255 privatesector P U B L I C P O L I C Y F O R T H E NUMBER NOTE 2003 Water Services in Chile MARCH Gabriel A. Bitrán and Comparing Private and Public Performance Eduardo P. Valenzuela In 1988 Chile put in place a new regulatory regime for water and Gabriel A. Bitrán sanitation, allowing rates to reflect the actual cost of providing services. (gabriel@bitran.cl) is a founding partner of The government then reorganized the sector under 13 state-owned Bitrán & Asociados regional water companies and, in 1998, started to partially privatize Regulated Markets. He has worked extensively in some of them. Four years after the first sale, it is now possible to assess NETWORK regulated markets, both the early results of privatization. This Note examines the outcomes for with government agencies investors and consumers and compares the performance of the privatized and with private companies. And he has companies with that of companies remaining under state ownership. given legal testimony and INFRASTRUCTURE acted as an arbitrator in Chile has long been a pioneer in privatization. Water and sanitation companies became some conflicts between private The country began privatizing power and of the biggest buyers of water rights, which they AND companies and between telecommunications in the mid-1980s--even needed in increasing amounts to meet the grow- government agencies and before the United Kingdom did. Only water and ing demand in their service areas. And as their private companies. SECTOR sanitation remained under state ownership service coverage grew, water companies drove up Eduardo P. Valenzuela longer, mainly because a change in government the prices of water rights in urban areas. In some (evalenzuela@bitran.cl) moved the public debate to the center left of the regions the cost of new water rights created pow- PRIVATE has worked in the political spectrum. But sector regulation was erful incentives for companies to reduce electricity and water dramatically changed, allowing rates to reflect unaccounted-for water. sectors on issues ranging the actual cost of delivering services. from privatization to Another important change in the legal and GROUP Share of water and sanitation customers tariffs. regulatory framework occurred in the early Figure served 1980s, when a law was enacted that allowed Percent BANK 1 water rights to be separated from land owner- ship and freely traded. Water rights became 1998 highly mobile and changed hands swiftly within 2001 local markets that emerged along water courses. 0 20 40 60 80 100 WORLD Different types of water rights were defined, Private companies Public companies depending on the ability of the owner to use the THE water or restore it to its natural source. Source: Chile, Superintendency of Sanitary Services. W A T E R S E R V I C E S I N C H I L E C O M P A R I N G P R I V A T E A N D P U B L I C P E R F O R M A N C E adopted to adjust prices gradually. In 1990 the Figure Real annual capital expenditure Superintendency of Sanitary Services was created 2 Index (1998=100) to periodically set rates and to define and enforce 200 service standards for concession companies. By Private companies 1995 water and sewerage services had been 150 extended to nearly all households in most parts of the country. 100 Privatization becomes a must 2 50 Public companies Although the new center-left governing coali- 0 tion that took office in 1990 was not entirely 1998 1999 2000 2001 comfortable with the concept of privatization, promises of social spending made privatization Source: Chile, Superintendency of Sanitary Services. a must for the cash-hungry public sector. Moreover, Chile's success in negotiating free Figure Average water and sewerage rates trade agreements with such trade blocs as the 3 Index (1998=100) European Union began creating pressure for 160 the country to improve its poor environmental performance. Sewage treatment became a top Private companies 140 priority, an undertaking for which the govern- ment lacked the resources. 120 Privatization of Chile's largest water and san- itation companies thus became inevitable. The 100 Public companies process started in late 1998, and in less than three years more than three-quarters of Chilean 80 households were being served by private water 1998 1999 2000 2001 companies (figure 1). Although only 5 of the 13 Source: Chile, Superintendency of Sanitary Services. regional companies were privatized, they included those serving the three largest urban Average annual water consumption centers: Santiago, Valparaíso, and Concepción. Figure per customer Privatization was carried out through con- 4 Index (1998=100) cessions and full divestitures of assets. Initially 105 only 51 percent of the shares of each company were sold. In 2002­03 the Chilean government 100 is expected to sell part of its remaining stake in Private companies 95 the privatized companies. The investments needed to reach the target Public companies 90 of treating 100 percent of Chile's sewage were estimated at about US$1.5 billion, a sum the 85 Chilean government could ill afford. But the 1998 1999 2000 2001 British, French, and Spanish consortia that Source: Chile, Superintendency of Sanitary Services. bought the privatized companies brought with them not only technology but also the massive At the same time, the government began to set capital needed to carry out the new investments. water and sewerage rates according to a new methodology based on long-term incremental Investment jumps--and so do user rates costs. The rates moved closer to the actual cost of Privatization was followed by renewed invest- providing services, a shift intended to be the first ment by the privatized companies but also by step toward privatization. Because of the severe more apparent limitations for their public coun- price hike expected, a crawling peg scheme was terparts. While private companies invested 70 percent more in 2001 than in 1998, public com- Figure Efficiency performance, 1998 and 2001 panies invested almost 70 percent less (figure 5 Percent 2). The decline for public companies reflected Sales and Public companies the growing difficulties the government was hav- administrative ing in funding their cash flows. expenses/sales Private companies Sharp differences between the two groups of companies also emerged in price behavior. In Public companies Return 1998­2001 private companies' rates rose 20 per- on equity cent more on average than did public compa- Private companies 3 nies' rates (figure 3). Public companies Most of the difference in price behavior Return stems from the fact that privatized companies on assets Private companies invested more, in part to add new services (mostly sewage treatment). But the remaining Operating Public companies gap raises interesting questions about the effects income/ Private of privatization. Although new rates were set sales companies after privatization (nine months afterward, on 0 10 20 30 40 50 average), some speculation may arise (though it 1998 2001 is not shared by the authors of this Note) about the government's capacity to reach informal compromises with investors on rate adjustments Source: Chile, Superintendency of Corporations and Insurance Companies, financial statements for publicly traded water and sanitation companies. for privatized companies. This thesis points to the moral hazard a government faces when sell- Figure Staff employed ing assets whose value can be increased simply 6 by raising the price for the services they pro- Index (1998=100) 120 duce. A second line of thought points to the superior bargaining skills of private manage- ment when dealing with technical issues such as 100 the negotiation of water rates. Public companies Even so, the rates charged by private compa- 80 nies are still 40 percent lower on average than Private companies those charged by their public counterparts. The explanation for this difference might lie in the 60 fact that the state has kept the highest-cost com- 1998 1999 2000 2001 panies, especially those in northern Chile, Source: Chile, Superintendency of Sanitary Services. which has one of the world's driest climates. Figure Share of unaccounted-for water Customers mind the leaks 7 Index (1998=100) The rise in water rates has taken a toll on con- 120 sumption, which has steadily declined since the new methodology for setting rates was intro- 110 duced. Increasingly aware of the cost of water, Private companies customers reduced their consumption by almost 100 10 percent in only three years (figure 4). The reduction in consumption has brought clear 90 Public companies benefits for the utilization of installed capacity. 80 The change in consumption is not a direct 1998 1999 2000 2001 effect of privatization. But it is an indirect one, since the adjustment of water rates was a pre- Source: Chile, Superintendency of Sanitary Services. condition for private investment in the sector. W A T E R S E R V I C E S I N C H I L E C O M P A R I N G P R I V A T E A N D P U B L I C P E R F O R M A N C E A management gap emerges Although privatization may raise user rates in Although private investors took over water and the short term, the efficiency gains from supe- sanitation companies less than two years ago in rior private management will translate into most cases, efficiency differences have already lower rates in the long term as long as the rate become apparent. While private companies setting system allows an expeditious transfer of viewpoint have improved their performance on four com- efficiencies to final prices (as the Chilean system mon indicators of efficiency, public companies does). But the issue of short-term hikes in water have seen their performance worsen on all of rates should be dealt with carefully, for it may is an open forum to them (figure 5). become a significant political obstacle to priva- encourage dissemination of A comparison of labor productivity is even tization. Surprisingly, in Chile a social consensus public policy innovations for more dramatic. While public companies reduced has emerged that has made the higher water private sector­led and theirworkforcebyamere5percentin1998­2001, rates acceptable given the improvements in serv- market-based solutions for private ones slashed their staff numbers by more ice quality and the addition of new services such development. The views than 30 percent--even while expanding their as sewage treatment. But a similar consensus published are those of the client base by more than 6 percent (figure 6). may not arise in countries with less cultural and authors and should not be Still remaining to be explained is the differ- social acceptance of privatized public services. attributed to the World ence in outcomes for unaccounted-for water. The companies that were privatized were Bank or any other affiliated From the data, one could easily conclude that already among the most efficient water and san- organizations. Nor do any of public companies have been more efficient in itation utilities in Latin America (public and pri- the conclusions represent managing their water losses (figure 7). But the vate). The results of the comparison show that official policy of the World opportunity cost of the water lost becomes a key further improvements were possible beyond this Bank or of its Executive issue when deciding how to deal with apparently superior performance. Directors or the countries unaccounted-for water. As noted, the largest they represent. water companies remaining in state hands are those in northern Chile, where water is scarce To order additional copies and thus very expensive. Under circumstances Note contact Suzanne Smith, like these, taking direct measures to reduce Chile's Superintendency of Sanitary Services makes managing editor, water losses is probably the most cost-efficient Room I9-009, general, detailed, and performance information on water way to control unaccounted-for water. By con- The World Bank, and sanitation companies available online at http:// 1818 H Street, NW, trast, where water is more abundant, the most www.siss.cl. And the Superintendency of Corporations and Washington, DC 20433. efficient way to deal with water losses may be to Insurance Companies makes financial statements of buy more water rights. publicly traded water and sanitation companies available Telephone: online at http://www.svs.cl. 001 202 458 7281 Conclusion Fax: Perhaps the most notable finding of this analy- 001 202 522 3480 sis is not the obvious differences between private Email: and public companies, but the speed with which ssmith7@worldbank.org those differences emerged. Private equity appears to provide a powerful boost in meeting Copyedited and produced by the investment needs of a highly capital-inten- Communications sive sector such as water and sanitation. The Development Inc. investment gap between the private and state- owned companies has become so evident that Printed on recycled paper the remaining companies will probably be pri- vatized in the long term. Not least among the reasons will be the smaller aggregate size of the state-owned companies, which will make it diffi- cult for them to exert the necessary pressure within government to get their capital require- ments approved. T h i s N o t e i s a v a i l a b l e o n l i n e : h t t p : / / r r u . w o r l d b a n k . o r g / V i e w p o i n t / i n d e x . a s p