Privatizing Argentina's public enterprises

NUMBER 100 * ED Precis = Operations Evaluation Department December 1995 Privatizing Argentina 's Public Enterprises Restructuring and privatizing major the government's quick actions pre- scheduled. Shortly after elections, public enterprises entail high risk. But vented opponents from mobilizing op- the new government sought Bank when reforms are backed by strong gov- position. And the lessons learned from assistance in articulating and im- ernment commitment and grounded in the initial rounds of privatization were plementing reforms to restructure carefiul sector work, they can achieve used to improve subsequent rounds and privatize the public sector. substantial results. Argentina's large- (see box). Emboldened by public discontent scale privatization of the early 1990s, with the crisis, the new govern- recently audited by OED, provides a Background ment introduced plans that went striking example.* deeper and were more ambitious By the mid-1980s, a large, ineffi- than any the Bank had proposed, The World Bank's $300 million Pub- cient public enterprise sector was calling for the privatization of vir- lic Enterprise Reform and Adjustment widely seen as a major reason for tually all public enterprises. Loan I to Argentina helped finance one Argentina's disappointing eco- of the most far-reaching public enter- nomic performance in the postwar Project goals prise reforms ever carried out by any period. Although attempts were country. But for the Bank the loan was made to reform and privatize pub- The $300 million Public Enter- highly risky. At the time of loan ap- lic enterprises, they were not far- prise Reform and Adjustment praisal, Argentinia was in the midst of a reaching and two of the most Loan I (PERAL I, approved in severe economic crisis and the country ambitious efforts-reform of the 1991 and closed in 1993) was the had a history of unfulfilled reforms. To national airline and telephone com- first of several Bank adjustment reduce the risk, the Bank insisted that panies-had to be abandoned be- loans (totaling $1.5 billion) to help the government show its commitment cause of strong congressional Argentina restructure its economy. to reform by privatizing the state tele- opposition. By the end of 1989, fed- The loan's objectives were to help communications utility before loan ap- eral public enterprises employed restructure and privatize public proval. Thus assured, the Bank swiftly nearly 300,000 people and gener- enterprises in three major sectors: committed significant financial and ated a huge operating deficit. Costs telecommunications, railroads, staff resources to the reform program. were high because of overstaffing, and hydrocarbons. The loan also The government's commitment and procurement from overprotected proposed repealing legislation that ownership, coupled with the Bank's domestic industries, and uneco- required public enterprises to fa- quick and substantial response, pro- nomic activities undertaken for po- duced important results: All three sec- litical reasons. Price controls and *Performance audit report, tors reduced their costs, expanded their indirect taxes created distortions, "Argentina: Public Enterprise output, improved the quality of their and inadequate investment led to Adjustment Loan," Report No. products and services, rationalized their severe shortages, obsolete technol- 14809, June 1995. Performance prices, and experienced increased com- ogy, and poor service. audit reports are available to petition (albeit more in some sectors Bank executive directors and staff than in others). Macroeconomic conditions dete- from the Internal Documents riorated so badly toward the end Unit and from Regional Informa- Other factors were also important in of 1989 that a new administration tion Services Centers. the success of the reforms. Most notably, took office five months earlier than l  steps were taken toward creating Factors contributing to success independent regulatory agencies. Argentina's success story in cooperation with the legislative Telecommunications privatizing public enterprises illus- branch. trates the importance of several * An appropriate legal and regula- After being split into two re- factors: tory framework, relatively free of interference from special-interest inal cons, ENti e wa sol . The administration's strong po- groups, with rules perceived as fair n 1990 to consortia led by Euro- litical will to proceed with largely and consistent with international pean telephone agencies; competi- economically justified proposals. practice-rules that favor benchmark tion was permitted in nonbasic * A careful analysis and clear un- competition and discourage vertical services; and a new regulatory derstanding of sector issues and integration and dominant players in agency was created. Because options. the market. Argentina needed speedy reform, * A strategy and clear objectives . A financial structure that pru- it adopted a "sell as is" strategy in for sector reform. dently combines leverage and eq- telecommunication. As a result, the * An open, transparent privati- uity, to allow room for future price of the sale was lower than it zation (bidding) process. indebtedness (for growth). would have been with divestiture. * Comprehensive privatization, . Good, competent political and Another reason for the low price so private firms in a sector do not technical managers supported by may have been the high country have to compete with state-owned adequate consultancy resources (in risk perceived by investors at the companies. this case, financed largely by the time. Nevertheless, privatization v A constant dialogue with Bank through PEREL and the Gas produced rapid results (see table). vested interest groups and close Utilization Loan). The growth rate of the telephone network quadrupled (from 3 per- cent a year in 1989 to 12 percent vor domestic suppliers, to reduce * strengthening sector regulation in 1994); price distortions were the public-enterprise staff by more in telecommunications; reduced (although charges for com- than 35,000, to draw up plans to mercial users continued to substan- privatize three other public enter- * privatizing part of the state rail- tially subsidize those of residential prises, and to sign performance way freight business, terminating users); internal efficiency and the agreements with four public enter- uneconomic intercity passenger quality of service improved; tax prises. To support PERAL I, the services, creating a new enterprise revenues increased; and private in- Bank also made a parallel $23 mil- to take over passenger service in vestors earned an attractive return lion technical assistance loan, the Greater Buenos Aires, reducing on investment. Public Enterprise Reform Execu- the railway staff by 30,000, reduc- tion Loan (PEREL). ing government subsidies, and Railroads creating new regulatory agencies; PERAL I entailed high risk for and Argentine railways were known the Bank, not only because of the for their inefficiency and cost. And severe macroeconomic crisis, but * setting natural gas and crude competition from other transport also because Argentina had a his- oil prices at international levels, modes had not spurred the state tory of unfulfilled reform commit- lifting trade restrictions on oil and railway to become efficient or cus- ments. To reduce the risk, the Bank gas, restructuring and privatizing tomer-oriented, but it seems to have insisted the government show its parts of the state oil and gas com- had that effect on privatized firms. commitment to reform by privatiz- panies, and creating new regula- The monolithic state railway com- ing ENTEL, the state telecomm- tory agencies for oil and gas. pany was divided into several pas- unications utility, before loan senger and freight companies approval. Thus assured, the Bank Implementation and results before privatization. As part of invested a higher than average this process: amount of staff resources to the The loan was fully disbursed reform program. and closed ten-and-a-half months * Eighty percent of freight services ahead of schedule. On the whole, were placed in private concessions. Bank sector work carried out loan covenants were complied The result was a doubling of the during the previous administration with or exceeded. In all three amount of freight moved by rail, as also proved invaluable in fleshing sectors, state involvement in pro- prices fell 20 percent. out the rapidly emerging Argen- duction ended almost fully, com- tine reform strategy. In addition to petition was enhanced as barriers * All suburban passenger services privatization of ENTEL, project to private entry and international in the Buenos Aires region, includ- components included: trade were lowered, and the first ing the subways, were privatized. December 1995  In the months that followed, rider- privatization of the state oil com- more competitive as regulatory bar- ship in suburban rail and Buenos pany, Yacimientos Petroliferos riers to entry and competitive ri- Aires metro increased 30 to 40 Fiscales (YPF), and the state gas valry were lowered. Rail freight had percent. company, Gas del Estado (GdE). already been exposed to fierce com- Three refineries and miscellaneous petition from trucking and subur- * Seventy percent of intercity pas- assets belonging to YPF were sold, ban passenger service and, to a senger services were shut down and and what remained was divested lesser extent, to competition from the rest placed under private or pro- through international public offer- buses and cars; under privatization, vincial control. ings. GdE was privatized as ten rail service responided to that compe- independent companies (two trans- tition by becoming more customer- * Employment in the sector fell mission and eight distribution sys- oriented. In telecommunications, by from 90,000 in 1990 to fewer than tems), with restrictions on vertical contrast, basic services were shel- 20,000 in 1994, and labor productiv- integration. As a result of reform, tered from competition in the short ity increased by a factor of seven or the private sector (excluding term. The government gave pri- eight. privatized YPF) controlled more vatized firms exclusive rights in than half the reserves and produc- long-distance service for up to ten Investors fared moderately well, tion of both natural gas and oil; years, partly to make ENTEL attrac- with some exceptions, but the big- more than 25 international oil and tive to potential buyers at a time gest beneficiaries were the taxpay- gas companies entered Argentina; when the government's reputation ers, as privatization of the railways competition was introduced into among in investors was poor. In ended the single biggest drain on oil and gas production and the re- retrospect, a five-year monopoly government funds. Federal subsi- fining and distribution of oil prod- would probably have sufficed. dies to the sector fell to half what ucts; and labor productivity dou- they had been (an annual $700 mil- bled. YPF is now a major private Regiulatory reform lion before privatization) and were oil company, with shares traded projected to end altogether in ten in Europe, Japan, and the United Regulatory reform was the years. States. government's Achilles' heel. The administration followed the Oil and gas Competition Bank's recommendation to create an autonomous, industry-funded Reform introduced a flurry of Reform was intended to encour- regulatory agency for telecom- activity in hydrocarbons. Domestic age competition or to maximize munications at the time ENTEL prices began to track international its disciplining effect in all three was privatized. But the agency did prices, and restrictions on interna- sectors. Pockets of monopoly re- not function as hoped because the tional trade in oil, gas, and hydro- mained in hydrocarbons and rail- government was reluctant to del- carbon products were lifted. The roads. But in varying degrees com- egate critical decisions about licens- government realized almost $10 petition changed all three sectors. ing or tariffs to a body insulated billion from the break-up and The oil and gas sector became far from political pressure. Regulation was also the major challenge for railroads. One challenge, for ex- Telecommunications performance before and after privatization ample, was to motivate concession- aires to maintain track and rolling Telefunica de Argentina Telecom Argentina stock in good condition. But freight (south) (north) concessionaires were reluctant to Indicator Nov. 90 Sept. 94 Nov. 90 Sept. 94 invest in track, not only because Total lines 1,915 3,013 1,571 2,624 such investment was expensive but in service (000s) also because it would be unrecover- Telephone penetration 12.06 16.4 11.30 13.40 able if concessions were terminated (lines per 100 inhabitants) Waiting time for 27 2 27 4 for any reason. A new regulatory new lines (months) agency was created for gas, but as of late 1994, the one for oil had not Quality of service been created. (% of calls completed) (94 target) (94 actual) (94 target) (94 actual) Local 74 93 74 97 Lessons learned Domestic long-distance 64 91 64 93 Repair time delavs (davs) 6 1.7 6 4.4Considering how few prece- Repair time delays (days) 6 1.7 6 4.4 dents there were to learn from, Note: Privatization took place in November 1990. Argentina's accomplishments in all three sectors were impressive. Al- OED Precis  most everyone benefited: taxpay- * Speedy privatization makes it it where it is latent. Except in tele- ers, investors, and to a lesser ex- more difficult for opponents of the communications, Argentina had tent consumers, whose greatest policy to organize and signals the more success doing this than many gains are likely to come in the country's resolve for reform. It can other countries, chiefly by break- long run, as competition takes also lead to mistakes and flip-flops ing up monolithic state enterprises hold. And the reforms are un- in strategy, a weakening of the before privatization. In the railway likely to be reversed, not only government's bargaining power and hydrocarbon sectors, the gov- because they have produced vis- with buyers, and underpricing of ernment did not fall into the trap ible gains, but because the politi- firms. But when an economy needs of granting extended monopolies cal costs of renationalizing these dramatic action, as Argentina's did, to improve the enterprises' selling enterprises would be high. More- the advantages of speedy reform price. over, the number of private firms clearly outweigh the disadvantages. with an interest in keeping the As international experience accu- * Privatization of infrastructure sectors open is growing, and the mulates, late-privatizing countries and public utilities creates complex privatized firms have been able to can learn from the mistakes made regulatory issues and challenges, raise money in domestic and in- in earlier privatization efforts. And and each sector poses special regu- ternational capital markets to each country can use the lessons latory problems. fund growth and modernization. learned from one round of priva- Among the lessons learned from tization in some sectors to improve * It takes a lot more than laws the Argentine experience: subsequent rounds in others. The and decrees to create effective low price the Argentine govern- regulatory institutions. The Bank * Deep and speedy reform is ment got for its state telecom- must be as concerned about the possible only when a country munications company, for example, process and politics of regulation fully "owns" that reform and is was more than offset by the much as it is about regulatory structure willing to make politically diffi- higher prices realized subsequently and techniques. In that context, the cult decisions. The Bank can serve in the divestiture of the gas and oil Bank may want to compare the only as catalyst, providing advice companies, as the government's merits of creating autonomous and technical assistance, helping reforms gained international regulatory agencies for each sector maintain program continuity, and recognition. (as Argentina tried to do) with lending international credibility those of creating one high-pow- to the government's reform * Different businesses and dif- ered economic regulatory agency efforts. ferent situations call for different (like the Mexican Fair Competition approaches to restructuring and Commission). * Sweeping changes in owner- reform. Businesses that face compe- ship and regulation can be imple- tition must be handled differently * The Argentine government's mented fairly quickly if (1) the from those that enjoy monopoly desire to sell public enterprises to country has access to substantial power, and those with noncommer- strong private investors restricted technical advice and consulting cial goals must be treated differ- the set of potential Argentine in- resources. (In Argentina, the level ently from those that are commer- vestors to a handful of large busi- of reforms called for an unprec- cially viable. ness groups. Such concentration of edented amount of Bank staff in- economic power, where it is un- volvement and risk-taking.) And * Reformers must seize every op- avoidable, may result in problems (2) a good deal of preparatory portunity to create competition to which governments should be work has been done beforehand. where it does not exist or to unleash i fully alert. OED Preis 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. This and other OED publications can be found on the Internet, at http:// www.worldbank.org/html/oed. Please address comments and enquiries to the managing editor, Rachel Weaving, G-7137, World Bank, telephone 473-1719. Internet: rweavinghworldbank.org Decemnber 1995