The key arguments for private commercial involvement in water are simple: to use the marketplace to boost investment and enhance efficiency at lower public cost. Many cities, particularly in the developing world, urgently need to stop water infrastructure deterioration, promote efficient and sustainable water use, and generate revenue for needed investments. But given the essential nature of water and the need for the public to feel assured about safety and access, how far should private participation be allowed to go?
Despite the rise in private sector participation in the water sector worldwide over the last decade or so, it is estimated that still little more than 5% of the world’s population is provided with drinking water through private operators. While the nature of private sector participation may range from partial financing of investments to a major role in the operation of services, in most cases it involves managing some services while the public sector retains ownership of the system.
This is broadly the picture within the OECD area, although there has been a shift in emphasis from government as provider of water supply to a role as regulator. There is a broad range though, from some private involvement (the case for most OECD countries) to fully private. Water supply in France, for instance, is in public ownership, but management is a mix of public and private systems. The French municipal authorities act as economic regulator. This compares with the UK where ownership is private, as is management, while the economic regulator, Ofwat, was set up as an independent body. The US has a partpublic, part-private ownership structure. And even where there is extensive public ownership, it has become more common to set up “parastatals” or state-owned enterprises, with a large degree of financial and institutional independence.
All these arrangements have their advantages and disadvantages, but their common point is that the government always retains responsibility for setting and enforcing performance standards. Water services are widely accepted as a natural monopoly, and so their provision and maintenance requires close policy attention, including a high degree of regulation. And while water supply systems remain largely publicly owned, management is increasingly being shared with private operators, though on top of this, many governments have also focused on creating operating environments in which civil society becomes more involved, too.
Private involvement would not be needed, of course, if public management was perfectly efficient and rich in financial resources. Conversely, beyond the importance of safeguarding public interests, private business would not have to be tightly controlled if there were no danger of market breakdowns, price overruns or, indeed, corporate governance failures. Partnerships should overcome the shortfalls, with each partner concentrating on what it does best. The ideal partnership is to have an efficient, lean government vigilantly overseeing a water market operated by transparent, responsible businesses backed up by good practices and scientific and management expertise. The bottom line is for business to improve water supply and for governments to assure the public interest. This means water will always be subject to effective public intervention and scrutiny.
If governments ignored private sector involvement completely, they would probably forgo technical and managerial expertise, capital injections and greater efficiency. Involving business in, say, management is likely to increase responsiveness to consumer needs and preferences.
But while private participation is evolving in the OECD area, there appear to be obstacles to greater business involvement in water in non-OECD countries. Indeed, several water sector projects with private sector participation are in crisis, often due to the difficult economic situation in the host country. Worse still, the number of projects with private involvement is in decline (see graph) and investment flows have been slowing.
The causes of this appear to be systemic. Businesses and many government officials agree that weak regulatory set-ups are mostly to blame, together with a lack of political support for private sector participation, for instance. Other barriers on the list often include a need for long-term debt finance, low returns on investment, fragmented deal size and poor contract structuring. There may be an inappropriate allocation of risks between government and business, or problems caused by the creditworthiness of government hosts. Government thinking about involving private firms in improving water provision and operations would do well to consider several points.
First, it requires a change in behaviour. Government stops being the day-to-day manager and becomes the overseer of the work. Making this shift is not easy for many governments. Also, investors scrutinise the government’s regulatory capacity. If this capacity is weak and creates uncertainty, private capital will not flow in, particularly if the investment looks less attractive than competing opportunities elsewhere. In other words, governments must remain involved, but differently.
A second issue concerns water charges. These are often too low to support major private investments. Many governments sell drinking water at prices well below the cost of providing the service. In some cases, this is to ensure that the basic needs of all citizens are met, in others it is to avoid unpopularity, even civil unrest. But the truth is, the price rarely reflects economic realities. For sanitation services and raw water abstraction the prices are usually even lower. For potential private investors, the conclusion is simple – depending on how low revenue streams are, they will either not engage in the project, or adjust the level of investment, thereby reducing the attractiveness of any partnership.
Yet, water users are often more able to pay for many services than their governments think. Drinking water is a basic need and most ordinary people in cities already pay something to get it; even slum-dwellers are known to buy clean water from vendors. In fact, poorer, non-networked urban neighbourhoods often pay more for their drinking water than wealthier areas do. Government charges mostly do not reflect demand and governments do not realise that the potential revenue streams are sufficient to interest private investors in drinking water services over the long term.
Difficulties arise for other parts of the water cycle though, particularly wastewater collection and treatment. While people are often willing to pay to have sanitary waste removed from their residences, they often value this service lower than access to clean drinking water, even if the healthcare costs of this choice might be high. Still consumers typically place less value on treating sanitary waste once it is taken away.
Ensuring that all citizens have access to clean water, regardless of their ability to pay, is a key goal for most governments and an important prerequisite for the success of private sector participation. Business ventures can help to achieve that goal, but in many cases, insufficient measures to accommodate the poor have undermined social acceptance of private participation, contributing to the collapse of the underlying project.
Also, governments that feel they must subsidise the costs of water for the poor have to do so in a way that bolsters income flows. Simply applying universally lower fees for water use would not work. If water rates need to rise as part of water service reforms, public funds can help ease the transition. And governments can also provide retirement, relocation or retraining support for employees that might be affected by any shift to private investment. If properly handled, investors can be persuaded to carry some of the temporary costs of transition if they feel confident about the long-term returns.
But in most cases, business costs and risks are often simply too high. Apart from the high capital costs and the prospect of modest revenue streams, there are high upfront transaction costs, as well as issues like sovereign and financial market risks. Hence the attraction for private businesses to engage in lower-risk forms of participation, such as management or leasing. These options leave most of the responsibility for the heaviest financing with the public sector.
Governments and users often find it hard to minimise risks to attract investor interest. Clearly, private investors have to meet those costs they are best suited to manage, such as construction costs, treatment plant performance and billing. However, other risks, like foreign exchange and political or regulatory risks, are more properly assigned, to governments.
One point about private water operating companies is that they are limited in number. Nor will they have an unlimited capacity for investments. Most governments understandably aim to attract large international water companies in the hope that these one-stop shops can meet all investment needs, including the kitchen sink. But these firms want to concentrate on the largest, most potentially profitable opportunities – typically municipalities of more than 500,000 people. Governments should spend more time studying the role that the local private sector could play in providing water services.
Once a business partnership is in place, the job is far from over. All good partnerships require work and governments have to constantly tend to them. Their municipalities have to set infrastructure performance standards to reflect local needs and demand. Customers, environmental advocates and raw water users will continue to look to governments to set and enforce standards for pollutant discharges to surface and groundwater. Neglecting their demands would not just hurt social objectives, but undermine the business project, too.
The levels at which standards are set will naturally have cost implications. So, a realistic balance has to be struck between customer and environment protection and the need to maintain affordable water services. But health must be a priority. And honesty and transparency between partners and with the public will help to maintain confidence. Public vigilance and scrutiny of private partners must be embedded in any contract; setting targets and imposing strict reporting mechanisms are vital to maintaining good governance and commitment on all sides.
Realistically, governments must shop for the form of private involvement that best fits local needs. Many models are possible and there is no universal solution. Some may decide that public-only is best, others might be attracted by independent oversight. Some private partners will be eager to take on more risk, others may prefer to start with less.
Knowing where the real limits lie comes with negotiation and experience. But the ultimate test is public response. The public’s awareness and involvement can help foster understanding and patience, as well as infuse the project with the discipline of public demand. Users will pay more for water services only if they feel it is worth it. Information and community participation are the social rocks on which all good partnerships can be built.
World Bank/OECD (2002), Private Sector Participation in Municipal Water Services in Central and Eastern Europe and Central Asia.
OECD (2001), Water Management and Investment in the New Independent States, Paris.
OECD (2000), Global Trends in Urban Water Supply and Waste Water Financing and Management: Changing Roles for the Public and Private Sectors, Paris.
©OECD Observer No 236, March 2003