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Economic development and the private sector Infrastructure: doing more with less - The private sector can play a major role in setting up and maintaining infrastructure as official resources become restricted

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
December 1981
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Christopher R. Willoughby

Weak infrastructure, one of the characteristics of developing countries, can seriously impair the growth and efficiency of activity by private entrepreneurs in agriculture, commerce, and manufacturing. As a result, the expansion and improvement of public infrastructure—such as transport networks and terminals, communications facilities, energy and water production and distribution works, and waste collection and disposal systems—has always properly occupied a prominent place in national development efforts. The central problem in expanding infrastructure today is a shortage of financial resources, a more serious shortage in most developing countries than existed a few years ago.

Both domestic and international factors—a reduced pace of economic growth, lagging expansion Of international trade, and a slow increase of foreign aid—have contributed to this restriction of resources. The oil price increase has exacerbated the deficiency because many of the techniques for economizing on petroleum—such as hydroelectric development, alcohol production, oil exploitation, and railway electrification—are expensive in terms of foreign and domestic capital requirements. In addition, governments have been under strong pressure to divert more resources to such public services as education, training, agricultural extension, and health.

More, therefore, has to be done with less. First, the capital cost of building new infrastructure has to be lowered. Second, existing infrastructure has to be made to last longer, and costs of operation and maintenance have to be minimized. And finally, more use has to be made of existing, or new, facilities.

The developing countries have traditionally been able to make better use of their investments in infrastructure than the industrial countries. When the growth of domestic transport utilization is related to investment in domestic transport infrastructure, for example, we find that the poorer developing countries, accounting for slightly more than half the world’s population, have had to make do with an investment per incremental traffic unit that is only about one third or one quarter that of the industrial countries. To improve these ratios still further, the developing countries are shaping a new approach that emphasizes heavy reliance on local and individual initiative within a framework of appropriate market prices and technical support from government agencies. Particularly in mobilizing self-help efforts, contracting maintenance work, and charging for infrastructure use, some of the developing countries are ahead of many of their industrial counterparts in mobilizing the effective participation of the private sector.

Reducing capital costs

Many infrastructure undertakings can be designed to rely more on revenues from services to reduce the need for government resources for financing investment. Such self-financing frequently enables the system to expand more rapidly and thus to attain scale economies more quickly than before. Now increasing attention is being given to encouraging the private sector to become involved more effectively in the provision of infrastructure. For example, the use of competitive bidding is being extended into areas where contracts were formerly negotiated. In addition, tender specifications are being defined more in performance terms to allow enterprising parties to come up with new technical solutions.

The basic costs of infrastructure extension can also be reduced by lowering design standards. In water supply and sanitation, for example, there is potential for using standards that are lower in terms of convenience than those typically used in the industrial countries but that are equally satisfactory in terms of health and hygiene—such as standpipes and pit latrines in place of house connections and sewer networks.

Costs can also be cut by evolving construction techniques that make more effective use of local human and material resources, which tend to be cheaper than nonlocal resources and are sometimes available to the project without cost under “self-help” arrangements. The use of labor-intensive construction techniques—particularly for rural infrastructure—is being expanded in many countries in Africa and Latin America. Asian countries that have traditionally used such methods are taking steps to improve their efficiency. For instance, a recent Bank loan to India for rural roads included a special provision for the purchase of some simple equipment—principally rollers for compaction, asphalt mixers, and distributors—to improve the performance of small contractors in the areas where research had shown purely manual techniques to be less cost effective.

In many countries, a significant obstacle to the use of labor-intensive construction techniques is a legally established minimum wage that is substantially higher than the levels of earnings outside the modern sectors of the economy. Mexico and Kenya have developed imaginative ways around this obstacle, so that people employed on labor-intensive rural works are effectively paid about 80 per cent of the legal minimum wage. The Mexican solution has been to agree with the local communities that one day in each week spent on such works will be contributed free, while Kenya has established a special minimum wage for these activities which is lower than that for other construction work. Other countries, too, are reviving traditional systems for people to contribute some portion of their time free to community work. A critical element in the effective use of local initiative is the availability, from regional offices of public agencies, of good technical advice and essential items like cement and pumps.

Efficiency of maintenance

Particularly interesting in the maintenance field is the growing use of private contractors even for routine maintenance of highways. The traditional view, prevalent in developed and developing countries alike, has been that this type of work—which involves operations such as cleaning roadside drains and patching bituminous pavements—is best done directly by government labor forces. Recently, however, Argentina, Brazil, and Colombia have turned over increasing proportions of this work to private contractors and significant economies have resulted. Private contractors can operate more efficiently and cost the government less than its own workers because of the incentives to lower costs inherent in competitive bidding and the greater flexibility that private enterprises have in hiring, remunerating, and retaining personnel according to their performance and the actual workload available.

Another quite different form of maintenance contracting that is now being revived by several countries for rural roads in inhabited areas is the “lengthman” system. Kenya now maintains some 2,000 kilometers of rural road in this manner and is planning to extend its application substantially. The locally resident lengthman is responsible for a short stretch of road, which entails spending one half of his working days on roadwork. He is paid a halftime wage at the end of each month provided the supervisor finds the road in satisfactory condition. In several countries individual concessionaires play an important role in operating and maintaining standpipes and distributing water locally.

Operational efficiency

In many infrastructure undertakings, both maintenance and operations have to be centrally managed and controlled, at least on a regional basis. These may be termed “natural monopolies,” and include electric power grids, railway systems, local telephone networks, and city water supply systems. They often present vast scope for improving efficiency and reducing waste. When run as government or municipal enterprises, as they are in most of the developing countries (as well as in many industrial ones), political factors may prevent tariffs from being adjusted for inflation or may keep them low for particular categories of customers; the resultant departure from budgetary equilibrium, and the consequent need for compensating subsidies, both take the edge off the pressure to operate efficiently. Alternatively, if the subsidies are not provided, operating efficiency deteriorates for lack of funds.

It is striking, however, that despite political sensitivities, there is an increasing understanding and acceptance of the principles of budgetary equilibrium that the Bank has continuously promoted. In areas where a case can be made for subsidizing some users, particularly of water, many Bank borrowers have succeeded in introducing the concept of a “lifeline consumption level” as a basis for charging the poor. Charging for other groups, by contrast, is based upon a flat rate approximating long-run marginal costs or on a progressive schedule that discourages “excess” consumption. The combination yields revenues sufficient to cover all costs. In transportation, where such cross-subsidies have little justification, the May 1980 report of the Indian Transport Commission is interesting for the consistency with which it argues against subsidies and cross-subsidies in each mode; and several appropriate actions have already been taken by the Indian Government, particularly to raise certain railway tariffs and airport charges.

While sound standards of financial performance provide a crucial overall framework for these natural monopolies, it is equally important in many of them to introduce and develop more internal flexibility. This is largely a matter of management systems, staff incentives, and staff training. Some countries, for example, have been introducing into public enterprises management systems drawing on experience with market incentives. These may require regional offices to pay full market charges for the use of equipment owned by the enterprise (the Malawi Public Works Department operates in this way) or separate accounting to be established for groups responsible for particular portions of the service (as in the Yugoslav railways).

Some countries have had great success with contracting the operation of their infrastructure services. The Ivory Coast, for instance, has contracted the maintenance and operation of its national water supply system with a private company, and its operational performance has been among the best in the developing world. Other countries have been moving toward sub-contracting particular parts of the job, such as the installation of ancillary telecommunications equipment or the operation of subsidiary parts of a water system.

Services using infrastructure

Most transport services are neither natural monopolies nor subject to significant economies of scale in operation. These services operate most efficiently when competition among them is promoted and the economic regulation—introduced in many countries in the face of worldwide depression in the 1930s—is reduced. In the same way, deregulation can be expected to stimulate imaginative and economical private initiative in other areas besides transport, such as long-distance telecommunications, solid waste collection, and the disposal, treatment, and reuse of liquid wastes for agricultural purposes.

The developing countries, with the Bank’s encouragement, have traditionally taken a rather pragmatic attitude to the organization of transport services. Some that had developed government-owned companies are now reducing the role of the public sector or are even turning the service over entirely to private enterprise. In the Congo and in Guinea, despite state socialist ideologies, most road freight is carried by private companies, mainly owner operators. In Zaire, private enterprises have been providing a steadily increasing share of river transport services, while Sudan is planning to break the public monopoly of river transport on the Nile. Both India and Sierra Leone closed their central government trucking companies a few years ago. In Sri Lanka, private enterprise is rapidly penetrating the intercity and rural passenger transport market, both of which were previously reserved to the state monopoly.

Many developing countries are gradually relaxing inappropriate economic controls on road transport and are slowly strengthening the enforcement of rules that are important, such as those regarding vehicle overloading and safety. A particularly dramatic case of successful deregulation involves the interurban and rural bus transport in Chile. In 1977-78 the requirement for government preapproval of fares was eliminated. In 1979 all route and service licensing was abandoned. In 1980 even the requirement to report fares to the Government was dropped. As a result, there has been a large expansion of bus companies and services. Fares are about the same now in real terms as they were in 1970—except on the longer routes to the north and south of the country where quality of service has been vastly improved. In the five years between 1974 and 1979, and despite some deterioration of road quality due to a shortage of resources for maintenance, the number of long distance bus passengers in Chile quadrupled, reaching more than 60 million in 1979.

In India, where the development of road freight transport has traditionally been severely limited to protect the railways, steps have gradually been taken to ease restrictions. The report of the recent Transport Commission recommended further liberalization. The People’s Republic of China, which has also traditionally followed a strongly prorailway policy, has recently seen a great expansion of “own account” trucking by manufacturing and agricultural enterprises; moves are underway to reduce restrictions on the use of these vehicles, which will greatly increase the competitiveness of the short-haul transport market.

Efficient pricing structures

Deregulation opens the way for local initiative and can cause tariffs charged by competing services to move closer to real costs. It also adds to the importance of correct charging for basic inputs, including the services provided by publicly managed infrastructure.

A basic input for most infrastructure, particularly for transportation and for some electricity undertakings, is liquid fuel. The large majority of oil importing developing countries have passed on to users increases in the international price of oil, often more rapidly than some of the industrial countries. This has been a more difficult issue in those developing countries that are important oil producers. But many of them have taken some measures to raise domestic prices. Many countries now need to bring the price for diesel fuel more closely into line with that for gasoline or, where there is a particular shortage, even to raise it above the price for the latter. Brazil made important moves to raise diesel prices late in 1980.

There is increasing recognition of the distortion that results from price controls that subsidize some services at the expense of others. Development of domestic air and sea transport services has often suffered from attempts to force cross-subsidization of them from international services. Regional development patterns have been distorted by subsidization of particular categories of rail passengers and freight out of revenues on others. Such pricing structures can often be changed only gradually because strong vested interests grow up behind them. But a better understanding of their negative consequences, as is now developing, is the first step to reform.

Perhaps the most interesting examples of the effort to guide the private sector to get the best use out of the available infrastructure are the numerous efforts at “scarcity pricing,” using marginal costs that reflect the cost to society as a whole when demand is too great for the infrastructure to bear. The principle is to price the use of the congested road or port facility or telephone network at what the last user who could be accommodated is prepared to pay and to expand the system to the point where the price he will pay just exceeds marginal costs. A number of telecommunication administrations, in Brazil, India, Thailand, and elsewhere, have at various times approximated such scarcity prices for new telephone connections, and India has established call charges on a somewhat similar basis. The power utilities of many developing countries have begun to assess the adequacy of their tariff structures in relation to marginal costs, and some, such as Thailand and Tunisia, are beginning to introduce important changes to better reflect the costs of meeting peak demands.

Innovative efforts have also been made to price transport in this way. Examples are the Area License Scheme and substantial increases in parking charges introduced for central Singapore in 1975, the seventeenfold increase in downtown parking charges for San Jose in Costa Rica in December 1978, a tenfold increase in port storage charges at Karachi in Pakistan in August 1979, and large increases in railwagon demurrage charges on the Nacionales de Mexico system at the end of 1980. All had significant effects in securing a better allocation of available capacity, attracting provision of new private capacity in some cases (such as certain public transport services in Singapore and warehousing in Karachi), and raising funds for infrastructure extension.

The main effect of these various efforts to accomplish more with less is to give added scope and support to private and local initiative for building, maintaining, and operating infrastructure and for running services. Although a principal theme in discussions of infrastructure in the 1960s and early 1970s was the need for systems analysis—and such integrated planning can make major contributions to the efficiency of resource allocation—yet integrated planning does not necessarily entail centralized operation. In many cases the work, even the planning, is better subcontracted in one way or another, with appropriate incentives, to private and local initiative. In some cases, the savings from centralized planning or scale economies are outweighed by the sacrifices in terms of innovation and efficiency that arise from limiting the role of local initiative. As education and the numbers of educated people gradually increase in developing countries, the scope for mobilizing local initiative for development also grows.

In the infrastructure field, the Bank has persistently emphasized financial discipline to promote efficiency and avoid the costly and incentive-reducing burden of taxes to pay for subsidies. It has discouraged the build-up of large government labor forces and encouraged the use of local contractors. It has helped reduce economic regulation of transport services, and it has strongly urged better alignment of prices with costs so as to give competitors and users appropriate opportunities and incentives.

Much has been accomplished but much remains to be done. For instance, there is a need for combining more frequently structural/regulatory reforms introduced under infrastructure loans with financial assistance on market terms through development banks to the local enterprises. Additional assistance is needed for training programs in ministries of works (which are often the main source of future contractors and contractor staff) and for the development of these ministries’ regional services for supporting community initiative. More attention needs to be directed to the desirability of subcontracting responsibility for the operation and maintenance of particular parts of the infrastructure and of making more use of management contracts. Many countries need to place more emphasis on the development of appropriate prices for the use of infrastructure. Measures of this sort can make a critical contribution to developing countries’ efforts to spread limited funds yet further.F&D

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