Privatization and deregulation in Mexico

/7 .- -.)- 77? NUMBER 97 O: F Precis z Operations Evaluation Department November 199 Privatization and Deregulation in Mexico Mexico's restructuiring of telecomtmud- tions and road transport. The operational functions of the Minis- nications and road tranisport-tzto World Bank supported these mea- try of Communications and Trans- sectors vital to the country's businiess sures with a $380 million sector ad- port (SCT) while strengthening the activities and external trade-resulted justment loan approved in 1990. ministry's regulatory function. in thle privatizationi of the public tele- Toward the latter goal, the Bank phone compnpay, Telmex, anid deregu- Project goals approved an additional $22 mil- lationt of Mexico's trucking industry. lion technical assistance loan. The reforms, beguni ini 1989 as part of In telecommnllwlications the large a larger program of structtural reforms state-controlled monopoly, Tel6- In road tranisport, the principal and supported by a $380 million fonos de Mexico (Telmex), was objectives of the reforms were to World Bank loan, aimed at prom71oting inefficient. Despite connection deregulate the trucking industry, private sector participationi anid charges as high as $600 for residen- increase funding for highway increased reliance on1 market forces. tial and $1,100 for commercial maintenance, and initiate an emis- users, would-be customers faced sions inspection program. A recent OED audit*found that waiting periods of one to two in botli sectors the reforms achieved, years. The telephone excise tax of In both telecommunications and in maniy cases exceeded, their 60 percent was one of the highest and road transport, reform was goals. In telecommunicationzs, priva- in the world. Tariffs were highly initiated, designed, and champi- tization reduced costs, expanded distorted, with long-distance rates oned by Mexican officials-a fac- telephlone coverage, increased labor subsidizing local service for which tor that counted heavily in the produictivity, and added to government charges were far below cost. program's success. The Bank revenue and investor profits. With maintained close, continuing dia- deregulation, at least 30,000 new In road trantsport, major problems logue with Mexican officials and truckingfirms entered the market, plagued the trucking industry. worked with them in formulating rapidly increasinig competition. Trucking, which transported about the reforms. Thle result was greater operatinig two-thirds of the cargo in Mexico, efficiency and lower tranisport costs. was until 1989 highly regulated. At the time the Bank loan was Regulation was thought to promote approved, reforms in the telecom- Background evenness of service and prices and munications sector were well un- to prevent cost-cutting practices derway. In road transport, the In the 1980s, Mexico's telecom- that might increase accidents and munications sector, particularly pollution. But regulation served its state-owned telephone system, only to restrict competition, limit- suffered from poor service and ing the industry to only a few ^'Perforniance Audit Report: sluggish growth. And the country's firms. As a result rates remained Mexico-Road Transsport anld trucking industry was heavily high and service poor. Telecommunications Sector regulated with layers of restrictions Adiustment Loan," Report that impeded its efficiency. As part In telecommunlications, the reform No. 14400, April 1995. Perftr- of broader reform measures to re- measures aimed principally at mntw7re auz.dit reports are t avalable duce government regulation and privatizing Telmex (about 49 per- to B1ank executive ilzrectors and increase reliance on competitive cent of whose shares were already I staff from the Initernali Docui- market forces, the Mexican govern- owned by private domestic and nmenits Uiit undf from Regional ment in 1989 introduced reforms to foreign investors). At the same Information Service Cernters. restructure both telecommunica- time, reforms sought to divest the  government introduced a compre- Measures complemenling deregulation hensive array of reforms and moved quickly to implement * hiiipri'iim- In-hia.iwau -afelu. Road ac- about 30 percent of what was them. It scrapped the excise tax, cidentk acco unt for about 3 percent needed to repair the roads, result- partially rebalanced local and of all deaths in Mlexico, a consider- ing in a large backlog of work. long-distance telephone rates, and abtli igher rate than in countries The government agreed to budget began selling shares of the com- with much greater motorization. 475 billion pesos in 1991 to reduce panyselling same the cm- Studies showed that 25 to 30 percent that backlog. The government has pany. At the same time, it success- of trucks were overloaded. Al- in subsequent years continued its fully renegotiated labor contracts, though the government embraced commitment to highway mainte- bringing the unions on board in deregulation of the trucking indus- nance. Nonetheless, it will be support of the privatization effort. try, it had no intention of stopping many years before the backlog By May 1994, the government had hight%aN safetv regulation. The go%-- is eliminated. divested itself of all but 2 percent ernment prepared a study that in- of its holdings through global cluded recommendations for in- * Adjusting rail tariffs. The govern- offerings. The controlling block, creased regulation of the sizes and ment agreed to raise railway tariffs as initially required, was sold to %% eight, of trucks. After the study by at least 25 percent (in real a consortium of Mexican and was conmpleted the gov ernment in terms) on most commodities trans- foreign investors. February 1994 issued new size and ported by Mexico's state-owned %% eight regulations to be phased in railway company. The purpose In the divestiture, Telmex within three years. was to reduce the large subsidies was granted exclusive rights to received by the railway. The rail- domestic and international long- * Increasing thi p ice of diesel fuel. To way company raised rates twice distance service for six years after force truckers to pax their full costs during 1990: by 23 percent (in distance All or activitiese of road use, the go% ernment agreed nominal terms) and then another privatization. All other activities, to raise the price of diesel fuel at 15 percent. The increases brought such as Yellow Pages, value- least 10 percent in real terms. In fact, tariffs to 97 percent of costs. How- added services, cellular telephony, the gomernment raised diesel prices ever, the policy of matching tariffs were opened to private participa- 17 percent in Nlav of 1I40 and an- with costs was not sustained. In tion. (Private networks had been other 10 percent in November of 1991, the percentage of revenues to liberalized earlier in the aftermath that year. With these change.. the costs fell to 87 percent. of the 1985 earthquake.) Telmex real price of diesel fuel increased by was permitted to diversify into 21 percent in real terms during 1990. * Installing a J'Pl..I lf it' 1ib it- emis- most other businesses so long as Cost recovery has increased further sion inspection. The government the new activities were carried in recent years. According to the also agreed to put in place a sys- out through subsidiaries. NlinistrN of Finance. triiclers in tem for periodic inspection ot 1994 were pa% ing nearlk' the full trucks for compliance with federal Institutional developnent cost of road use. emission standards. In May 1990, the government issued regulations The overnment moved uickl * IPIL W lc'C'li filil .?I.-ii Q rLr highway for mandatory inspections. As of g q y maintenance. In 1991 about 60 per- May 1994, some 370 emission in- and decisively in divesting SCT's cent of the roads In the federal high- spection stations were operating in major operating function to way system were rated in poor or Mexico. Of these, 147 were in the Telecommunicaciones de Mexico, v erv poor condition. During the late Mexico City metropolitan area, a new, commercially oriented 1'I)S the government spent only where air pollution is most severe. public agency, thus permitting the ministry to concentrate on regulat- ing the sector. But the idea of cre- ating a separate well-staffed and Bank believed that certain addi- Telecommunications autonomous regulatory agency tional measures were needed to was not pursued in the short run. improve the subsector as a whole. Privatizationi Interviews conducted during the Five measures were identified, audit suggest at least two possible ranging from highway safety im- Privatization of Telmex pro- explanations for this decision. provement to the establishment of ceeded much faster than could First, Mexican officials were trying a vehicle emission inspection pro- have been predicted at the time. to reduce the size of government, gram (see box). The Bank made Before 1989, the only countries and the creation of an autonomous the implementation of these mea- that had privatized their telecom- regulatory agency for telecommu- sures conditions for the release munications sectors were Japan nications might have sparked de- of the second tranche of the loan. and Great Britain. And in those mands for similar agencies from All measures were carried out cases, the process had moved other ministries. Second, there was on time. slowly. In the case of Mexico, the concern that such an independent Novemnber 1995  Performance indicators for Telmex, 1988-93 Indicator 1988 1989 1990 1991 1992 1993 Lines in service Annual increase (OOOs) 288 460 508 670 729 867 Percentage increase 7.0 10.5 10.5 12.5 12.1 12.8 Total lines (OOOs) 4,387 4,847 5,355 6' 1-2 6,754 7,621 Lines installed Annual increase (OOOs) 354 535 705 759 711 975 Percentage increase 7.4 10.4 12.4 11.9 9.9 12.4 Total lines (OOOs) 5,152 5,687 6,392 7,151 7,862 8,837 Telephone density 5.6 6.1 6.6 7.2 8.0 8.7 (lines per 100 pop.) Capital expenditure 1,080 987 1,831 1,967 2,352 2,282 ($ million) Employees 49,995 49,203 49,912 49,488 48,937 48,771 (telephone service only) Employees per 1,000 11.7 10.5 9.6 8.5 7.5 6.6 lines Taxes paid to government 658 1,098 1,293 1,301 1,677 1,749 ($ million) agency would lack the power to with 7 percent in 1988. And tele- In 1993 revenues from Telmex in enforce its role. phone coverage reached 8.7 lines the form of telephone tax, income per 100 people in 1993 compared tax, value-added tax, and divi- Nevertheless, regulatory issues with 5.6 lines in 1988. The company dend withholding tax amounted are now being handled reasonably met its goal of two public tele- to $1.75 billion, estimated to be well in the sector, for three rea- phones per 1,000 population in an increase over revenues before sons: (1) the high level of compe- 1993, a year ahead of target. privatization. Some investors also tence of some key Mexican offi- profited handsomely from the cials associated with the reforms, Pricing. Rates were increased and sharp run-up in stock prices after (2) the involvement of a number of rebalanced prior to privatization. privatization. experts in conducting background Under the price-cap system put in studies and providing advice, and place in 1991, average rate increases Labor productivity. Although (3) most important, the growing have been kept slightly below infla- Telmex's network expanded by number of private firms entering tion. Subsidization of local service 42 percent during 1991-93, em- the industry, which have begun to by long-distance service has been ployment in telephone operations provide valuable checks and bal- significantly reduced, with the actually feli by 2.3 percent (from ances on each other. sharp increase in local rates. But twelve employees per 1,000 lines in 1994, businesses (which paid a in 1988 to seven employees in Outtcomes $940 installation fee-lower than 1993). Part of the decrease came before, but still excessive) contin- through attrition-part through Demuand. Privatization of ued to subsidize residential users laying off nonunion workers, in- Telmex brought about positive (who paid a $540 fee). cluding some 350 senior manag- changes across almost all perfor- ers. The company sees further mance indicators (see table). As Retutrns to government and inves- productivity gains ahead as the required under the concession tors. As a result of privatization, need for services of operators agreement, the company ex- both the government and investors and repair technicians declines. panded the number of lines in ser- gained. The government realized vice by 12 percent or more in each more than $6 billion from Service qunality. In one important of 1991, 1992, and 1993, compared the sale of its holdings in Telmex. respect, however, the company OED Precis  lagged. Service quality continued to be replicable in other countries transport, solid evidence of the to draw complaints, particularly where trucking is heavily regu- benefits of deregulation helps in Greater Mexico City. In 1992, lated and the degree of potential bolster the sustainability of Telmex averaged a million cus- competition uncertain. that policy. tomer complaints per month. In the worst month of the 1993 rainy Outcomes Conclusions season, one in nine telephones was out of service, compared with a The deregulation of the truck- * The outcome of Telmex's target of one in seventeen. In hind- ing industry had a major positive privatization has so far been sight, linking price increases to impact on Mexico's economy. largely positive. The government quality improvements might have Among the outcomes: and investors made substantial improved service more quickly. profits; consumers benefited by Since 1993, however, Telmex has * Many new truck operators expanded service (although the launched an aggressive campaign entered the field. By the end of quality of service remained poor to improve quality and has taken August 1990, about 51,000 federal and has only recently started to steps to modernize and upgrade trucking permits had been issued, improve in some parts of the coun- its equipment. of which 30,000 were for new en- try), labor productivity increased, trants and 14,000 for previously modern technology was intro- Trucking deregulation illegal operators. duced, and several companies stand ready to enter the long- Approach * Tariffs for trucking services distance sector once Telmex's fell-by 23 percent in real terms exclusivity ends. The government feared that during 1987-94. The Ministry of in the absence of competition, Trade and Industrial Development * The success of privatization deregulation would result in estimated that general distribution and deregulation provided signifi- sharp increases in transport rates. costs in real terms during the same cant opportunities for reducing It therefore chose to deregulate period dropped 25 percent. cost and improving service in both the trucking industry in three sectors. Given Mexico's experi- stages to allow time for competi- * Service improved in frequency, ence, the Bank should continue tion to develop. access, and speed of delivery. to emphasize policy support for privatization and appropriate * In July 1989, the government * More flexible pricing of both regulation (both formally and in- negotiated a pact with the truck- truck and rail transport increased formally), as well as traditional ing association under which competition in the transport in- project lending. truckers agreed to cooperate dustry and helped to lower overall in the deregulation. transport costs. * In both sectors, structural re- forms changed the nature of regu- * Immediately following stage 1, Sustainability lation. In telecommunications, the government issued a decree regulations on price and quality eliminating many restrictions on Because of strong government and policies promoting competi- entry into the trucking business commitment, reforms in telecom- tion became important issues. In and abandoning the notion that munications and road transport transport, economic regulation trucking operations would require are likely to be sustained. In gave way to environmental and a concession. telecommunications, the number safety regulations. of private firms involved in * In January 1990, the government nonbasic services has increased, * The Mexican experience in issued a decree abandoning tariff and these firms have a vested in- privatization of telecommunica- ceilings and thus freeing truckers terest in keeping the sector open. tions and deregulation of trucking to set their own rates. Telmex's monopoly on local and demonstrates the critical impor- long-distance service will end tance of borrower ownership in the Mexico's three-stage approach in 1996, opening the way for success of Bank support to public to trucking deregulation appears yet more competition. In road sector reform. OED Precis is produced by the Operations Evaluation Department of the World Bank to help disseminate recent evaluation findings to development professionals within and outside the World Bank. The views here are those of the Operations Evaluation staff and should not be attributed to the World Bank or its affiliated organizations. Please address comments and enquiries to the managing editor, Rachel Weaving, G-7137, World Bank, telephone 473-1719. Internet: rweaving@worldbank.org Novemtiber 1995