and managed by an internationally recognized financial manager. The financial manager will be selected by Banco de Inversi6n y Comercio Exterior S.A. (BICE), a second-tier, government-owned bank acting as administrator of the Fund. In addition, BICE will designate banks that meet established standards of credit to participate in the program. Banks that participate will be required to demonstrate that their pool of term loans meet- ing certain quahfying criteria grows by at least as much as the issuance of backstopped bonds.

Why was this design chosen and what is the role of the Backstop Facility?

A more conventional approach would have been a World Bank term loan extended through a government-backed institution to private intermediaries. However, this would have dis- couraged development of a more sustained market source of fmancing to banks already able to bring (short-dated) paper to market.

Instead, the Backstop Facility aims at minimizing intervention, by allowing first-tier market transactions to occur. It encourages the market to respond to the credit of individual institutions. And it does not provide financing when the markets are already willing to do so.

The Backstop Facility provides a "last resort" for liquidity to banks that need to redeem maturing bonds. In addition, the Facility helps create many of the building blocks of capital markets, including:

Creation of a pool of reasonably standardized securities, introducing a class of high-quality nongovernment bonds for investment by budding institutional investors. This is accomplished by the Backstop Fund's


endorsement of the forms of the securities it is willing to backstop or buy. Reliance by the Backstop Fund on the ratings provided by domestic Argentine rating agencies. In order to sell a bond to the Backstop Fund, a commercial bank must maintain its credit rating above a certain minimum standard, as determined by at least two approved local credit rating agencies. The loan's reliance on the ratings enhances the agencies' responsibilities and credibility. Support of secondary market liquidity through the Fund's management of its bond portfolio. In addition, the financial management agreement specifies that the financial manager will be responsible for proposing new ideas for developing the domestic capital market.

What is the function of the Backstop Fund?

The Funcl will sell backstop commitments to purchase new bonds issued by a participating bank when that bank's original boncls mature. The yield at which the Fund will buy bonds from participating banks (expressed as a spread over LIBOR) will be at a multiple of the original spread. The multiple is calculated to establish the Fund as an investor of last resort, and not as a source of subsidy to the banking sector. After exercise of commitments, the Fund actively manages its inventory of bank deben- tures (including, for example, the lending of such bonds). When the markets stabilize, the Backstop Fund sells its bond holdings in the domestic or international markets, or both, thus creating additional liquidity in the secondary markets.

Investors bear the full commercial risk of each bank. If the quality of a bank's credit declines (as measured by local ratings), the Backstop Fund has no obligation to honor the backstop option. It is also up to the participating bank to use the proceecls of a sale of bonds to the Backstop Fund to repay its creditors. The assurance provided by the Bacltstop Fund allows a bank to match its assets and liabilities, quantify

its maximum refinancing cost, and provide long-term funding to creditworthy clients.

What local factors shaped the project design?

The Capital Market Development Loan was possible because Argentina had successfully implemented broader reforms. Economic reforms have created a more stable environment, and capital market reforms have enhanced and simplified the domestic capital markets. For banks that have

begun to issue debt securities in international capital markets, the objective of ttus operation is to broaden the development of the Argentine market.

Reforms concluded prior to the loan that were instrumental to the design and implementation of the project include:

The convertibility law, which established a fmed pes*U.S. dollar exchange rate Pension security reform and mutual fund laws (creating institutional investors) Securities laws defining the powers and

36 'Backstop" Lending for Capital Market Development in Argentina

responsibilities of the Argentine National Securities Commission Removal of restrictions on foreign portfolio investments Negotiable obligations law (creating primary and secondary corporate bond markets) Removal of stamp and transfer taxes Equalization of tax treatment of capital gains for foreign and domestic investors Market transparency and insider trading regulations External debt agreements (although not a

In essence, the government provides systemic dsk insurance to qualgying banks (not directly to investors) through the issue of backstop options. D i s insurance should encourage banks and investors to participate in the markets.

reform, these were instrumental in reopening access to international markets).

Can this loan structure be applied in other countries?

The general design features of this loan--contingent disbursement, disbursement against the purchase of financial assets, appraisal of local institutions to which ongoing surveillance is delegated, use of established market firms as project manager-could be applied to a wide range of challenges facing countries whose financial markets are still developing.

Whether there is a need for this type of operation by the end users-creditworthy small and medum-size businesse+as well as by the financial system The soundness and the capabilities of domestic financial institutions, banks, and brokers, as well as the status of securities regulation and taxation and pension and insurance laws.

In general, the rollover facility concept underlying the Backstop Fund will apply to those countries whose markets have begun to develop, but are constrained by longer-term liquidity concerns, the absence of broadly used financial instruments, and the lack of well-established institutions (credit rating agencies, market- makers, and the like).

Odo Habeck, Consultant, Financial Sector Dmelopment Dqartment

The details of the implementation, however, would be determined in each case by the economic, capital, and money market environments. In particular, they would depend on:

The country assistance strategy agreed upon by the borrower and the Bank

Competition Law

Large fiscal deficits, pressures to downsize the public sector, and the high costs and poor economic

performance assdated with most government intervention have led many developing and formerly

centrally planned economies toward more market-oriented policies. These economies-featuring

highly concentrated industries, large state-owned sectors, and inM~cient firms operating in small

markets insulated by trade barriers-can strengthen market forces through competition law. Not

only will competition law help to lower costs and prices and increase consumer welfare, it also will

foster sound business discipline, culture, and ethics--especially as state monopolies are being

privatized. Promoting such business principles is important in an increasingly integrated world

economy where countries can no longer protect their industries without losing profitable opportunities

and international competitiveness. This Note offers a framework for designing and implementing

competition law.

The scope of competition law

Competition law seeks to prevent anticompetitive business practices and developments in industry suucture that facilitate these practices. It stops unfair b~~siness tactics and abuse of market power to gain excess profits. The rules applied by competition law are not regulations, as some critics claim. On the contrary, they help to minimize government involvement in business. If a government has a clear set of competition rules, it can more easily bat away lobbying by special interest groups for intervention.

Competition law has an interface with a broad range of economic policies affecting competition in local and national markets, including the regulation of transport, power, telecommunications, and other sectors where natural monopolies are likely to occur, international trade, foreign direct investment, intellectual property rights, financial markets, and privatization policies. Thus, a broad

range of competition policies play an important role in determining which markets are accessible to firms. These policies can therefore enhance the effectiveness of competition law-and vice versa. For example, just before the North American Free Trade Agreement (NAFTA) was signed, Mexico updated its competition law to lower internal market barriers and ensure nondiscrimi- natory treatment of business. Provisions in the European Union's treaty have similar objectives.

Some argue that deregulation and liberalized trade are sufficient to promote competition. But a high and increasing share of economic activity is related to nontradable products and services. And competition law is better at addressing situations where: * International cartels restrict competition with

price fixing and geographic market sharing agreements. Interfirm contracts tie up scarce raw materials or distribution channels.

High transport costs or the perishability of products shrinks the pool of suppliers. Government regulations on product safety, consumer protection, and technical standards, or differences in these regulations or standards, work to restrict competition.

The sequencing of competition law is important. For example, it needs to precede or to be enact- ed at the same time as privatization programs, to prevent government monopolies from merely being transferred into private monopolies.

Objectives

The principal objective of competition law should be to maintain and encourage competition in order to promote economic efficiency and consumer welfare. Making economic efficiency the principal objective of competition law supports consistent application of policies and is more l~kely to limit lobbying by vested interests. This is especially important for countries with Limited administrative capacity and weak institutional structures.

In some countries, however, competition law has multiple goals under the rubric of public interest, including fairness, regional development or employment, and pluralism or diff'usion of economic power through promotion of small and medum-size businesses. Multiple objectives invite lobbying by different stakeholders in the economy and can lead to inconsistent application of competition law, so that governments end up protecting some f m from competition. That result is at odds with the basic aim of competition law: to protect the competitive process and not competitors. Trying to balance a wide range of (often conflicting) social, political, and economic concerns is sure to undermine long-term competitiveness, economic growth, and jobs. Instead, different goals are better pursuecl by different policies.

In recent years, Canada, the European Union, Italy, New Zealand, and the United States have placed more weight on the economic efficiency objective. Several developing countries, including Colombia and Mexico, have done the same. But

some countries, notably France, India, the United Kingclom, and some economies in Central and Eastern Europe, pitch competition law toward multiple objectives.

Instruments

Competition law can be applied in two ways. The first approach is structural, focusing on mar- l e t share and industry concentration. The second is behavioral, with the focus on combating anticompetitive business practice and pricing policy.

Economic theory suggests that industry structure has an important bearing on firm behavior and performance. Large firms operating in industries with few competitors are more likely to engage in anticompetitive practices. In reality, large firm size does not necessarily confer market power. If there are no barriers to entry, the market will be contested by new competitors every time established firms try to hike prices and cut output to earn excessive profits.

Economies with large domestic markets have little difficulty using the structural approach. The large number of frms in these economies generally ensures vigorous competition. Market share thresholds can be specified to trigger government action to maintain competition. The United States and Canada use such thresholds in the administration of horizontal merger provisions. In countries with small markets, however, the potential risks of misapplying competition law, and the impact on the economy, tend to be greater. These economies tend to be character- ized by industries with few firms and high concentration. Applying structural measures to ensure competition may prevent domestic firms from achieving the minimum size needed to compete in international markets. In these circumstances, governments can best alleviate wor- ries about high concentration by removing curbs on foreign trade and investment and l~fting regulatory barriers to entry, such as licensing.

The behavioral approach focuses on how firms do business. Some business practicessuch as collusion between competitors to fi prices,


ALTERNATIVE APPROACHES TO COMPmTlON U W

- - O B J E C T I V E S

reduce output, allocate customers, and share markets--are clearly anticompetitive and should be per se illegal and subject to heavy fines and penalties. But the effects of such business practices as exclusive dealing contracts between sellers and buyers, interfirm cooperation in research and development, and product standards are less easily decided. These need to be examined case by case, applying a rule of reason approach. Structural arrangements such as mergers and acquisitions and joint ventures should be examined in the same way.

Enforcement

The best watchdog of fair competition is an impartial, independent competition policy agency. Investigation, redress, and policy intervention are the main features of a sound process.

Triggering an investigation

Competition law requires a mix of stmcn~ral and behavioral criteria to touch off an investigation. The criteria for triggering cases or investigations must be clear. If they are not, the law will create business uncertainty and undermine the competitive market process. Too lax an approach can allow monopolies to become entrenched, a situation that takes a long time for market processes to correct. Conversely, too vigorous an application of the law may arrest the development of the market and slow economic growth.

Competition authorities can help maintain business certainty by clearly indicating the firm size that, if exceeded, would launch a review by the competition policy agency. Canada and the United

10 Compdiion Law

States publish guidelines on market shares in merger transactions that are likely to trigger a competition review. In other countries, market share figures define the monopoly, or dominant market, position of a firm.

Virtually all jurisdictions specdy which business practices are strictly prohibited or per se illegal (such as price f i g ) and whch w d be examined case by case applying the n ~ l e of reason approach (such as exclusive d e a h g and mergers).

economic interpretation.

Administering a fair redress mechanism

Sound competition lam, will include a redress mechanism for consumers and firms that have suffered from anticompetitive practices. (Many complaints to competition offices in industrial countries are raised by business firms.) Care must be taken, however, to ensure that this provision does not become an instrument for firn~s and consumers to impede the competitive process. Although the law should apply equally to gavel-nment and private firms, some exemp- tions may be necessary to allow certain kinds of economic activity-for example, collective bargaining, underwriting new stock issues, and insurance-without reswaining competition in the final market.

The investigation and prosecution functions of the law should be separate from adjudication. Otherwise, a competition agency may become investigator, prosecutor, judge, and jury rolled into one. Still, the competition agency can negotiate settlements. For example, in merger transactions, firms might voluntarily agree to divest assets to maintain competition and avoid costly litigation. But in a disagreement bemeen the competition agency and a firm, alternative reso- lution mechanislns should be available. Countries without appropriate or adequately developed legal systems or with courts that get backed up could establish a separate competition board or tribunal of experts from the academic, business, government, and legal communities.

Private legal actions by business firms and consumers should also be possible. The burden of enforcing competition law need not rest solely with a government agency.

Intervening in other government decisions

affecting con~pet i t ion

An effective competition agency should clearly spell out the implications of public policies for competition and efficiency so that government decisionmaking takes them into account. This process makes governments and con~petition agencles more accountable, increases awareness of the costs and benefits of alternative policies, and helps ensure that government policy objectives do not work at cross-purposes.

Shynm Khemnni, Senior Industrial Econonzzst, Private Sector Development Department

Back to the Future The potential in infrastructure privatization

iMichael Klein and Neil Roger

7his Note is a sylzopsis of an essay 6-y Michael Klein and i\kil Roger that won the Siluer Azuarcl prize zn the 1 9 4 Arnex Bank Reviau ascry competition

The wave O F inFrastlucture privatizations that swept Chile, New Zealand, and the United Kingclom in the 1980s is now sweeping the globe. At least 300 Lnfrastn~cture privatizations and greenfield projects have been undertaken since 1989-mostly in Latin America, East Asia, and selected OECD economies. The momentum is driven by disenchantment with state provision, precarious government finances, and new technology. Whether this privatization wave will lead to lasting welfare gains or is just part of a hstorical cycle of privatization and nationalization is not yet clear. The answer will depend on m~hetlier governments can find competitive solutions to the provision of Lnfrastructure services.

The advantages of private ownership

Private firms can be more efficient than public entities to the extent that they are better able to resist nefarious political interference. Government ownership almost certainly blurs the line between the firm's finances and the general budget. Typically, firms getting budget subsidies have trouble maintaining quality operations when fiscal problems arise. Or governments may be tempted to dip into the firms' treasuries in times of fiscal clistress. The cost of this blurring of lines can be measured by the rapicl system expansion after privatization, mihen corporate finances were freed from the public purse (Galal and others 1994). With this separation, shareholders and debtors have some confidence that the firm's financial integrity will no longer be in danger.

Why ever nationalize infrastructure?

In the nineteenth century, railways, canals, roads, and gas, power, and water systems were initially privately owned, operated, and funded in most countries. But with time, more and more infra- stnlcture companies were regulated or nationalized, although the pattern varied substantially across and within countries and sectors. Wars and economic depression gave another boost to nationalization and stronger regulation, which increased in the 1940s and 1950s. Disenchantment with the performance of regulated or nationalized firms led again to deregulation and privatization in many countries from the 1970s onwarcl. A stylized illustration of the cycle described above appears in figure 1.

Some of the motives underlying nationalization have been misguided. For example, governments have justified nationalization as a way to provide subsidies to industry, to control prices, and to extend patronage. These were never sound reasons. Other concerns about system integration, national security, health and safety, and foreign domination could be addressed while still maintaining private ownership. For example, where private firms were allowed to work out suitable arrangements, they managed to establish voluntary demarcation agreements between service areas as well as interconnection agreements. While it is clear that emergency national security situations may trigger government intervention, it need not take the form of prior nationalization. National emergency regulations affecting all sectors of market economies can cover infrastructure as well. Health, safety, and environmental concerns can be dealt with through the setting and monitoring of standards independent of ownership arrangements. And

42 Back to the Future

concerns about foreign ownership are subsiding. The profitability of the emerging international infrastructure firms will depend on their ability to maintain a reputation for reliability in all countries, leading them to become world citizens not to be feared by individual countries.

such arrangements can be implemented through well-designed regulatory frameworks, history shows satisfactory regulatory regimes have rarely been achieved.

Regulatory pressures

Can private infrastructure last?

While government can pursue all its social objectives for infrastructure provision under private ownership, important policy issues exist

FIGURE 1 THE PRIVATIZATION-NATIONALIZATION WHEEL

riatization Enirepre-

neurship

Consolidation

h r c w G m e z Jbanaz and Meyr 1983.

because many users are dependent on a common facility-such as an electricity network-that does not face head-to-head competition. Whoever controls such a "natural" monopoly can emact excessive profit. (rents) from it. The network owners, consumers, and the body politic all try to get their hands on these rents. Therefore, a sustainable ownership arrangement requires a rent-sharing system that protects consumers, provides owners with incentives to operate the network efficiently, and reduces the temptation for governments to exploit monopoly rents for political advantage. While in theory

Pressures for some h d of regulatory mechanism arise soon after a new infrastructure network is set up. Rail, gas, and water networks all emerged in the first decades of the nineteenth centur)~ in Britain. The first attempts to limit wasteful competition in the water and gas networks by establishing monopoly franchises started around 1820. Rent regulation arrived with Gladstone's 1844 Railway Act, followed by dividend limits (10 percent) for gas and water companies under the Gas Works and Water Works Acts of 1847. Similarly, limits on prices or returns were introduced in Canada (Toronto) for town gas and in some U.S. railroad statutes in mid-century.

The notion of a "fair" price or return has played a role in all regulatory systems. It has always been clear that price or return regulation risked undermining the incentives for firms to invest and operate efficiently, and various mechanisms have been used to cope with the tradeoff between fairness and efficiency. When prices are controlled, quantity and quality are regulated. Typically, service and access obligations are embedded in all regulatory mechanisms. But this opens the door to endless arguments and policies about whom to serve and at what price. There's a good chance, then, that governments will introduce inefficient and unjustified subsidies and cross-subsidies for different customer groups.

The institutional solutions to regulatory goals have varied according to the balance of interests in each situation and the country's political and administrative system. Ownership may be private, mixed, or public. Regulatory powers rest in varying degrees in the legislative, executive, or judicial branch of the government. Separate regulatory institutions may exist. Different levels of government may be involved-municipal, provincial, or central.


Points in a continuum

These various institlltional arrangements are points on a continuum. All interfere with flrm- level pricing and investment decisions. At one end of the spectrum, full nationalization places all decisions in the hands of the state. Decisions are not transparent, and consumers are not represented directly, but only in their capacity as voters. Further along the spectrum, the state establishes autonomous corporations governed by performance contracts, which generally specify key pricing and investment decisions. Transparency is enhanced. Still further along, private firms may be subject to regulatory oversight by agencies that influence price and investment decisions, as in the United States. At the other end of the spectrum, in French municipalities, no separate regulatory agency exists. As in the case of nationalized firms, consumers can exercise their rights through complaints and by voting in mayoral elections.

No best solution

Results of empirical work on the merits of alternative arrangements remain inconclusive. Given that different combinations of ownershp and oversight exhibit similar problems, it is not clear why and how performance should systematically vary among them. However, it is clear that regulatory systems are costly and often fail to achieve their goals. Recent estimates of the benefits derived from deregulation in the United States amounted to some 9 percent of the output of formerly regulated infrastructure sectors (Winston 1993).

For this reason, another turn in the privatization- regulation-nationalization cycle is possible. As in the past, regulation imposed on private firms tends to weaken their incentives to perform and involves "the public" in decisions about levels of income and subsidy. When firms receive insufficient revenues and when prices are kept artificially low, demand will be large and supply will be insufficient and of poor quality. More government intervention culminating in nationalization will cloak the problem. When the public

purse can no longer pay the level of subsidies required to get acceptable sewice, privatization will once again be seen as a remedy. And so it could go on.

Can the costs and failures of regulation be reduced?

The only way to reduce the need for administrative solutions to the rent-sharing problem is to expand the scope for more automatic "regulation" through competition. Competitive solutions

7be only way to reduce the need for administrative solutions to the rent-sham'ng problem is to expand the scope for more automatic "regulation" through competition.

are feasible where consumers of infrastructure services can migrate to the service area of their choice (for example, residential developments) and where competition among providers can be introduced (for example, among airlines). Technologcal change and innovative policies for services until now considered natural monopolies have further enlarged the scope for head-to-head competition. Prominent examples are long-ds- tance telecommunications and power generation. The best hope for subjecting remaining inescapable natural monopolies to competition lies in repeated f'ranchise bidding, under which monopoly service franchises are auctioned off from time to time and awarded to the firm offering acceptable service on the best t e rms fo r example, at the lowest price.

Franchise bidding can clearly be effective for infrastructure services that do not require investments tied to a particular service area- for example, many forms of transport sel-vices or solid waste collection. Problems may arise for the remaining natural monopoly services- mainly water pipelines and power transmission

Back to the Future

and distribution. Problems in telecornmunica- tions, gas pipelines, and railways tend to be less severe because of the stronger intermodal competition.

But is franchise bidding really substantially different from utility regulation? First, no contract can cover every conceivable circumstance. Therefore, either party may have (good or bad) reasons to renegotiate after the award. Second, at the time of transfer of the franchise to another firm, the assets to be transferred need to be correctly valued to ensure that the incumbent maintains them in good condition (Laffont and Tirole 1993). The franchiser therefore needs to maintain a capability to prepare, award, monitor, and renegotiate the contract, including the capability of valuing the assets fairly. Such a capability is similar to that required for "normal" regulation. Franchise bidding will only be superior if abuses after franchise awarcl are contained and repeated bidding is practical.

Reputation and competition for the market

with municipalities, they have developed a worldwide reputation for quality and efficiency and simultaneously a relationship with municipalities that has protected them from attempts at nationalization.

Implications for policymakers and financial markets

For the policymaker interested in efficiency gains, the pursuit of private infrastructure constitutes a risk-minimizing strategy. Private solutions are generally no worse than public ones, but hold the potential for greater benefit through competition. If policymakers follow the current fashion to promote private competitive franchises throughout the world, the emerging international infrastructure industry will grow. In its wake, private cross-border flows financing Lnfrastn~cture will increase. In the nineteenth century, annual cross-border flows for private infrastructure projects amounted to the equivalent of several hundred billion dollars (adjusting for output growth and inflation)--compared with only US$10 billion a year today.

Whether contracting parties abuse their position depends on their interest in maintaining a good reputation and on the availability of information crucial for judging adherence to the contract. A review of the experience of over 3,000 cable TV franchises in the United States (198C-86) found fewer than sixty cases of operators reneging on contracts (Zupan 1989). Reputation was found to be the main explanation for companies not exploiting loopholes in their contracts.

REFERENCES Galal, Ahmed. Leroy R. Jones, Pankakaj Tandon, and Ingo Vogelsang.

1994. Wel/hre Consequences oj' Sellirrg Public En-. New York: O\-ford University Press.

Gomez-lbanez, Jose, and John R. Meyer. 1993. Going Pri~ale, 7he Inrer~zcit~onal Fxperience wilh Tra~7sporl Ptivalisntion. Wash~ngton, D C.. Brookings Insrirution.

Laffont, Jean-Jacques, andJean Tiole. 1993. A Tl,eoy of In~enlzufs In Procrrren7enl and Rqzrla/~on Cambridge, Mas.: NllT Press.

Wmston, CliHbrd. 1993. .l?c.onomic Deregulation: Days of Reckoning for M~c~.oeconornisLs. ' Journal oJEco?~onzlc Lilerulrrre 31 (3).

Zupan. Mark. 1989. 'Thc Efficiency of Franchise Bidding Schemes in the Case of Cable Television." Jou~ncrl o j h u ) and Economics 32.

The key problem of repeated bidding schemes-asset valuation-may be more difficult to deal with. In particular, it may require a preference in favor of the incumbent at the time of franchise rebidding (Laffont and Tirole 1993). One example of a successful system that allows rebidding but provides strong incentives favoring incumbents is that of the private French water companies, established in the nineteenth century. Despite incentives to collude and to abuse the nontransparent and discretionary relationship

Michael Klein, Manage Private Sector Develop- ment Department, and Neil Rogq Senicn-Ecmis4 Private Sector Development Department

Restructuring the Power Sector: The Case of Small Systems Robert Bacon

New paradigm

The recent worldwide interest in power sector privatization and restructuring has focused on a few high-profde cases, such as Argentina, Chile, and the United Kingdom. As a result, the pattern of restructuring now taking shape in many power systems largely reflects the experience in these few countries. Consultants working in locations as diverse as Jamaica, Kenya, and Poland are applying a privatization model in which generation is separated from transmission, which in turn may be separated from distribution. The generation sector is then split into several competing firms. This model of restn~cturing, based on capturing the benefits of competition in the generation sector, is accompanied by regulation for those parts of the new system that cannot be competitive and that may therefore open up possibilities of monopoly exploitation.

Relevance to small systems

In small power systems, however, the balance of advantages and disadvantages from these changes may be quite dfferent from that of systems in larger economies. When there is only a single generator, it can be more efficient to leave it joined to the transmission system. But that is not the advice some countries are getting. For example, a consultant report for Kenya, which had net installed public capacity of 706 megawatts (MY) in 1990, said that there was no scope for competition between the existing generating plants. Yet consultants have still advised separating the single private generator from the transmission and distribution company.

The arguments for this vertical separation are quite different from those for horizontal separation

and need to be mdividually addressed. Indeed, even when it is possible to introduce limited competition in generation and hence achieve

Even when it is possible to introduce limited competition in generation and hence achieve some benefits, the costs of veflical separation may be so large as to offset the gains from competition.

some benefits, the costs of vertical separation may be so large as to offset the gains from competition, E'nerefof-e, any restructuring p h n for a small system must take into account that it may be harder to achieue real competition in the generation sector.

This issue is relevant to many small countries contemplating power sector reform. In 1990, there were sixty countries with capacity of less than 150 MW, thirty with a total net public capacity of between 150 and 500 M\V, and seven- teen with between 500 and 1,000 MW. The experience of countries that have already restructured their power sectors (United Kingdom, system size 70,000 hfW; Argentina, 15,000 MW; and Chile, 3,000 MKT) may be of very limited relevance to systems of, say, 1,000 M\V or less.

The most efficient structure for a small system may be quite dfierent from the fully disaggregated model. Reform proposals thus need to be flexible,

Restructuring the Power Sector: The Case of Small Systems

and alternative systems under consideration need to be closely evaluated. This Note reviews the sources of the kinds of gains and losses from privatization and restructuring that need to be considered in any proposed power sector reform strategy. It also looks at the preconditions for effective competition-one of the main sources of gain-in the generation sector. Each of the issues raised relates to system size.

Costs and benefrts of privatization

Comparing the performance of a vertically integrated public monopoly with that of a vertically integrated private monopoly exposes the gains and losses due to privatization alone. The key change that privatization introduces is the profit motive. The impact of this change should not be confused with the effect of restructuring. In fact, the benefits to society as a whole from ending state control of the power sector can be so large that the additional gains due to restructuring may be relatively unimportant.

Performance assessments of publicly owned entities should make a distinction between entities that have been corporatized and commercialized and those chat have not been. Commercialization is possible only if the government removes itself from day-to-day interference in such issues as tariff setting and employment. Some countries that have not been ready to privatize their power sector have introduced commercialization (New Zealand, Portugal), an important intermediate step between the most interventionist form of state ownership and privatization. Commercialization may allow many of the potential gains in efficiency to be captured, especially where there is little scope for competition. Small systems may thus find it of little incremental benefit to privatize, provided that the government maintains an "arm's length" relationship with the company. Where this is more difficult, because of the political situation or because of the traditional approach to state companies, privatization may bring permanent benefits that would not be sustainable with a commercialized state entity.

rhe allocative gain or loss from a change in pricing due to a sh~ft from a state monopoly to a private monopoly depends on the extent to which prices were being held below costs in the first case and the extent to which prices are limited by regulation in the second. Writ11 no subsidization, a move to unregulated pricing by a private monopoly produces a "deadweight" loss of consumer surplus as n~ell as a tmnsfm.. of consume surplz~s to producer surplus. If the public sector were pricing below cost, the removal of this implicit subsidy would produce a "deadweight" gain, and a transfer back to tax- payers and away from power consumers. Because subsidies have been very large in many countries and the state has financed new investment, moving from public ownership to regulated private ownershp (even if monopolistic) can produce large allocative net benefits for the economy.

This shift involves a potential gain in productive efficiency if private industry can cut costs. Public ownership tends to result in productive inefficiency, both because managers have little incentive to reduce costs and because politicians often are willing to increase costs to serve other purposes-for example, providing secure employment. The political incentive to collect revenues or prevent theft of power can also be low.

Whether a private monopoly wiU be productively efficient (that is, produce a given output at minimum cost) is uncertain. The few well- established private monopolies (Barbados, Bermuda) appear to work well. The poor performance of many state companies is more likely to be attributable to the nature of their ownership than to their structure.

Costs and benefbrts of vertical separation

Vertical separation-the separation of distribution, transmission, and generation into private monopolies-has two important implications for private capital. It can increase monopoly power, but it can also lead to the loss of economies of coordination. When each stage is monopolistic and the technology is relatively fixed, a classic

The World Bank Group 4 l

result is for an unregulated chain of vertical monopolies to sell at a higher price than an unregulated integrated monopoly (the "double wedge" problem). Regulation becomes more important in this case. But the fact that many private industries, even in competitive markets, show evidence of vertical integration indicates that there are gains to be made from unified ownership, as in the U.S. power sector.

The first general reason for the success of vertical integration is the existence of economies of scope. Certain activities need to be undertaken by both parts of the industry, but there is the possibility of sharing some inputs. A typical example would be the need to have an accounting department in each company. The activities of these depart- ments would include handling the transactions between the two companies. Integration would not do away with such transactions, although they become internalized, but they would be accounted for just once rather than twice. Related to this would be an economy of scale. An accounting department would not need to be twice as large to deal with a company double the size. Some basic setup costs (computers) could be shared. A very important aspect of this argument is the existence of economies of scale to top management. Good managers often are scarce (especially in small economies), and integration will likely save on this resource. There can also be financial economies of scale, which can be achieved when the component firms combine their borrowing needs, reducing the cost of borrowing money.

A separate argument concerning vertical separation, or de-integration, relates to the decisionmaking process itself and economies of coordination. This issue affects both day-today working of the system (dispatch) and its longer-term size (investment). In an integrated company, coordination takes place through physical commands and, to be effective, requires complete information about all parts of the system. In a de-integrated structure, the coordinating mechanisms are the prices and contracts agreed between the two parties. Since each firm is trying to gain more of the profit for

itself, there is a strong incentive in bargaining not to divulge information to the other, leading to contracts that are suboptimal for the system as a whole. In addition, there are transactions costs in negotiating and contracting.

A key argument in favor of separation is that it increases transparency and allows the responsibilities of managers to become more focused. The larger the firm, the more difficult it is for a manager to have oversight of all its component parts and their interrelationships.

The arrangement in England and Wales, m*tb two hlge private generators

nuclear company), bas already dmomtrated that a larger number of companies is required to induce truly competitive behavior:

Costs and benefits of horizontal separation in generation

The possibility of introducing competition into generation is critical to a power restructuring strategy. The key issue is the mechanism by wl-~ich competition takes place. If it is not possible to introduce effective competition through vertical separation, on balance it may be better to leave the industry integrated even though it has been privatized. Nor does the existence of several generating companies by itself necessarily introduce competition. So, breaking up the state company into several private generators could lead to the loss of some benefits of scale or scope, yet without producing any benefits through competitive downward pressure on prices.

In large privatized power systems (Argentina, Chile, England, and Wales), repeated bidding, in which the generators bid to supply power on a

I Restructuring the Power Sector: The Case d Small Swum

daily or even half-hourly basis, allows competition to be effective. If costs can be cut, then prices can immediately reflect this, forcing a hlgher-priced rival out of the way. This bidding system is too complex for most smaller power systems and for economies at lonrer levels of developnient, which instead use a contract system. With a long-run contract system, opportunities for generators to use cost reductions to gain market share are much more mfrequent.

A second condition for effective competition is that there be a s u . i e n t number offirms to avoid implicit collusion and gaming in the system. A two-generator industry, for example, may be susceptible to each firm's tacitly allowing its rival to behave in their mutual interest. The arrangement in England and Wales, with two large private generators (plus a smaller, subsidized public nuclear company), has already demonstrated that a larger number of companies is required to induce truly competitive behavior. In small systems, the market can be too small to suppol-t enough firms to achieve competitive conditions-unless the firms are so small that they lose economies of scale.

A third condition for effective competition is that the size and cost structure of the generating firms must be fairly similar. If they are not, there would be no possibility of using cost saving to increase market share (by altering the "merit orderJ' with respect to a rival). A related issue in determining the competitiveness of rival generators is the "strength" of the transmission system. A system with very high transmission costs per unit of distance can allow some generators to be virtual monopolies, since the extra costs of delivering supply across the transmission system to meet demand at a given node effectively prevents competition from more "remote" sites.

induce existing Firms to become cost-efficient. But where entry is difficult (because of problems in obtaining licenses and constructing the plants, for example), the threat of entry may be too small to affect the behavior of established firms. Where existing firms have some cost advantage not available to new entrants, there is an "intrinsic margin" that may not be competed away. Common intrinsic advantages are privileged access to local fuel supplies (especially hydro) that cannot be bid away by higher contract prices for the fuel, proximity to fuel source or to market, and environmental suitability of existing sites or even the nonavailability of new sites.

In existing systems, de-integration may bring about some losses of economies of scale. One factor in such losses is the need to maintain a "reserve margin" against uncertainties. The experience of US, power pools has shown that pooling has enabled individual firms to reduce resenre margins, and thus to reduce costs. In developing countries, it is unlikely that such sophisticated devices can be made to work, so a de-integrated system will incur the extra cost of maintaining reserve margins. Similarly, separation will increase the demand for managers, who may be in scarce supply in many small and less developed economies.

A more deta~lecl velsion of this Note RIII be produced in the Industry and Energy Depa~ tmcn t ' s Occasional Papers se~ies.

Robert Bacon, lndustry and Energy Department

In an existing industry, there must be eycess capacity for competition to be successful in the short run. If all plants are needed on a regular basis, there is no incentive to cut costs. The force of competition must come from new entry (such as independent power producers). If entry is easy and rapid, the threat of entry may be sufficient to

The Global Information Economy and the Eastern Caribbean Robert Schware and Szlsnn Hume

The information industry offers significant export opportunities to the countries of the Organization

of Eastern Caribbean States (OECS).' Focused action-especially in telecommunications price

reductions and aggressive international promotion-could quickly deliver jobs and new export

earnings. Investor interest is strong. US.- and European-based customer service centers, image

processing and claims fulfillment operatiom, and transcription and secretarial services see the

potential to cut labor costs through offshore operations. Neighboring countries such as Barbados,

the Dominican Republic, and Jamaica already are pursuing investment and contract work.

One possible strategy for the OECS countries is to offer office-park-style "free tonm" that provide

liberal business climates and to authorize affordably priced teleports (satellite earth stations that

bypass the local telephone network) that especially benefit export-oriented information service

providers. Teleports today can be made operational within three months at a cost of well under

USS250,OOO and can offset a country's disadvantages in cost and frequency of air freight service

by eliminating the need to physically ship materials offshore for processing. One such teleport is

now established and operating in Grenada. This earth station--financed and installed by a North

American data entry firm and transferred to Cable & Wireless-has led to the creation of more

than 200 jobs. Workers receive 100.000 images of waybills daily from Federal Express in North

America for processing. With its daily volume of 1.2 million waybills, this one customer could

ultimately create as many as 2,000 jobs offshore. This Note reviews the competitive strengths and

weaknesses of the Eastern Caribbean countries in information senrices and suggests remedial

actions to help them expand in that industry.

Competitive advantage

The Eastern Caribbean possesses sevel-al advantages as a base for offshore production of services: = Relatively affordable labor costs. Eastern

Caribbean direct labor costs for a range of information processing services are about 25 to 40 percent of North American and Western

European levels (table 1). At the top (or, more accurately, the bottom) of the league is the United States, where it costs US$8 an hour to hire a data entry worker. St. Lucian and Jamaican workers are cheaper, at US$l an hour. Data entry companies operating in the Caribbean have found that keyboarding productivity is approaching U.S. levels,

50 The Global Information Economy and the Eastern Caribbean

TRENDS IN THE GLOBAL INFORMATION ECONOMY

Since 19BO. developing counbies have been the bendciarim af an inflow of export-oriented information processing operations.

Labor cosi diimmials with OECD economies have created expod jobs in such operations at:

Slow-turnaround dats entry

Fast-$ntnamnnd imaging and claims processing Camptmtided design and geographic information systems Software development and services Electtonic publishhg Multimedia and bypermedia data bare dewelopment Voice center operalions

= Remote tecretarial d c e s Customar wppott and technical support lndealng and ahWlctlng sewices Research and technicti1 writing smd~es.

Until recently, most mport jobs have depended on air freight delivery of murce documadr for conversion. But with the introduction of competithly priced telecommnnications mndces, countries can now eompete much mom aggdwely w U M#hora

firms for fast-twnaround w o k Telepowatsll ite eerth rtatium that bypass publi tolepbow networks ta provide cornponies witb aftonlable, tiiibqmlity iatemati0nsl telecommunications semices- am emeging as a key enubling W r for these operations.

This pmanb significant opporbnities, la Notth America atme mom than 10 million workers am now employed in highewkill doc- tmio publishina claims pmcsrriog technical writing, and other "backdce" operatiom k a m h of the W25 percent tabor co8t

ravings they offer reIative to mjor Mot many remote comnun&ie in tbe Ulllted States ham a x p e r i d g d in back-ace market segments ouertbe past decade. Mow ths sea& for gmbr labor coa ravings ir compelling many of these operations to look oversees, primarily to M o p i n g co1111Mes that can offer direct labor cost savings of 70 percent or nl- to prewailing krlfi American Iswk. h evaluating abmatiw localionr anilabil i i of trkcommw nicaUons b Pftan a critical factor. Bwauae Wi wlh sWom kaM fallen in cost, m~~llinational corporatiam are prepared to Rnano, needed equipnent to enrurs! clom links with clients and suppliers

despite differences in initial skills. Caribbean workers attracted to "back-office" computer services are drawn from the top third of the work force and tend to have far lower turnover rates than their U.S. counterparts. That means labor costs per unit of output vary by much more than pay differentials alone would suggest.

= Good to excellent local and international public telephone systems. Cable & Wireless has made substantial investments in the Eastern Caribbean, resulting in a generally high-quality local and international service for voice communications. Linguistic and cultural affinities w i th major markets. Historical relationships, shared values, and a common language have created strong language and cultural ties between North America and Europe and the Eastern Caribbean. And the educational base in the Caribbean compares favorably with that in many potential competitors in the developing world. The language and Ilteracy of operators can be critical, especially d data entry is based on hand-written material. Time-zone affinities with major North American and Western European markets. Many potential job-generating sectors for the Eastern Caribbean-voice center operations, remote secretarial services-are used heavily during business hours. Compatible time zones should enable the Eastern Caribbean to sustain a competitive advantage over other (lower- cost) English-speaking countries, such as India and the Philippines. Relative transport convenience (for air-freight- oriented information services). Although air freight service to some islands is less frequent than to others, the Eastern Caribbean as a whole benefits from relative proximity to North America and, to a lesser extent, Western Europe compared with its Asian and Pacific competitors.

I Open environment for private investment. The Eastern Caribbean countries are market- based economies with prudent macroeconomic management. In addition to free capital flows, they enjoy a stable currency system thanks to independent central banks.


Constraints

Despite its competitive advantages, the Eastern Caribbean still must overcome significant near- term constraints if it is to become known as a world-class choice for offshore information processing firms: = The main constraint is t he high pr ice of interna-

t i ona l "d ia lup" communicat ions , rendering operations of many kinds in the Eastern Caribbean uncompetitive. A comparison of dialup service prices gives a sense of the magnitude of the obstacles. Jamaica's Digiport offers overseas calls for as little as US$0.22 per minute, as well as "fast-fax" connections that can bring the price of transmitting documents offshore down to US$0.024.03 per page. Direct-dial overseas calls to the United States from St. Lucia, by contrast, cost US$1.85 per minute, and local firms face prohibitive price and access constraints when seeking to set up fast-fax 56/64 kilobits-per-second circuits on a dialup basis.

Prices for leased international circuits are also uncompetit ive relative to those in alternative locations. In Jamaica, monthly lease prices for connecting to Intelsat satellites are less than US$1,900 for nonstop 56/64 kilobits-per-second Imks. The Eastern Caribbean, by contrast, quotes monthly lease prices of more than US$4,000 (table 1). Obstacles in the investment approval process, especially for export-oriented local enterprises, deter growth, as do rigidities encountered by foreign firms in obtaining visas for needed per- S O M ~ ~ .

Gaps in skills t ransfer have arisen because of the rapid pace of change in technologies and market conditions, compounded in some cases by inertia in training institutions. A lack of promotional visibility keeps investor interest lon~er than for other locations; few prospective investors and outsourcers have a clear appreciation of the Eastern Caribbean's potential as an offshore dormation processing location.

TABLE 1 LABOR AND TRECOMMUllCATlONS COSTS IN SELECTED COUHTRIES (U.S. dollars1

Hourly wage Uourty wage M ~ t h l y c o S of dedicated Yollrly WriW for secretarial fm voke M i l o h i t international

Grenada 1.26410 t42 3.05 4,118

St. K i 1.40 225 4,118

St. Vincent 1.10-1.57 2.15 1 .# 4,118

Jamaica am-1.00 1.75 t.10 1,850

United States 7 .W.09 8.5&1&Ml 8.W12.00 1.120'

a. kt&t d a m r d c dfim h n s l price. Mew Yolk to Ldl Angrlw [1!B41. S m c r St Luob N d o n a l Bevelopnbnt Cqrp~ratiw (1Wfi L s k m C I ' M ~ M 1- PmmDtiOn Suvicr 1180+34k fh Sewires &oup F d d Gredles (1993 Cable

The Global Information Economy and the Eastern Caribbean

Future action

A possible "jump-start" strategy for promoting growth in informatics exports would incorporate the following elements: * Authorizing affordable and privately financed new

teleports to serve the informatics export sector. Local and foreign teleport investors can meet in full the costs of teleport purchase and start-up if they retain access to basic Intelsat wholesale rates (US$490 per month per half circuit). At present, telephone companies in the region mark up these wholesale rates by an average of 800 percent. Designating free economic zones as a stimulus to local and foreign investment. Free zones-areas offering relief from customs duties, bureaucratic delays, taxes, and foreign exchange c o n t r o l s are well known and positively viewed by international investors, who may be slower to rec- ognize and respond to other reform initia- tives. Free zones should provlde transparent business climates for eligible local firms as well as for foreign firms, and should be promoted as a near-term stepping stone to (and demon- stration area for) further systemic reforms. - Introducing new skills acquisition opportunities. Through low-cost global satellite links, it will be possible for the Eastern Caribbean to access a far wider range of practical business and technical courses. This will benefit technical institutions, entrepreneurs, and employees. Ensuring that new entrants to the labor force are equipped with the basic education and keyboarding skills essential for information processing jobs could help solve some of today's unemployment problem. Improving the climate for private investment, To create an environment more conducive to private investment, the Eastern Caribbean countries will need to continue to liberalize authorization and registration procedures and relax limits on profit remittances, capital repa- triation, and technology payments. Moreover, to attract foreign investment, these countries need to reconsider laws and regulations that restrict the right to buy land, foreign participation in certain economic activities and in the ownership of companies, and the ability of

foreigners to work locally. 'The countries should also explore ways to extend the favor- able telecommunications prices to areas beyond the physically segregated free zones. Pursuing aggressive marketing and promotion. The counuies should seek strategic alliances for investment promotion, coupled with a targeted international marketing campaign. This effort should concentrate on catalyzing out- sourcing relationships between medium-size and small firms in North America and their Eastern Caribbean Counterparts and on inviting direct investment from large corporations.

I The countries of the OECS are Antigua and Barbuda, Dominica, Grenada, klontserrat, St Kitts and h'evis, Sr. Lucia, and Sr. Vulcenr and chc Grenadines.

For further information on the potential of the information industry in thc OECS, contact the authors: Rolxrt Schware CJi.lecommunic~rions and Info~matics Division) and Susan Hume (Caribbean Operations Division).

N E W B O O K S

L Creating Private Enterpri~ -

; - 1 Effici - t i f -7s

I Clpattng 7 -

and l3Ticim-I

In June 1994, leading reformers in the Russian government, academics, private sector consultants, and officials in international financial institutions such as the EBRD, OECD, World Bank, and International Finance Corporation participated in a conference on privatization and private sector development in Russia.

This book contains a collection of papers presented at the conference and a detailed summary of the conference proceedings, including presentations made by Anatoly Chubais, First Deputy Prime Minister of Russia, Andrei Shleifer, Professor, Harvard University, Maxim Boycko, Chief Executive Officer, Russian Privatization Center, and several resident advisors to the Russian State Property Agency (GJSI).

Among the themes addressed: What will happen to firms privatized by the mass privatization process? What mechanisms will facilitate secondary share trading-a necessary step for restructuring? m a t reforms are required in the financial sector and capital markets to support the newly emerging private sector? And in what kind of environment is the new private sector operating? Both prescription and analysis are provided-that is, information is offered not simply on what was done and why, but also on what remains to be done and how to address some of the critical issues that impede further economic reform.

Creating Private Enterprises and Eficient Agarkeg, 2nd edition, was edited by Ira W. Lieberman and John Nellis, with Enna Karlova, Joyita Mukherjee, and Suhail Rahuja and will be published in March 1995 by the Private Sector Development Department, the World Bank Group.

To order, write: World Bank Publications PO Box 7247-8619 Philadelphia, PA 19170-861y

Or call: (202) 473-2941 Or fax: (202) 676-0581.

Request stock no.: 13187 Price: $15.95

Orders must include check or credit card number with expiration date.

4 1 Les ~ r i v i - ---- ons un defi stratirgi(ue, juridique et institutionnel (Privatization-A Strategic, Legal and Institutional Challenge)

Lesprivc~tisntio~zs draws lessons from recent privatization esperiences in over fifty countries. The special focus is on strategic, legal, and institutional issues that arise as the state shifts from production to enabling and regulatory functions.

The book describes the wide range of possible strategic approaches to ancl techniques for privatization. The legal issues span the constitutional requirements, the overall business environment (inclucling labor law and legislation for capital markets), state enterprise law, the development of regulatory mechanisms, and privatization legislation proper.

The best-laid plans for privatization will not work without effective implementation. One chapter specifically adtlresses this ofien neglected issue-including the role of privatization agencies, comnissions and filnds, and advisors. The last chapter looks at the special issues that arise in privatizing telecommunications and other Lnfrastn~cture sectors.

The author concludes that the real challenge for policymakers is to go beyond the simple sale or transfer of assets, which is in fact the relatively easy part. Broader liberalization measures are often critical to ensure the success of privatization and should be implemented at the macroeconomic, sector, and enterprise levels.

The author, Pierre Guislain, is Principal Private Sector Development Specialist in the Private Sector Development Department of the World Bank.

Lespriuntisntions will be publishecl in April 1995 by De Boeck Universite (Bnlssels, Belgium) and is available in French only (342 pages).

To order, write directly to: ACCES+ Fond Jean-P2ques 4 B - 1348 Louvain-la-Neuve Belgium

Or call: (int'l access code +) 32/10/482500 Or fax: (int'l access code +) 32/10/482519.

Price: DF 2,500 (approx. US$80), plus shipping.

T H R E E W A Y S T O O R D E R

Fill out and ma or fax this card 2 To Suzanne Smith, Editor, 68105, The World Bank, 1818 H Street, NW, Washington, D.C. 20433, USA, fax: 202 676 61246

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Topics of interest: -- Finance Privatization Law & regulation Telecommunications & informatics Energy

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