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OPS -23/1 POLICY RESEARCH WORKING PAPER 2311 The Buenos Aires Water Transparent, rule-based decisionmaking is important Concession to maintaining public trust in regulated infrastructure. The Buenos Aires water and Lorena Alca'zar sanitation concession led to Manuel A. Abdala remarkable improvements in Mary M. Shirley delivery and coverage of services and to lower prices for consumers. But a poor information base, lack of transparency in regulatory decisions, and the ad hoc nature of executive branch interventions make it difficult to reassure consumers that their welfare is being protected and that the concession is sustainable. The World Bank Development Research Group Regulation and Competition Policy H April 2000  I POLICY RESEARCH WORKING PAPER 2311 Summary findings The signing of a concession contract for the Buenos Aires charges. And these improvements would probably not water and sanitation system in December 1992 attracted have occurred under public administration of the system. worldwide attention and caused considerable controversy Still, as Alcazar, Abdala, and Shirley show, information in Argentina. asymmetries, perverse incentives, and weak regulatory It was one of the world's largest concessions, but the institutions could threaten the concession's sustainability. case was also interesting for other reasons. The Opportunities for the company to act opportunistically concession was implemented rapidly, in contrast with - and the regulator, arbitrarily - exist because of slow implementation of privatization in Santiago, for politicized regulation, a poor information base, serious example. And reform generated major improvements in flaws in the concession contract, a lumpy and ad hoc the sector, including wider coverage, better service, more tariff system, and a general lack of transparency in the efficient company operations, and reduced waste. regulatory process. Moreover, the winning bid brought an immediate 26.9 Because of these circumstances, public confidence in percent reduction in water system tariffs. the process has eroded. The Buenos Aires concession Consumers benefited from the system's expansion and shows how important transparent, rule-based from the immediate drop in real prices, which was only decisionmaking is to maintaining public trust in regulated partly reversed by subsequent changes in tariffs and access infrastructure. This paper - a product of Regulation and Competition Policy, Development Research Group - is part of a larger effort in the group to analyze institutional issues in regulated infrastructure. The study was funded by the Bank's Research Support Budget under the research project "Institutions, Politics, and Contracts: Private Sector Participation in Urban Water Supply" (RPO 681-87). Copies of this paper are available free from the World Bank, 1818 H StreetNW, Washington, DC 20433.. Please contact Paulina Sintim-Aboagye, room MC3-422, telephone 202-473-8526, fax 202-522-1155, email address psintimaboagye@worldbank.org. Policy Research Working Papers are also posted on the Web at www.worldbank.org/ research/workingpapers. Mary Shirley may be contacted at mshirley@worldbank.org. April 2000. (62 pages) The Policy Research Working Paper Series disseminates the findings of work 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 polished. 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  THE B3UENOS AIRES WATER CONCESSION Lorena Alcazar Manuel A. Abdala and Mary M. Shirley* *IThe authors are, respectively, Professor of Economics, Universidad del Pacific, Lima, Peru; Director, Navigant Consulting, Inc. and Universidad de San Andres; and Research Manager, The World Bank.   TABLE OF CONTENTS I. INTRODUCTICON .1............................................................. I II. CIRCUMSTANCES LEADING TO REFORM ................................................ 2 A. Circumstances in the Water Sector ............................................................... 2 B. Political Circumstances ............................................................... 8 III. CHARACTERISTICS OF THE BUENOS AIRES CONCESSION ................ 19 A. Information ............................................................... 19 B. Incentives .............................................................. 24 C. Credibility .............................................................. 29 D. Access and Affordability ................... ........................................... 33 IV. REVISIONS AND RENEGOTIATION ............................................................. 35 V. EFFECTS ON PERFORMANCE AND WELFARE .................. ...................... 41 VI. CONCLUSION ............................................................... 53 TABLES TABLE 1. WATER AND SANITATION COVERAGE BEFORE PR[VATIZATION ................................................ 4 TABLE 2. POPULAR APPROVAL OF CERTAIN GROUPS .12 TABLE 3. PUBLIC OPINION OF PRIVATIZATION .13 TABLE 4. VOTES FOR MENEM IN THE 1989 PRESIDENTIAL EL:ECTIONS COMPARED TO WATER AND SEWERAGE CONNECTIONS AND INCOME GROUP .15 TABLE 5. PROJECTED SOCIOECONOMIC STATUS OF HOUSEHOLDS WITH NEW WATER CONNECTIONS .16 TABLE 6. PERFORMANCE TARGETS IN THE BUENOS AIRES CONCESSION CONTRACT .25 TABLE 7. ACCESS CHARGES IN 1995 .34 TABLE 8. COMPARISON OF AVERAGE BIMONTHLY CHARGES 39 TABLE 9. SE:RVICE INDICATORS .47 TABLE 10. WE,LFARE EFFECTS FROM CONCESSION ............. ................. 50 TABLE 11. SENSITIVITY ANALYSIS ........................................................... 53 i  FIGURES FICGURE 1. RATE OF GROWTH IN POPULATION SERVED BY OSN.......... 5 FIGURE 2. INVESTMENT BY OSN AND AA, 1991-1998 . . 42 FIGURE 3. WATER COVERAGE ......................................... 43 FIGURE 4. AGUAS ARGENTINAS: SOURCES OF FUNDS . . 43 FIGURE 5. AGUAS ARGENTINAS: REAL REVENUES PER CUBIC METER OF WATER PRODUCED .. 44 FIGURE 6. NET PROFIT MARGIN ....................................... 45 FIGURE 7. UNACCOUNTED FOR WATER . .................................................... 46 FIGURE 8. TOTAL FACTOR PRODUCTIVITY ..................................... - 46 ii  I. INTRODUCTION The signing of a concession contract for the Buenos Aires water and sanitation system in December 1992 has attracted world wide attention and been the subject of considerable controversy in Argentina (see for example, Idelovitch 1994, The Economist various, Artana et. al 1997). In addition to being one of the world's largest concessions, the case is interesting for a number of other reasons. First, the rapid implementation of the Buenos Aires concession is in contrast to the slow moves towards private participation in other water systems, such as Santiago or Lima. We explore in Section II the circumstances in the water sector and the political and institutional factors that led Argentina to implement the concession. Second, the reform has been widely acclaimed for generating major improvements in the sector, including wider coverage, better service, more efficient operation of the company, and a reduction in waste. What makes these improvements especially striking is that the winning bid brought an immediate 26.9 percent reduction in water system tariffs.' We explore the features of the contract that explain performance improvements, and consider how institutions affected outcomes in Section III. Finally, the Buenos Aires case is of interest because the contract was renegotiated in 1997, provoking criticisms of the original bid and the regulation. We describe these revisions in Section IV and measure the extent to which Buenos Aires was better off because of ithe concession, with and without the renegotiation, in Section V. Section VI concludes with lessons for reform design. As we will show, water and sewerage services improved dramatically thanks to the concession. Consumers benefited from the large drop in real prices, which was only 'This decrease was subsequently eroded, as we explain later.  2 partly reversed by subsequent changes in tariffs and access charges, and from a large expansion of the system. Quality and reliability of service also improved, and wastage of water was reduced. We will argue that these improvements would not have occurred under any reasonable assumptions about continued public operation of the water system. These gains notwithstanding, we will demonstrate how information asymmetries, perverse incentives and weak regulatory institutions could threaten the long-run sustainability of the concession. In particular, politicization of the regulator, a poor information base, serious flaws in the concession contract, an obscure tariff system and a general lack of transparency in the regulatory process, have created opportunities for the company to act opportunistically, and the regulator, arbitrarily. These circumstances have led the federal executive to by-pass the regulator, and public confidence in the process has eroded. The Buenos Aires concession shows the importance of transparent, rule-based decision making in maintaining public trust in regulated infrastructure. II. CIRCUMSTANCES LEADING TO REFORM A. Circumstances in the Water Sector Reform is more likely to occur when the water sector is in crisis, but only if the causes of the crisis are tractable (Alcazar and Brook Cowen 1996). Problems that result from a failure to expand supply as fast as demand or from mismanagement are easier to address than those that stem from scarce and costly raw water. Buenos Aires did not have a public health crisis, but it did have serious problems. We argue in this sect ion that it was ripe for reform because its sector problems were highly tractable, given the right political circumstances.  3 (i) Cost and Scarcity of Raw Water. Buenos Aires sits on the west bank of the Rio de la Plata, which has an abundant flow of 29,000 M3 per second (World Bank 1994) and supplies 92 percenLt of the system's water needs.2 As a result the supply of raw water is ample throughout the year and transport costs are low. Nasser 1997 estimated that the marginal cost of water in Buenos Aires could be as low as US$0.15 per cubic meter, even taking into account the investments being implemented under the concession. This is - cheap compared to cities with scarce water supplies, such as Lima, where the marginal cost of water and sewerage was estimated at US$0.45 per M3 in 1994 (World Bank 1994). (ii) Supply and Demand Notwithstanding the ample availability of cheap raw water, before the concession only 70 percent of the population in the metropolitan area were connected to the water system, and only 58 percent to the sewerage system. The shortfall was in the poorer, suburban areas, which had been growing by 5 to 6 percent a year prior to the concession and totaled 5.6 million people at the time it was signed in December 1992. 3 Only 55 percent of persons in these areas had access to water and only 36 percent to sewerage. Almost all of the 3 million inhabitants in the older center of the city, the Capital District, were connected to the municipal system (Table 1 ). 2The rest is from about 300 wells that are becoming increasingly contaminated by untreated sewerage. 3 Approximately, 2 million people are in the province of Buenos Aires but are not in the concession area. They are served by municipalities.  4 Table 1. Water and Sanitation Coverage before Privatization Water Sewerage Capital District 99% 990%g) Suburban areas 55% 360% Total metropolitan area 70% 58