The Needs of the Pooy in Infrastructure Privatization: The Role of Universal Service Obligations O. Chisari, A. Estache and J. J. Laffont 4 December 1997The Needs of the Poor in Infrastructure Privatization: The Role of Universal Service Obligations December 1997 . Chisari, A. Estache and J.J. Laffont This note discusses how universal service obligations (USO) built in privatization contracts can be used to reconcile social concerns with competition and private sector financing of infrastructure Many would agree that anybody should be entitled to_access a minimum supply of affordable water, electricity, transport and even phone services addition to the obvious individual direct benefits to the poorest, this right also generates gains to society as a whole. Better access to water and sanitation reduces the incidence of water-borne diseases and improves labor productivity for instance. Similarly, a new road or basic phone services can lead to commodities otherwise unavailable or provide new employment opportunities.! This are some of the reasons why the scope of responsibilities for infrastructure monopolies often include universal service obligations (USO). What exactly are USO? USO can be defined as the obligations imposed on the provider of infrastructure services 10 ‘ensure anyone in their service area the access to af “alfordabte Tminimum level of a standard quality service bundle. This is not Wecessafily access to the network which would be a more specific requirement. This distinction is important in the case of water for instance, where alternative technologies can be more effective ways of meeting the needs of the poor. ‘A. major source of concem for potential investors is that sometimes “affordable” meansat_a price that_may not necessarily jelivering the service. ATS0, the precise definition of the range of services to be covered through the obligation varies from sector to sector and from country to country. It can also vary in terms of the main beneficiaries of the USO. It may address spatial or geographical differences, specifying for instance that rural areas or inner cities are to be serviced just "in the specific case of telecoms, universal service ‘obligations also increase the benefits of using the network since the larger the number of people connected the larger the potential benefit each user of the phone can enjoy. to these like richer urban areas. The USO is then said to be aiming at benefiting high cost-customers. It can also be focusing on criteria more related to the income level of the potential users or to specific demographic or institutional characteristics (retirees, schools, hospitals). Low income groups for instance cannot necessarily afford the connection costs to a water main at prices that other income groups can afford. Moreover. they typically cannot borrow cither-- because of capital market imperfections in many developing countries-- which further limits their access Reconciling social and efficiency concerns The desire and the possibility to meet the social objectives should not_di iniroduction— of competition and the widespread privatization of infrastructure. It only requires new mechanisms to ensure the participation of the private ‘operators the government wants to see compete for the right to deliver these services. These mechanisms, including the choice of the regulatory regime, have to be designed to provide the private operators enough incentives to invest in activities they may otherwise have considered not profitable enough for the expected risk level, including, the delivery of services to the poorest. A regime, such ‘as a pure price cap for instance, shifts all the risks, including those from the obligation to cover users. When a large share of the clients are poor, private firms often argue that they face higher levels of commercial risks and hence demand a higher-return. A. cost-plus regime allows the private operators to pass ‘on risks and any associated cost onto the users and it is then only a matter of designing the appropriate tariff structure to ensure that the poor have access to affordable services.USO. In fact, to avoid political problems, governments sometimes impose uniform pricing requirements as a complement to USO, explicitly impeding price discrimination and implicitly imposing subsidi The resulting average pricing approach may be sufficient to ensure that the operator does not make losses in the delivery of the service but implies st_users (those who need new connections, often the poor) are subsidized by low cos users (those who already have conne tions, often the middle and upper class or the businesses) which often leads to political tensior Unfortunately, the international experience suggests that the sross-subsidies are often_poorly ned and typically f sing and expansion goals, The typical suggestion made by economic advisors is tO reject the use of crosse subsidies as well and to pay a targeted subsidy financing a life line to the poorest beneficiaries of the USO. But this only works if the govemment has the ability and the resources to manage a life line program If a private company cannot rely on price discrimination and targeted subsidies, it will typically ee comimiersial risk, The excluded potential clients are “TIOST Tikely to be the neediest in the population. In sum, in countries in which the tax system cannot be relied on to finance well targeted subsidies, some degree of difficult 10 avoid. The first suggestion often made is to differentiate between new users and existing users so that only new users pay for the new connections. But this is offen politically difficult and is untikely to help much the poor in developing countries. They are likely to represent the largest share of new connections and. the concessions contracts seldom recognize that this fact can influence the commercial risk faced by the investor. For instance, the concession contract for the delivery of water and sanitation services in Buenos ‘Aires in Argentina says that the concessionaires of the 30-year long concession has to spread the recovery of its connection costs over two years or more. The financially rational decision for the concessionaire was to recover these costs in exactly two years, The concessionaire is however being forced to reconsider. Many of the connections neighborhoods and many poor_cannot_afford_the connection tariff recovery of the investment cost, This connection tariff would indeed represent about 20% of the monthly income of the poorest. This is one of the items in an ongoing renegotiation of the concession contract, between the government and the private investor new are in poor Many governments are also. considering financing USO either through sector specific levies on users or on operator sh oorest_or distortions due 10 cr0ss~ subsidies_Some countries are also now discussing the possibility of introducing various types of se specific funds. A recent report by Cremer. Gasmi and Laffont provide detailed examples from many OECD countries in all sectors. In Argentina, a sector specific levy finances the expansion needs in distribution and transmission in the poorest provinces. The telecoms sector is the one in which USO are most commonly funded out of sector specific funds or fees. In Australia, the costs is divided among the participating carriers in proportion to share of timed traffic. A similar fund has been under consideration in France. electricity Minimizing the costs of USO To minimize the financing requirements, reformers are also trying to minimize the costs of USO from the beginning of the reform process. This means essentially that in regions in which government financing of USO costs will be as unavoidable as the need to rely on the private sector to deliver a service, the concessioning of the service must be designed to minimize USO costs. There are several ways of doing” this. ‘One approach currently under consideration in Peru is the design of an_auction of the rights to use a “spectrum, The service and the related obligations will bbe awarded to the bidder asking for the lowest subsidy to meet the USO. A similar idea was initially considered for the concessioning of freight rail service in one the poorest regions of Brazil. The need for subsidy in that case was eliminated by a reallocation of idle public assets from regions that could be concessioned for a positive profit to that poor region. This asset reallocation was sufficient to lead to an