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«Organisation de Coopération et de Développement Économiques the OECD Advisory Group on Privatisation Twelfth Plenary Session in co-operation with ...»

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Organisation for Economic Co-operation and Development

Organisation de Coopération et de Développement Économiques


OECD Advisory Group on Privatisation

Twelfth Plenary Session

in co-operation with

the Finnish Ministry of Industry and Trade




Pablo Serra

Helsinki, 17 - 18 September 1998


Helsinki, 17-18 September 1998




Summary In Chile most telecom and electricity companies were privatised between 1985 and 1989. Prior to privatisation, new legislation opened all services to competition and established tariff regulation based on marginal-cost pricing in simulated efficient enterprises for services that were provided under insufficiently competitive conditions. Privatised companies have substantially improved their efficiency, but problems inherent to incentive regulation have prevented efficiency gains from being fully passed on to consumers.

This situation has led to high rates of return in firms providing regulated services, with significant price reductions occurring only where competition has emerged. The Chilean experience shows how hard it is to achieve competition when a privatised public monopoly retains a large share of the market, especially when competition regulations are few and lax.

Privatisation came to a halt at the beginning of the 90s. The first democratically elected government after the military regime, which took office in 1990, did not have the privatisation of utilities as one of its priorities, and it was left to the subsequent administration to restart the privatisation process. Between 1994 and 1998 the majority of state-owned transportation companies were transferred to the private sector and electricity privatisation was completed; water companies are now also starting to be privatised. Since 1994, several construction projects in airports, highways and tunnels have been put out to tender, and the franchising of public ports is expected to start soon. There is not yet sufficient evidence to make an assessment of this process; however, the initial projects have suffered from the “so-called” winner’s curse.

* Pablo Serra is a professor at the Center for Applied Economics, Department of Industrial Engineering, University of Chile, Cassilla 83-D, Santiago, Chile. This article builds on an earlier paper co-writtenwith Eduardo Bitran (Bitran and Serra,1998), and has benefited from the able research assistantship of Daniel Hojman.

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II. Introduction The military government (1973-1990) carried out three rounds of privatisation. Between 1974 and 1979 the government privatised all enterprises that had been nationalised or simply confiscated by the socialist government (1970-73), except for the utilities. However, many of the privatised firms fell back into government hands during the severe economic crisis of 1982, as either their owners were unable to continue servicing the debt they had acquired when buying these enterprises, or the government decided they were too important to go bankrupt. In the second wave of privatisation (1984-1985) these firms were re-privatised.

The third round, which took place between 1985 and 1989, focused on the so-called traditional public enterprises, i.e. companies set up by the State itself along with utilities that had been nationalised by the previous government (Bitran and Saéz, 1994). According to government figures, total proceeds from the sale of shares in such enterprises between 1985 and 1989 amounted to US$ 2,571 million, at December 1995 prices (see Table 1).

The first government elected after the military regime (1990-1994) virtually stopped the privatisation process. In 1990 it sold minority shareholdings worth US$ 42.3 million in utilities that were already under private control, and between 1991 and 1993 it sold 48% of the Zona Franca de Iquique tax-free zone for US$ 32.2 million, as well as its remaining 27% holding in the national airline. The second elected government, which took office in 1994, gave new impulse to the privatisation process. Between 1994 and 1998 transfers to the private sector included a shipping company, two railways in the northern part of the country, the freight railroad in the central zone and a mining company. In addition, privatisation of the electric sector was nearly completed. Total revenue from privatisation amounted to US$ 1,073 million up to December 1995 (Table 2). The government is currently preparing privatisation of the water sector, which will start by the end of 1998. Since the authorities were not totally satisfied with the way the regulation of privatised utilities was working, they strengthened the regulatory framework for the sector before privatising, with legislation setting a lower limit of 35% on the State’s participation in water companies once privatised. This limit will be phased out, however, as the government will not participate in capital expansions.

The Government has been looking at ways of expanding the role of the private sector in the economy. In 1992 a new concession law was passed allowing the private sector to finance, construct and operate highway and airport projects. Since 1994, several construction projects in airports, inter-urban highways and tunnels have been auctioned through build-operate-and-transfer concessions amounting to over US$

3.3 billion. In 1997, a law was passed permitting the franchising of public ports, and the bidding process is expected to start during the first half of 1999. At the same time, four private ports have been developed in the central-southern zone of the country for general freight (Ventanas, Lirquén, Coronel and Corral), in competition with state-owned ports and half a dozen privately owned specialised ports.

The main force behind privatisation during the military regime was its preference for a small State. There was widespread dissatisfaction with the performance of the economy before 1970, and the economic advisors to the military government attributed the low growth rates of previous decades to the State’s involvement in all areas of the economy; most economists were critical of the entrepreneurial role of the State. The inefficient operation of state-owned enterprises had resulted in significant losses. Political meddling usually led to significant labour rigidities: it was almost impossible to dismiss low-performance workers, especially if they were political appointees. It was also difficult for state-owned utilities (SOUs) to suspend services to customers who did not pay their bills, or penalise the theft of services.


Helsinki, 17-18 September 1998 Utility privatisation was conducted through three mechanisms. The first was the auctioning of whole companies or controlling shares packages to the highest bidder. The second mechanism was the sale of non-controlling shareholdings on the stock market, and the third involved the direct sale of stock to the workers of privatised companies, public employees, and small investors − so-called labour and popular capitalism. Workers and public employees were able to finance the purchase of shares with the advance payment of severance benefits and loans from public institutions at subsidised interest rates. Private pension funds, which started operating in 1981, actively participated in the privatisation process through the acquisition of share packages on the stock market. Privatisation was also carried out though a mechanism that involved giving shares in return for the financial deposits users had to make to connect to public utilities (Bitran and Sáez, 1994).

Why were public utilities privatised last, and why are water and sanitation companies still state-owned?

There are three reasons for this. Firstly, the military government saw these industries as strategic − particularly telecommunications. Secondly, it was afraid that their privatisation would generate opposition from workers and the public in general. Thirdly, the privatisation of utilities, which had traditionally been considered natural monopolies, raised certain economic and social issues, for which new regulatory legislation had to be introduced and regulatory institutional capacity developed prior to privatisation. The new legislation establishes total separation between the regulatory function and service operations.

Previously, regulation, operations and to some extent policy-making were all in the hands of the SOUs.

Accordingly, for each utility a regulatory body was created, which in general terms is responsible for granting licenses, calculating charges for services provided under insufficiently competitive conditions and monitoring service quality. More recently, the regulatory bodies and the anti-trust institutions have been working on the design and enforcement of competition regulations. The antitrust system had been modified in 1973, with the introduction of new legislation. Decree Law 211 (1973) classifies as an infraction any act tending to impede free competition. The Decree established three agencies in charge of defending and promoting free competition: the two Antitrust Commissions known as the Preventive Commission (Comisión Preventiva) and the Resolutory Commission (Comisión Resolutiva); and the National Economic Prosecutor’s Office (Fiscalía Nacional Económica). The President of the Republic appoints the National Economic Prosecutor, or Fiscal. Each of the two antitrust commissions has five members, who hold unpaid office for a two-year term.

What have been the effects of privatisation? In the first place, privatised utilities have significantly expanded their services. Telephone density increased from 4.7 in 1987, the year before privatisation of the main local phone company, to 20 in 1997, with the waiting list for local phones being cut from 232,000 to 97,000 over the same period. Outgoing international calls, which in 1987 amounted to approximately 21 million minutes, had grown to 300 million minutes by 1997, while the mobile telephone system, which began operations in 1988, could claim about 650,000 subscribers by mid-1998. Domestic electrical power generation increased from 7,420GWh in 1987 to 13,325 GWh by 1997.

This rapid expansion of privatised utilities can be explained by the relaxation of financial constraints faced by public enterprises; fast economic growth —a doubling of GDP between 1988 and 1997— to which privatisation itself has contributed; and a comparatively stable and impartial regime of contract law for privatised utilities (Levy and Spiller, 1994). Regulatory systems that grant too much discretion to regulators may not generate the high levels of investment and welfare expected from privatisation, as private utilities would invest less than the optimal amount in order to reduce their exposure to administrative expropriation. On the basis of the 1980 Constitution, decisions and rulemaking by

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regulators are subject to judicial review. Such arrangements are credible because the country has a long tradition of judicial independence in these matters.

Another positive effect of privatisation has been a substantial increase in the productivity of privatised utilities. The largest electricity distribution company managed to cut energy losses from 19.8% to 8.3% and raised the number of clients per worker from 376 to 703 between 1987 and 1997, while in the largest generating company, GWh generated per worker went up from 2.2 in 1989 to 7.9 in 1997. The privatisation of telecom firms has also led to substantial improvements in their internal efficiency, as exemplified by the number of phone lines per worker in the largest telecom company which rose from 74 to 347 between 1987 and 1997. Thus, privatisation has led to a tremendous labour productivity increase, explained partly by the outsourcing of certain activities.

Private-sector managerial capacity and technological advances, especially in telecommunications, explain labour productivity gains. The isolation of public services from political pressures has also helped to improve performance indicators. Last, but not least important, is the setting up of a regulatory system that encourages efficiency (Levy and Spiller, 1994). The Chilean price-setting system attempts to correct the main problems of the rate-of-return approach, by explicitly separating prices from firms’ actual costs. The legislation defines rate-setting schemes based on marginal-cost pricing in simulated efficient enterprises.

The new legislation attempts to provide incentives to efficiency, by separating rates from firms’ actual costs.

After two rate reviews, the prices of regulated services do not reflect the huge productivity gains that have been achieved since privatisation, charges have fallen dramatically only in sectors where competition has emerged. Regulated local phone rates have risen by about 16% since privatisation, whereas prices on long-distance phone calls have fallen by over 50% since deregulation in 1994. Moreover, the arrival of new mobile phone operators with the introduction of the PCS system in March 1998 cut charges by about a half. In the central zone the price of electrical energy, which is supplied by various generators, has fallen by 37.4% from US¢ 4.65 per kWh in April 1988 to US¢ 2.91 per kWh in April 1997 in constant April 1997 dollars. In the same period the regulated distribution price has come down by only 11.4%, from US¢

14.73 per kWh US¢ 12.16 per kWh, despite the fact that the generation price accounts for about 50% of total cost.

Table 3: Rate Of Return On Equity In The Largest Firm Providing Each Service: 1987 And

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Source: Compiled by the author from companies’ annual reports.

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