COSATU Position Paper on Privatisation Tabled at NEDLAC, 30 July 2001

Table of Contents

This paper both answers the governments response to our Section 77 Notice, and presents our basic arguments on privatisation.

The paper first explains the definition of privatisation used by COSATU in its Section 77 notice of dispute. It then reviews some government policies on privatisation, demonstrating the commitment to this inappropriate policy.

The third section of this paper provides a general analysis of why privatisation is not appropriate in the South African context. The central problem is that it is inherently difficult, if not impossible, to compel private interests to serve the poor or intervene strategically to restructure the economy.

The final part of the paper gives examples of the damage already caused or likely to occur from current practices and proposals associated with privatisation.

Defining privatisation

COSATU’s Section 77 Notice defines privatisation in terms of the extension of the control and wealth of the private sector at the cost of the state. In effect, it refers to the process that the DTI, in its recent discussion document on industrial strategy (DTI 2001), calls the extension of the market.

This definition of privatisation covers, not only the open sale of state assets, but also other processes that turn state functions over to the private sector and the market. These processes include:

1. The sale or partial sale of state-owned assets or enterprises.

2. The introduction of private competitors in sectors historically controlled by the state. Effectively, this approach privatises part of an industry or sector, even if the state does not itself sell any assets. It effectively subjects state interests to pressure to compete on the market, ultimately reducing their capacity to meet social needs.

3. Relinquishing the management of state functions to private interests. This can take the form of outsourcing services from the public service. It also takes the form of contracting management of municipal services to private companies. In these cases, the state does not necessarily sell assets, but they nonetheless fall under private control.

4. The requirement that state functions operate on a commercial basis, in some cases registered under the Companies Act. Commercialisation both often forms a first step toward privatisation and subjects state activities to the logic of the market. As with the privatisation of historically state-run industries, it makes state interests pursue commercial imperatives rather than broader social needs.

Given this definition, it is clear that COSATU demands, not just an end to the sale of state assets, but re-examination of whether it is desirable for market forces to govern the delivery of basic services. It is also clear that:

1. COSATU’s definition of privatisation is not covered by the NFA for State-Owned Enterprises, and therefore cannot be dealt with in that forum, and

2. COSATU is not objecting to a lack of consultation about privatisation, but rather to privatisation itself.




Government policy on privatisation

In public, government generally voices some cautions on privatisation, arguing that it will not privatise on a wholesale basis or without regulations. Virtually without exception, government documents avoid the term privatisation, preferring euphemisms such as "restructuring" or "public-private partnerships."

Yet examination of key policy documents points to an overwhelming belief in the efficacy of markets and private managers. They also support privatisation as a way to compensate for budget cuts in recent years, to attract foreign investors, and generally to satisfy foreign interests. At the same time, they fail entirely to propose consistent, strong regulatory structures or to analyse systematically the costs and benefits of proposals for privatisation.

We here first examine some important government policies related to privatisation – the Budget Review 2001, the Department of Public Enterprise (DPE) policy framework, the Department of Trade and Industry (DTI) discussion document on industrial policy, and the 2000 Municipal Systems Act. We then look at ANC positions, starting with the Freedom Charter.

Budget Review 2001

The National Treasury has adopted a particularly uncritical approach to privatisation. In the Budget Review 2001, it argues that what it calls "restructuring [of] state-owned assets" can "broaden economic participation, recapitalise public enterprises and reduce state debt..." (page 91)

The National Treasury makes no bones about its main motive for pushing privatisation: to raise funds so that it can stick to the GEAR targets. In effect, these targets set limits on taxation – which mostly affects the well off – and on government borrowing. Thus, the Treasury expects privatisation of the major parastatals alone to raise R18 billion for the fiscus in 2001/2. This sum is equal to 7,4 per cent of the budget in that year. Only these proceeds permit the budget to grow faster than inflation in 2001/2.

The National Treasury has also played a leading role in demanding that government agencies bring in private investors in infrastructure. It justifies this push in large part by contending that the private sector is inherently more skilled and competent that the public sector.

While public-private partnerships will not necessarily lead to additional capital expenditure, they should lead to greater efficiency as private sector expertise is utilised in the planning process and in the operation and maintenance of buildings and equipment. In addition, a key objective of such partnerships is to shift some of the risks to the private sector… (National Treasury 2001, page 137)

The National Treasury has established a special unit to encourage local governments to enter into arrangements that increase private participation in service delivery. It has made some funding for local government contingent on acceptance of this type of arrangement.

The DPE’s Policy Framework

In August 2000, the DPE published a policy framework on restructuring state-owned enterprises (SOEs) – An Accelerated Agenda Towards the Restructuring of State Owned Enterprises: Policy Framework. The framework effectively commits government to bringing in private interests wherever possible - again, using the euphemism of "partnerships." Thus, it suggests that options to "enhance productivity, profitability, investment and innovation... will often entail equity sales (full or partial privatisation) in order to access additional funding, technology or markets. Where this is not required, other approaches such as corporatisation, joint ventures, employee participation schemes and community partnerships may be more beneficial". (DPE 2000, page 153)

In general, the framework favours the sale of assets, arguing that, "While many forms of restructuring can improve the efficiency with which SOEs use resources, a process that involves a transfer of ownership can have important additional macroeconomic benefits." (DPE 2000, page 34) It lists the potential benefits as reduced government debt, improved credit rating, and increased foreign direct investment.

While the DPE acknowledges that it cannot privatise all SOEs immediately, it strongly voices the belief that as a rule, competition will improve services for all.

The promotion of competition and competitive markets should be an integral element of any restructuring strategy to ensure that the benefits of restructuring (such as efficiency gains) translate into lower prices, higher quality goods and services, and wider coverage. (DPE 2000, pp. 153-4)

This approach has led the DPE to push for the privatisation of parts of industries that were historically controlled by SOEs – notably electricity, rail and telecommunications. The DPE generally acknowledges that competitive markets may require some forms of regulation or subsidy. Yet it never explores the implications of South Africa’s unusually large inequalities in incomes.

Although the DPE provides some broader ideological reasons for privatisation, it is clear that, as with the Treasury, a major aim is to raise money. The policy framework implies that private capital will, somehow, be provided at no cost to either government or consumers.

Unfortunately, the state lacks the immediate resources to address these investment and infrastructure backlogs. There is thus an inescapable demand for new financing through different forms of domestic and foreign partnerships to promote the infusion of new equity capital and technology… [T]he South African context of infrastructure backlogs and limited government resources indicates that, in many cases, there will be some level of equity sales to provide capital, technology and/or access to markets for infrastructure expansion. Given the limited fiscal resources, further infrastructure investment can only be achieved through an accelerated programme of the restructuring the SOEs and more extensive use of public-private partnerships. (DPE 2000, p. 36)

The policy framework admits the need for careful analysis of the impact of "restructuring" on society. It contends that "Such an analysis should address the costs and benefits to society, both direct (e.g. immediate impact on pricing or employment) and indirect (e.g., social costs from non-delivery of certain essential services or the impact of unemployment on specific communities)." (DPE 2000,l page 47) Yet the DPE has never published such an analysis of its own proposals for the biggest parastatals.

The DPE contends that an important part of privatisation is to make it harder for companies to provide internal cross subsidies.

An important lesson from the international experience, however, is [to account for social impact] .. in a more transparent manner. This would mean that Government's intention of making SOEs more responsive to market incentives (i.e. promoting microeconomic efficiency and effectiveness) should not be undermined by other social or political obligations to preserve employment and/or deliver services uneconomically. (DPE 2000, p. 44)

By "transparent," the DPE means that subsidies must be made part of the annual budget allocation. It ignores the fact that, as discussed below, on-budget subsidies are more subject to short-term fluctuations and political lobbying.

The DPE argues that it can control negative effects of privatisation through shareholder compacts and regulation, particularly in terms of competition policy. Yet it never explores the capacity required to achieve these aims. Moreover, it does not seem prepared to publish existing shareholder compacts, for instance with Telkom.

In sum, the DPE argues that privatisation is the best way to achieve efficiency, and that government regulation, shareholder compacts or subsidies will ensure adequate services for the poor. As with the National Treasury, it is clear – despite these commitments – that raising money off budget remains the main reason for pushing privatisation.

The DTI’s Driving Competitiveness: An Integrated Industrial Strategy

The DTI recently published a discussion document, Driving Competitiveness: An Integrated Industrial Strategy For Sustainable Employment And Growth (May 2001). This document adopts the DPE’s assumption that competition will almost inevitably ensure more efficient and effective service delivery.

The principle insight underlying our industrial strategy is one that acknowledges the power of market forces - that the market is a force for low prices and extended choice, for innovation and for new entry into the economic arena. (DTI 2001, page 8)

[E]nsuring the introduction of feasible levels of competition into [historically state-controlled] sectors is also vital. Transport, energy and telecommunications facilities will not be extended at affordable prices or at the required levels of competence if the providers are not subject to powerful disciplines and it is clear that market forces, or competition, is one such source of discipline. (DTI 2001, page 14)

Like the DPE, the DTI calls for regulation, without specifying its content or assessing whether the state has the capacity to implement it.

[O]ur industrial strategy also recognises that, like all-powerful [sic] forces, the market needs to operate under a clear set of rules. In the absence of clear and enforceable rules it runs the risk, indeed, the certainty, of capture by the most powerful participants and the undoing of all the positive outcomes associated with an effectively functioning market. (DTI 2001, page 8)

The DTI appears to see state ownership as justified only in the case of natural monopolies – that is, in industries where the unit cost is lowest only when one enterprise produces enough to meet the entire market demand. Natural monopolies often exist where large investments in basic networks are necessary, for instance electricity and local telephony. But the DTI agues that technological advances mean that natural monopolies no longer exist in these sectors. By extension, they should be privatised and regulated, rather than remaining in state hands. (DTI 2001, page 14)

The Municipal Systems Act 2000

The Municipal Systems Act is the only legislation on restructuring the state. It applies only to local government. The Act does set limits on privatisation – limitations very similar to those demanded by COSATU in its Section 77 notice. Unfortunately, faced with the national government’s broader pressure to privatise, municipalities have largely disregarded the Act’s prescripts.

In Section 78, the Act requires that local governments assess options for service delivery in terms of sustainability, the ability to provide the service through its own capacity, the impact on employment and development, and the views of local government. Moreover, if the local government contemplates introducing a private service provider, it must first notify the community. It must also conduct a social cost-benefit analysis, assess the sustainability of the delivery system, and consult with the affected communities and with labour.

Section 81 requires that even if the local government uses a private service provider, it must set the tariffs, ensure adequate services for the poor, and generally ensure that services align with its overall integrated development plan.

It appears that local governments, under pressure to hand service delivery over to private managers and investors, have rarely undertaken the analytical work and consultation required by the Act. They argue that it is too onerous and time consuming to conduct a proper investigation of delivery options and to consult stakeholders. It is not surprising, then, that – as detailed below – many instances of privatisation at local government level have turned out badly.

Summary

Government views on privatisation are contradictory. They praise market forces, yet at the same time call, without detail, for regulation. Ultimately, they endorse wholesale privatisation, driven by three key assumptions:

1. Competition will lead to lower costs and better quality services for all consumers.

2. The private sector generally is more competent than the public sector.

3. Privatisation will bring in additional resources for government services at no cost to the state or consumers.

The rest of this document discusses the flaws in these assumptions. The next section points to some theoretical problems, and the final part looks at actual experiences with privatisation.




Shortcomings of privatisation

The main arguments for privatisation are that it will enhance efficiency in addressing social needs and leverage private investment to that end.

The first argument assumes that South Africa has relatively efficient markets from a social standpoint - an assumption that holds neither in theory nor in practice. Above all, because of very unequal incomes, private providers have little incentive to serve the poor and cannot easily capture the benefits of broad-based development. The result is that they simply cannot take on the developmental role of the state. They also undermine cross-subsidisation, increasing the pressure to raise tariffs for the poor.

In these circumstances, government lacks the capacity to compel private providers to met national targets. Moreover, the attempt to restructure on a broad front, combined with excessive faith in private expertise, has led to management mistakes.

Given these realities, the argument that privatisation will bring in funds really only means that it will increase the off-budget resources available for infrastructure. The cost may be high - to the state, in terms of subsidies or lost assets, and to poor consumers in the form of rising tariffs and limited access.

When are markets efficient from a social standpoint?

Much of economic theory analyses the question of when markets will prove efficient from the standpoint of society. In essence, the challenge is to define when private interests, intent on making a profit, will also meet social needs. If those conditions are not met, the market outcome may be inefficient from a social standpoint.

Conventionally (1), economic theory has defined specific conditions for socially efficient markets. In essence, they are:

1. Incomes are sufficiently equal that market demand essentially expresses social needs (2),

2. The price of a product reflects its full costs and benefits to society – to use the economics jargon, there are no externalities,

3. Market actors have sufficient information,

4. Resources move easily between activities, and

5. A high degree of competition exists.

In South Africa, especially in industries that meet basic needs, most of these conditions are noticeably absent. Yet where these requirements do not exist, the market will not compel private interests to meet social needs.

We here review the three main market imperfections that mean privatisation will not meet social needs: mass poverty aggravated by massive job losses since 1990; the fact that producers cannot capture the long-term gains associated with improvements in basic services, and therefore cannot carry out for the developmental role of the state; and factor immobilities – that is, the difficulty of moving resources between sectors – associated with high unemployment.

Privatisation cannot meet the needs of the poor

South Africa has inherited a particularly unequal distribution of income. Estimates suggest that in this regard, we rank third worst in the world, following Brazil and Uruguay. The richest 10 per cent of South Africans get around 45 per cent of the national income, compared to between 30 and 40 per cent for almost all other middle-income developing countries, and 24 per cent in South Korea. (UNDP 2001)

In part, inequality is rooted in the injustices of apartheid, which denied the majority of our people formal qualifications and access to basic infrastructure. It has been aggravated by the massive loss of formal jobs in the past decade, fuelled in part by downsizing in the public sector. As a result, despite improvements in government services to the poor, income distribution has not improved.

The particular impact of unequal access to basic infrastructure emerges in the Human Development Index (HDI), which combines GDP per capita, life expectancy and educational achievements. South Africa ranks 94^th in the world in terms of the HDI, but 46^th in terms of GDP per capita, taking purchasing power into account. (UNDP 2001)

The distribution of income ineluctably shapes the outcome of the market. After all, the market is only designed to reach those who can pay, not to raise living standards for the poor. Consider the housing market: effective demand has been met, every single participant may be acting efficiently in their own terms – and yet millions go homeless.

The DPE’s policy framework argues at length that as consumers exercise their market choices, the market will bring about efficiency.

Price-sensitive consumers may be prepared to accept a lower quality of service in exchange for a reduced price. Other consumers may be prepared to pay a premium for a high level of service. (DPE 2000, page 41)

One wonders where the authors live. Few South African households have the luxury of deciding between quality and price. After all, most earn well under R1000 a month. They have no choice but to rely on the state to provide a minimum of basic services at an affordable price.

In the industrialised countries, which have relatively equal incomes, the market will compel private service providers to meet the needs of the majority. In contrast, South Africa’s mass poverty makes a mockery of the belief that the market will secure efficient services for the masses.

Markets and the role of the state

The market will not meet the social and economic requirements of development, since private companies cannot capture the long-term benefits of developmental measures. To understand the implications, we here explore the functions of the developmental state, and analyse why the private sector cannot carry them out.

1. Social protection

The state must enhance social protection – that is, the basic services provided to ensure no South African lives in extreme poverty. This is critical both to raise productivity, for instance by improving skills, health and security, and to expand the domestic market. In addition, improvements in household infrastructure such as water and electricity should lay the basis for home-based employment.

In effect, poverty in itself creates poverty, by lowering productivity and employment. The market cannot break this vicious cycle, since in the short run, the poor majority cannot afford to pay the full cost of basic services. This problem is particularly acute in the rural areas, where provision of services generally costs more. Yet failure to provide services in the countryside fuels rural-urban drift and the associated social and economic costs.

It follows that the poor, especially in rural areas, cannot rely on the private sector to provide basic services. Only the state can do that, breaking the vicious cycle of poverty and initiating broad-based, rapid economic and social development.

In the language of economics, given widespread poverty, the market price of basic services does not reflect the long-term economic and social benefits. As a result, left to itself, the market will under-provide basic services. If it privatises these services, the state will have to compel private agents to undertake a role that fundamentally contradicts market signals.

2. Industrial strategy

The developmental state must support a strong industrial policy to restructure the economy toward growth. To that end, it needs to direct the development of economic infrastructure to support employment-generating activities. Indeed, the allocation of infrastructure is one of the main ways the government can support desirable economic activities. By privatising the main infrastructure sectors, the state undermines its own capacity to intervene strategically in the economy. It reduces its own control over key national assets.

Privatisation is especially hostile to the growth of home-based micro enterprise, particularly in rural areas. Privatised industries will generally seek to serve large, formal enterprise, which can buy in bulk and often afford relatively high tariffs. In contrast, the arduous and expensive task of extending infrastructure to households is less profitable. Moreover, as discussed in section 3.3, private infrastructure companies do not want to cross-subsidise poor households. As a result, micro enterprises may not be able to afford such critical infrastructure as telephones and electricity.

Industrial strategy also may run counter to the focus on competition as an aim in itself. Often, restructuring the economy and competing internationally requires large-scale enterprises compared to the economy as a whole. In these circumstances, breaking up state enterprises or requiring the introduction of private competitors may undermine the efficiency of the economy as a whole.

Again, we can explain this issue as one of externalities. Private companies cannot capture the long-term benefits of strategic investments to restructure the economy. The situation also reflects the market’s inability to anticipate the need for major investments – an information problem.

3. Increasing the asset base of the poor

Both social protection and economic strategies must increase the asset base of the poor by improving housing, land reform, support for SMMEs and skills development. More equitable distribution of assets enhances the stability of the economy, supports employment creation, and leads to greater overall equality. Again, as privatised industries will not serve the poor, they will not carry out this function.

4. Strengthening democracy

Finally, the developmental state must strengthen democracy in both political terms and in the economy. Otherwise, the rich and powerful can always hold it hostage.

How does privatisation affect democracy? In the short run, it increases the voice of capital in social and economic policy. It takes assets out of the control of the democratic government and turns them over to private interests. It reduces the capacity of the state to ensure support for micro enterprise.

The government has stressed that privatisation should enrich black capital, in the name of black economic empowerment (BEE). This approach makes a mockery of the aims of BEE as articulated, amongst others, by the BEE Commission, which defines BEE as:

.. an integrated and coherent socio-economic process.. located in the context of the country’s national transformation programme, the RDP.

It is aimed at redressing the imbalances of the past by seeking to substantially and equitably transfer and confer the ownership, management and control of South Africa’s financial and economic resources to the majority of its citizens.

It seeks to ensure broader and meaningful participation in the economy by black people to achieve sustainable development and prosperity.

In a democratic South Africa, state ownership is critical for black people to participate in the economy. On the one hand, in itself it represents a critical way for the majority to take part in and benefit from economic decisions. On the other, only the state can extend basic services and assets to poor black communities.

5. Summary

Privatisation undermines the ability of the developmental state to fulfil its core functions in terms of social protection, industrial strategy, increasing assets for the poor, and enhancing democracy.

In this context, any assessment of costs and benefits must take the impact on broader national policy aims into account. Privatisation, with a short-sighted target of maximising profits, may well end up imposing large costs on the government and on society.

Resource mobility

Markets will not ensure efficiency if resources cannot move rapidly and without cost to new uses. In this situation, a resource – including labour – may become unnecessary in one sector, but not find employment in another. The result may be substantial costs to society.

Privatisation (including commercialisation) often leads to substantial job losses. Private management quickly closes down less profitable operations, typically those that serve the poor. They do not take political or social responsibility for the survival of the workers who lose their jobs. Furthermore, where companies plan to list shares, they often want to look lean and cash rich – and subcontracting or downsizing help in achieving that aim, although sometimes at substantial long-term cost to the company and the country.

The DPE’s policy framework simply assumes that factors are mobile, and therefore the costs of retrenchment will be limited.

[S]ome declining sectors will experience an irrevocable loss of jobs. However, where restructuring brings about significant efficiency improvements and new technology, the result is often the development of new niche industries able to absorb retrenchments in other areas. (DPE 2000, pp 39-40)

This naïve belief that restructuring will create new jobs is borne out neither by experience nor by theory. Unemployment is now officially over 20 per cent, and the formal sector continues to lose thousands of jobs every year. In these circumstances, workers who lose jobs as a result of privatisation cannot count on easily finding new employment. This is especially true because the majority of those affected are in the lower skill levels, and many live in rural areas where unemployment is highest. Very substantial costs to society and the economy have resulted.

Summary

The argument that markets and private investment are inherently more efficient than public-sector delivery does not reflect South African realities. In the event, markets are inefficient because of massive income inequalities, the failure of market returns to reflect the full benefits from development, and factor immobilities in a period of very high unemployment. In these circumstances, state control is necessary to ensure adequate, quality provision of services to the poor, and to initiate strategic investments to restructure the economy.

Why regulation won’t work

Because the developmental inefficiency of South African markets is undeniable, virtually all government policies on privatisation admit the need for regulation. But closer examination of this commitment demonstrates a lack of seriousness.

Effective regulation – whether through regulations or contracts - requires appropriate targets, monitoring and feedback mechanisms, and capacity to enforce regulations. South Africa has inadequate capacity in all these areas.

1. Most policies on privatisation are not linked to targets for service delivery, and often the targets are inadequate and poorly publicised or even secret. For instance, the targets for Telkom are badly defined. They require a specific number of new connections every year, without any standards for affordability or sustainability. As a result, although Telkom has met the targets for new connections, a large number are terminated every year, and as discussed below, basic telephony has become increasingly unaffordable. It appears that the new strategy on telecommunications sets even weaker targets for new actors in the market.

2. Given vague and inappropriate targets, monitoring and feedback mechanisms cannot function well. In any case, the new regulatory agencies at national and local level do not have capacity to monitor privatised agencies consistently. That would require a profound and independent understanding of the finances of the private sector interests as well as developmental needs.

3. Finally, regulatory agencies generally have very little capacity to enforce regulations. Once it has turned its own capacity over to the private sector to own or manage, government is in a weak position. It cannot easily impose strong sanctions, since that could in itself disrupt service provision. This has been the experience, for instance, with the contracts for pension pay-outs, where companies have reportedly violated agreed targets. It has also happened with water-supply contracts around the world, and more recently in the Dolphin Coast and KwaZulu Natal. In these case, the company accepts high targets in order to get the contract, then demands renegotiation after a year or two. The local government no longer has the resources or systems to provide water, and must cave in to the private investor’s demands.

A fundamental problem underlies these weaknesses in the regulatory framework. The practice of arms’ length regulation of basic services emerged in industrialised countries, where income inequalities are less extreme and developmental needs less pressing. The demands of the regulators therefore do not diverge greatly from the imperatives of the market. It is relatively easy for the private provider to comply. In contrast, in South Africa, developmental targets impose a considerable cost on the private company.

Furthermore, industrialised countries have far more resources and skills to use for regulation, and have developed their systems over many decades. In South Africa, regulatory agencies have inadequate resources, and must develop new systems in the course of a few months or years. It is not surprising that most of them do not function efficiently or effectively.

As one observer notes about electricity regulation,

Even now – ten years since privatisation - Ofgem, the UK regulator - is struggling to prevent market abuses by private firms. This is in a wealthy country where the regulator has substantial resources. How much more difficult then is the job of the regulator in developing countries where organisations are staffed by poorly paid public sector workers with little exposure to international corporate activities and where the ‘opposition’ consists of highly paid internationally trained corporate executives. What is more, the regulator has little at hand in the way of sanctions, should the firm refuse to adhere to the rules of the regulator. In low-income economies, sometimes few bids are received for privatisation tenders. In such a context, the ultimate sanction of the regulator of terminating the concession and awarding it to a competitor may not be a valid option. (Bayliss 2001, p 23)

In the event, we need only point to our experience with regulatory agencies so far to suggest that government is overly optimistic about its ability to control privatised services.

Cross subsidisation

Privatisation makes cross subsidisation to cut costs to the poor more difficult, even impossible. In the case of fully privatised companies, management will not see why it should engage in relatively high-cost, low-profit services for the poor. Where government permits competition with parastatals, private companies will pick the most profitable opportunities. The parastatal therefore loses the option of the cross subsidising less profitable customers. In any case, it must compete with the private suppliers, and cannot afford loss-making operations.

As discussed below, this situation has already emerged in the telecommunications, and has been officially proposed for electricity. In the case of electricity, the result will be declining costs for larger companies, but 20 to 50 per cent higher tariffs for households and, by extension, micro enterprise.

Some government officials argue that cross subsidisation is inherently inefficient, since it subverts market prices, and that it is not politically accountable. They say that they should therefore replace cross subsidisation with direct subsidies from the budget.

This approach is deeply flawed.

1. It rests on the assumption that markets are inherently efficient – an argument already countered.

2. Leaving decisions to the budget process introduces annual fluctuations, which can introduce costly instability into service delivery.

3. Budgetary subsidies are no more accountable than cross subsidies. After all, parastatals are ultimately accountable under a law. If Parliament objects to cross subsidisation, it can change the law.

4. Budgetary subsidies typically only show the cost, not benefits such as the long-term gains from providing basic services to the poor. As a result, they are vulnerable to political opposition, especially from the relatively rich and business, who see them as an unnecessary redistributive expenditure.

The recent experience of the corporatisation of Eskom illustrates these problems. Eskom has spent around R1 billion a year on electrification in the past few years, mostly through cross subsidisation from industry. With corporatisation, these revenues were supposed to go to taxes, and the national budget would pay for electrification. The Department of Finance promptly proposed to cut electrification funding to R600 million.

This cut in electrification funding would have longer-term consequences, since Eskom would have to reduce the capacity it has put together for electrification over many years, which it could not rebuild easily. Even if, as promised, government increases electrification funding to 2000 levels, the process demonstrates the risks of subjecting subsidies to annual decisions.

Mistakes and wastage

The adoption of policies that effectively require wholesale privatisation, and not the case-by-case approach adopted by the RDP, has led to a number of basic management mistakes.

Many privatisation projects, some of them of enormous significance to the country, have been based on wholly inadequate research. For instance, the proposal to commission parts of Spoornet apparently did not derive from a consistent analysis of the financial implications. In the case of Eskom, corporatisation was accompanied both by (1) a commitment to use tax revenues to pay for electrification, and (2) an agreement not to tax Eskom for the next three years.

Consultants on privatisation can expect huge fees, often for shallow advice. There appear to be no guidelines for fees to consultants on privatisation. All too often, the big consultancy firms push privatisation out of ideological grounds, without doing any serious research into alternatives.

Privatisation is also supported by merchant banks and financial institutions, which hope to make fees off the privatisation process; and by foreign and local capital, which hopes to find new markets and obtain state assets at bargain prices. In addition, of course, capital – as expressed through business commentators in the press – generally supports privatisation on ideological grounds.

Given unnecessary urgency, poor advice and research and pressure from capital, the push to privatise ends up tampering with systems that are working, rather than focusing on problematic areas. For instance, the demand that Eskom be privatised ignores the fact that it is one of the cheapest electricity producers in the world. The problem in electricity lies in distribution, not in generation. Similarly, detailed analysis finally concluded that Spoornet’s current operations, although they need to become more efficient, will not benefit from fundamental restructuring.

A problem in this connection lies in the way that privatisation reduces the capacity and power of the state. In particular, restructuring of the state-owned enterprises has been associated with fragmenting strong, integrated and flexible systems. For both Eskom and Spoornet, for instance, the push has been to fracture large and powerful entities into a host of small companies. That in itself weakens the ability to the state to bring about transformation.

Finally, the push to accelerate privatisation means that management pays inadequate attention to building consensus or minimising transition costs to workers and communities. As a result, considerable conflict results. In many cases, a deadlock emerges, and restructuring is halted altogether. For instance, the Department of Public Works in Northern Province has had plans for several years to outsource construction work, losing 10 000 jobs. This plan has been blocked by public pressure, but the department has not developed others to ensure more effective service delivery.

Fiscal policy and privatisation

Finally, we need to examine the presumption that privatisation will make up for under-budgeting. This belief has two legs: first, that private investment is a virtually costless supplement to the budget; and second, that government must sell its assets in order to reduce the national debt.

Far from being free, a private investor imposes a cost on the budget and/or the public. It will participate in providing infrastructure only if it will make a profit. To serve those who cannot pay, it will require a subsidy. For the rest, it must have tariffs that ensure at least a normal rate of return. In contrast, a state-owned service provider can decide on a lower mark up in order to realise broader social and economic benefits.

If private capital were inherently more efficient than the public sector, it could still cut costs to the state. But there is virtually no evidence that private managers are magically more skilled than public-service ones. Indeed, the experience with SAA and the U.S. partners in Telkom suggests the opposite. In the absence of efficient market pressures, private managers will not generate efficient outcomes.

A second fiscal motive for privatisation lies in the desire to reduce the public debt. In itself, this approach cannot justify privatisation of any single asset, as the DPE policy framework points out. Privatisation in order to free up government funds for other purposes makes sense only where there is no justification whatsoever for keeping an asset in state hands. An excessive focus on the immediate returns from privatisation will lead to short-sighted and costly sales – as seems likely already with the Telkom IPO.

The real problem lies in an excessively restrictive fiscal policy. This is expressed through the attempts to cut the Public Sector Borrowing Requirement (PSBR) and local government budgets, as well as tight targets for the national budget.

Between 1996 and 1999, the budget declined in real terms, dropping some 10 per cent per capita. Real growth in total spending in 2000/1 and 2001/2 did not bring a proportionate increase in expenditure on basic services, because of the increase in military spending. In light of the tight deficit and tax limits, the growth in spending is predicated on wholesale privatisation – which will soon undermine any improvements in services brought about by higher budgets.

Currently, too, state-owned enterprises face pressure to privatise so that they do not have to borrow to fund investment. The argument is that the state must reduce its contingent liabilities. Yet there is no systematic attempt to quantify the relative costs and benefits of raising funds through parastatal bonds and privatisation.

Overall, the fiscal arguments for privatisation really seek to use accounting conventions to reduce on-budget costs in order to meet deficit and tax targets. If the private sector provides services in return for payments by users, government can reduce its on-budget costs – but not the cost to society. Indeed, the costs to the public will be higher in the long run, even though government can fulfil its fiscal targets.

Conclusions

The arguments for privatisation are deeply flawed. They essentially start by assuming the efficiency of markets and private managers – an assumption that is belied by examination of South African realities. They also evince an unwarranted belief in government’s ability to regulate private interests irrespective of market imperatives.

Ultimately, it is clear that fiscal policy is a primary driver of privatisation policies. Yet if market forces are not efficient, privatisation will not reduce the costs to society – indeed, it may well increase them. It merely takes the cost off the budget.




Some experiences with privatisation

We here summarise some experiences with privatisation related to SOEs, the public service and local government. In light of the wholesale approach adopted in recent years, we cannot specify all of them. Moreover, where we are still dealing only with proposals, we can only point to the likely consequences of adopting these proposals.

SOEs

Spoornet

Spoornet is the freight and long-distance passenger rail operations subsidiary of Transnet. It operates as five distinct but integrated business units: Main Line Passenger Services (MLPS), now re-named Shosaloza Meyl; Coallink (the coal operation running from the coalfields to Richards Bay); Orex (the iron ore operation running from Sishen to Saldanha Bay); Luxrail (the Blue Train); and General Freight Business. There is a high degree of interdependence between the five business units. In particular Coallink, Orex and General Freight Business have high degrees of synergy. For example, for every coal carrying trainload on the Coallink line, there is a general freight train running on the same tracks.

Government's initial intention, announced in various public forums in early 2000, was to concession all of the business units independently, with the exception of the General Freight Business. General Freight Business was to be "turned around" from unprofitability within three to five years, and thereafter to be considered as a candidate for concessioning or another form of privatisation.

After considerable interaction through a joint labour-government task team, it was agreed that this plan was not viable. Instead, agreement was reached that:

1. The general freight business of Spoornet should be retained in state hands as a strategic transport asset, but that efficiency improvements as well as investment are urgently needed within it.

2. The low-density lines of Spoornet should be considered for a separate decentralised management structure within Spoornet. After local avenues have been explored to improve the customer base of these lines, options for the future of each line should be considered on a line-by-line basis.

3. Main Line Passenger Services (MLPS) should be retained in public ownership as a strategic transport asset. A merger between MLPS and Metrorail should be explored.

4. Luxrail (the Blue Train) should be concessioned to a private operator, subject to approval by Labour's membership.

Labour and government still do not agree on the future of Coallink and Orex, Spoornet's profitable coal and iron ore transport operations. In effect, these lines have paid for the extension of the General Freight Business, especially rural lines that have an important developmental role but remain unprofitable in themselves.

The government argued that Spoornet need substantial investments, which it could best meet by using the revenues from concessioning these two profitable lines. In addition, the concessionaires would be required to invest in Coallink and Orex. Officials also said that separating out Coal-ling and Orex would ensure greater transparency into the cross subsidisation of the general freight business. Finally, they held that Coallink and Orex are not strategic businesses but commercial operations, which can just as well be operated by the private sector.

For its part, labour argued that Coallink and Orex should be retained in an integrated Spoornet, that should remain fully in the hands of the state. There are various reasons for this.

Coallink and Orex form the most reliable source of funds for the general freight business, and would permit Spoornet as a whole to remain financially viable. This type of cross-funding is entirely in line with international practice in rail freight, whether in the public or private sector.

Cutting off the cash-flow generated by the ore lines would render the general freight operations unsustainable on their own and would force the operations to shrink dramatically and to rely for the first time ever on government subsidies. This outcome would contradict Cabinet's objective of increasing the use of rail for freight. Furthermore, reliance on government subsidies would make it extremely difficult for Spoornet management to plan ahead. They would depend on annual national budget decisions rather than on longer term business planning, and could be condemned to failure.

The proposed privatisation plans fall into the classic mould of selling off the most profitable activities while retaining social responsibilities – and costs – in the hands of the state. Concessioning the profitable sections of Spoornet would result in the transfer of the least risky bits of the network to the private sector, and leave government responsible for the most risky bits. Spoornet's current ability to borrow (and pay back) for infrastructural investment would be totally undermined.

In almost every instance where railways have been concessioned in other countries, the concessionaire has not met its investment obligations and has re-negotiated the initial concession contract within the space of three to four years of the concession agreement being signed.

In light of these debates, a second labour-government task team was set up to investigate the concessioning of Coallink and Orex. For the first time, together with Spoornet management, it embarked on a detailed financial analysis of the proposals. It became clear that the economic rationale for the proposals was not sound. In particular:

1. Spoornet’s investment requirements are not so high that they cannot be funded more cheaply through borrowing and internal returns.

2. The costs of separating out Coallink and Orex in themselves will be quite high.

3. To survive without Coallink and Orex, the General Freight Business would need either subsidies or drastic downsizing. The latter would entail closing all so-called unprofitable lines, stopping all services to unprofitable clients (thereby reducing the customer base from over 1000 to less than 300), and slashing the workforce to around 7,000 workers (from the current 33,000). This would obviously have developmental consequences, both undermining many rural enterprises – at least one agro-processing plant has already been closed because of the closure of rural lines – and adding to the burden of unemployment.

In light of these factors, the evidence before the task team shows that an integrated Spoornet stays cash positive for the full 20 years, taking into account all capital requirements, finance costs and severance pay. No external funding is required. Debt financing ranges from around R200 million to R800 million over the full period, depending on the size of the network and volumes carried. The company pays for all its debt. In contrast, if Coallink and Orex are taken out of Spoornet, the remaining General Freight Business loses money for most of the next twenty years.

The task team has not yet finalised its recommendations. It is, however, indicative of the shortcomings of the push for privatisation that basic economic research into the proposals were not completed until labour insisted.

Portnet

The DPE and the Department of Transport have been working on a ports policy for the past five months. It appears that the main thrust of this policy is to introduce concessioning of port operations that are currently carried out by Portnet.

Labour has, however, been excluded from all the deliberations to date. Letters requesting meetings to discuss the ports policy have not been replied to. Officials have informed the union verbally that labour will not be consulted until after the policy has been submitted to Cabinet for approval.

Despite this, government has already announced its intentions to concessions port operations at various local and international conferences, and in the press. We are thus likely to end up in a position similar to that with Spoornet eight months ago: that is, the policy will be announced to the world before any financial analysis has been done, and without prior consultation with labour.

Electricity

The current proposals for restructuring the electricity industry are idiosyncratic: they meddle with the parts of the sector that work well by international standards, while leaving fundamental problems unsolved. In consequence, they promise soaring costs to households, a slowdown in electrification, and may undermine investment in the industry.

No one denies that South African electricity is amongst the cheapest in the world, in part because massive investments in the late 1970s and ‘80s have limited the need for new investment in generation. In this context, government’s restructuring proposals apparently seek to address four key problems.

1. The chaos in distribution, which is controlled by local municipalities and, in some townships, Eskom. Many local governments, especially in the former homeland areas, cannot afford to maintain, much less extend, electricity systems.

2. The need to plan for new generating capacity when demand outstrips current supply around 2010.

3. Inefficient pricing systems, which do not generate sufficient returns to maintain investment. It is not clear whether government here means investment in maintenance or in new capacity.

4. The lack of a competitive market in electricity, which government officials apparently see as a problem in itself, without specifying the presumed ill effects.

In response to these perceived problems, government plans to set up a market in electricity. That, in turn, requires multiple sellers and buyers. This approach is apparently driven in large part by the unreflective commitment to free markets described earlier. The central proposals aim:

1. To set up regional distributors, which would consolidate existing local-government systems into six Regional Electricity Distributors (REDs). The regional distributors would compete to buy electricity from generators.

2. To permit private generation of up to 30 per cent of electricity.

3. To separate Eskom into competing groups of power plants. The characteristics of this internal competition have not yet been explained in any detail.

4. To establish transmission as a single independent service for all distributors and producers, belonging to Eskom but ring-fenced.

5. To move toward market prices for electricity, while maintaining cross-subsidisation of poor households by rich ones.

The shortcomings of this restructuring proposal reflect the imperfections of South African markets that are summarised above.

First, in terms of distribution, the maintenance of regional distributors limits cross subsidisation between regions. That approach ignores the huge spatial inequalities left by apartheid. If REDs have to compete for skills and funding as well as wholesale electricity, there is little doubt that the poorer regions – especially around the Eastern Cape and Northern Province – will come off worst. The main profits in distribution come from supplying industry, which is heavily concentrated in the metro areas.

The government has agreed to a national holding company to support the weaker REDs for at least six years. But the regional approach remains deeply flawed, and it is not clear whether the national holding company will be able to counteract the negative effects of a regionally based competitive system.

Even within regions, if REDs have to maximise profits, only regulation can compel them to maintain services to the poor. Establishing a regulatory framework able to monitor services and set appropriate targets will certainly require a substantial increase in resources.

Second, in terms of supply, government officials have not been able to give us evidence of any kind that private generation is either necessary or likely to be cheaper than Eskom production. As far as we can tell, no serious study has been done to back up this presumption. Such a study would

1. Analyse projections of demand and supply.

2. Explore alternative sources of electricity, including imports and the use of renewables and other forms of off-grid electricity.

3. Assess investment needs on the basis of this analysis.

4. Compare the costs and benefits of private and public generation in terms of the cost to the state and consumers. These costs would take the form of the cost of capital – the profits required for the private investors as opposed to Eskom bonds – and increases in tariffs to different classes of customer.

The risk is that, in the absence of this type of detailed investigation, South Africa could licence private producers – and down the line face their pressure for soaring tariffs hikes as the price of electricity security.

Third, the proposed tariff system would end the cross subsidisation of households by industry, resulting in massive hikes in the cost of electricity to households and a small reduction industry tariffs. Specifically, it would increase the cost to households by at least 20 per cent, and possibly up to 50 per cent – the difference depends entirely on the extent of savings from the rationalisation of distribution. It would reduce the cost to industry by about 5 per cent.

This proposal, which is already being implemented under the name of the Wholesale Electricity Pricing System (WEPS), appears to be based on three flawed assumptions: that the state should reduce electricity costs to big users; that cross-subsidisation within households can protect the poor from the proposed tariff hikes; and that market prices are intrinsically superior to fixed prices.

The first assumption argues that we should cut electricity prices to industry in order to cut their costs. That ignores the relatively capital-intensive nature of electricity-intensive industries. In effect, the proposals would raise costs to home-based micro enterprise, while cutting them for large companies. It would also raise the cost of electricity to ordinary consumers, restricting domestic demand for appliances and generally reducing the standard of living. Nowhere in the documentation provided by government is there a study of the impact of the proposed changes in electricity costs on employment, regional development, living standards, investment or economic growth.

Government has also not provided any evidence to support the second assumption – that cross subsidisation between households will control tariff hikes to the poor. COSATU strongly supports cross subsidisation to reduce tariffs to the poor. If well-off households have to bear the full cost of the proposed increases, however, the system may break down due to consumer resistance. After all, South Africa’s skew income distribution means that the top 10 per cent of households get close to half the national income. It would aggravate poverty and undermine micro enterprise to raise electricity costs substantially for the remaining 90 per cent. As a minimum, the commitment to free electricity for the very poor should benefit the poorest 40 per cent, in households that earn under R1000 a month.

The third assumption – as discussed above – simply ignores the problems with South African markets and, by extension, market-based prices. In particular, it effectively ignores the external benefits of affordable electricity for households and the associated economic activities. Besides, it is internally contradictory: it praises market prices as the best guide to resource allocation in general, but accepts cross subsidisation within the household sector. Apparently market prices are only worthwhile if they benefit big business.

Finally, the proposal on market structure is driven purely by a misunderstanding of economic theory. Certainly monopolies can be inefficient – but so can competitive markets, given massive income inequalities and poor information. This argument simply functions as an ideological argument against a fully state-owned energy sector. The analysis here of the proposals for distribution and supply points to the hazards of this approach to restructuring state assets.

The very cheap cost of electricity in South Africa certainly does not suggest Eskom suffered substantial inefficiencies, despite its monopoly status. More generally, an academic study of private and public electricity utilities found that private electricity companies do not generally outperform public ones. For generation, the results provided "strong empirical support for the view that, given the technology employed, IOUs [privately-owned plants] and MUNIs [publicly-owned plants] were being operated equally efficiently." In transmission and distribution, the conclusion again was that there was "no significant difference in technical efficiency between the two ownership types." (Pollitt 1995, quoted in Bayliss 2001, p 15)

In this context, it is worth noting that the international experience of privatising electricity has often been disastrous. A study by the PSIRU (Bayliss 2001) gives examples from, amongst others, New Zealand, Australia, California, the U.K., Argentina, Brazil, the Dominican Republic, Moldava and Kazakhstan. To take two examples:

1. New Zealand had two months of power cuts in 1999 because the private electricity company didn't maintain the underground cables. It simply wasn't cost effective for them to do this.

2. California has also experienced protracted power cuts since the deregulation and privatisation of the electricity industry. Since this process started in 1996 prices have risen by up to 300 per cent, the system is completely fragmented, and there have been massive shortages in the generating capacity, resulting in frequent power failures. As a result, production in the state dropped by 10 per cent in 2000.

California Governor Gray Davis said in his State of the State address, "We must face reality: California's deregulation scheme is a colossal and dangerous failure. It has not lowered consumer prices. And it has not increased supply. In fact, it has resulted in sky-rocketing prices, price-gouging and an unreliable supply of electricity. In short, an energy nightmare… We have lost control over our own power. We have surrendered the decisions about where electricity is sold - and for how much - to private companies with only one objective: maximising unheard-of-profits."

Telkom

Privatisation has affected telecommunications in two way: the sale of 30 per cent of Telkom to U.S. and Malaysian investors, with a further 20 per cent planned for an IPO; and the liberalisation of the telecommunications market, initially to cellphone operators and more recently to a fixed-line competitor and the internet. Again, these policies appear driven by a naïve belief in the efficiency of private companies and the market.

The RDP pointed to the important economic benefits of ensuring basic telephony for all South African households. The DTI’s discussion document on industrial strategy (DTI 2001) stresses the need for telecommunications in the modern economy. In this context, ensuring affordable universal service should be a priority.

In the event, the results of introducing competition have been – as in most countries that privatise telecommunications – increasing costs for poor users and lower costs for business and the rich, and relatively slow improvement in access.

According to the 1999 October Household Survey, among the African population, less than a third of urban households and less than 8 per cent of rural households have access to telephones, compared to over 85 per cent of white households in both types of region.

Overall, South Africa has lagged behind in new connections. Between 1995 and 1999, the middle-income countries as a group increased connections per 1000 inhabitants by 60 per cent, while in South Africa they rose by 30 per cent. In 1995, South Africa had about 65 per cent more than the average for middle-income countries; by 1999, it had dropped to the average. (World Bank 2001)

Poor access has been compounded by increasing costs for poor people, even as the cost for higher-end services have declined. In the past three years, the price of local calls, which the poor use, has increased in real terms by around 35 per cent. In contrast, the price of domestic long-distance calls has dropped, and international calls have become cheaper by 40 per cent, again in real terms. In addition, basic rental costs are high, at over R60 a month.

The increases in the cost of local calls and basic rentals have pushed telephones beyond the reach of most South Africans. Many connections are terminated every year, largely because users cannot pay. Thus, in the year to March 2001, Telkom provided 620 000 new connections – and 220 000 lines were terminated.

Given the impact of privatisation, the regulatory framework seems unlikely to ensure affordable universal access. It does not set any time frames, and considers households have access if they are up to half an hour away from a telephone. The latest policy directions (DoC 2001) give only the vaguest guidelines on universal and affordable access. While they require the regulatory body, ICASA, to set new targets for universal access, they do not set timeframes or give much direction. In the absence of clear targets, the Universal Service Agency has not had a significant impact.

The new policy directions also permit small-scale producers and co-ops to provide telephony in underserved areas. This seems like an attempt to remove the burden of ensuring access from the larger companies, including Telkom, as well as the state itself.

The partial privatisation of Telkom itself has appears in its commercialisation and the introduction of foreign partners. Although the foreign partners have only a minority share in the company, it has become clear that on key issues – including investment and employment – they have effective veto power.

The loss of jobs associated with privatisation is a particular concern for COSATU. In the past three years, Telkom has lost about 17 000 jobs, or around a third of its total labour force. The lay offs have impacted above all on unskilled African workers, many in rural areas where no other job opportunities exist. It seems that the downsizing is largely an attempt to slim the company down to make it more attractive for its IPO. With unemployment already at record levels by world standards, the IPO is thus being bought at a high cost.

In short, privatisation in telecommunications has followed the classic path: worse services for the poor, high job losses, and improvements only for formal business and the rich. For this reason, COSATU argued that new entrants should be allowed only at the top end of the market, where the market would function efficiently to provide better services. Access to this market should be contingent on paying a levy to help achieve universal access and cross subsidise local phone calls. The state, through Telkom, must take direct responsibility for achieving these developmental aims.

Public service

Privatisation in the public service has taken two forms: outsourcing of work to private companies, and the piecemeal privatisation of assets, especially in education, corrections and housing. In the absence of a clear policy, however, privatisation takes place mostly piecemeal, without adequate consultation with communities or labour. We here briefly consider only two examples: the outsourcing of welfare payments and the effective privatisation of general education.

Welfare payments

Welfare payments have been outsourced in many provinces. The Minister has expressed dissatisfaction with the results, saying that the companies have not met contractual requirements to provide shelter and toilets for the elderly. (SABC 2001) Again, the problem was the assumption that private business would serve very poor people because of regulation – and then the regulatory system proves unable to monitor or compel compliance.

Education

In education, the government decided to turn key ownership and control functions over to school governing bodies. These decisions relate to charging fees, the use of revenue, and hiring employees, including teachers.

The result of this form of privatisation of education has been continued inequalities between schools. Suburban schools in historically white areas have been able to charge high fees, and use them to improve facilities, equipment and staffing. Around one in seven teachers is now hired privately by a school in a well-off neighbourhood. In contrast, historically black schools in the former homeland regions and townships have far lower incomes.

The importance of these inequalities can be understood by considering two schools with a thousand learners each, one in an historically white suburb, the other in an informal settlement. The first school can charge fees of R500 a month, for an income of R6 million on top of its government support. The second school can raise, with great sacrifices by parents, at most a tenth as much.

The inequalities in resourcing as a result of the privatisation of schools emerge in persistent differences in results. In particular, the failure rates in historically black regions remain far higher than in white ones. This difference is reflected in provincial matric results, with consistently higher pass rates in Gauteng and the Western Cape.

Water

Water supply is one of the main areas facing privatisation at local-government level. Both in South Africa and abroad, the experience of water privatisation, especially in developing countries, is that it leads to higher prices and worse services. Moreover, far from leveraging private capital, the investment funds used typically end up coming from the public sector – either national parastatals or international multilateral financial institutions.

Yet South Africa faces particular challenges around water. According to the UNDP, water provision in South Africa lags behind many middle-income developing countries. About 86 per cent of South Africans have access to improved water, compared to 95 per cent or more in Uruguay, Cost Rica and Malaysia, all of which have a lower GDP per capita in terms of purchasing power parity.

We here consider the experience of two high-profile water privatisations – the Dolphin Coast and Nelspruit, and then briefly review additional local and international examples.

Dolphin Coast

Government policies generally say that regulations and contracts will compel private owners or managers to meet social needs. In water, contracts with private providers generally set out the basis on which tariffs will be increased, the time period over which they will be increased, and investment and service plans.

While the initial terms of the contract might seem reasonable, often the service provider renegotiates them after a year or two. In effect, they use a "bait and switch" tactic: the municipality is forced to accept higher tariffs, less investment by the concessionaire, and a watering down of clauses in the contract that gave the most protection to residents.

This is exactly what has happened in Dolphin Coast. In 1999 a contract was signed there between the KwaDukuza municipality and Siza, in which SAUR holds 58 per cent of the shares. Just one year later, the contract had to be renegotiated. Siza argued that the development of middle-income and mass housing did not meet the projections, so that demand for water is not as high as expected, cutting into its profits. Siza now faces a R12 million shortfall. Since the contract provides for renegotiations if returns are above or below the expected rate, the municipality must now accept changes.

Specifically, the renegotiations provided:

• a 15% increase in the tariffs

• both parties examining ways to reduce costs. One possibility is that the concession fee paid by Siza to the municipality will be reduced. The problem with this is that this fee is supposed to be used to set up and operate a contract compliance monitoring office.

• Siza's investment commitment will drop by more than half, to R10 million from R25 million over five years.

These are serious inroads into the aspects of the contract designed to protect residents from the profit-making priorities of the company. Clearly the company's need to maintain a particular rate of return is the primary consideration, with issues of social equity, meeting needs and ensuring access for all have become secondary concerns.

Nelspruit

A 30-year contract was signed between the Nelspruit municipality and Biwater for a water concession covering the Nelspruit municipality. Since then, there has been little progress in meeting the contractual obligations. There were numerous complaints from residents:

• they don't have access to water

• their water is being disconnected

• even where people pay, water is cut-off without warning, sometimes for up to a week

• tariffs have increased and are now too high - particularly for residents who never paid for water in the past

• communities who never paid for water in the past are now being billed, without any attempt to explain the situation to them first

• households get inflated bills or bills for water when they are not even connected

• leaks are still a major problem.

Biwater did not carry out the promised developments and improvements in part because it lacked the funds to meet its investment promises. Eventually, it fell back on the public sector. On November 9, 2000, the DBSA announced it would loan R150 million to Biwater to carry out the investment programme. And has been handed a new water treatment plant as part of the contract - a plant which was funded by the government of Portugal and built by the South African government.

This accords with international experience which shows that international consortiums generally don't use their own funding to finance investment. They rely on parastatals like the World Bank or the European Bank for Reconstruction and Development. As with Biwater, for example, in Buenos Aires Suez Lyonnaise only invested $30m of their own money. It then raised $1 billion from the IFC (a World Bank agency), the IDB and local Argentinean banks.

Some other experiences

Generally privatisation of water leads to higher prices, since the systems must operate according to financial criteria. In France, where some water is managed by the municipality and some by private companies it has been found that the private companies, or public-private partnerships consistently charge higher prices. In 1999 the prices of the private companies was 13 per cent higher. In Paris, auditors found that the company that took over water supply – Suez Lyonnaise, which recently obtained a management contract for Johannesburg’s water – enjoyed a profit margin 2,5 times the level it reported to government.

South Africa recently experienced particularly high price hikes with Umgeni Water in KwaZulu Natal, which increased water costs by over 20 per cent in June 2001. Management blamed the cost of connections in the rural areas. At the same time, however, it paid inflated sums – over R100 million – to outsource functions that were then poorly performed.

In Manila, water was privatised two years ago because of a World Bank/IMF imposed structural adjustment programme. Just months after the privatisation, the consortium tried to increase tariffs by a massive 196 per cent. After two years of privatisation seven million Manilans remain without a regular water supply and 60 per cent of the city's water is lost through leaks. To get access to water people make illegal connections. An outbreak of typhoid has been traced to these illegal connections.

In some cases – for example in Johannesburg and Fort Beaufort - the private partner requires secrecy about its contract. This obviously undermines both regulation and monitoring, and democratic control of local government in general.

In Puerto Rico, the management of the water authority, PRASA, was contracted to Vivendi. In 1999 an official report was released which was highly critical of the way Vivendi was fulfilling the terms of the contract. It identified a number of the problems such as problems with maintenance, administration and operation of aqueducts and sewers; a lack of response to residents needing help; charging residents who never got water; and an increasing operational deficit - $241.1 million by 1999.

In Walkerton, Canada seven people died from the e-coli bacteria which found its way into the water system. The water was tested regularly, and the problem was picked up. But the testing of water had been privatised to a private company and the company simply didn't inform the municipal or regional authorities in time to avert the disaster - there was no legal requirement for them to do so, and since they are therefore completely unaccountable, they simply didn't pass on the potential danger to the right authorities. The fact that the testing of water had been privatised was as a result of municipalities being given more responsibilities (like the testing of water) but without sufficient funds to cope with the extra responsibility. The response of the municipality was to contract out water monitoring.




References

Bayliss, K. 2001. Privatisation of electricity distribution: some economic, social and political perspectives. PSIRU / University of Greenwich: 2001

DoC. 2001. Telecommunications Policy Directions. Pretoria. Government Gazette. March 20.

DPE. 2000. An Accelerated Agenda Towards the Restructuring of State Owned Enterprise: Policy Framework. Pretoria.

DTI. 2001. Driving Competitiveness: An Integrated Industrial Strategy For Sustainable Employment And Growth. Pretoria.

National Treasury. 2001. Budget Review 2001. Pretoria.

Pollitt, M. 1995. Ownership and Performance in Electrical Utilities. Oxford University Press

UNDP. 2001. Human Development Report.




Footnotes:

1. This approach started with Adam Smith, who includes a brief list of the factors that make markets inefficient in The Wealth of Nations.

2. This condition is usually made explicit only in development economics. It can be deduced from the conditions of perfect competition, however, since it follows necessarily from the existence of myriad buyers and sellers.

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