BOX 3.1 PRIVATIZATION IN CAPE VERDE: A PARTICIPATIVE APPROACH

The government of Cape Verde has successfully mobilized public support for the need to reform its public enterprise sector and implement its divestiture program. This has been achieved by:

· A well-conceived, aggressive, and sustained television and radio information campaign on the theme "Let's modernize Cape Verde," highlighting opportunities for higher growth led by the private sector.

· The involvement of local consultants, alone or in joint venture with respected foreign firms, in designing the program and assisting in its implementation.

· The sensitivity to local constraints and conditions and sense of ownership generated by the fact that the privatization agency is staffed entirely with Cape Verdean nationals, including one resident adviser of Cape Verdean origin.

Once the program got under way, public anxiety nonetheless built up regarding the impact of-the program on an already difficult unemployment situation. In response, the government, with the support of IDA, organized a series of eye-opening visits to countries that had gone through a similar economic reform and opening-up process, such as Mauritius. Participation in these sensitization programs was targeted to such opinion leaders as journalists, union leaders, local elected officials, local business representatives, and key civil servants. During these trips, meetings and discussions were arranged with labor leaders, local entrepreneurs and foreign investors, managers of free-trade zones, and government officials in such ministries as justice, labor, industry, tourism, economy, and planning. The visits proved instrumental in convincing a large segment of the public of the potential of the reforms—and in rallying support for the necessary steps to complete them.

The privatization agency has tried at every step to ensure that the needed liquidations, restructuring, and privatizations are carried out with a minimum of labor unrest and social disruption. For instance:

· Its approach to the whole process has been participatory, with constant efforts to involve the persons most affected (workers and managers) in the discussion of divestiture options.

· Its creativity led to the design of socially acceptable solutions, mainly through the use of management-employee buyouts.

· And its proactive provision of support to the newly privatized enterprises identified potential domestic and foreign sources of technical assistance and financing.

The way forward is:

· To sell what can be sold, particularly the large industrial firms formerly classifed as strategic, the banks, and the functions of crop marketing boards and distribution companies.

· To involve the private sector as much as possible in enterprises in which outright sale is not (or not yet) feasible, particularly infrastructure firms and utilities.

· To redouble efforts to commercialize any remaining state-owned firms and strengthen government's essential supervisory and regulatory roles.

· To liquidate unsellable persistent loss-makers in the industrial sector.

None of this work will be easy. But, as will be shown, it is essential that steps be taken to stop the hemorrhaging of wasted resources.

BOX 3.2 CHINESE INDUSTRY MOVES TOWARD THE MARKET

China possesses more than 100,000 state-owned enterprises (SOEs). They account for 43 percent of production, employ more than 100 million people, yield in aggregate a positive return on capital—and are increasingly thought to be posing serious problems. Despite reform efforts, close to 40 percent—up from a third not long ago—make losses. They also burden the banking system: in mid-1993, SOEs commanded 70 percent of all loans from state banks, of which an estimated 15 percent (or some $40 billion) are nonperforming. China's State Economic and Trade Commission has concluded that as much as half the public industrial sector requires radical restructuring, and another third could be declared bankrupt. The causes of the problems are evident: SOEs are heavily burdened with social objectives, such as maintenance, housing, and clinics. Their managers lack autonomy. Reforms that might result in increased unemployment are resisted fiercely.

These enterprises co-exist with several types of collectively owned enterprises (COEs). Numbering more than 1.8 million and employing 112 million people (in 1993), they account for at least 40 percent of industrial production (while absorbing only 30 percent of domestic investment) and produce 25 percent of industrial exports. COEs are growing at an average rate of 30 percent a year and, along with other types of private firms and joint ventures, account for three-fourths of China's industrial growth. Owned by subnational governments or collectives, their focus is on profits, and they are much less burdened with social objectives. The local officials controlling them can appoint and dismiss managers, assume direct control, dispose of assets (sell or close the firm), and control residual income. Operating in competitive markets, they can and do go out of business.

COE managers are rewarded and penalized on the basis of performance. They have much greater freedom than SOE managers to hire and fire according to need and to make decisions on plant location, product lines, and prices. COEs rely heavily on retained earnings and private capital for their investment needs. They come closer to private firms than to public enterprises. But those who control them are not private owners in that they do not have title to the assets. Further, unlike private owners, there is a need to respond to community demands, such as a preference for employment maintenance over maximizing profits.

Adapting this package of commercialization reforms to local conditions and implementing them in a wide range of public enterprises formed the bulk of IDA's public enterprise reform efforts in the 1 970s and early 1980s. And it continues as an important activity to this day in enterprises that, temporarily or indefinitely, will remain in the hands of the state (box 3.3). Commercialization is particularly applicable in low-income countries in transition, with their vast public enterprise sectors and difficulties in mounting rapid and mass privatization programs, and where the state typically remains as a major shareholder even after the first steps toward privatization. But experience clearly shows that successes in commercialization have been elusive—the record of reforming public enterprises without involving the private sector is largely unsatisfactory. Why is this so?

This midway position between public and private ownership would be difficult to replicate elsewhere. But evidence shows that COEs are performing much more productively than SOEs. A key reason is that the subnational governments and agencies that own the COEs rely crucially on the revenues they generate. Without COE profits, these governments would have no resources.

While many SOEs are creating less-constrained COEs and joint ventures, a massive amount of capital and labor (particularly in heavy industries) is still tied up and used inefficiently. The drag of the SOE sector could be tolerated during the recent period of high and stable growth, but the costs are greater and more evident in the current period of higher inflation—and threatening the health of the financial system. Recognizing these costs, the government is taking steps to:

· Experiment with supervisory arrangements that give greater autonomy and more focused oversight to SOE managers.

· Subject SOEs to market forces on both the debt and equity sides—by reducing guarantees, making SOEs compete for credit with nonstate firms, and floating minority shares of SOEs on stock exchanges inside and outside China.

· Remove social obligations from the SOEs, and transfer them to subnational governments.

· Impose a harder budget constraint on all SOEs.

· Close or severely downsize the most hopeless performers.

Partial reform

The first lies marshaling the wild and resources to install the complex and often contentious commercialization reform package. Partial reform does not do the job. In Africa, in South Asia, and in many low-income countries in transition, the landscape is littered with inadequate, unsustained attempts of government owners to keep output prices at cost-covering levels, to lay off excess workers, to restructure the powers and composition of boards of directors, and to increase the autonomy of managers to hire, fire, locate plants, and choose suppliers.

Soft budgets

Attempts to impose a hard budget constraint on public enterprises have all too often proven ineffective. Early reforms often stopped unjustified direct transfers to public enterprises from the budget. But they were quickly replaced by concessionary credits from the banking sector. When and where that flow has been fumed off, public enterprises have still managed to receive credits from nonbank financial institutions—and went unpunished when they did not pay taxes, dividends, customs duties, suppliers, or each other. Enterprises usually register improved performance when forced to operate with retained earnings, with what they can borrow on strictly commercial terms without a government guarantee, and with what they can raise from the private sector in terms of joint ventures or equity.

BOX 3.3 BENIN'S BROADLY BASED PROGRAM OF PUBLIC ENTERPRISE REFORM

Benin's experience shows the benefits of using a wide range of reform measures to address the problems of a poorly performing public enterprise sector. In 1986 the country had about 60 parastatal entities, accounting for 75 percent of industrial production and monopolizing most productive subsectors, including manufacturing, agricultural processing, mining, and transportation. These entities employed 28,000 people and utilized 55 percent of all bank credit to productive firms in the country. Enterprise performance was poor, suffering from both over-regulation and ineffective regulation, controlled prices, and lack of managerial autonomy.

But by the end of 1994, 32 enterprises remained in the government's portfolio, of which only 15 were commercial entities. Five more are scheduled to be divested in early 1995. In eight years, the number of firms has been cut by more than half. Employment in the sector has been reduced by about half. The percentage of total banking credit absorbed by public enterprises has declined to 18. The amount of enterprise debt guaranteed by government has fallen by 80 percent. And the turnover of privatized firms has more than doubled—from 9 billion CFAF in 1988 to 21 billion CFAF in 1993, indicating strong post-divestiture performance.

How did this come about? The government's reform program started in the mid-1980s when, alarmed by the increasing number of insolvent enterprises and the harm nonperforming debts posed to the banking system, IDA assistance was sought, and a program was adopted. Twenty-one lossmaking operations were liquidated, including the airline, a textile corporation, and a freight firm. Six operations were sold (some with IFC involvement), including the brewery and a cement company. And ten operations were subjected to restructuring measures, including management contracts for several hotels and increased rigor in the public investment review process. Although some of the liquidated firms were small, moribund units, the reform program as a whole has resulted in the withdrawal of the government from entire sectors of the economy, including imports, consumer goods distribution, transportation, brewing, and cement.

The removal of price controls, changes in the legal and regulatory frameworks, and major alterations to the banking sector, including the liquidation of the three former state banks and the introduction of private commercial banking, accompanied these divestiture measures. As downsizing produced layoffs, NGOs successfully launched a special program to generate jobs in small and medium-size private firms. These measures have set the conditions for the resumption of private sector growth, as evidenced by the improved performance of the firms transferred to private owners.

Benin's program illustrates most of the reform principles and measures espoused in this chapter. It attacked simultaneously enterprise reform and privatization. It took extensive and bold steps to liquidate persistent losers. It sold or closed firms that couldn't be sold immediately. It combined enterprise reforms with far-reaching financial sector reforms (including liquidation and reliance on new private entrants). And it made a concerted effort to make the transition palatable to those most directly affected. The next step in the process should be to expand privatization into the infrastructure fields—areas that still remain under state control (for an example of how this is being done elsewhere in Africa, see box 3.7 on the electricity sector in neighboring Cd'lvoire).

The upshot: Implementing the entire reform package has proven just about as difficult, administratively and politically, as privatization itself. Governments tend to pick and choose from the package those elements they find tolerable. Reforms tend to be partial—and therefore inadequate. Research has shown that some of the public enterprise reform mechanisms used most heavily in the past are of dubious utility. A 1994 World Bank study, for example, reviewed 12 agreements laying out the mutual obligations and responsibilities of the owner (the state) and public enterprise managers. It concluded that they did little to improve performance and in some cases may have contributed to performance declines (World Bank 1995).

Backsliding

Even in the few cases where the whole package of reforms is put in place, it tends not to stay in place—for backsliding is frequent. The common story is that bad times make for good policy. In crises, especially financial crises, governments muster the will to install tough reform packages that establish the precedence of commercial objectives, impose a hard budget constraint, reduce excess work forces, give managers the autonomy to achieve commercial aims, and pay them according to their performance.

But once the crisis fades, commitment fades with it, and the reforms are diluted or shelved—meaning that cost-cutting measures are stopped or reversed. For instance, Pakistan pioneered a system in the 1980s to measure industrial public enterprise performance each year and reward management for goal achievement—and for a time it produced positive results. But in 1993, supervisory officials indicated that the system was no longer being energetically applied. The conclusion: Even when not partial, reforms tend not to endure. While retreat from reform has also occurred in richer countries, backsliding has been both more common and more devastating in low-income countries, with their larger public enterprise sectors.

BOX 3.4 THE ZAMBIAN PRIVATIZATION TRUST FUND

Created as part of an IDA-supported reform program, the Zambian Privatization Trust Fund holds for future sale to small Zambian investors blocks of shares in companies in which 51 percent or more of the equity has been sold to core investors. If fund managers consider the minority shares offered to them by the government an unsound investment, they are free to reject them. Once the shares have been transferred to the fund, the government is no longer allowed to vote them but still collects dividends and proceeds from share sales.

The fund's main purpose is to develop the equity market and stimulate share purchase by local investors. It issues shares through public offerings and financial intermediaries, offering deep discounts and establishing ownership limits to avoid large concentrations. Small investors receive encouragement to retain their shares.

The members of the fund's board of trustees are drawn from the banking sector, the Zambia Chamber of Commerce, the Law Association of Zambia, and private persons and entities. The fund will be managed by the private professional management company that wins a competition for the contract. The selection process will be supervised by the board of trustees. The contract is structured so that fund management has an incentive to dispose of—not hold or manage—the portfolio. If all shares have not been sold at the end of five years the fund will be converted into a unit trust and offered to Zambian investors. If there are few takers, remaining shares could be distributed free to Zambian citizens.

Larger industrial public enterprises

Using such methods can speed the sale of small and medium-size industrial firms, but what about the larger industrial public enterprise firms, many formerly classed as strategic—steel mills, fertilizer companies, cement plants? As the limits on the managerial and financial capacity of the state have become more evident, the concept of strategic enterprise has narrowed and in many instances vanished, Many of these large firms can also be moved and should be moved to the sales block—if there is reasonable assurance that competitive forces can be brought to bear on them.

But governments in low-income countries have resisted the sale of such firms. They argue that their operation in monopolistic markets means that privatization would merely transform a publicly owned, constrained monopoly into a privately owned, unconstrained monopoly. Efficiency might rise, but people's well-being would decline. Moreover, even when the principle of divestiture of large firms is accepted, it is often accompanied by plans to restructure the entity before sale, ostensibly to increase the purchase price.

BOX 3.5 BOLIVIAN INFRASTRUCTURE GOES PRIVATE PART WAY

With IDA assistance, Bolivia is transferring into private hands half the ownership and all the management of the six largest public enterprises in the country—the railway, the airline, electricity generation and distribution, telecommunications, the hydrocarbons company, and the mining smelters. New international partners will invest in the companies rather than buy assets and in this way can acquire up to halt the equity in each firm. While this will generate capital for investment-starved firms, the government will receive no revenues from the transactions and could incur substantial short-term costs. Core investors will sign management contracts containing an option to purchase additional shares when the contract expires. The other half of the equity will be held by five to ten newly created private pension funds serving all 3.2 million adult Bolivians. Proceeds from these managed funds will pay shareholders retirement and disability benefits.

IDA is supporting this program through adjustment and technical assistance operations designed to strengthen the Ministry of Capitalization, establish a regulatory framework for the privatized utilities, and begin capitalizing the Bolivian national telecommunications and airline companies.

The power of the first argument is declining. Adjustment programs in lowincome countries over the past decade have set macroeconomic frameworks in order and liberalized the trade and fiscal regimes. These reforms increase the competitiveness and contestability of markets, making it more likely that privatized firms will face competition.

Many low-income countries, especially those in transition, are deeply attracted to the idea that industrial public enterprises, particularly the largest, could and should be restructured before sale. Restructuring is a broad term. When it consists of defensive or passive measures, such as labor-shedding before privatization (box 3.6), or changes in management and organization, or even settling some of an enterprise's debt, it is acceptable—even though some governments have left all these tasks to the new private owners. What is unacceptable is making new physical investments to boost value before the change of ownership.

New physical investments seldom add enough value to recover their cost. Most often, governments would have been financially better off selling at a lower price. Moreover, physical restructuring in a large firm is inevitably a long process. A growing body of evidence indicates that delaying privatization leads to further deterioration of the assets, decreased revenue for the state, and probably decreased welfare and efficiency for the economy.

The financial and economic costs of not privatizing can thus be very high. So even the large-scale public enterprises producing tradables should be sold—once it is clear that competition is present or imminent-and there should be no physical restructuring or new investments before sale.

Divestiture of utilities

What about utilities, the natural monopoly infrastructure service providers? Until recently, these have not been on the divestiture agenda in most low-income countries. But that is now changing. In telecommunications and electricity generation, technology has changed and introduced competition into areas and markets formerly closed. Organizational changes to enhance competition—such as vertical or horizontal unbundling of formerly integrated networks- open the door to increased private participation in many infrastructure firms.

In low-income countries, the privatization of a few utilities, or the heavy involvement of the private sector, would have a large impact on the budget. If experience elsewhere is a guide, it would increase the quantity and quality of service. It would stimulate local shareholding and capital markets—and signal the domestic and foreign private sector about the seriousness of government's intents. And it could slow or stop the hemorrhaging of resources and increase domestic savings. Even in the least developed settings where the asset value of major utilities is sometimes low, the franchise value remains substantial.

BOX 3.6 LABOR RE TRENCHMENT: A SLOW AND DIFFICULT JOB

India. Because a fear of labor retrenchment was holding back reform of India's huge public enterprise sector, IDA introduced a Social Safety Net Sector Adjustment Program in 1992. The National Renewal Fund, established to help workers affected by adjustment, includes an Employment Generation Fund (EGF) and a National Renewal Grant Fund (NRGF). The EGF finances the delivery of labor counseling, retraining, and redeployment services and area regeneration schemes that create jobs and use newly acquired skills.

Five agencies (including two private entities) are now in charge of EGF programs. Located in cities where major industrial restructuring is taking place, these agencies have conducted surveys of retrenched workers, regional labor markets, and training institutes—information that helped India devise detailed actions now being implemented.

The NRGF finances severance payments to retrenched workers. By March 1994, it had compensated roughly 66,000 retrenched workers from 67 public enterprises-less than the 80,000 targeted in NRGF's Business Plan for fiscal 1992 because industrial restructuring has been slow. These achievements are commendable, however, given that labor retrenchment in India was, until recently, entirely taboo.

Bangladesh. In Bangladesh, labor retrenchment has also been a contentious issue. New owners of privatized enterprises had been required to retain workers for at least one year after privatization. With these restrictions now removed, efforts are being made to retrench as much surplus labor as possible before privatization—usually through voluntary departure schemes based on generous severance benefits.

Telecommunications is a likely priority candidate—for several reasons. In a large number of low-income countries the demand for phone services is unfilled. Government can no longer meet investment needs. Overstaffing is less of a problem in this sector than in others, and the likelihood is good that expansion, and perhaps even increased employment, will follow sale. Considerable knowhow on telecommunications divestiture has been built up in the past five years in the business community and in the governments of lowincome countries. Above all, international investors continue to be interested in acquiring stakes in telecommunications firms in emerging markets. Sales of such firms in Argentina, Chile. Mexico, and Venezuela have produced a stream of positive benefits and account for about half the capitalization of the stock exchanges in those countries. Low-income countries are starting to follow this trend, with partial sales of telecommunications already completed in Pakistan and under way in Bolivia, Burundi, Sri Lanka, and Tanzania.

Severance benefits for all public sector employees were substantially increased in July 1989. A public enterprise employee with 30 years of service, for example, could be entitled to five years' pay. Training and jobsearch services also are being provided. The response has been encouraging. In public jute mills, about 18,000 workers applied for voluntary separation during fiscal 1991 - 93.

The recently approved, IDA supported Jute Sector Adjustment Project will develop training and selfemployment schemes to be administered by nongovernmental organizations (NGOs) and existing government training mechanisms. A reputable NGO will be contracted to act as principal coordinator for delivering training services and to establish a Jute Training Resource Center, with training facilities to be located in areas with a concentration of jute mills. Employees will have the choice of participating in several months of skills training or taking a self-employment course and receiving guaranteed loans to partially finance the set-up of businesses.

Cape Verde. An IDA project sponsoring technical assistance for privatization in Cape Verde helps match retrenched labor with demand in the private sector. The project helps former employees set up their own businesses, subsidizes the costs of retraining retrenched public employees incurred by their new employers (up to 40 percent of the employee's salary for six months), and financially supports the organization of private training workshops and evening courses. So far, the project has financed the retraining costs of 150 retrenched employees, who were subsequently hired by private companies. Progress has therefore been slow, but the program works. Once it is properly advertised, it should expand its operations.

There are two issues for increasing private participation in utilities in lowincome countries. First, how will countries regulate portions of privatized (or partly privatized) infrastructure that cannot be subjected to competitive forces in the marketplace? Institutional and legal deficiencies make regulation onerous. Second, how can private investors be assured that government will maintain policy and pricing frameworks for them to earn a reasonable return on their investment? Investors want stable and predictable business environments, something in short supply in many low-income countries.

The two questions are related, and so are the answers. First, with changing technology the experience from privatization efforts around the world is that many fields of infrastructure can be subjected to some form of competition. So, the scope and need for direct government regulation have been reduced. Second, in recent years there have been promising experiments with tailoring market structure and regulatory choices to institutional capabilities. But there still is much to learn. One option, as yet untested, may be to contract out some regulatory functions. Building credibility in pricing and policy frameworks is likely to take time. Various approaches may be possible in the transition to enhance credibility of the government's commitment. An innovative approach may be recourse to foreign arbitration for dispute settlement. For example, the private operator of the Jamaica telecommunications company can appeal contract disputes to a U.K. court—but this approach may not be easily replicated. Multilateral institutions like the World Bank Group can also provide guarantees against the failure of governments to live up to their policy frameworks.

Privatizing management—and beyond

The economic and business uncertainty in many countries means that buyers will be hesitant and governments will be judged incapable of creating and maintaining a proper regulatory framework. And some governments will remain adamant that outright sale would pose intolerable political problems. In these cases, consideration can go to privatizing management without fully or immediately privatizing ownership. This solution is most appropriate for infrastructure firms operating in monopolistic markets. Methods to privatize management include management contracts, leases, concessions, and franchises.

A recent Bank study shows that in two-thirds of 20 cases reviewed, management contracts improved performance (World Bank 1995). But their use has been concentrated in a few sectors (hotels, agroindustries), and they place great demands on governments in devising, implementing, and monitoring the contracts—and leases and concessions, even more so. Nonetheless, the privatization of management retains its attraction in low-income settings—particularly in infrastructure enterprises, where the need for improved performance is overwhelming—since both government sensitivities and investor wariness are especially high. Between 1988 and 1994, IDA supported 23 operations to privatize management, most of them in the past few years. Sectors and countries included airlines (Cameroon and Chad), telecommunications (Guinea), power (Cote d'Ivoire, Guinea, Mali, Rwanda, and Sierra Leone), railways (Burkina Faso, Cameroon, India, and Tanzania), and solid waste management (Benin, Burkina Faso, Ghana, and Tanzania). For an example from the power sector, see box 3.7. The mechanism is not limited to infrastructure firms. In Guyana, a management contract dramatically improved the performance of a major bauxite mining operation.

The beneficial impact of privatizing management is greatly enhanced when the management provider takes an equity stake—or at least takes direct collection risk. A variation on this theme is the lease with an option to buy an ownership stake—partial or majority. In several World Bank infrastructure projects under preparation (telecommunications in Jordan, water in Trinidad and Tobago), private providers assume responsibility not simply for management but also for a percentage of needed investments during the period of the contract. The contractors have the option of becoming owners of the entity at the expiration of the contract. If they choose to exercise the option, the price of the investments is converted to equity, and World Bank guarantees provide assurance that the government will maintain its commitments. The familiarization period allows the government to examine the benefits of improved performance—and the investor to test governrnent policies and price schedules. This approach can also be used for large-scale industry and for banks, both in great need of reform in almost all low-income countries.

These management and ownership approaches could and should be applied much more widely in low-income countries (for an example from a low-income country in transition, see box 3.8). In these operations, as in Cote d'Ivoire, IDA can provide more than finance for the rehabilitation of infrastructure. It also can provide technical assistance to improve government operations. Comfort levels of private managers and investors can be raised by the traditional mechanism of lending the government, increasingly in support of or in conjunction with private investors.

The path for donors

Donors have to tread a narrow path between helping a government undertake painful reform and providing a government with the means to avoid or delay reform. A 1994 study of privatization in Sub-Saharan Africa argued that aid flows often "delayed rather than promoted" public enterprise reform and privatization (Berg 1994). The report was particularly critical of recapitalizations of stateowned financial institutions that then continued the soft budget for public enterprises, removing incentives for their reform or sale. It is regrettably clear that many governments postpone fundamental reform, especially about an issue as sensitive as privatization, until a crisis or near-crisis stage is reached—that is, until their backs are against the wall.

BOX 3.7 PRIVATE PARTICIPATION IN Cd'lvoire'S POWER SECTOR

Before private participation. In the 1970s and 1980s, Energie Electrique de Cd'lvoire (EECI) built the most extensive power grid in West Africa. Total capacity reached 850 megawatts. But its hydropower plants were poorly designed, its thermal units were not well maintained, and the power system never performed close to full capacity. Moreover, as economic decline set in in the mid-1 980s, EECI was hit by budget cuts, bringing weaknesses in financial management to the fore. By 1990, the company was carrying large arrears on accounts receivable and debt in excess of one year's revenue. Losses were more than one-third of revenues.

The lease. In 1990 the government decided to lease the sector's assets to a private firm, Compagnie Ivoirienne d'Electricite (CIE), with 51 percent of the equity (CFAF 10 billion) held by a joint venture of the French utility companies, SAUR and EdF International. The rest of the equity was held by the government until it could be sold to local investors and company employees. At the outset, average power prices were reduced by 10 percent to CFAF 44 per kWh ($0.16)—still high by international standards and a major contributing factor to the country's high factor costs. Following the 50 percent devaluation of the CFA franc in January 1994, prices were adjusted to CFAF 53 per kWh ($0.09)—close to the average price in OECD countries and the long-run marginal cost of power in Cd'lvoire.

Efficiency gains. Observers calculate that while the cost of the concession was high, it was more than offset by efficiency gains. Since the introduction of the lease, system power losses have fallen from more than 20 percent to about 17 percent, and average outage time from 50 to 18 hours per system failure. And collections have risen to 98 percent of billings. In addition, the number of employees has dropped from 9.5 per 1,000 customers to 6.9, and revenues have risen from less than CFAF 90 billion to CFAF 112 billion. In 1991, CIE posted its first profit of CFAF 1.2 billion, and profits have since grown steadily.

The government has already sold half its 49 percent share to 4,000 small investors through a public offering on the Abidjan bourse.

Winners. All stakeholders have benefited from private participation in the sector. Shareholders have received dividends of 10 percent each year. The government can now focus on sectoral policy and regulation. It no longer provides cash injections and other subsidies, and it receives all revenues (net of lease fees and the cost of fuel and energy purchases), plus corporate taxes and dividends. Current tariffs are high enough to ensure the sector's financial equilibrium, with self-financing ratios of about 25 percent.

Employees have also fared well, receiving a 5 percent stake in the company under advantageous terms, a 2 percent wage increase in 1994, and generous benefits by local standards. More than half the employees have also received on-the job training. Compulsory layoffs have been avoided with staff reductions limited to natural attrition and firings limited to cases of malfeasance. Consumers also are better off. Tariffs have fallen in real terms, and in the wake of the devaluation, lifeline rates for lowincome families were introduced.

The future. Capitalizing on the recent discovery of oil and natural gas, the government negotiated an independent power project with private investors. Construction of the gas fired 100 megawatts unit is near completion, with negotiations for an additional 65 megawatts of capacity already under way. While much remains to be done to secure a competitive and efficient power sector, early experience with private participation has produced substantial benefits and convinced the government to redouble efforts to encourage more private investment.

Donors thus have to be selective in their assistance, expending greater effort in assessing whether country conditions—and commitment—are suitable for carrying out the policies and projects recommended. Donors must recognize that there are few technical solutions to what are basically political problems and that the commitment to cut off credits to nonviable public enterprises, to establish biting fiscal controls, and to impose macroeconomic stabile must come from within. Donor coordination in this fashion was particularly effective in Zambia.

For tradable goods, -the first lesson for donors is to create no new public enterprises and to expand no old public enterprises—a lesson largely learned. Almost no donor today lends or offers grants to create a purely public enterprise, at least one designed to produce a tradable good. Some low-income countries are still creating public enterprises, but without donor aid and usually contrary to donor advice. Better use of the public expenditure review exercise is required to consolidate this viewpoint of what constitutes priority actions.

BOX 3.8 PRIVATIZATION OF ENTERPRISE GOVERNANCE IN THE KYRGYZ REPUBLIC

The government of the Kyrgyz Republic has demonstrated its eagerness to privatize most state enterprises rapidly. State ownership will nonetheless remain significant for a period of time, including utilities excluded from the privatization program; shares retained by the State Property Fund (SPF) in partly privatized enterprises, pending their disposal through cash and voucher auctions; and shares in enterprises included in the next two years' privatization program but not yet privatized.

The SPF is responsible for managing the state's ownership interest in the last two categories of enterprises. But it has not effectively exercised its responsibility—in part because of the institution's lack of expertise, coupled with its legitimate focus on implementation of the privatization program, and in part because of the lack of appropriate information, reporting, and control instruments. As a result, the SPF gave up its portfolio management responsibility in some key sectors to line ministries or to state holding companies (thus recreating the old dependence of enterprises on the state). In other sectors, the SPF's supervision has been little more than formal, and the accountability of managers to shareholders, including the state, has been minimal or nonexistent.

To overcome these problems, the SPF is appointing independent private financial and management experts to act as fiduciaries on its behalf, as owner. The experts will be selected in a transparent manner on the basis of their expertise and experience in management. They will be appointed on a one-year renewable contract and compensated according to their performance, including payment in enterprise shares held by the SPF. The SPF intends to implement this approach in 1995 in about 20 enterprises distributed across various sectors in which the state still holds 50 percent or more of the equity. If the experiment succeeds, it will be extended widely.

This approach has several important merits. First, by privatizing the corporate governance function, it promotes the use of market mechanisms and is thus consistent with the current reform philosophy of the government. Second, it places responsibility for governance in the hands of skilled resources. Indeed, while the enterprises' managers and the line ministries have considerable engineering and technical skills, they generally lack entrepreneurial, financial, and market management expertise and orientation. Third, it avoids the creation in the SPF (or elsewhere in the government) of a large civil service— to deal with a mostly temporary issue, the full and rapid privatization of all but a limited number of enterprises.

The second lesson: the legitimate donor operations for industrial public enterprises are those that assist in the reform and privatization processes. These involve "passive" restructuring—preparing the firm for sale, dealing with excess labor, cleaning up the balance sheet, determining environmental liabilities, and assisting in the attraction of stable, competent private managers, lessors, and purchasers.

For public enterprises in infrastructure, the situation is much more complex and the recommended actions more nuanced. The objective is clear: to create an environment in which infrastructure firms can attract private financing, management, and ownership, while protecting social welfare. But given typical country and market conditions, donors are likely first to have to assist in removing major distortions in pricing, correcting regulatory deficiencies, and enhancing competition in and contestability of markets. And while these reforms are being constructed, direct long-term financing of infrastructure fines, by the donors, may be justified—if the country has endorsed a sound policy approach, and agrees with the goal of moving to greater private sector involvement.

In more advanced countries, donors should examine the prospects for immediate involvement of the private sector as manager or financier of the infrastructure firm in question. And it is even possible that partial or full private ownership of the enterprise might be the optimal course of action. Even when the latter actions are preferred, donors retain a substantial role: as facilitators of the process, as providers of technical assistance, as lenders for investment and financing (though more and more rarely), and as guarantors of private loans and equity investments.

Donors must also redouble their efforts to help governments remove subsidies (box 3.9), retrench labor (box 3.10), rationalize tariff regimes, create good regulatory systems, and unbundle integrated firms and networks into smaller, more manageable, more accountable units. In particular, donors must help governments bring public enterprise finances out of the dark and shed light on the complete flow of funds between government and public enterprises— to reveal the real gains and losses of the sector and the cost of inaction, in terms of forgone job opportunities. For example, a 1994 audit of public enterprise performance in Uganda showed that in the 1990s direct and indirect subsidies to public enterprises have averaged $180 million a year, five times the spending on health. The return flow from the enterprises to the government has been very small. The sum transferred is equal to about $6,000 per state enterprise employee per year, over and above the wage and salaries bill. Alarmed by these numbers, the country's leaders immediately stepped up the pace and scope of reform.

BOX 3.9 WHO BENEFITS FROM PUBLIC ENTERPRISE SUBSIDIES?

The professed rationale for subsidized provision of goods and services by public enterprises is to help the poor. In practice, the benefits of such subsidies rarely reach the poor. Indeed, the poor often bear the burden of financing the subsidies. All too often, the poor either consume very little of the goods or services being subsidized, or intermediaries reap much of the premium created by subsidies.

A recent survey of electricity consumption in the urban areas of several low-income countries shows that the poorest income groups have little access to electricity. In Lusaka, Zambia, only 28 percent of households in the poorest income quintile had access to electricity compared with 70 percent for the richest quintile. In Praia, Cape Verde, while 82 percent of the richest quintile enjoyed access, less than half of the poorest quintile did. Even where the poor have access, they consume far less electricity than do the rich. In Manila, Philippines, nine of ten households in the poorest quintile had access to electricity, but their per capita consumption was only 77 Kwh/month— 17 percent of the consumption of the richest quintile. The benefits to the poor from subsidizing electricity are marginal. They would be better off if subsidies were reduced and the resulting increase in investable funds used to expand access.

In Mauritania, richer households have access to subsidized piped water provided by the public water authority. The poor get their supplies from itinerant water-sellers, who obtain water from public enterprises at subsidized rates, and then charge poor customers several times those rates. In Tanzania, it has been estimated that the poorest fifth of the population receives only about 10 percent of government subsidies for water, whereas the richest fifth receives about 40 percent.

In manufacturing as well, subsidies usually do not benefit the poor. In Bangladesh, the publicly owned sugar and cotton spinning mills had poor financial results for many years. Subsidized provision of the goods produced was a major cause of this. The poor did not benefit because sugar is consumed mainly by richer urban households and poor households rely on sugar substitutes. Yarn was indeed consumed by poor weavers, but the price they paid was substantially higher than the factory prices. The difference went to marketing intermediaries, who took advantage of excess demand to jack up retail prices. The publicly owned jute industry frequently tried to subsidize jute farmers by buying raw jute at much-above market prices, incurring huge losses in the process. Farmers did not necessarily get the higher prices. Benefits were reaped instead by dishonest enterprise staff colluding with marketing intermediaries.

Only when armed with such information can decisionmakers and the public assess the real costs of performance and the opportunities forgone. And only then can public enterprise managers be judged. Otherwise, poor performance will continue to be attributed to the costs of meeting noncommercial goals and strategic objectives.

To repeat, none of this will be easy. Scant human resource bases and weak institutional systems—common problems in low-income countries, and ones that are not capable of overnight resolution—will impede the adoption of the proposed approach. And one must not underestimate the political obstacles to fundamental reform of public enterprises. Fears of increased unemployment, foreign ownership, concentrated wealth, and lost patronage and perks—all constitute powerful barriers to change. Many thus conclude that gradualism is the more realistic strategy, and that optimal donor efforts are those devoted to education, training, and institution-building—actions that, it is hoped, lay the base for progressive change in the longer term.

While not disputing the severity of the impediments, three concluding observations that question the gradualist perspective are in order:

BOX 3.10 WHAT ABOUT LABOR? CREATE RATHER THAN PRESERVE JOBS

The fear of adding to unemployment is one of the biggest obstacles to privatization of any sort. Four encouraging observations: First, and critical, private investment in most low-income countries creates more jobs than public investment. Governments in these settings would do better to concentrate on job creation through private initiative rather than job preservation in less efficient areas. Second, the incidence of increased unemployment as a direct result of privatization is lower than anticipated. Some countries have started their privatization programs with companies that were in good condition and not overstaffed (in Morocco, for example) or where the new owners immediately invested and actually hired new workers (telecommunications in several countries). In other countries (Bangladesh, Malaysia, Tunisia, Venezuela. and elsewhere) policymakers have issued instructions to selling agents and buyers that no layoffs would be allowed for a certain period after sale. Third, where layoffs have been sizable, they almost always have been "sweetened" by generous severance packages, with terms greatly exceeding the existing labor laws (in Argentina and Pakistan, for example).Fourth, labor can be persuaded that the privatization process is beneficial by means other than cash payments. Many countries give shares, or sell them at a low price, to workers. In Russia, workers and managers in enterprises obtained at least 25 percent and often 51 percent of the shares before voucher auctions. In Egypt, one firm being privatized solved the problem of excess labor by offering parcels of farmland to those who departed voluntarily. The demand far outstripped the supply

First, regarding public enterprise reform, gradualism is exactly what has been tried, and found wanting, in the vast majority of lowincome countries over the past 15 years. A recommendation for gradualism is, in many low-income countries, an acknowledgment that the losses and the missed opportunities will continue indefinitely. One must aspire to action of a more immediate impact than can be expected from training or educational programs.

Second, the proposed strategy—moving farther and faster with private involvement in public enterprises, and concentrating efforts on the largest firms—is actually quite sparing of institutions and administrators in low-income countries, as it reduces demands on government to monitor and manage productive activities and stimulates the growth of the indigenous private sector.

Third, the political sensitivities are many and real, but reforms in industrial and middle-income countries have generated great public support by calling attention to the high costs and low quality of public enterprise goods and services. Some bold leaders in lowincome countries have embarked on this path—and more can be expected to follow.