Source: The Diplomat
Date: 31 August 2021
A big debate in economics and public policy is whether utilities like electricity and water should be provided by the state or by private companies. On the one hand, the argument goes that exposing utilities to market forces will make them more efficient and reduce public expenditures. On the other, should market incentives like the rate of profit be used to determine prices and investment decisions when it comes to basic necessities like water or electricity? Couldn't that reduce the incentive to invest in low-income communities, for instance?
This is obviously not a debate we are going to solve in this blog, but for what it's worth I don't think there is one single and objectively correct answer. The way that a particular place and people structure their economic system depends on a number of political, social, and historical factors that make one-size-fits-all approaches rather inelegant. The divergent experience of private water companies in Jakarta and Manila helps illustrate this point.
In the 1990s, when lightly regulated free markets had more cachet than they maybe do today, the prevailing wisdom was that privatization was the way to go. You saw this quite clearly as many utilities in emerging markets were fully or partially privatized, often with support from the United States or the World Bank. Jakarta and Manila were two such cities where the provision of municipal water was turned over to private companies in the 1990s.
In 1997, metro Manila offered private companies the opportunity to bid on a pair of municipal water concessions. The winning companies, Maynilad and Manila Water, both secured their bids by offering very low tariffs. Too low, it turned out, to be commercially viable, and when the Asian Financial Crisis hit it further constrained their ability to invest in necessary capital improvements. Maynilad struggled financially and was taken over by Metro Pacific Investments Corporation in 2007.
The solution, eventually, was to raise water tariffs. Since the system was privatized, rates have steadily risen over the years, but so has service coverage. According to their 2020 Annual Report, Maynilad achieved 94.3 percent service coverage in its operating area, up from 58 percent before privatization. The company has been consistently profitable, paying nearly 11 billion Philippine pesos ($221 million) in cash dividends from 2017 to 2020 while investing 41.5 billion pesos ($834 million) in system upgrades over the same time period. It had about $1 billion in equity in 2019.
This is basically what proponents of privatization envisioned: The utility earns a decent return and more people have access to water. Of course, consumers bear much of the cost of improved service but that's all part of the privatization trade-off. It is not, however, a trade-off everyone agrees with and President Rodrigo Duterte threatened to jail and sue officials from the water companies during a dispute over rates in 2019. That spat appears to be settled now, and Manila seems committed for the foreseeable future to continue supplying municipal water via private companies, with operating and capital expenses passed through to customers.
Privatization played out differently in Jakarta, where in 1997 two water companies were also granted 25-year concessions to supply water. Since then they have gone through numerous ownership changes and divestments, and made little progress in expanding service coverage or increasing efficiency. According to the Jakarta Post, after nearly two decades coverage had reached only 59 percent, with average water prices pretty similar to those in Manila. The water companies were eventually sued for failing to meet their contractual obligations and the court ruled against them, which you might think would be the end of Jakarta's experiment with water privatization. Yet even now, there appears to still be some confusion over what will happen next.
What we do know is that after almost 25 years of privatization, Jakarta's municipal water system has responded poorly to market incentives, with little success in expanding access or controlling user fees. Manila, on the other hand, saw fees go up under a market-based scheme but so did access to water service and investment in capital improvements. That these two cities experienced privatization so differently hints at my broader point, which is that sometimes markets are a good solution, and sometimes they aren't.
The 1990s were all about privatization as an efficiency-enhancing mechanism but also as a kind of universal ideal that could be applied with a broad brush to many countries facing many different kinds of challenges. The failure of private water companies in Jakarta doesn't tell us conclusively whether utilities should be public or private. What it does tell us is that we need to do a better job understanding when and under what conditions to apply market-based mechanisms, and also when not to.