Winners and losers from utility privatization in Argentina : lessons from a general equilibrium model

WPs 1%Q2Y POLICY RESEARCH WORKING PAPER 1824 Winners and Losers from The economic rates of return for utility privatization projects Utility Privatization in Argentina are very high, n .Argentina whether or not distributional ingentina weights are considered. But there is a very high shadow price for regulatory activity, Lessons from a General which tends to be ignored in Equilibrium Model most privatization exercises. And how serious a government is about the fair distribution of gains from Omar Chisari reform is reflected in how Antonio Estache serious it is about regulation. Carlos Rtomero The World Bank Economic Development Institute Regulatory Reform and Private Enterprise Division September 1997  POLICY RESEARCH WORKING PAPER 1824 Summary findings Chisari, Estache, and Romero assess the macroeconomic GDP. This cut in gains represents an implicit tax of 16 and distributional effects of the privatization that percent on the average consumer, paid directly to the Argentina began in 1989 in gas, electricity, owner of the utility rather than to the government. For telecommunications, and water and sanitation. Using a the poorest income classes, this implicit tax is about 20 computable general equilibrium model, they track the percent, meaning that good regulation is in the interest effects of the changes observed between 1993, the first of the poor. year by which all the major privatizations had taken The authors also shows that the privatization of place, and 1995, the most recent year for which data are utilities cannot be blamed for the significant increase in available. In an innovative use of the model, they also unemployment observed in Argentina since 1993. assess the importance of the regulator in determining the Effective regulation can lead to a decline in distribution of gains and losses from utility privatization unemployment, and ineffective regulation leads to only a among sectors and income groups. small increase in unemployment. But the gains from They conclude that when regulators are effective, the utility privatization were not sufficient to offset the annual gains from the private operation of utilities are negative efficiency and distributional impact on the about $3.3 billion, or 1.25 percent of GDP, and that all economy of the Tequila effect, which increased income classes benefit. Ineffective regulation cuts the unemployment dramatically by limiting access to credit gains from the reform by $1 billion or 0.35 percent of for users and producers alike. This paper - a product of the Regulatory Reform and Private Enterprise Division, Economic Development Institute - is part of a larger effort in the institute to understand the importance of effective infrastructure regulation. The study was funded by the Bank's Research Support Budget under the research project "Efficiency and Equity Implications of Argentina's Privatization of Infrastructure Services" (RPO 680-65). Copies of the paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contactTenaMalone, room G2-153, telephone 202-473-7198, fax 202-473- 3483, Internet address tmalone@worldbank.org. September 1997. (36 pages) The Policy Research Working Paper Series disseminates the findings of Cork in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polisbed. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the view of the World Bank, its Executive Directors, or the countries they represent. Produced by the Policy Research Dissemination Center  Winners and Losers from Utility Privatization in Argentina: Lessons from a General Equilibrium Model Omar Chisari (Universidad Argentina de la Empresa) Antonio Estache (World Bank) Carlos Romero (Universidad Argentina de la Empresa) The paper was (paially) financed by a grant from the World Bank Research Department (and we are grateful for this financing). We would also like to thank Mr. D. Benitez for extremely competent reseach assistance as well as Shanta Devarajan, Mathias Dewatripont, Francisco Ferreira, Cheikh Kane, loannis Kessides, Abel Mejia, Martin Rodriguez-Pardina, Chantal Roucolle and Suzanne Smith as well as participants in a seminar at IDB for very useful comments, discussions and suggestions.   3 1. Introduction In 1989, Argentina initiated a process of privatization of its infrastructure services that was at the forefront of the international experience. The breadth of the sectoral changes and their quick implementation did not initially reflect a dramatic concern for efficiency in the delivery of basic public services. They were driven instead by the need to alleviate the fiscal burden imposed by public utilities and the need to get the private sector involved in financing the increasingly pressing expansion requirements of these sectors. The concern for efficiency was a byproduct of the need to regulate the sector to avoid abuse by the private providers of activities with monopolistic features. But efficiency improvements are now becoming one of the expected benefits of the changes as more is known about the regulatory options available throughout the country. Indeed, Argentina's reforms are not concluded yet as many provincial water and electricity distribution companies are still in the hands of the public sector. But overall, Argentina's structural adjustment is proceeding well, including a clear technological change, the flexibilization of its labor market and the change in the pricing rules of the key utilities. Much has been written on the institutional aspects surrounding these changes but, besides the publication of a few sector specific performance indicators, no detailed assessment of their inpact on the economy is available. This is why the lessons from this paper could still be useful to the design of provincial regulatory schemes as well as to other countries considering similar reforms. The main purpose of this paper is to assess both the macroeconomic and distributional impacts of privatization in electricity, gas, water and sanitation, and telecommunications services.' This is done by comparing the economy in 1993, the first year in which all the major privatization had taken place, and in 1995, the last year for which data is available. The paper assumes that the changes observed in the privatizations already implemented in these sectors will be duplicated when most provincial services are privatized. It is unlikely that all provinces will manage to concession their water and electricity distribution services but in terms of the macroeconomic impact, what has already been achieved accounts for most of the impact the reform is likely to have. About 33% of industrial production, almost 50% of services and over 40% of the population are concentrated around Buenos Aires. Moreover, large electricity users throughout the country can bypass the local distribution companies and access the wholesale electricity market. The only sector significantly affected by the assumption is the water sector where privatization has been limited so far to a few provinces in addition to Buenos Aires. Shirley and Galal recently published the results of a detailed Bank study that focused on the efficiency aspects of privatization in the UK, Chile, Mexico and Malayisa but followed quite a different methodology and did not address the equity aspects of privatization. For a quick overview of their main results: see Galal, A. and M. Shirley (1994), "Does Privatization Deliver? Highlight from a World Bank Conference," EDI Development Studies.  4 The analytical framework is provided by a computable general equilibrium model. In spite of its well known general limitations, this approach is particularly useful in this context for the following reasons. First, in a structural adjustment context, it allows a careful calibration of the key technological parameters based on information requirements much less demanding than those of econometric models. Second, it allows comparative static simulations of the impact of changes within the sector or across the economy one at the time or simultaneously, as needed. This is quite useful because it tracks down the direct and indirect impacts of all the changes in one utility or assesses the impact of a similar change (e.g. changes in all tariffs, in productivity or even in quality standards) across utilities. The direct effect focuses on the impact of these changes through the direct consumption of the privatized goods. The indirect impact accounts for the impact of the reform importance on the capital and labor markets, and through the consumption of other goods and services. Third, it allows an assessment of the interactions between privatization and other significant macroeconomic changes such as the "Tequila Effect." A last advantage is the possibility of using the design of the model to assess the importance of the effectiveness of the regulator. More specifically, this assessment is based on a comparison of two types of simulations. The first set of simulations computes a solution to the model in which the utilities' tariffs are endogenous (within the limits imposed by regulation), and productivity and quality gains are diffused throughout the economy. This would be the outcome expected under perfectly effective regulation. The second type of simulation assumes fixed utilities prices which means that the gains from privatization are appropriated by the capital owners of the sector as a quasi-rent. This would be the expected outcome under ineffective regulation and it is a lower bound for the gains from private operation of utilities. The difference between the results of the first and second simulation provides an estimate of the potential quasi- rent the new owners are likely to fight for as well as an indication of the economic gains from effective regulation.2 The paper is organized as follows. The next section provides a brief summary of the major changes that have occured in the delivery of utilities service in Argentina since 1989. Section 2 describes the structure of the model. Section 4 provides an overview of the key changes observed in each sector in terms of prices, technical efficiency and quality standards. Section 5 presents the results of simulation of the overall efficiency and distributional effects of private operation of these services. Section 6 estimates the initial impact of the transfer of operation from the public to the private sector. Section 7 compares the relative importance of the Tequila effect and of the Privatization effects. Section 8 concludes. 2 An alternative interpretation could be that the wairasian solution illustrates what a full pass through would imply for the economy while the fixed price solution measures the implication for the economy of a cost plus regulation in which the "plus" factor is detemined by the efficiency gains achieved by the private operators of utilities or a price cap regulation in which the cap is equal to the price under the public operation of the sector and the productivity gains (the ' x" factor in RPI -x) are set at 0 for ever.  5 2. Argentina's Privatizations Some degree of restructuring took place in each sector before the transfer to private operators. This section summarizes for each sector the changes most relevant for the simulations to be discussed later. The description is not encompassing but gives a sense of the major structural adjustment mentioned earlier. Electricity. The restructuring of the sector began in 1991 with the transfer of most public enterprises under federal control to the private sector, the reorganization of the institutions of the sector and the introduction of a new regulatory framework. The three stages of production in the sector-generation, transmission and distribution- were vertically disintegrated and different regulatory criteria where adopted for each activity. Generation became competitive, and transmission and distribution became regulated private monopolies. The regulation of the tariff and of the quality of the distribution and transmission services is particularly detailed in the new regulatory framework to ensure that the final users enjoy the benefits of competition in the generation sector. The regulatory mechanism is essentially and RPI-x where the productivity gains x will be adjusted after 5 years. Roughly a third of all distribution companies have now been concessioned. These cover over 60% of the population of the country. Since the provincial concession strategies are essentially copies of the National distribution concessions, the conclusions drawn from simulations of the model based on the first wave of concessions are likely to be representative of what will be observed in the area of jurisdiction of each distribution company. Gas. Gas restructuring took place at the end of 1991 when the transport and distribution activities were separated into two transporters and eight regional distribution concessions. Its production activities are included in the Mining sector of the National Accounts (the major gas producer, YPF with over 60% of total production, was not as successful in terms of the promotion of competition in the economy). It provides the major input for the privatized companies and sales are concluded at an unregulated price. However, since the other activities are controlled by local monopolies, as in electricity, a good regulation of tariff and quality was needed and was introduced with the reform. The regulatory mechanism is essentially an RPI-x where the productivity gains x will be adjusted after 5 years. Water. While few provincial privatizations in the water sector have occured, the largest and the best documented is the privatization that transferred the responsibility for water and sanitation service in the Buenos Aires Metropolitan Area to Aguas Argentina in May 1993. Competition was achieved through a bidding process and the resulting concession contract has become the main regulatory instrument available to the regulators. It stipulates service obligation, investment requirements and quality standards monitored by the national sector regulator. The tariff adjustments are based on a cost plus rule. It is clear that the analysis of sector performance is based on the information for a single company but since this company involves about 30% of Argentina's population and its regulation is serving as a model for most of the others, it still seems reasonable to model this privatization experience as well.  6 Telecommunications. The transfer of the telecoms company to private operators was concluded in November 1990. It was in fact the first infrastructure service concessioned. The service is now provided by two companies. Their tariffs are regulated and service and quality obligations detailed in their concession contracts. The regulatory mechanism is essentially an RPI-x where the productivity gains x will be adjusted after 5 years. Since it was the first concession, the government ended up gave up the effective short term control over monopoly powers to ensure the entry of private investors and operators in the sector. This is the reason why current tariffs are likely to be revised soon. There is an ongoing debate about the need to rebalance tariffs but since a decision has yet to be made, the current rates have been used to assess the efficiency and distributional impact of privatization in this sector. 3. Basic Analytical Structure of the Model The model is built around a social accounting matrix (SAM) constructed for 1993 which isolates every utility from the other accounts.3 It is consistent with national accounts for 1993, which is also the first year in which all national utilities were formally managed by private operators. Its basic structure is provided in Table 3.1. The figures in parenthesis provide the value (in billion US$) at current prices. As can be seen, spendings have to equate revenue for each aggregate account. The model identifies 21 domestic production sectors, 10 for goods and 11 for services. In addition to the usual activities under services, the SAM identifies electricity generation, electricity distribution, gas, water and communications as separate sectors. Three factors of productions are accounted for: labor, physical capital and financial capital. Labor and financial capital are mobile across sectors while physical capital is sector specific. Domestic consumer groups are divided into 5 income classes and there is only one foreign consumer and one foreign producer. The small open economy assumption is relied on, implying that Argentina is a price taker in the international markets. Details on the data sources used to construct the accounts are provided in an appendix available (in Spanish) from the authors but it may be helpful to summarize here the most critical assumptions we had to make. First, some of the basic production data was not readily available for 1993 and we had fill the holes with 1986 data, the last year for which detailed information was available. Second, the matrix of intermediate purchases is based on the 1984 data adjusted to the values of the national census of 1993. Third, the distribution of the factor income across income groups is based on the distribution observed in the province of Buenos Aires in 1991. Finally, the distribution of the consumption basket per type of goods and services is based on the 1986 household consumption survey. In both the input and output matrix and the household consumption, consistency for consumption and production with the national 3An earlier version of the model without detailed infrastructure accounts was presented in Chisari, 0. and C. Romero (1996), "Distribucion del ingreso, asignacion de recursos y shocks macroeconomicos," Serie Financiamento del Desarollo #36, CEPAL, United Nations.  7 accounts data was obtained by relying on the RAS method.4 As for the government distribution between goods and services, data is available for 1993 for the national and provincial governments. Municipal expenditures are assumed to be distributed in the same proportion as the average for the two other government levels. The infrastructure data was based on the information on assets, inputs and expenditures available in the annual balances of the companies of the sector and complementary data provided by the national regulatory entities and the Sectoral Secretariat (Energy, Water Resources, Communications). The rest of this section presents a simplified non-analytical version of the model to help the reader follow its main economic aspects. Consumers. Consumers' utility is modeled as a Cobb-Douglas between all goods except for retail trade which is assumed to be purchased in fixed proportions with the rest of the goods and services. The preferences of domestic agents are assumed to follow an Armington specification which implies no perfect substitutability in preferences between domestic and imported goods. Expenditures are distributed between domestic and imported consumption goods and investments. Goods and services of "privatized" firms combine quantity and quality features but a change in quality is not necessarily associated with a change in the price of the service provided by the privatized firm. An increase in service failures increases cost for the buyer of services because the consumer needs to buy a higher number of physical units to reach the desired flow of services. This "naive" modeling approach allows for instance to model the costs of power losses or interruptions as a proportion of unit costs. Prices can be differentiated per income groups. The budget constraint for each income group reflects total expenditures in goods and services as well as indirect taxes varying by the type of good and service, and direct taxes. Income sources are labor income in the private sector and in the public sector, and capital income in private firms; revenue from profits on domestic sales and sales abroad, and revenue from participation in the privatized firm redistributed in proportion to shares owned. Total capital wealth (physical + financial) can be negative if the consumer group is in debt.6 Families also get public sector transfers. Private Firms. The private firms are those for which there was no change in ownership or any major organizational change during the period covered by the study. They produce goods and services intended for intermediate and final consumption as well as export and investment. This differentiation is necessary to account properly for the differences in the tax treatment of the various destinations (for instance, exporters See Bacharach, M. (1970), Biproportional Matrices and Input-Output Change, Cambridge University Prcss. Although not necessary to ensure that the economy does not end up specializing, by assumption, the capital installed in the tradeable sectors cannot be reallocated. 6 An increase in the cost of debt leads to an increase in the supply of labor and a decrease in consumption by the indebted income classes.  8 do not pay the VAT and benefit from discounts on their gross income tax). There is no technological differentiation across these sectors. Exporters of goods are price-takers abroad and exports of services are price inelastic (i.e. they are constant). Non-tradeable prices are determined as solution variables and adjust with factor income until markets reach equilibrium. Credit requirements are constant per unit of output. Table 1: Summary SAM and Economic Features of the Model for 1993 (in billion USS; 1993 GDP: US$256.329 billion) Expenditures | Domestic Prod. Private Government Investment External Sectors Consumption Consumption Sector Domestic Domestic Spending on Spending on Final demand Exports: Production Purchases: domestic goods goods and for investment * the foreign Sectors *CES value * Cobb-Douglas services: goods consumer has a (21 sectors, added for utility in goods * Cobb-Douglas (42.816) Cobb-Douglas including private firms * fixed social welfare utility in separated *Leontief value proportion with function in exports and infrastructure added for goods for retail purchases of imports services) privatized firms trade goods and * he can issue *non-tradeable * separate service, bonds, Bonds to pay prices are quantity, price retirees services for net imports market clearing and quality for and investment; *Argentina is a for given levels each privatized * purchases of price taker in of rationing in service goods and exports and factor markets * rationing services are in imports *combination possible fixed * whatever with other goods (175.082) proportions Argentina can't and services in (6.085) consume is sold fixed abroad at given proportions price (132.370) (16.237) External Imports Spending on Imports of Sector * fixed imports capital goods proportion with * imperfect * fixed value added substitution with proportion with domestic value added substitutes (8.182) (8.727) (4.150) Trade tax Trade tax e revenue revenue v (1.282) (1.133) e Government Direct taxes Direct taxes paid n paid by firms by households u (22.461) (4.519) . e Indirect taxes (25.283) __ Families Labor income Salaries and (5 income net of taxes: Public Sector classes) * initial Transfers unemployment (60.786) (43645) Capital income net of taxes * can be domestic or foreign (122.266) Investment Private Savings Public Savings Foreign (37.196) (4.948) Savings (4.822)  9 The product is obtained by combining intermediate inputs and value added in fixed proportions. The value added itself is obtained by combining labor and capital inputs in a CES production. The inter-industrial transactions requirements are proportional to total production and to exports respectively. Privatized goods and services are also proportional to output which is different from the assumption made for consumers where rationing could occur.7 However, firms can be subject to adjustment in quality of services just as consumers and hence can face differences in cost for the same service.8 A quality improvement is equivalent to a cut in the absolute value of the input requirements. Remuneration includes total payments to capital and hence amortization. This means that the savings and investment decisions are taken by households in the model. Privatized Utilities. The privatized firms sell mostly to the domestic market, except for gas where some exports occur. With the exception of some differentiation due to regulation, service obligations or to taxes according to their final users, each utility sector is assumed to sell a single product. Their profit function includes any subsidy that could be transferred by the public sector a differentiation of tariffs into retail, wholesale or commercial and residential as necessary. The quality variables are modeled as an improvement in the overall efficiency of the sector. Outputs are limited by capacity and transmission constraints are incorporated through the value added function. The product of the privatized sector is also based on a fixed proportions production function for intermediate inputs and the value added function in the privatized sector are assumed to be Cobb-Douglas. This description of the technology of the private and privatized firms is key to model the changes in productivity, efficiency and quality. Price regulation in turn is modeled as RPI-x, where x is set to 0 at the beginning of the contract. The Public Sector. The government maximizes social welfare including current collective goods produced with goods and services purchased, employment, credit (which can be domestic or international), retirees services and a proxy for future collective goods: public investment. The function is a Leontief in which goods and services are combined in fixed proportions as a single input. Pensions, bonds services, investments, and current operative expenses are a constant proportion of total government income in this model. The government faces a budget constraint given by the sum of tax revenue, bonds but also revenue from their share of ownership in the "privatized assets." The Rest of the World. The foreign consumer has a Cobb-Douglas utility function. He faces faces a budget constraint. His revenue includes payments from its share of capital in the privatized sectors. Argentina is supposed to be a price taker in the international markets. 7Purchases of electricity in the wholesale market correspond to generation, purchases on the retail market correspond to distribution. 8 This assumes that there is no possibility of using "home-made" substitutes for infrastructure services.  10 The Factor Markets. The labor market in not in equilibrium so that unemployment is a possible outcome of any reform. The investment goods industries are divided into two main categories: those providing capital goods for private firms and those that construct specific capital for each one of the privatized utilities (electricity, gas, water and telecommunication). This procedure allows the recognition of the differential impact of investment schedules established by the regulatory contracts-for example, as network expansion commitments-on the economy (mainly on the rate of unemployment and the trade balance); therefore, special effort was devoted to determine the input composition of each industry. The Market for "Bonds." The financial market is highly simplified in this model-when compared to the sophistication of Argentina's financial sector. Its inclusion in the model is, however, important because it allows an assessment of the distribution of the welfare consequences of changes in access to credit. This access is particularly important to the financing of infrastructure investment but it is also very important to assess the extent to which the expected gains of infrastructure reforms can be offset by failures to reform other sectors, the capital market in this case. As previously mentioned, there are fixed requirements of credit per unit of output in each production sector, including recently privatized utilities. Additionally, domestic consumers can be separated into net debtors (typically the four poorest income brackets, to meet their demand for durable goods) and net creditors (the fifth income bracket); the rest of the world was considered a net creditor too for the benchmark. In terms of the bonds market, debtors were represented as issuers and creditors as subscribers. Therefore for domestic families and for the foreign consumers, bonds were introduced in the model giving them initial endowments but also introducing preferences for bond holdings as arguments in their utility functions.9 The domestic bonds market adjusts to the internal credit disequilibria of the families and of the government and to Argentina's disequilibrium with the rest of the world. Internally, the first 4 quintiles sell "bonds' (which is basically a credit instrument) to the richest. A net increase in the demand for bonds thus reduces the purchasing power of the 4 poorest income groups. An increase in the price of bonds is compensated by a decline in the purchase of other goods and with an increase in the labor supply which can contribute to an in increase in unemployment. The firms also demand bonds as a fixed proportion of their value added. For them, an increase in the price of bonds implies a cut in the marginal product of labor; which in turns leads to a reduction in the demand for labor, adding to the unemployment problem. The benchmark simulation of the model includes both a positive unemployment level and a commercial deficit. This implies that in addition to a disequilibrium in the labor market, the rest of the world is financing consumption and domestic investment. The implication for the bond market is an increase in the demand for bonds issued by 9The information on sectoral and personal net financial positions was obtained from monetary authorities and estimated using purchases of durables goods and total capital holdings.  11 with some care as many different elements are interacting and the time span used to compare is relatively short-which for infrastructure services is quite important as it takes time to invest and it takes time before these investments lead to increased production. For the water sector for instance, labor productivity initially increased tremendously as employment was reduced by 47% to determine the base year data used in this table. Since then, the expansion requirements have been such that the company has had to recruit to work on the investment program without a short run increase in water production which explains the deterioration observed in Table 4.1. Table 4.1: Changes in Performance between 1993 and 1995 Electricity Electricity Gas Water Telecoms. Generation Distribution Distribution Distribution First year of private operation 1992 1992 1992 1993 1990 Efficiency gains 19.51% 6.26% 8.84% 4.86% 11.28% (measured as reduction in intermediate inputs purchases as a share of total sales value) Labor productivity gins 23.1%. 17.59% 4.79% -27.58% 21.25% (measured as GWh/staff for electricity, OOOm3/staff for gas, population served/staff for water, lines in service/staff for phones) Increases in investment (as 8.65% n.a. 4.56% 75.97% 28.1% in concession contracts for gas and actual investnents for the other sectors). Improvements in quality n.a. 10% 27.8% 6.12%. 4.56% (measured as reductions in losses (net of consumption by transmission)/production for electricity and gas, water unaccounted for/production for water, lines in repair/lines in service for phones Changes in real average n.a. -9.5% -0.5% 5.5% -4.9% tariffs (defined as total sales value by a physical indicator of production) Note: The table reflects the changes achieved under private management of the services. Indeed, 1993 data reflects the first year in which all sectors had benefited from some initial adjustment by the private operator. 1995 is the last year for which data is available at the time of this writing. In general however, Table 4.1 shows continuing improvements under private management. For most sectors, the most dramatic adjustment in labor productivity took place immediately after the private take-over of operations in 1990-1991 for all sectors except water. This can be seen in Table 4.2 which shows the changes in labor productivity observed just before the private operators actually took over. It took a bit longer to achieve the efficiency gains measured in Table 4.1 and used for the main simulations discussed below.  12 As for other performance indicators, the assessment task was quite challenging. Non-labor productivity indicators (such as purchases of intermediate inputs) were difficult to assess because most of the public companies did not follow commercial accounting practices. There was also problem is assessing the impact on investment because, the investment program is typically spread over several years. As typical, the largest increases in relative terms occurred in the first year of operation of each firm since the public managers did not invest at all in most cases as a result of the fiscal constraints of the country. None of the available quality indicators can easily be modeled so only simulations on the yields from gains in this area for 3 sectors could be done, having to exclude water. Finally, average tariffs continued to fall in electricity and gas. After a reduction in tariff at the time of the privatization in water, the average tariff has begun to increase even if the legal tariff is still below what it was under public management. Our best estimates of some of these indicators are in Table 4.2. Table 4.2: Chan es in Performance at the Time of Privatization Electricity Electricity Gas Water Telecoms. ]______________________________ -Generation Distribution Distribution Distribution Efriciency gains 43.4% 21.3% 1.3% n.a. n.a. (measured as reduction in intermediate inputs purchases as % of total sals a __ _ Labor productivity gains 95.1% 80.3% 35.6% 75.2% 37.8% (measured as GWh/staff for electricity, OOOm31staff for gas, population served/staff for water, lines in service/staff for phones) Changes in real average tariffs n.a. 4% n.a. -1.92% n.a. (defined as total sales value by a physical indicator of production) _ Sources: see Data Appendix Available upon request from the authors S. Assessing the Long Run Efficiency And Distributional Effect of Private Operation There are many ways to assess the effect of the changes described in the previous section on the rest of the economy and on the various income classes. The main focus of the discussion of the efficiency effects of the reforms on the rest of the economy is on the standard macroeconomic indicators. This includes levels of activities in the 21 sectors of the economy identified by the SAM as well as prices and the usual expenditure categories. As for the distributional effects of the reform, the analysis is based on an indicator of welfare change in each income group as well as the calculation of a Gini coefficient for the economy. Since personal distribution depends heavily on factors relative rewards, they are also included in the table. The choice of simulations can also be quite helpful in differentiating the analysis of the effects of the reform by type of change. In addition to tracking down the effects of all the changes observed in each sector on the rest of the economy, the simulations can also be designed to isolate the effects of each one of the changes identified in Table 4.1. For instance, the effect of improving labor productivity gains in all infrastructure sectors on the country's unemployment rate can be a very important policy concern.  13 From this point forward, we are considering the total operational gains achieved in each utilities' sub-sector to be the sum of the effects of four specific changes: Efficiency: changes in inputs per unit of output modeled as a reduction in an in equation [9] in the appendix; the efficiency gains are taken as reductions in the quantity of inputs used by the privatized sector to obtain one unit of output (i.e. as a cut in the same proportion of the input-output coefficients of the column corresponding to the specific sector); the gains are unincorporated and generate an increase in capacity of the economy to generate a surplus. * Productivity: changes in labor productivity modeled as a reduction in the relevant Lri in equation [10]; productivity gains are computed as efficiency gains in work so that less L is needed to obtain a given level of service; * Quality: changes in quality measured in terms of product changes and modeled as changes in a,i, and ari in equation [9]; they are computed as reductions in the coefficients of the quantity of the privatized inputs needed to produce one unit of output in the other sectors; 3 Tariffs: for fixed prices: they are modeled as the actual utilities price changes observed. There are also other ways of squeezing information out of the model. The selection of the closure rule is an important instrument to that effect. To mimic the adjustment that takes place in Argentina now that price deregulation is the prevailing policy, prices can be assumed to adjust freely throughout the economy to any of the changes identified in Table 4.1. But this implies that regulation is effective and that the private providers of public services are unable to generate their monopolistic positions to extract rents. In that sense, this kind of simulation provides an upper bound for the gains from privatization in Argentina. On the other hand, if the regulator is ineffective, the rent could be quite significant. This can be simulated by keeping the price of the infrastructure services fixed, implying that any reduction in cost that results from the reforms accrues to the private operator. This then provides a lower bound for the gains from privatization. It turns out that this effect is most important in terms of the distribution of income since the distribution of ownership of capital is the key determinant of who gets the rent. More specifically, the design of the two closure rules used can be summarized as follows: * Flexible price: under this closure rule, all domestic prices adjust to clear the markets, except salaries so that there is unemployment in the model; for the markets for privatized services, prices are determined by the economy as in the case of all non-tradeable goods; the prices of tradeable goods are fixed in foreign currency since Argentina is assumed to be a price taker in international markets; the capital market is also somewhat peculiar since capital is sector specific, the rates of return are endogenous to each industry; finally, the outcome of the trade  14 balance is offset in the bonds market and if the domestic economy requires financing, the prices of bonds increase. * Fixed price: under this rule, the prices of privatized services are given but the rule for the determnination of tradeables and non-tradeable prices and the rules for the labor market are not altered; since the prices of the privatized utilities are set in foreign currency, quantity variables are needed to have all the required endogenous variables; in fact, their price function is as if they were minimum prices. If the tariff declines, say as a result of improvements in efficiency for instance, rationing occurs: at the regulated price, a competitive industry would be willing to sell more than the monopoly but cannot do so; this approach reproduces the process in which the firm can capture a monopoly rent. As discussed in more detail below, the effects of technological improvements and efficiency gains have a substantial impact on the interpersonal distribution of income through the effects of changes in the unemployment rate. In general terms, the poorest tend to depend much more than the richest on the state of the labor market and this is turn is directly and indirectly influenced by the privatization of utilities, The impact of privatization is indeed not only through labor productivity gains in utilities and through reduction in the costs of sectors using utilities services as an input, but also through reductions in input requirements of the production of utilities services. For instance, the privatized utilities buy intermediate inputs from the manufacturing sectors for an equivalent of 23% of their value added, services for 19% and primary inputs for 12% as seen in Table 5.1 which summarizes the input-output matrix. Moreover, the interaction between utilities is quite significant as well. The water sector is the largest client of the electricity sector for instance. Table 5.1: Summary Input-Output Matrix Uses for the SAM (% of Gross output value) Agriculture Industry Infrastructure Construction Services Agriculture 8.48 13.29 5.88 3.32 0.37 Industry 7.08 20.37 8.88 41.67 10.14 Infrastructure 0.12 2.22 18.43 0.39 1.56 Construct. 0 0 0 0 0 Services 12.31 12.76 8.86 12.59 17.37 Imports 0.18 5.98 0.45 0.94 0.35 Value Added 71.5 45.4 57.5 41.1 70.2 Output 100 100 100 100 100 Source: see Data Appendix available upon request from the authors. The changes in performance derived from the privatizations act on the level of welfare of the various income groups through the following channels: * directly, through the consumer (residential) prices of the privatized services * indirectly, through the changes in input costs of the industries using these services * indirectly, through the reduction in prices of the inputs purchased by the privatized utilities * directly or indirectly through remuneration in the factor markets. The effects can be separated into tw6 main types: macroeconomic and income distributional. Just to give the reader a global feeling for the changes brought about by  15 the operational gains estimated, Table 5.2 presents a summary of a general equilibrium calculation of the levels and distribution of gains across income classes from the efficiency and quality improvements due to the privatization process and those that could be achieved from effective regulation. To give some perspective on the relative importance of the gains achieved, these gains are also expressed in terms of the annual expenditures of each income class on utilities in 1993. Table 5.2: Gains from Private Operation of Public Utilities Income class Savings from Savings from (A)/income class (B)/income class operational gains effective regulation expenditure on expenditure on (A) (B) utilities utilities (in millions of (in millions of 1993 US$) 1993 US$) 1 (poorest) 197 138 29% 20% 2 259 142 31% 17% 3 373 121 37% 12% 4 403 214 32% 17% 5 (richest) 1047 302 59% 17% Total 2279 915 41% 16% Note: these figures represent annual gains. (A) is the equivalent variation computed in terms of the S revenue of each income class. It is calculated by applying the total gains in the fixed price simulation to the income in the base year. (B) is computed by applying the differences in gains between the fixed price and the flexible price simulations. In net present value and over a period of 10 years, the (A) gains represent a total varying between USS 8.2 billion and USS14.4 billion with discount rates varying between 12% and 18% and amortization rates between 0% and 10%. The gains from efficient regulation under similar assumptions vary between USS 3.3 billion and USS 5.8. This table summarizes some of the key lessons of the paper: