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Early Warning System Special Edition

The Privatisation of Natural Monopolies

This Report ushers in a series of specialised reports designed to give national voices an important contribution to the development of BiH and on meeting the challenges of 2015. We hope you enjoy them. Moises Venancio

Deputy Resident Representative UNDP Bosnia and Herzegovina 1

FOREWORD
The question of privatisation continues to generate much controversy in Bosnia and Herzegovina. Certain powerful stakeholders, not least the international financial institutions, are lobbying hard for the rapid transfer of various public enterprises to the private sector. On the other side of the debate are strong national voices advocating for a less radical and more considered approach. For this section of opinion, privatisation is far more than a narrow financial process, but one which has very considerable social and economic risks. This special Early Warning System (EWS) Report reviews this ongoing policy dispute in the context of the so-called 'natural monopolies' given by the water, telecommunications and electricity sectors. Like other industries, the case for their privatisation is justified in terms of improved economic efficiency and ensuring the success of other transition reforms. Yet these particular enterprises are special. First and foremost, because natural monopoly status brings with it certain production and delivery 'realities' that fundamentally constrain the potential for competition. In short, the bulk of these industries are monopolies by definition and not by policy choice. This has the effect of limiting both the scope of the efficiency gains to be had, and the contribution private, as opposed to public, ownership can make to the transition process. Second, each of the sectors has a distinctly strategic character; their strength is central to the performance of economy, and they constitute national assets of some considerable value. Transfer of ownership inevitably carries with it inherent dangers and pitfalls, both for ordinary citizens and the country as a whole. The debate over these matters is also somewhat coloured by the failures of the existing privatisation process in BiH, and it is worth noting that surveys of public opinion, point consistently to widespread and growing levels of disquiet and cynicism. This is unsurprising given that the wider transition reforms have taken place with little regard to the social impacts of change, whilst also, certain large privatisations have spurred a series of allegations, if not clear instances, of impropriety and corruption. Moreover, there is an ongoing absence of accountability for the privatisation process. We have seen national experts blaming the internationals for the introduction of wrong laws, weak responses to requests for assistance, and the introduction of voucher privatisation schemes which have already proved a disaster in many other transition countries, and in turn the internationals blaming the nationals for the tardiness of decision making and the eventual options selected. The bottom line is that neither party has accepted, nor seems willing to assume responsibility for these activities. This report, which has been prepared by a high level group of national academics and policy advisers, carefully reviews the evidence from both within BIH and around the globe. It concludes in favour of an 'eclectic' approach to privatisation; this position neither rejects the potential benefits nor accepts them uncritically. It recognizes that a variety of alternative models exist for managing these industries and that a non ideological, case by case approach, should be taken which brings the wider social and longer term consequences into the decision making process. To quote George Bernard Shaw, 'the only golden rule is that there is no golden rule' and this most definitely applies when it comes to the scope and nature of privatisation. The history of these reforms throughout the former socialist world is neither a happy nor a successful one, and it would be a great pity if policy makers in BiH repeated the well-documented mistakes which have been made. Yet this remains a very real danger, so long as we, the politicians and the international community, continue to regard ourselves as the real stakeholders, and not the ordinary BiH citizens who live with the social, economic and political consequences. Thus I close with a demand for dialogue and inclusiveness, and I commend the findings, conclusions and recommendations of this report, as a positive contribution to such a process.

Jens Toyberg-Frandzen

Resident Representative United Nations in Bosnia and Herzegovina 3

United Nations Development Programme EARLY WARNING SYSTEM

Senior Portfolio Manager Project Coordinator Review Editors Authors

Armin SIR^O Tarik ZAIMOVI] Admir SALKI] Moises VENANCIO, Deputy Resident Representative Armin SIR^O, Senior Portfolio Manager Tarik ZAIMOVI] Richard MARSHALL MSc (Econ) Tarik ZAIMOVI] Aleksandar KALMAR Ph.D. Slavo KUKI] Ph.D. Fikret HAD@I] Ph.D. Kasim TATI] Ph.D. Armin AVDI]

BH version proof-reading Translation English version proof-reading Photo & Design DTP & Layout Print For the printing house

Mufid MEMIJA Reza M. KEIVNZADEH M.A. Reza M. KEIVNZADEH M.A. Tamara KOREN Samira SALIHBEGOVI] Arch design d.o.o. Esad ]ESOVI]

Although publication of this report is supported by the United Nations Development Programme (UNDP), the opinions stated in this Report do not necessarily reflect the official position of the United Nations Development Programme (UNDP) 4

EXECUTIVE SUMMARY
This report examines the case for the privatisation of the so-called 'natural' monopolies in Bosnia and Herzegovina, specifically the Electricity, Telecommunications and Water Sectors. It is argued by many mainstream economists, that the presence of state owned monopolies in transitional economies 'locks-in' inefficiencies and impedes the progress of other essential reforms, including liberalisation and restructuring. Thus in BiH, as elsewhere in the transitional world, the clamour for privatisation has become a 'mantra' of the Bretton Woods institutions and other influential voices within the international community. But is the case for privatisation as solid as is claimed when applied to cases of 'natural monopoly' where the patterns of production and supply, mean that the potential for competition, the key ingredient for securing economic efficiency, is extremely limited? Indeed, some form of monopoly in these sectors seems both inevitable, and arguably the most 'efficient' outcome. The privatisation process implies, in the case of these industries, the transformation of a public monopoly into a private one. Furthermore, a review of the empirical evidence of past privatisations in the transitional and developing worlds gives few grounds for optimism. As the research for this report shows, time after time, privatisation programmes have failed to live up to their promised economic pay-offs, and have at the same time contributed to significant social dislocation, felt in terms of bankruptcies and unemployment. Yet, the history of privatisation within the advanced industrial economies of Europe and North America has yield somewhat better outcomes. Moreover, it is not true that all sub-sectors of the industries examined in this report constitute 'pure' forms of natural monopoly, and thus competition in theory at least, should be both possible and beneficial. This added to the potential for the introduction of overseas management experience and crucially, capital investment, underlines the reality that a dogmatic stance against all forms of privatisation is ill-advised. Indeed, there is no doubt that these sectors, like others in BiH, require rationalization, investment and a fundamental reorientation in their approach to their business dealings, and the quality of service provided to consumers. However, although the report does not suggest retaining the status quo as the best solution, it also does not argue for a rapid mass transfer to private ownership either, rather it presents a series of options and models, some of which do not require the effective privatisation of public assets at all. These include using innovative partnership arrangements and measures to improve the organization, management and efficiency within the existing utility companies. Overall, a more considered and consultative process to deciding the future shape and ownership of these necessarily strategic industries is recommended. The ongoing goals should be securing the maximum benefits and value for BiH citizens both in the short and long term, whilst also minimising the costs and inherent risks It is concluded at the strategic level that: A consensus needs to be established on the objectives and goals of privatisation, and the commitments to be sought from potential new owners and operators. The strategic long-term interest in some of these areas must be a major decision-making factor and future position of BiH in the region. That the process should be properly phased and well managed; ensuring that appropriate and socially responsible restructuring takes place prior to the transfer of ownership; and that tough regulatory structures are put in place to protect both the interests of the state and citizen, as the current owner of the assets in question. That all sectors, and the conduct of all operators, state, municipal and privately owned, should be regulated by strong and independent agencies, in the interests of the consumer. And this is a fundamental prerequisite of the wider liberalisation process. A variety of forms of ownership and management arrangements should be considered, including models of partial privatisation (of sub-sectors and certain functions) and schemes in which majority and/ or effective ownership remains within public hands. These include various partnership mechanisms (public-private and public-public), management contracts and operating concessions. 5

And at the industry level: For the Electricity Sector; restructuring to be followed by the privatisation, using a mixture of methods, of the distribution companies as regional concessions, recognizing that some may remain in public ownership. Retention of existing power generation, in state ownership as a strategic longterm export resource for BiH. With the privatisation of unexploited potential, to be done on concession and time limited basis. And for the transmission mechanism, which represents a 'pure' natural monopoly to remain as a state owned, but arms-length, managed entity. In the case of the Telecommunications; the report acknowledges that technology has done much to permit effective competition to operate. And thus authors conclude in favour of a more liberal approach and see no benefit for retaining the existing companies wholly in state hands, save for the need to ensure access to the fixed line networks they operate. In contrast, they find that Water Services presents the clearest example of natural monopoly, and thus should be retained in state or municipal ownership. However the authors also recognize that this sector would benefit from the introduction of modern and commercial management practices; and that there is a desperate need to make substantial new investment in infrastructure. Therefore, it is concluded that there are potential benefits to be secured from management and partnership arrangements. The report is throughout, anxious to underline the political and social dimensions that surround this difficult issue. There are considerable 'knock-on' consequences, both external to the industries in question, and to the time frame typically used to appraise the outcomes of privatisation. These range from the poverty fallout of rapid downsizing, to the diminution of public accountabilities. In sum the challenges which confront us are neither simple to overcome nor short in duration. Most of all this report counsels the authorities against proceeding with unnecessary haste, or taking decisions based on a dogmatic or politicised position.

CONTENT
1. INTRODUCTION 2. KEY CONCEPTS
2.1 The Dangers of Monopoly and the Case for Privatisation 2.2 Natural Monopolies 2.3 Policy Developments: Regulation, Privatisation and Liberalisation
9 9 9 9 11 14 14 16 17 18 18 18 18 22 23 24 24 24 25 25 25 26 26 27 27 28 28 29 31 32 32 34

3. INTERNATIONAL EXPERIENCE AND THE BiH CONTEXT

3.1. Discussion 3.2. Water as a Major Local Natural Resource 3.3. Electricity Production - the potential for recovery and long term gains 3.4. The Dynamic Telecommunications Sector

4. DETAILED REVIEW OF THE KEY SECTORS


4.1. The Energy sector in BiH
Background and Key Issues Specific International experience Prototype models of organisation for the electricity sector in the transition period

4.2. The Telecommunications Sector


Telecommunications in BiH Reform activities being undertaken The current position of the telecom sector and the privatisation process The socio-economic impacts of privatisation Proposed privatisation models and reform of the telecoms sector as a task for the future What privatisation model to apply? Next Steps: priorities for the sector Government decisions on divestiture The International experience

4.3. The Water Supply System


The International Conetxt - Water as a limited resource Privatisation of the Water Sector Experience of Developed Countries Experiences from the region The Situation in BiH Recommendations

5. CHARTING A WAY FORWARD: CONCLUSIONS AND RECOMMENDATIONS

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1. INTRODUCTION
In spite of much rhetoric to the contrary, the occurrence of monopoly, or near monopoly, market conditions is far from rare in the modern world. Moreover, the tensions and pressures which give rise to such conditions are particularly strong in transitional economies, where an institutional history of state ownership is supplemented by invariably small and structurally constrained national and regional market places. The formal causes and the factors which sustain monopolistic behavior can be complex, but are frequently rooted in the domestic legal and political environment. It is argued by many mainstream economists, the 'problem' of monopoly and its claimed fundamental inefficiencies, runs in parallel to the dominance of state ownership. It is unsurprising then that in the BiH context, as elsewhere in the transitional world, the clamor for privatisation as an antidote to monopoly power, and inter alia, the elimination of economic inefficiency, has become a 'mantra' of the international financial institutions and others within the international community. But is the case for privatisation as solid as is claimed? And specifically, what is to be done about so-called 'natural monopolies', where productive and delivery (typically infrastructural) realties mean that some form of monopoly is inevitable, and the arguably the most efficient outcome? This report examines these very questions in the BiH context for three sectors which exhibit naturalmonopoly characteristics; electricity generation and supply; water and sewerage services; and telecommunications. The report has three principal parts: the first section provides a conceptual discussion of the issues; the second investigates the BiH situation in the context of relevant international experience; whilst the third and most substantial part looks in detail of each of the sectors in question. Following this, overall conclusions and recommendations are presented.

disregarding allocation and cost pressures. Operating in a competition-free environment, monopoly producers are less motivated to introduce new technological solutions, which results in reduced effectiveness, compensated for by higher prices which exceed the real value of the product. In Bosnia and Herzegovina, as was the case in the majority of transitional economies, natural monopolies are state-owned. It is generally believed that such an arrangement perpetuates inefficiencies slowing the general trend rate of growth, and discouraging positive social and institutional development of society and the economy. Thus the economic case for privatisation is bound up both with the market failures implied by monopolistic forms of production and the claimed inefficiencies of state ownership. Three principal arguments are usually advanced in support of this: The efficiency and productivity case; this come in two forms, first it is argued, that producers by adopting a profit maximization objective, minimize costs and optimize output, achieving what is termed 'productive efficiency'; and secondly, via the operation of effective competition, the system better matches demand with supply, thus consumers, producers and the wider society benefits, as 'allocative efficiency' is secured. Fiscal Gains; being the direct receipt of the proceeds of the sale of assets by the state, and the ongoing benefit of higher tax revenues or lower subsidy payments, from/ to the newly private and (as is claimed) revitalized, industries. Institutional development; being the intangible economy-wide behavioral spin-offs and values which it is argued follow mass privatisation. Problematically though, these arguments rest not merely on privatisation, but the creation of effective competition, and this is fundamentally limited in the case of natural monopoly. A proper appraisal is therefore required of each an every sector, to determine the real scope of the gains to be had.

2. KEY CONCEPTS
2.1 The Dangers of Monopoly and the Case for Privatisation
Different from other market participants, monopolists are in a position to be able to pursue price policies that ensure maximum profits,

2.2 Natural Monopolies


A 'natural' monopoly represents a situation in which the technology or the character of the industry are such that the demand can be met, achieving the lowest costs and the greatest social benefit, through the existence of a single producer. 9

Under these conditions, a key assumption is that the free entrance1 of other companies would lead to an irrational waste of limited factors of production, requiring cycles of excessive investment, which would result in excessive rivalry between companies (stimulated by a large difference between marginal and average costs). Moreover, if the pressure of excessive capacity leads to a price war, a consequence could be the suppression of prices to a level very close to the critical short-term marginal costs, which can jeopardize companies' capacities to maintain production at a satisfactory level of production, to carry out necessary adaptations and the modernization of production, and to continue offering high quality services. The basic characteristic of a natural monopoly is an inherent tendency for average costs to decline over the whole production range. This situation appears when the scale economies are so large to overwhelm normal rules of production. The main source of this tendency is a necessity to undertake extensive investment in order to meet the effective market demand2. This outcome is most clear in relation to industries requiring expensive large scale infrastructures; water, electricity, gas transmission and distribution, and telecommunications, companies must dig up the streets, lay down infrastructure and physically connect output to every potential consumer. These costs can be absolutely static regardless of the quantity of the end product produced. Thus, average costs per product or service unit will decrease disproportionately with the number of units sold. This tendency is emphasized by certain common and mutually dependant characteristics:

Fixed and essentially non-transferable physical connections between the supplier and consumer or locality; No, or very limited, possibilities to store productive output; Stringent delivery obligations, a need to meet the demand instantly, in accordance with consumers' wishes (flipping an electric switch, switching on a thermostat, or lifting a telephone receiver); Significant fluctuations in demand - both by individual consumers and the system as a whole All of these characteristics lead to a need to make large initial investments in capacity and to maintain a considerable margin of safety, i.e. sufficient infrastructure and plant, in order to meet the demands even under peak load conditions. This can be most efficiently accomplished by a single supplier, with one fixed connection to each consumer. These infrastructure or 'network economies', which are apparent in the electricity, telecommunications and water industries can lead to the formation of vertically integrated monopolies. These large firms ensure there is scope for production costs to be minimised, and secure supply (including via in some cases, the right to import supply), through transmission, and distribution networks to the end user. Yet equally, in some areas, particularly the energy sector, the precise borders between which parts of the supply chain represent natural monopolies, and which do not, are difficult to define. For example, whilst electricity transmission clearly exhibits all of the characteristics of natural monopoly, electricity generation does not.

In microeconomic analysis, a theoretical model of a monopoly is built on the following assumptions: - There is only one seller and a multitude of small buyers. A monopoly market also recognizes the modalities of a monopoly, consisting of one buyer and a multitude of small sellers, and a bilateral monopoly, where there is one seller and one buyer. - There are no substitutes or complements to the product or group of products sold by a monopoly. This assumption ensures that events on other markets have no impact on the events on the monopoly market. In other words, cross-demand elasticity on a monopoly market equals zero. - There is no freedom of entrance for new companies. The effective demand volume on the local market represents a specific form of a barrier to entrance. An example can be a sparsely populated area where there is usually only one shop in which one can buy almost everything. Opening specialized shops, considering the demand volume, would not be lucrative. "This example indicates two important things related to market monopolization: (1) a monopoly relates to the market size and (2) a monopolistic company does not necessarily have to be large" . - Both buyers and sellers are in possession of perfect (and free) information on market conditions. This assumption is least realistic but is necessary. For example, the most important thing for a monopolist is to have a complete knowledge of demand, but, at the same time, the demand schedules are the hardest to determine. Without this assumption, we would be unable to claim that a monopoly has the knowledge of its average and marginal revenue curves, and thus, that it is capable of determining its optimal production. Economies of scale can also be external for some companies. External economy of scales represent a reduction of average costs of a company in a situation of production growth, caused by factors on which the company has no influence. For example, in the case when a whole sector grows, companies have an opportunity to acquire their inputs at lower average costs.

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Natural monopolies, which dominate the infrastructure sector in any economy, are extraordinarily important. The added value they provide often accounts for considerable part of gross domestic product (GDP) while investment into infrastructure is even a greater percentage share of the total investment. Still, their importance, to a great extent, arises from the fact that their services and products are sizeable inputs for all other sectors. The two most important features of network infrastructure providers are the following: Extensive investment can pay off only over a relatively long period of time, and The phenomenon of accumulated costs make divestiture practically impossible, in the case that a decision is made to leave a particular market, the function cannot be reprogrammed and rearranged for rendering different services. By using network infrastructure, a monopoly company is in a position to use the effects of the economies of scale (the sheer scale of services rendered to end users) to amortise the costs which are accumulated by the necessarily high level of activity. This is one of the main reasons why the state decides to preserve a monopoly in the form of a public company and a reason to decide to regulate or control the business of such a natural monopoly. The state tries to preserve the advantages with regard to the potential low costs while at the same time finding adequate ways to limit the monopolist's market power; it forces them to increase production while reducing the price, in order to move closer to the manner in which a fully competitive market would function (were this option available). It is necessary to emphasise the characteristics of these sectors in order to show clearly the difficulty and complexity of the measures and activities which are directed to achieving the full liberalisation of the market and the development of competition as a mechanism to change the behavior of the existing dominant participants, and thus to secure a reduction in prices and an improvement in the quality and range of services for the end users. Network services (telecommunications, electricity, water, gas) can be either: Intermediary services, maximising efficiency in managing the traffic in the network infrastructure; and

Final services, meeting the demand of the end users of the network. It should be noted that a natural monopoly is not necessarily present in the field of services, whether intermediary or final. In fact, investment in the field of services should aim to address the sources of monopoly with regard to intermediary costs (in order to direct better the oscillations of traffic in network infrastructure) and final services (in order to adequately respond to the demands of end users, in particular businesses whose effective demand for this kind of service grows very rapidly). Flexibility of offer and short-term adjustability in the field of services are vital and suggest that the most adequate market structure would be made up of several service providers who would then be mutually competitive. It could be said, therefore, that the period when integrated monopolies necessarily managed and used infrastructure with the objective of rendering all services has passed. The appropriate future industry structure of these companies should be a compound model, where the dominant operator maintains its monopoly position in that segment of the business which is subject to the conditions of natural monopoly but is exposed to competition from several operators in other segments. Competitive operators or those proposing the introduction of services which the dominant operator does not offer, may find themselves represented only in some links of the vertical supply chain. Therefore, they have to gain access to other parts of the chain and obtain dedicated connection to the key resources, most frequently to the basic infrastructure, from the dominant operator who exclusively operates the given infrastructure.

2.3 Policy Developments: Regulation, Privatisation and Liberalisation


Natural monopolies in the sphere of infrastructure play a key role in the process of economic development and can have a considerable impact on living standards and economic growth. By the mid 1980s, a large number of underdeveloped countries relied on public monopolies for the funding and management of infrastructure3. In the mid 1990s, the world began turning to the private sector to take over the management and ownership

Assessments are that technical inefficiency in the sphere of electricity, water, roads and railways alone caused losses of about 55 billion US dollars per year in the early 1990s, which is an equivalent to 1% of the total GDP of all underdeveloped countries or a fourth of the annual investment into the infrastructure sector.

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of the existing infrastructures as well as to finance new investment4. Deciding to privatise, governments were simultaneously oriented towards economic, political and financial goals. The goals were often interdependent, yet were also sometimes in opposition. Different countries ranked some of the goals in accordance with adopted macroeconomic policy aims, some with the sectoral characteristics and/ or priorities, and specific conditions in their respective countries. Moreover, it was not unusual for a country to change the ranking of goals adopted over time. Reliance on the private sector in terms of finance and management culture was introduced with the expectation of numerous beneficial effects. The most important aspects of this were the need to facilitate access to private capital in financial markets, an increased motivation for more efficient business practices, and a reduction in demand for constrained and often meager public funds. It is worth noting that natural monopolies (with the characteristics of legally regulated monopolies) in practice unify commercial and regulatory functions of the government. And in the field of infrastructure, countries have opted for different programs of deregulation and privatisation with a view to separating these two functions5. Following the general trend of liberalisation and deregulation, and in order to achieve the best possible economic efficiency and rational use of precious resources, a large number of countries made the decision that it was necessary to ensure a much greater level of competition in the delivery of infrastructural services which was dominated by public monopolies. This encompasses following three separate processes6: Privatisation - the transfer of ownership from the public to the private sector; Liberalisation - the introduction of competition into markets which were either monopolistic or oligopolistic; and Deregulation or perhaps more accurately Transregulation - the change, or introduction of new

and independent regulatory mechanisms with a view of monitoring and controlling these markets. The expression trans-regulation is argued to be appropriate because it makes it clear that this is not about abandoning or eliminating, but about reshaping regulatory mechanisms and practices to new realities. Privatisation is a process which refers to changes to the legal form and ownership of companies in terms of the transformation from government (through the process of incorporation7) into public and finally into private hands. Indeed, process issues like the speed of transfer and the phasing of necessary legal institutional issues dominate the policy debate; best practice suggests there are a number of stages to be followed in a systematic manner. The first stage in the process of privatisation may be partial privatisation or 'commercialisation' of the enterprise, which results in greater transparency, permitting better performance evaluation of the company, increased financial flexibility, the introduction of performance-based incentives for managers (through vehicles like stock options), better corporate governance and pressure on management to realise value for stockholders (increased shareholder value) rather than political goals. In many countries, the ownership dimension of partial privatisation (disposing of a portion of the equity capital) was undertaken as a strategy to gradually introduce companies to the financial market because of the limited absorptive power of the financial markets. This was the case with many British (British Telecom, British Gas), Spanish (Telefonica, Argentaria) and Italian companies (ENI, Telecom Italia). In other cases, partial privatisation was the end of the process not an intermediate stage; Deutsche Telecom, France Telecom and Dutch Royal KPN were only partially floated on the financial markets with the State as the majority owner. This approach has some advantages and

4 5

6 7

In the period 1992-2000, the scale of investment into private infrastructure projects in underdeveloped countries amounted to over 680 billion US dollars. An important function entrusted to public monopolies was that of protecting citizens' living standards through the maintenance of low prices for services, often much below average or even below marginal costs of their production. The difference to full costs was compensated by the State through a system of the subsidies . However, an accepted conclusion in the field of contemporary welfare economics is that this policy of redistribution of revenues could be much more effectively implemented by means of direct transfers or transfer of the purchasing power or targeted subsidies than is the case with non-selective subsidies when prices of products are kept low for all buyers. A direct consequence of such an approach is reflected in the excessive use of production inputs (in particular of energy). Whilst a somewhat less obvious consequence, is that this is also reflected in the lack of funds for modernization and expansion of activities in the infrastructure sector. In this Report we will focus only on the first two. Incorporation of the British Telecom lasted nearly two years.

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the experience of certain countries, which preserved majority ownership in former public companies by selling only small packages of stock to strategic foreign investors, may be useful for Bosnia and Herzegovina. The most relevant examples are telecommunications in the Czech Republic and electricity management in Belgium. The move from the partial to final privatisation may be the most sensitive stage in the privatisation process. It must be borne in mind that a certain period of time must elapse after incorporation, a period long enough for the company to adjust to new commercial and cultural realities and working within the framework of the market economy. The company in question must go through a process of adjustment and of building new management and business structures. The fact that this period has usually taken five years in Holland tells us best how sensitive this process is. Clearly we must take note that a long period of time is required even in very stable countries with long traditions of operating liberal market economies with sophisticated demonstrates legal environments. Bearing in mind the current economic-political and legislative situation in Bosnia and Herzegovina, we must be utterly scrupulous in setting down and observing the timing and phasing of strategies to be used in the privatisation of publicly owned companies. Final or full privatisation is an obvious solution for those sectors where commercial or profit-oriented goals are more pronounced and dominant in relation to the public interest, and particularly when they can be viewed separately. When commercial goals are narrow and limited in comparison to the public interest (in particular in the area of rendering services such as health care, education, public security, basic services) advocating privatisation is far less justified. Separation of these two functions (commercial and public) in the process of full privatisation improves economic efficiency by: Eliminating traditional conflicts of interest, and the insufficiently defined and nontransparent role of the state as the owner, operator and sometimes the regulator, of a business entity8; Increasing motivation for managers to run companies in more effective ways; and Ensuring relevant and reliable information is available, about the value of the company to

potential investors and its performance by way of shares on the financial market. We should bear in mind that privatisation is often a part of a wider reform (often transition) strategy which aims to change the role of the state in the economic sphere - and thus, includes regulatory reforms, to introduce (or strengthen the existing) competition policies, in order to stimulate an increase of material and social wealth. Privatisation has interdependent and often conflicting political, economic and financial goals. The projected goals of privatisation can be summarised as follows: Changing the manner in which public companies are managed and improve their productive efficiency and business results by introducing incentives based on private ownership instead of bureaucratic supervision and control. Ensuring better access to necessary financial sources of additional investment. Creating considerable revenues for the state budget and an improvement of certain macroeconomic indicators, particularly a reduction of the public debt and demand for borrowing by the public sector. Increasing the use of equities in financial markets and the creation of a critical mass of stockholders, as well as increasing the equityownership route for the channeling of savings into the economic system. Introducing competition into markets that were closed until recently, leading to reductions in prices and an improvement in the quality of infrastructure, products, and services. However, we need to emphasize that in the context of a transitional economy, privatisation is a necessary, but not sufficient condition for improving the performance of the economic system as a whole. In a formal sense, privatisation does nothing other than change the structure of the ownership relations between market participants. However, its potentially powerful beneficial effects are manifest only when the structure of the market adapts and other reforms are progressed successfully. In other words, if we can not fulfill the above mentioned reform goals then the question arises; why privatize at all? concerns the structure, Liberalisation flexibility and openness of an industry. Key issues

In the majority of OECD countries, responsible ministries abandoned the function of managing shares of public companies regardless whether they were partially privatized later. This ensures a better separation of commercial goals (for example, returns of the invested funds)

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are whether a single company or a number of companies make up a certain sector, and the conditions under which these companies operate or are connected in some way (vertically or horizontally). The criterion of efficiency, which is relevant here, refers to the cost structure and the degree of the economies of scale. The entry of new companies competing with the dominant operator in a network economy can ensure greater efficiency so long as this competition occurs in a field in which there are not constantly increasing returns to scale, and if the entrance of new companies is accompanied by lower costs and consequently lower prices for services. When these conditions are fulfilled, a fragmented market structure would enable the adjustment of supply to the constantly changing needs of the users, expressed as a diversified, flexible and dynamic perfectly competitive market place. Market liberalisation inevitably leads to disturbances, and can result in the overlap of regulatory goals. The former clear goal of ensuring incentives to a monopoly company, public or private, is replaced by the goal of disabling former monopoly companies of abusing their still dominant position in the market - and terminating the practice of 'cross subsidy'. This is the practice of realising insufficient revenues by calculating low competitive prices (often below actual costs) in those market segments where competition is present, and cross-subsidizing by the revenues made from the sale of services at unjustifiably high prices in the still monopolised part of the market. De-regulation or perhaps more appropriately Trans-regulation is concerned with changing the governance and management of economic activity, by (but not necessarily) governmental agencies. The objectives of regulatory policy are bound-up with securing the public good in the face of competing private interests and market failures. Regulatory reform has to accompany both privatisation and liberalisation if social and economic goals are to be realized, at least in the early stages, and in the case of natural monopoly and/ or market dominance, on an ongoing and permanent basis. Best practice has shown that a crucial issue in the privatisation process is the proper phasing of reforms and policy instruments. Both empirical evidence and theory, suggest that there are very significant risks of rapid, ill-prepared programs of divestiture. To succeed in securing the potential economic and social benefits, policy makers need to ensure appropriate regulatory structures are in place and are functioning well before full divestiture takes place. Liberalisation also requires a phased
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and considered approach tailored to local circumstances; chiefly the level of competition and the presence of supportive market institutions, ranging from commercial law to modes of business conduct.

3. INTERNATIONAL EXPERIENCE AND THE BiH CONTEXT


3.1 Discussion
It has been argued that de-monopolisation, aided by the privatisation of major enterprises, will permit the restructuring process to occur in BiH. But is privatisation the best way to move ahead and in which manner? In the light of the above conceptual discussion, it is necessary to build a market that will ensure competition for the purpose of securing greater efficiencies, given by profitability for producers and lower prices for consumers, and where competition is not possible, such as in the case of natural monopolies, establish regulatory structures which result in the same desirable outcomes. Market structures and institutional changes are particularly important. In the case of the energy sector for example, two market models are possible for the production, transmission and distribution of electricity: The one buyer market model where production and transmission are managed within a vertically integrated electricity system. Under this model, production can be privatised partially or fully, without major disturbances in the system itself. The entry of new producers from outside the existing system can certainly improve efficiency, leading eventually to lower prices within a central pool or exchange system. This model builds on the discussion above, recognising that whilst transmission and distribution have 'pure' natural monopoly characteristics, production does not. The open market model presupposes a full separation of the existing units in the system. This model implies a total restructuring of production, transmission and distribution - and their complete separation and eventual privatisation. Under the open market model, vertically integrated units disappear. This model ensures competition in production and eventually in supply, which leads to greater efficacy when using limited energy resources. But, dangers do exist, not least the

threat of leaving the country without its own energy sources, and a lack of emergency capacity9. Indeed, the telecommunication sector in BiH already somewhat mirrors this model in relation to the provision of mobile telephony services, and it is one of the most liberal in the Central and Eastern Europe (CEE) region. We have three state owned operations and two of them have their own GSM and Internet operations. There is also one GSM operator linked to Croatian Telecom and DeutscheTelecom and working without the licence for more then eght years. The present independent Communications Regulatory Agency (CRA) has set a number of rules and conditions for operators (but of course, the rules and regulations do not apply to illegal operators present in BiH); they are obligated to share basic infrastructure, links, GSM space and infrastructure, and provide services to the entire territory of BiH. Moreover, the operators are required to make preparations in order to attain European Union standards and management practices. The water supply industry is in a completely different place. This sector has never been one state owned company, but smaller local monopolies that operate in municipal areas with licenses, with the authority and the responsibility to provide every household with drinking water in their limited local community areas. The privatisation of these entities would be a locally driven process and questionable when it comes the overall efficiency gains and income generated. This is unsurprising as the water supply industry is the sector which most clearly approximates conditions of natural monopoly. It is important to recognise that the questions raised by these different models of production and supply are not solely related to the nature of the ownership model adopted. Indeed, securing efficiency particularly if a wider social calculus is employed rests more on the structures and regulatory institutions which are in place. And the existence of public companies represents a certain advantage because such companies, regardless of how imperfect have some, though not guaranteed, interest in maximizing overall social welfare rather than private gain. The presence of often substantial market failures, costs and benefits external to the productive
9 10

process, termed 'externalities', make a socialised approach to provision more favorable in the context of natural monopolies. Expressed in microeconomic vocabulary, we could speak of an approximated or 'second-best' accomplishment of allocative efficiency; services are mainly ensured in the required quantities and mix; prices are calculated for end users within acceptable boundaries; and the benefits from public services accrue to the users regardless of location or supply constraints. Considerable progress in the work of public companies was made by many countries, by improving the internal management and culture of such companies10. Water supply is an example which suggests that publicly owned enterprises such as those in Holland, Japan and the USA operate more effectively than private companies in England and France. In the area of electricity, too, the results show that privatisation often does not yield the desired results. The emergence of an energy crisis in California in 2001, where it became apparent that consumers in Los Angeles were the only ones in California who were spared electricity restrictions because production and distribution of electricity in this city is in the hands of a public company owned by the city government, provides a valuable lesson. The public sector can be as effective if not better than the private sector in increasing productivity. An analysis of privatised industries at the time of Margaret Thatcher's government shows that the greatest improvements occurred before and not after privatisation. Where partial privatisation was implemented, as in the refuse collection and disposal sector, companies which remained in the ownership of local governments improved their work as much as private companies. Finnish economist Johan Willner, concluded in a study published in 2001, that political control, realised through public ownership, may lead to better economic results, in particular in those sectors which are "natural monopolies"11. In Honduras, for example, the branch trade union played a leading role in the process of successful, restructuring the water sector. It advocated the preservation of existing jobs,

11

Rumania is importing electricity produced by Rumanian power-plants and fueled by Rumanian coal. The function of managing the entrusted assets was improved by many countries by introducing the required flexibility which was so far a characteristic of the private sector. In Sweden, for example, a new government department for managing assets of public companies was established in 1999 with a mandate to govern commercially state participation in the 59 main industrial companies (including telecoms and air companies). The new department is authorized to sell stock of these companies when it is decided that withdrawal of the state from the given sector is the best investment decision. Johan Willner: "Ownership, efficiency, and political interference", European Journal of Political Economy, Volume 17, Issue 4, November 2001.

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however, the private sector commonly as a first step towards improving efficiency, reduces the numbers employed. This example indicates the fact that the current employees of public companies constitute an important resource of expertise imbued with a service ethic. State institutions in some countries have increasingly come to acknowledge this fact. Also, it is important to note that three of the most advanced and most powerful telecommunications operators in the Europe, DeutscheTelekom, Telenor and France Telecom, remain mostly-state owned. Moreover, the service provider with the best quality of service in CEE has been judged to be Slovenian Telecom which is still 67% owned and managed by the government. Examples of negative experiences of post-privatized firms include; Macedonia where Matav Telecom, 51% owned by Deutsche Telekom (following privatisation of Hungarian Telecom), increased GSM service prices to the highest levels in Europe (3 times higher then in BiH); and in Croatia, where Deutsche Telekom, after majority privatisation and restructuring, raised prices for fixed telephony by an average of 250%. One of the doubtless advantages of public corporations over private companies is that in hard times and unfavorable economic environments public companies can not simply stop operating and abandon a certain sector or segment of the market, and go in search of better profit in another sector. In the private sector, firms possess incentives to do just that12. While the private sector often cannot afford to continue providing certain services, a public company is not permitted to abandon provision. A current example is the EU telecoms market, where large operations, recovering from considerable outlays, are trying to find ways to cover their debt anywhere they can. Here, one must wonder how many of them would have been closed down had they not had government support at a time of global recession. Also, in many cases CEE Governments have been forced to intervene when weak management and foreign investors threatened the survival of telecom operations and the service provided to the local population in general. Therefore, the process of privatisation of natural monopolies, or transfer from public to

private management, can first be understood as an intention to secure direct realisation of productive efficiency which results from the care and endeavors of managers of private companies to increase their profits - in order to enlarge their own revenues - under the control exercised by stockholders and creditors. With regard to allocative efficiency, this is partly realised in the form of increased production efficiency (lower expenses largely lead to lower prices) which is partially guaranteed by the interventions of the regulatory bodies. It must be recognised though that the realisation of socially efficient outcomes within public ownership and management cannot simply be assumed either. Indeed, although public companies are often tasked with, and claimed to, operate their businesses in line with wider social and public interests, they often manifestly do not. Without oversight and regulation, publicly owned monopolists can behave as badly as unregulated private ones do. What is required is a balanced and strategic approach to these matters. Privatisation of natural monopolies should be accomplished as a longterm and strategic process, rather than simply a matter of divestiture of assets. It should be kept in mind that when it comes to the sectors of energy production and distribution, water supply, and telecommunications, that the long-term benefits should rank as the first priority, then the mid-term, in the form of liberalisation of the sector, and finally the short-term gains in the form of privatisation receipts and higher tax earnings.

3.2 Water as a Major Local Natural Resource


Water reserves per inhabitant are shrinking on all continents. The greatest reductions of water resources are in Asia, Africa and South America. This trend is a consequence of several factors; population growth, climate change, emergence of so-called 'mega-opolis' cities and more and more extensive pollution, in particular of surface waters. A dramatic increase of the population began in 1950 when Earth was populated with 2.5 billion

12

An American company operating in transmission and sale of electricity, AES, simply abandoned its work in 2001 in Orrisa, one of the poorest states in India, because it was not able to realize sufficient profits. A leading world company in the field of water supply, Suez, simply terminated supplying water to more than a half of Manila as it could not pay debts and realize profits. A British company, National Express, simply broke a contract in 2002 that it had in the province of Victoria, Australia, leaving the local bus company with a 55 million dollar debt. These are not exceptions, the basic goal of a private company is enlargement of its equity and if the circumstances are not right for that the private company simply terminates its business and searches for more profitable activities.

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people. Forty years later, in 1990, there were 5.3 billion people. According to some projections, by 2025 there will be 8.3 billion people, and by 2050 a critical 10 billion people on this planet. A trend towards the concentration of people in large cities is more and more pronounced. In 1950, 29% of the world's population lived in cities, while in 2000; this number had grown to as much as 47%. In 1950, only 78 cities in the world had more than a million inhabitants, while in 2000, there were 408 such cities. Large cities are in need of greater quantities of water within a relatively small area. After use, this water becomes waste which is let out into the environment and can pollute the scarce remaining water reserves. Water consumption increases constantly. Although a human being needs between 1 and 5 litre of water a day to sustain life, depending on climatic conditions, the actual consumption is much greater. To maintain a good quality of life and hygiene in urban conditions a minimum of 40 to 50 liters of water is consumed daily per person. The consequences of drinking water shortages confirm a deep division in the world between the rich and the poor (the developed versus the undeveloped). The rift between these segments will continue to widen in the future. Developed countries will probably rectify some of the current situation as they anticipate stagnation in population growth, further development of 'clean' technologies, building waste water purification plants, environment-friendly waste disposal, introduction of environment-friendly agro-technical methods and the building of desalinisation plants. The situation with water with respect to the undeveloped world, could well worsen in the future, as they are going through a cycle of demographic explosion that will put pressure on living and health standards and in extreme situations, people may face starvation or poisoning because of shortages of water and/or its pollution. Bosnia and Herzegovina is relatively rich in water resources. This, among other things, is indicated by the number of rivers on its territory; the Bosna, the Neretva, the Vrbas, the Una, the Sava and the Drina. There are a number of natural lakes and impounded reservoirs created by the construction of hydro-power plants on the Rama, the Neretva, the Trebisnica, the Drina, the Vrbas and the Pliva. These resources are vital to BiH's development for a number of reasons. The potential offered by hydroenergy is most worthy of attention. Thanks to this
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fact, BiH is today the only country in the Balkans which has a surplus of electricity. Waters in BiH are also relatively free from pollution. This opens opportunities for more investment into the production of drinking water as one of BiH's strategic natural resources.

3.3 Electricity Production - the potential for recovery and long term gains
Successful energy management is a general precondition for the economic and social development for every society, and this is fundamentally true of Bosnia and Herzegovina. Enormous efforts have lately been invested in BiH, and its entities, to ensure as much energy as possible is secured from local resources and thus energy dependency on others, is reduced. Coal remains the main energy resource in Bosnia and Herzegovina. Coal production in the 1980s surpassed 13 million tons. Performance of the local coal mines in this period was at European levels. In the last 50 years, considerable changes have taken place in the BiH energy sector. Energy consumption was considerably reduced because of the conflict and the transition to the market. As a result of these events, coal production today is between 30% and 40% of prewar production levels. Yet, we should have in mind that water-based energy plants are designed for maximum use and their true potential in BiH has yet to be exploited. Their export potential in a world of growing electrical energy demand could provide a strategic competitive advantage for BiH13. Aside from coal and water-based resources, the electricity sector also includes nonconventional resources, primarily solar energy. It is well known that BiH abounds in these resources and their potential for growth including export supply is high. Hydro-electricity provides the strongest potential. We should also have in mind that the average number of sunny days in BiH is also well above the European level. Energy management today has an extremely important impact on the development of the social system and on changes in the natural environment. The level of social development is directly correlated to the quantity of energy produced. Impacts on the environment are also strongly related to this. Therefore, it is important to address two questions: First, what is the quantity of energy produced in our country? And second, what

BH is already regularly exporting electricity to the neighboring countries - Croatia, Slovenia, Serbia, Montenegro etc.

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measures are necessary in order to increase it in an environmentally sustainable manner?

3.4 The Dynamic Telecommunications Sector


What was once a fairly stable and sedate, state-owned and monopoly-dominated sector has worldwide become a dynamic engine of growth. Competition aided and abetted by privatisation, new entrants and perhaps most significantly rapid technological change has grown exponentially. The new competitors that have appeared are no longer telecommunications companies, but horizontally integrated conglomerates including, cable TV operators, utility companies, software producers, financial institutions - indeed, even the French state water supply corporation has entered the telecom sector. Telecoms spurred by continuing technological innovation has reached the pinnacle of political priorities. Across Eastern Europe the demand for telecommunications services continues grow at dizzying rates. In countries such as Albania, where land lines are rare and links bad, satellite networks have sprung up in an attempt to catch up with the expansion of the long suppressed demand. But this growth is not confined to basic services. Several years ago, Russian connections to the Internet were notorious for their unreliability. Today, however, connection quality and speed are close to Western standards. Even the most lagging transitional countries are not been spared this hunger for new services. For example, in 1900, Russia had only 1,000 international telecommunications channels and one international exchange - in Moscow. Leningrad serviced an area of 12 million inhabitants with only 11 channels. Today, Russia has 45,000 international channels and all regions, and practically all telephones, have international access. In some countries, such as Poland, dozens of private operators, often supported by Western companies, directly face the one-time state monopoly in competing for subscribers. In spite of technological innovation, telecommunications still contain an element of a natural monopoly, in the form of the basic fixed line network. A new operator must be in the position to be able to connect to the existing network, but inevitably, this infrastructure is owned by the former monopolist with whom the new operator has to compete. Many former state monopolies have abused this control; either overtly, like the Polish TP SA, who smothered competition directly, blocking new competitors from accessing their network; or implicitly through
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controlling the allocation of access lines. Equally, business users are rarely keen to change their telephone company if they have to change their number because they risk losing customers and so things often remain as they are. Bosnia and Herzegovina is going through a phase of developmental transition. The telecommunications sector is relatively well undeveloped. A stimulus to its development was given with the separation of the telecommunications and the postal service providers. Telecommunications facilities and installations have been considerably renewed and modernized, powerful digital transmission systems and digital mobile telephony for GSM standards have been built, stet large on before ISDN technology has been introduced since 1999, and integrated enterprise recourse planning systems have been introduced to support the management and finance controll processes. There are three companies in BiH providing services in the domain of telecommunications: BiH Telecom, RS Telecom and Croatian Telecommunications Mostar. Relations in this sector at the state level are regulated by the Communications Regulatory Agency (CRA). The level of service is relatively good, and thanks to roaming, direct access to a large part of the world is offered. Mobile telephony is also going through expansion as well as internet networking. All this will ensure better links with the world, increases in the scale, types and quality of services, but also by improving the profitability of the telecommunications sector.

4. DETAILED REVIEW OF THE KEY SECTORS


4.1 The Energy sector in BiH
Background and Key Issues
The privatisation of energy companies in transition countries is largely complete, particularly in the case of small and medium size enterprises. There are some delays in the case of larger corporations, with differences between countries. BiH belongs to the countries in the region which have implemented about 70% of planned privatisation. The majority of large companies are still fully or partially in state ownership (about 35%), the approach adopted is generally for restructuring to be carried out before privatisation, and this matches with established best practice.

Some of the remaining large companies represent natural monopolies and considerable attention must given to conducting social and economic impact analyses in order to fully appreciate the consequences which will arise from their privatisation. Impacts will be felt by consumers and the state as the former owner, and other enterprises including those in neighboring countries. Given this reality, it is necessary to analyse in detail, the implications of the method and speed of the privatisation process for these companies. As noted, a natural monopoly is held by a company which can produce the total output at lower costs than several companies, and under such conditions, greater efficiency can be secured if there is only one large company rather than several operating within the market. Privatisation has been carried out so far in many countries, with different levels of coverage and utilizing a variety of methods. In Eastern Europe, Hungary and Poland have gone the furthest in the privatisation of energy companies and it is instructive to examine their experiences in some detail. Since the energy sector inherently possesses elements of natural monopoly, it is vital we determine the most desirable regulatory framework. A first question is; who should be operationally responsible for regulation? And there are two generic solutions to this: (a) an independent regulatory agency, or (b) a responsible ministry. Experiences from other countries show that it is much more favorable to establish a regulatory agency which is independent from the relevant ministry and external political and economic influences. It is important to recognize that the forms out influence to be resisted often include attempts by the monopolist being regulated to gain effective control or 'capture' the regulatory agency. A second question is the nature of price or economic regulation; three distinct alternatives are put forward: 1. Control over the rate of profit, a method used commonly in the United States which involves setting a ceiling or threshold above which penalties apply on the profits to be made as share of, typically, the capital employed. 2. Price-ceiling determination, an approach which specifies the maximum rate of change in enduser (consumer and commercial user) prices paid. This is a method pioneered in the United
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3.

Kingdom by Professor Stephen Liittlechild, typically, with increases being linked to the consumer price index less or plus a judgmental factor to reflect efficiency savings or investment needs over and above the rate of inflation (some times referred to as a 'CPI - X approach'). Profit distribution limitation, being the limitation of profits to be distributed to shareholders, commonly specified by a threshold defining extra profits. In contrast to method one, profits are permitted but have to be retained within the company.

Considering that there is significant inefficiency in the management of generation of electricity in BiH, a price-ceiling determination is considered the most favorable method of economic regulation. This is also the increasingly generally favored approach in that the welfare gain is directly linked to prices paid by consumers, and given the high level of transparency the control is difficult to evade. Turning to the process of privatisation of the energy sector, itself five key questions should be addressed: How rapidly should the division and restructuring of the sector be carried out before privatisation, including the establishment of functioning regulatory agency? How much will prices be permitted rise after privatisation? What return rate on the invested capital is considered a normal return? In what way will redundancies in these companies be taken care of? How can an open energy resource market is established, and what structural reforms are required for this? At the beginning of this analysis, it is worth noting several trends which are pertinent to the region: 1. The average growth of energy consumption in the region is between 2 and 5% per year14. For the period 1989-1998, energy consumption grew in Poland by 8%, in Slovenia by 20%, in Slovakia by 56% and Romania by 84%15. 2. All countries in the region have insufficient energy potential from renewable sources, such as water and wind generated energy. This also applies to BiH's neighbours, and in particular to Croatia and Serbia and Montenegro.

In Croatia, the annual level of electricity consumption grows by about 4% (HEP report for 2002). Reform of the Electricity Market In Transition Economies: How to Avoid Traps of Deregulation, Martin Siner and Jon Stern

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3.

4.

5. 6.

7.

Croatia imports about 24% of its total electricity consumption (3,724 Gwh per year16), while Serbia and Montenegro import about 5% (1,711 Gwh a year17). This trend is growing at a fairly constant rate. There are many agreements at the international level related to the reduction of pollution by means of reducing the production of energy from coal, oil and other sources which contribute to the pollution of the natural environment (chiefly the Kyoto agreement). BiH has the largest hydro potential per capita in Eastern Europe. BiH is second in the region in terms of exports of electricity after Bulgaria18 and with only about 40% of expected hydro capacity exploited. Collection rates for electricity supplied are good (at about 87%).

Herceg Bosne and EP BiH) into one company which would operate on the territory of the entire country19. Only after this would the privatisation process be commercially realistic, given the need for the new enterprise to achieve economies of scale sufficient to compete in the regional market place. Thus changes in the electricity sector should be undertaken in the following order: There are five basic models for the privatisation infrastructure companies: Restructuring Regulation Privatisation Liberalisation Market strengthening 1. 2. 3. 4. 5. Management agreement Services agreement Cession of facilities Concession Privatisation of equity capital

It can be concluded on the basis of these points that BiH is rich with renewable energy sources whose importance will grow in the coming years. Returning to the five key considerations noted above; in the majority of European countries, the energy systems are divided into three areas: production, transmission and distribution. Attempts are currently being made to divide the current electricity management in BiH into these three segments. This process attempts to address the
Privatisation model Management agreement Services agreement Cession of facilities Concession Privatisation of company capital - there are no effects Economic efficiency * * ** ** **

Each of these models has its advantages and disadvantages. The table below summarizes the characteristics of each model of privatisation by, the economic efficiency of companies, new investment needs, transfer of know-how and applicability.
Transfer of know-how * ** ** ** Applicability Yes Yes Conditional Yes Yes

New investment * ** ** strong effects exist

* moderate effects exist

questions about restructuring and market formation. The follow on questions which arise are; which of these parts of the electricity system should be privatised? and in what way, and to what extent? In different countries, this procedure and the subsequent regulation of the constituent parts of the system has been accomplished in different ways. Before beginning the process in BiH it is likely to be necessary to merge the three existing vertically integrated companies (EP Republike Srpske, EP

The table above shows that the full privatization of company capital is the only relevant model of privatisation of the energy sector considering its strong effects on all four criteria. Privatisation can then be carried out by means of applying several essentially different divestiture options: Public sale of stock Sale to institutional investors Sale to financial investors

16 17 18 19

Ibid Annual Report for 2002 by Electricity Management of Serbia and Montenegro OHR Report - www.ohr.int Note that this process is likely to begin shortly.

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Sale to strategic investors Distribution (assignment) to local investors. The table below evaluates the potential energy sector privatisation methods.
Privatisation model Public sale of stock Institutional investors Financial investors Strategic investors Local investors - there are no effects Economic efficiency * * * ** ** * moderate effects exist

condition and price, while Government could focus on management and production. In time through the concession arrangements, there should be a number of local generating companies that would compete for both local and international business.
Transfer of know-how * ** Applicability No Yes Yes Yes Yes

New investment * * ** * ** strong effects exist

From the above, the greatest value for the State can be obtained from the sale of electricity companies to a strategic investor, either local or foreign. The next factor that should be taken into consideration is the likely social impact of privatising production and supply of electricity. The policy of privatising energy companies should be based on three basic elements: 1. Partial and necessary restructuring of the electricity sector before privatisation; 2. Definition and development and efficiency goals to be achieved through privatisation; 3. Reform of the market and pricing policies, which in many cases implies growth of existing electricity prices (price based on the coverage of total costs, which is not the case now). Restructuring should serve to rehabilitate the business and lead to the fundamental restructuring of EP BiH. Restructuring should be based on vertical separation, i.e. separation of production, transmission and distribution. In the domain of production several mutually independent production companies need to be established. This will enhance competition between the production companies, but this does not necessarily mean reduced electricity prices. What is certain is that productive efficiency will be enhanced. Surface coal mines should remain integrated with the companies using their coal for electricity generation. This would ensure a more efficient business for both the coal mines and the energy production companies. The State should retain majority of control/ ownership in the areas of transmission and some generation, as opposed to distribution that could be offered to strategic investors, either local or foreign. In this way citizens would have local distribution companies that would be enable to purchase electricity from any producer at the best possible

We recommend distribution should be organized through a number of companies on a regional level. Privatisation of distribution will also lead to an increase of efficiency in this part of the electricity system. Transmission of electricity would be organised as one company, which would operate on the whole territory of BiH and would be owned in full by the state. In this way the state could retain an effective control over the production and distribution companies. The next factor that needs to be considered is what social impacts will the privatisation of the production and sale of electricity have within BiH? Considering that a very sizeable proportion of the population live in or close to the poverty line, it will be necessary to make a specific assessment of the effects of privatisation on this segment of the population. It is generally known that electricity companies owned by the state had an important social role and that they often produced losses, failing to cover even their average production costs. The current situation in the BiH is such that households spend on average between 10 and 12% of their overall income on energy. In comparison with OECD countries, where the population spends between 2 and 3%, we can conclude that the population of BiH is much more vulnerable to price increases than the populations in developed countries. Therefore, privatisation of the electricity sector should primarily enable price reductions for household consumption. The Polish and Hungarian experiences show that prices in these countries grew on average up to 25%. Prices have risen in most other countries which have carried out privatisation - Finland, Argentina, Chile and Australia. Another factor which needs to be kept in mind is price changes for commercial customers. Companies in BiH pay nearly the most expensive unit rates for electric in Europe and this considerably diminishes their competitive advantage in relation to 21

neighboring countries. If the price of electricity increases for these large consumers also, the companies will be still less competitive. And this will certainly worsen the overall socio-economic situation, ultimately in turn causing reduced consumption by households, implying still further pressure to increase prices again. It seems inevitable that prices will rise in the short term at least simply because prices will be based on the principle of full cost recovery. An increase in business efficiency will inevitably cause a reduction in the number of employees in the electricity sector. There are 6,095 employees in the BiH electricity production sector, while the other two companies employ 4,000 people. It is known from the experiences of other countries that the average rate of layoffs is between 25 and 40% of the total staff. Provisional estimates suggest that the number of employees in BiH would be reduced by about 30%, which are about 3,000 people. A sum of money would have to be provided from the national insurance funds (e.g. 5%) to take care of redundancies and ensure training and employment in other sectors. With regard to the consumption of electricity by the general population, a 13.5% reduction was recorded last year, while gross consumption increased by 0.1%. This is indicative of a saturation of demand in the market. This leads to the conclusion that surplus electricity will probably be exported in the future, bringing considerable revenues to the state and eventually the operating companies. The privatisation of natural monopolies has many detractors in the countries in which it was carried out. Many start from the assumption that the right to energy is a basic human right and that production, transmission and distribution of electricity should be left to the state. This is supported by the experience of California in 2002, was without electricity for 38 days because private producers could not agree with the state on the conditions under which they should supply electricity. There is also the possibility of creating an informal oligopoly between production and distribution companies, which may again lead to a conditional monopoly in the electricity market. It is necessary to assess the dynamics and manner of privatisation of the electricity sector in BiH in detail and with the participation of all interested parties. This is the only way optimal solutions for the privatisation of this extremely important sector can be found.

countries. Economic and technological developments have stimulated an evolution of regulatory systems, changes of ownership structures through the privatisation process, and changes in the structure of the sector itself. Since transmission and distribution networks are natural monopolies, the whole electricity sector can be considered to be dominated by monopolistic pressures. Countries have adopted two basic models in this sector: State integrated monopoly, and The regulation of private companies. Many countries (for example, Ireland, France, Greece and Italy) consolidated and nationalised their resources in the field of electricity in the form of state monopolies, assuming that state monopolies would operate with the primary goal of ensuring social welfare rather than profit. In Germany, there are regional state monopolies. Another model is found in the USA and Japan, where private companies are regulated on the basis of costs and indicators of profitability of the invested capital. In the largest number of countries, regardless whether this sector is centralised, state owned or private, electricity production and distribution companies always remain vertically integrated. But there are variations. Approaches to liberalisation and the degree of liberalisation in this sector are considerably different in the countries that have carried out reforms. Essentially, the reforms have been directed at: A functional division between generation and transmission networks, The introduction of competition in electricity production, and Expansion of access to transmission networks. In advanced stages, reform includes the formation of an electricity market and the guarantee of free choice of suppliers of electricity for consumers. In the final stages of reform, regulation of tariffs for companies operating in transmission and distribution (based on costs and indicators of profitability of invested capital) has been replaced by establishing maximum tariffs for transmission. Apart from the differences in the degree of liberalisation achieved, there are considerable differences between countries with regard to the degree of participation of private capital in the sector. The decision to carry out privatisation does not always coincide with the degree of liberalisation accomplished. Some of the countries with a considerable degree of liberalisation (e.g. Norway) did not proceed to privatisation at all, while privatisation for some other countries was

Specific International experience


During the last decade, regulation of the electricity sector has changed fundamentally in many developed - and some less developed,
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the primary goal of reform (e.g. Great Britain). In some countries (e.g. Japan), the electricity sector was historically predominantly state owned. In many countries which have included privatisation within their electricity reform programmes, the order in which privatisation and liberalisation were carried out differs. In Great Britain, privatisation preceded liberalisation, while in Scandinavian countries, liberalisation preceded partial privatisation. As a whole, there is a tendency to privatise production and the sale of electricity, both through an active privatisation programme and through allowing access to new private production companies.

Prototype models of organisation for the electricity sector in the transition period
With regard to the reform process, a great number of countries have been or are currently going through a transformation stage, indeed the position in those most advanced in this process is constantly evolving. With different institutional and social limitations, transition in many countries from a vertically integrated sector model was
C ompone nt s of e ac h i ndi v i dual pr ot ot y pe :
Electricity production Within one company

carried out into a competitive model by means of gradual adjustment of different market structures. Basic prototype models for the reform of this sector, which have been employed by a large number of countries at different stages of reform, along with the key advantages, are as follows: Vertically integrated model - guaranteeing a reliable supply of electricity with regulatory price controls. Independent generator model - satisfying growing demand for electricity thanks to guaranteed state agreements with independent producers within compressed vertically integrated models. Independent enterprises compete for contracts guaranteed by the state. Sole purchaser model - creating competition between producers but preserving consumer price controls. Competition for electricity supply contracts for a sole (state controlled) buyer. Competition model - creating a competitive market for producers and consumers of electricity. Competition in market place for both wholesale and retail energy. Regulated issuance of licenses for participants in the market.

Vertically integrated model Independent manufacturer model

Sole purchaser model Competition model

Cost optimisation mechanism On the basis of cost data Within one company On the basis of + cost data Some participation of + independent producers Private competition for contracts for dependent producer Independent producers Competition for delivery contracts Independent producers On the basis of competitive prices

Transmission No access to other participants Access through one supplier

Price mechanism Adjustable tariffs Adjustable tariffs or determined by means of a contract (for independent producers) Tariffs determined by contracts Competitive prices on a single market or bilateral agreements

Access through one supplier Access for other suppliers

A dv ant age s and di s adv ant age s of i ndi v i dual mode l s :


Vertically integrated model (Russia, France) Independent manufacturer model (South East Asian countries) Sole purchaser model (Hungary) Competitive model (Scandinavia, England and Wales) Positive factors Retention of vertically integrated structures within one company Price control Attraction of private investors in the presence of minimum change structures Retail price control Attraction of private investors in the presence of minimum change structures Retail price control Strong incentives for increased efficiency Negative factors Absence of economic incentives to increase efficiency For state companies - necessity for state funding of the sector Necessity to grant long term state guarantees (high risk for state budget) Necessity of concluding medium term contracts on the wholesale market because of limited possibilities of changing tariffs on the retail market Necessity for possession of considerable structural information Upward correction of price levels to economically justified levels

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4.2 The Telecommunications Sector


Telecommunications in BiH
The telecommunications sector in BiH is still considered to be relatively under-developed. According to data for the end of 2002, the penetration rate for fixed lines in Bosnia and Herzegovina was 27%, in Serbia and Montenegro 22%, in Macedonia 10%, and in Croatia 38%. If we compare the penetration data with mobile services at the end of 2002, it amounted to 22% in BiH, 8% in Serbia, 8% in Macedonia, 30% in Croatia and 54% in Montenegro. This data indicates that there is a still considerable potential for growth in BiH, and thus the sector is an attractive target for strategic investors. In order to attract strategic investors, who could ensure a wider spectrum of telecom services and the development and rehabilitation of the physical network, and specifically raising service levels to those in the European Union, it is necessary to undertake a series of interventions. According to a decision on BiH Telecommunications policy adopted by the Council of Ministers in 2002, the Government's intention is to achieve the following by the means of a balance between controlled liberalisation and appropriate regulation: a) Continuous and accelerated development of the sector with a view to ensuring telecommunications services operate completely under competitive conditions and at a defined level of quality for all BiH citizens; b) Attract investment with a view to promoting the development of the telecommunications sector; c) Further development of the regulatory framework in order to establish competition; d) Realization of mechanisms which will satisfy social policy objectives; e) Realization of maximum benefit for the State and citizens from the process of business operations and privatisation of the sector.

The liberalisation process, which emphases the primacy of end users, should continue to be rolled out. The telecommunications policy has already liberalised all speech and non-speech services except speech services on the international level. And it is foreseen that this too will be liberalised by the end of 2005, and this will requires a revision of prices (primarily in local versus international terms). The privatisation process, which has been relatively rather long in the preparatory sense (valuation of enterprises, preparation of information memorandums) in terms of defining the privatisation policies for important economic infrastructures (decisions of Entity governments and privatisation agencies with regard to the models, relations, role of the strategic partner etc), has begun nevertheless. Telecoms in the FBiH have been privatised to the extent of 10% (certificates) and extent of 20% (vouchers) in the RS. The views of the general public, has become clearer recently, which although not formal politics, is something that formal politics all the same, must acknowledge. Several key messages are emerging: First that privatisation should continue. Second it should be implemented gradually. Third that the majority owners should be primarily interested in development of the enterprises (employees, certificate owners, state, etc.). In the initial stage of the transition of the telecommunications sector, the Law on Telecommunications, which was adopted in 2002 at the state level specifies the Council of Ministers as having the responsibility for drafting and implementing policies for this sector, while the Communications Regulatory Agency CRA is responsible for regulating telecommunications networks and services, including issuance of licenses, specifying prices, interconnections and laying down the basic conditions for ensuring common and international communications standards are met. The post-war development of this sector in BiH was characterised by monopolies held by the three operators in a divided market. The operators in the Federation of BiH are PTT BiH Sarajevo and HPT Mostar and PTT Republike Srpske in the RS. Whilst PTT BiH Sarajevo has based its post-war development on its own resources, HPT Mostar did so on the basis of an investment made by HPT Zagreb. The result of this cooperation was the formation of a joint company for mobile telephony, Eronet Mostar, while services of fixed telephony are rendered by HPT Mostar. Mobile telephony services

Reform activities being undertaken


The reasons for the reforms, which are already being put into practice, arise from the wider processes of: globalisation, privatisation and liberalisation. The emphasis of these developments is a change in the generic role of telecommunications, in particular at a time of the economic transition and social restructuring. The globalisation process inevitably imposes a need to maintain the development of the technological capacity of telecommunications in the country in order to enable quality communication with others, in order that systems continue to track developed world standards.
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of the second company in the Federation, PTT BiH, remain together with fixed telephony within the framework of one legal entity. The same is the case in the Republika Srpska with Telecom Srpske. A decision on Telecommunications Sector Policy in BiH limited the number of operators to three. In accordance with this decision, state owned mobile telephony operators are allocated licenses free of charge (BH Telecom and Telecom Srpske have secured them already), and the proceedings for the allocation of the third GSM license are in progress. The companies which were allocated licenses committed themselves to covering at least 80% of the BiH territory with their services. Due to legal proceedings conducted over the ownership structure of Eronet, this operator currently operates without a license.

a) b) c)

The impact which privatisation has on the employees in the sector The impact on the living standards of the population; The impact on general economic and general social development in BiH.

The current position of the Telecom Sector and the privatisation process
The ownership structure of the telecommunications sector does not follow the same pattern throughout the country. HT Mostar has been in mixed ownership since 1996. The State, to be precise, owns the majority package of this company at 63% of the stock. But, co-owners of the company are two companies from the Republic of Croatia, HT Zagreb with 30% and HP Zagreb with 7%. If we set this fact aside, preparation for the further privatisation of the companies began in 2002, with the separation of PTT BiH and HPT Mostar into telecoms and postal companies, which meant the division of property, obligations, managerial structures and employees, drafting initial balance sheets, the revision of financial statements in accordance with international standards by independent auditors, and transferring obligations with regard to subsidised postal operations and so forth. The separation of telecom and postal services into separate legal entities in the RS was achieved much earlier. The first formal steps to divestiture were made with the privatisation of a proportion of the companies' share capital in the form of a public offer of 10% of the equity in the Federation of BiH (BH Telecom and HT Mostar), and 20% in the case of Telecom Srpske. It should also be noted that Telecom Srpske was granted a pre-privatisation credit by the EBRD, with an obligation to start the privatisation process by 2005.

It is certain that privatisation will, above all, result in the identification of a staffing surplus in the current operators, and pressure to reduce the number of employees to the levels of other European countries. The direct consequence of this will be, whether wanted or not, is the laying off of some of the employees working in the sector today. It is clear that, in the competitive European environment, there is one employee in the Telecom sector per 300 to 450 telephone connections. In Bosnia and Herzegovina, the number of connections per one employee is much smaller, particularly so in HT Mostar, but also to a considerable extent in RS Telecom, too. A considerable percentage of citizens share the conviction that privatisation could lead to an increase in unemployment. According to a public poll conducted for this study, 43.4% of citizens at the state level share this conviction (40.8% in the Federation, 47.7% in the RS and 33.3% in the Brcko District). Competition in the telecom sector implies this. However, it is also not certain that the change in ownership and management objectives, albeit with some service improvements, will not also have negative effects in terms of putting additional loads on household budgets. Citizens themselves share this conviction to a considerable extent. An opinion poll indicates that 36.5% of citizens of Bosnia and Herzegovina have fears of a negative impact. These fears are somewhat more intense in the RS. As regards the impact of privatisation on the longer term overall economic development of the country, it will most likely be positive.

Proposed privatisation models and reform of the telecoms sector as a task for the future
Reform goals: The goals of reforms are building the necessary information and telecommunications infrastructure, and the better matching of supply to demand; more appropriate services provided at a satisfactory level at acceptable prices. This implies raising the level of penetration of fixed and mobile users with reductions in the differences with other countries. Activities: The road into reform requires both a sound legislative and regulatory environment. This means that the activities of the CRA, which 25

The socio-economic impacts of privatisation


It is clear that the privatisation of the telecom sector will have an impact on the socio-economic position of the citizens of this country. These can be viewed from at least three perspectives:

now more than ever, are vital to securing the reform goals, need to be continued and intensified. The Council of Ministers needs to update and reformulate the telecommunications policy, linking it with information and internet technologies, which will encourage a broader and fuller application of ICT in general. In order to enjoy the full benefits of ICT there will have to be appropriate infrastructure, primarily highway, and later access points, which is the task of the newly constituted telecoms operators with their considerable market power and highly commercially favorable environment. Reform sponsors: these should include: The Council of Ministers, via the Ministry of Transport and Communications, Entity Governments, via responsible ministries, The Communications Regulatory Agency, The operators and service providers C ur r e nt pr oje c t s and i nt e r nat i onal as s i s t anc e : Projects that need to be inaugurated in the coming period are as follows: An Information-communications highway at the BiH level (fixed telephony operators are planning to build their own backbone networks using MPLS technology, with appropriate connections in 2003); Connection with neighboring countries using optic cable (regional highways); Development of a European Communications and Information Highway (EICH) Node in BiH (probably Sarajevo) A wideband CaTV network (for services: video, fast internet and IP telephony), with master and regional nodes interconnected with optic cables with digital transmission at the state level.

Many people share the conviction that privatisation is not a task to rush into. This means that gradual implementation is the recommended route. Citizens have a negative perception of the privatisation process in BiH thus far. According to the public polls conducted for this study, as many as 70% of citizens have objections to certain proposed privatisations. In response to the questions; 'How should privatisation be carried out? Should majority shares in telecoms be sold to international investors or local companies?', only 29% of respondents think that foreign buyers should be selected. But, citizens do have a positive conviction that they themselves should be given an opportunity to take part in the Telecoms privatisation (along with those of other natural monopolies).

Next Steps: priorities for the sector


Rebalancing tariffs and liberalisation of services: The current tariff structure is typical for a regional market before privatisation. It is characterised by very low prices for local calls, which are often internaly subsidized. Prices are still calculated on the basis of impulses (only for fixed telephony) and not on the basis of minutes20. Comparing this to international practice, we arrive at the conclusion that tariffs need to be brought to a level which is comparable to other markets, preparing the market for liberalisation, and preventing considerable loss of market participation in the liberalised market, and ultimately, the reduction of high international call tariffs. This means that rebalancing tasks should be carried out to achieve the following: Draw up a more market oriented tariff structure; Determine better cost structures for every service; Meet users' demands for every service; Promote operational performance; Optimise profit on the basis of services offered. In accordance with the generally accepted opinion that telecommunications services are best offered in a competitive environment, the goal of telecommunications sector policy is the full liberalisation of services. This creates the right conditions for private investment into public networks and services. Taking into consideration the level of development and inadequate

Which privatisation model to apply?


The issue of privatisation of the telecom sector is often in the public focus. In this context, several questions deserve special attention: Should privatisation be carried out as a once and for all event, or gradually? Should telecommunications companies be sold on the international market or should local capital be invested in them? Or, possibly, combine these two possibilities? Should citizens participate in privatisation, or should they be excluded from the process altogether?
20

Most of the operators are in the process of price restructuring and adjusting to EU standards.

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penetration in fixed telephony, the liberalisation of fixed telephony services should be carried out in stages: The liberalisation of non-speech services (data transfer and internet services); The liberalisation of local telephone services; The liberalisation of international telephone services. Privatisation Process: The following important issues are pertinent and must be taken account of in the implementation and management of the process: The commercial environment in which the newly private companies will operate (local business environment, world economic cycle, condition of international telecommunications market); Market and tariff regulation (regulation of competition, readiness of the government to change tariffs); Preparation of companies for privatisation (incorporation, corporate governance and information preparation and disclosure standards); Definition of obligations of strategic investors with regard to investment and employment (level and time period); Criteria for bidder selection (price relations, investment, employment, credibility); Size of the stock package that will be offered (majority, control, at once or gradually); Selection of advisors for privatisation transactions; Optimal timing of sale.

The International experience


Experience of the privatisation of traditional, vertically integrated monopolies in the field of telecommunications in Western Europe shows that after a series of concrete measures are undertaken, monopoly structures wane and disappear. Though it must be acknowledged this is often more formal than real, particularly in the early stages, with the former monopolists retaining substantial market power. New approaches in the field of Telecoms services (in the USA after 1996, and in the majority of European countries after 1998) tend to emphasize re-regulation of the sector, contributing to the easier entrance of new competitive companies. This is differentiated from the existing, traditional regulatory approach which is more concerned with rigidly specified amounts of compensation for rendered services and the rate of return for invested funds, in terms of overseeing cases of natural monopoly. Privatisation has become the most widespread method of implementing reform in the telecommunications sector, freeing companies from limitations imposed by former requirements to operate as state owned companies or as strictly regulated monopolies. The structure, organisation, means of financing and commercial environments of telecom companies have been transformed considerably. Political commitment and dedication to liberalisation and reform of this sector must be comprehensive and sincere; otherwise privatisation will not yield the desired results. Before the beginning of the privatisation process in the telecom sector, governments must modify all laws and provisions in areas such as rules on foreign investment, basic telecommunications policy, frequency allocation, technical compatibility, universal services and pricing structure. New laws must be introduced in order to ensure relocation of staff, changes in management, valuation of property and prices, reward and incentive schemes and accounting systems to enable former state bureaucracies to become efficient independent corporations. Sadly, for some countries, privatisation represented little more than a tender-based license sale offering exclusive rights to protected markets, for a period in which the return on investment could be ensured, and an acceptable rate of return on capital investment could be generated. Privatisation conducted thus far in this sector, has in the main, been successful. Though it must be recognized stockholders, governments and consumers have profited to varying extents. A further benefit of privatisation of international telecommunications 27

Government decisions on divestiture


The initial step requires a decision to be made on the sale of Telecoms companies to strategic investors. These decisions will draw the attention of both of the local public and international community, and the following considerations are required: a) Carrying out the sale on the basis of government decisions or special laws adopted by the respective parliaments; b) Sale of all companies in a package (BiH), only some (in the Federation of BiH), or separately; c) Should fixed telephony be separated from mobile telephony where necessary (BH Telecom, Telecom RS) before the sale; d) Further issues; the size of stock package, and the definition of the obligations of the strategic investor.

(somewhat like privatisation in general) is reflected in the fact that the whole process has brought millions of new investors into the international business system. The scope and distribution of privatisation of dominant operators has been substantial, not least in the developing countries as the following chronology shows: 1990 - Malaysia, Argentina, Mexico, Peru 1991 - Venezuela, Estonia 1992 - Puerto Rico, Lithuania, Ukraine 1993 - Latvia, Korea, Israel, Singapore 1994 - Kuwait, Pakistan, Hungary, Turkey, Czech Republic 1995 - Indonesia, Thailand, Columbia, Ivory Coast, Taiwan, Panama 1996 - Brazil, Nigeria, Paraguay, Poland 1997 - Ecuador, Madagascar, Guinea, Russia In terms of outcomes, the picture is more mixed than in the advanced industrial economies. For example, the privatisation of ENTEL in Argentina yielded only moderate results. The sale to a foreign investor brought a considerable capital receipt to the government, enabling it to reduce its foreign debt and attracted new foreign investors. Indeed, the successful sale signaled a new decisiveness and dedication on the part of the government to privatisation and reform - and this act strengthened its credibility. Yet, critics have argued that the government guaranteed the foreign investor monopoly profits in order to make the sale more attractive, thus raising the price of the tender, at the expense of other considerations. The government thus showed more concern for maximising the capital receipts than for creating a more open and competitive telecom market. Citizens complain that the quality of services have not improved in proportion to the increase in prices paid. Criticism directed at the inadequacy of the Governmental institutional apparatus for regulation of this sector appears also to be justified. A more stark, though rarer example of unsuccessful privatisation in the Telecom sector, is provided by that of Puerto Rico. As a result of unrealistic assessments, the legislature included within the privatisation statute, various conditions which made the state telephone company unattractive to foreign investors. The Law specified a minimum price of 2 billion US dollars plus a reduction of foreign debt by 1 billion US

dollars. It also prohibited any increase in tariffs and the dismissal of workers from the existing company. The tender failed and privatisation was not implemented. This case underlines the need for a balanced approach to the regulatory process. One should also have in mind that examples where telecommunication prices have doubled or even tripled21 after the privatisation and major investment where stopped, could also be viewed as failed privatisation process since in the long term the overall economic effect will be more then negative ones.

4.3 The Water Supply System


The International Conetxt - Water as a limited resource
Learned and senior commentators, including those within the departments for strategic planning of some larger powers (Great Britain, for example) believe that water in the 21st century will be what oil was in the 20th - the basic resource for development and a key cause of armed conflicts. Drinking water remains one of the key strategic resources in the world. Consumption of water in the world doubles every 20 years, twice as fast as the population grows. According to United Nation's assessments, 1.2 billion people in the world today do not have access to drinking water, while 2.4 billion people live without basic sanitary conditions (sewerage). Today, 31 countries in Africa and the Middle East are dangerously short of drinking water. Assessments are that another 17 countries will join them by 2025. Expectations are that, by then, two thirds of the population of this planet will live in countries where water shortages will become chronic. Many countries around the world, including parts of India, China, West Asia and the Arabian Peninsula as well as the countries of the former Soviet Union and western parts of the USA, are faced with the rapid exhaustion of underground sources22. The achievement of several of the Millennium Development Goals hangs on a sustainable approach to securing the supply of healthy drinking water. The acknowledgement of the physical limitation of water resources has led its value to grow greatly. Water supply has become big-business and several countries have sought by expanding the reach of their geo-strategic influence, to open a path

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Regional examples of Croatia and Macedonia. We must not forget that today in the world about 70% of overall 'drawn' water is used in agriculture, mainly for irrigation, and that a further continuous dynamic growth of its usage is predicted because of constant needs to increase food production in the world. Assessments are that about 22% of drinking water is used in industry.

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for their multinational companies to manage storage, production and distribution, and thus exercise control over national reserves of drinking water of many (mainly undeveloped) countries in the world. There is a real danger that the exploitation of water which is a basic source of life preservation, is becoming a highly profitable activity for a narrow circle of capitalists in the West, whilst also a potential cause of degradation of the quality of life of hundreds of millions of people all over the Third World23. Shortages of drinking water are becoming more severe every day. The most undeveloped countries in the world are in a particularly difficult situation. Their populations live in climatically unfavorable environments and conditions of extreme poverty. Projections indicate that nearly two thirds will soon live in urban zones without realistic prospects for stable access to drinking water and sewage. The affected areas are, primarily, regions of Africa, South and South East Asia and Central America. Apart from them, some areas of China and South America will also have serious problems in their attempts to ensure adequate quantities of drinking water.

Privatisation of the Water Sector


A coterie of international institutions, the World Bank (WB), the International Monetary Fund (IMF), the World Trade Organization (WTO) and the European Commission (EC) are trying to find a solution to this problem by means of supporting the privatisation of public utility companies operating in water supply and the treatment of waste water. They believe that existing state companies in this sector are inefficient, have too many employees and are not capable of ensuring sufficient investment in the reconstruction and development of water and sewerage infrastructure. They do not view the

supply of water simply a fundamental human right, but a commodity, an 'economic good' which has its price within a market which is subject to the laws of demand and supply. They often advocate that its price must fully cover the costs of exploitation, processing and distribution, as well as the costs of amortisation of the existing infrastructure. Therefore, its real market price should ensure funds for new investment. And they argue that the private sector is best placed to ensure efficient management of drinking water resources, giving it the status of a key player in the development of the water supply system and the treatment of waste water. Through the General Agreement on Trade and Services (GATS), the WTO obligates signatory governments to liberalise public services and thus lift barriers that prohibit international private capital into this socially sensitive sector. This has begun the process of providing incentives and support for governments of many poor countries, especially in Africa, in terms of full or partial transfer of the responsibility for water supply from public and state owned companies to foreign, private multinational companies. This process is often made a condition of their access to new loans and various kinds of assistance. In mid and late 90s, a process of accelerated privatisation of the water supply sector began in dozens of poor countries in Africa and Central and South America24. Private multinational companies (mainly from France25) have entered the privatisation process in a way in which they did not purchase the existing infrastructure but would operate supply by means of long-term concession contracts, new investment and more efficient management of the whole system. Thus, they are supported by favourable loans from the World Bank and other international financial and development institutions.

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According to the World Bank's assessments, the value of the water market in the world is estimated at 800 billion dollars and by value it compares to the fossil fuel market. That this is a stable, fast-growing and profitable business tells us that in 1990 about 51 million inhabitants in a dozen countries in the world were supplied with water by private companies while estimates today are that they supply more than 450 million inhabitants in 56 countries in the world. Projections indicate that this number will reach even 1.16 billion in 2015. In mid-2000, the following countries had various forms of agreements for privatisation of the water supply sector: Ivory Coast, Guinea, Mali, Senegal, Guinea Bissau, Lesotho, Djibouti, Zimbabwe, South Africa, Gabon, Morocco, Mozambique, Egypt, Kenya, Rwanda, Chad, and Cameroon, while tenders were prepared for Niger, Nigeria, Tanzania, Lagos, Congo and Ghana. Of the Central and South American countries: Argentina, Chile, and Bolivia, while: Honduras, Nicaragua and Panama, as well as Cambodia and Vietnam, prepared for privatisation of the water supply sector. Out of four largest private multinational companies operating in the sector of water supply in the world, three are from France: Suez-Lyonnais des Eaux with its affiliate Ondeo, Vivendi Environment with the affiliate Vivendi Water, and Bouygues with its affiliate SAUR. Today they together cover about 75% of the world water market. Besides these, other strong companies are also fighting for their share on the market: German RWE, British Thames Water (as part of the German RWE), American Betchel (cooperating with the French SAUR and British United Utilities), and Enron's Azurix. Different joint venture companies are also present on the market, and they are owned by the already mentioned large multinational companies such as Berlinwasser International (as an affiliate of the German RWE and French Vivendi).

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These loans are intended for the implementation of rehabilitation and reconstruction projects, the construction of new capacities and an improvement of the process of managing production and distribution of drinking water. Private multinational companies, beside investment returns, also expect profits, and at least at the level that would be realised by investing in other sectors of the world economy. Motivated by profit, multinational companies are mainly interested in supplying drinking water to the populations in urban or more densely populated areas. Supplying smaller towns, suburbs and rural areas, due to high rates of investment into the network, often remains the responsibility of the State, municipal or public companies26. Foreign investors tend not to be interested in privatisation of the sewerage network because of its low profits due to a typically large backlog of and difficulty collecting payment from users. Considering the social sensitivites of this sector, special approvals and/or consents from governments for the selection of concessionaries and/or conclusion of privatisation agreements are necessary. This process creates fertile ground for the appearance and development of various forms of corruption of high state officials by multinational companies27. Basically, two models of privatisation are applied in this sector: Public-Private-Partnership (PPPs); this represents the dominant model, according to which general responsibility for water supply and sewerage remains within the public sector, while water supply (sometimes including water
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treatment) in urban (usually densely populated areas) is ceded to a private company. The company collects fees or a rent for assets provided on the basis of long-term concession agreements and defines the price of services, which must ensure return on investment and realisation of profit for the company in the course of the concession period28. Build-Operate-Transfer (BOT); under this option the private company finances or provides assets, builds plants and/or networks and manages them, ultimately transferring back into state ownership after a certain period of time (from 20 to 30 years), after a return on invested capital and profit is realised. Assessments today show that only about 5% of the water supply and sewerage sector in the world is privatised. International experience of the process of privatisation of water supply and sewerage sectors in the Middle East and other developing countries are generally negative. Some specific positive results are however recorded; these include improvements in the water supply delivery, reduction of network loss and improvement of system management. However, a basic goal of the process - facilitation of access to water for the poorest strata of population - was largely not realised. In order to satisfy full cost recovery, private companies, as a rule, dismissed considerable numbers of workers of former public companies and increased the prices of water and other services29. They

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The privatisation proposal of Ghana's water supply system stipulated investment of a foreign company only into construction of a new network and not into the rehabilitation of the existing one, And that the state would subsidize the companies to compensate for the difference between the market price and the price paid by citizens, in the period before the market price principle takes effect. Assessments indicated that that this would have meant a rise of current water prices by 300%. And finally, the government would have had the responsibility for overall sewerage and water supply of small towns and rural areas. The examples of Indonesia and the Philippines may be the best illustration. The concession of supplying Jakarta was won by two consortiums: British Thames Water (later owned by German RWE) and French Lyonnaise des Eaux. Both consortiums included local partners whose owners were "friends" of the former president Suharto. The price of water rose rapidly. After political changes in the country, there were strong calls from the new political masters and trade unions to terminate these concessions. Additionally, the twenty five year concession to manage the water supply of Manila was entrusted to a joint venture private company consisting of private British and French multinational companies in cooperation with local private companies whose owners were members of the ruling family and/or their close and rich friends. Model applied in Albania, Montenegro, Jordan and Bolivia (El Alto). Thus, for instance, prices of drinking water after privatisation rose as a rule by several dozen to several hundred percent: in Guinea by 30%; in Germany (Rostock) after privatisation in 1992, water consumption in households dropped so that the private company Eurawasser, in order to protect its revenues, was 'forced' to increase the prices of water by 24% and sewerage by 30%; Kenya (Nairobi) by 40%; in the Czech Republic (in the period between 1994 and 1997 in areas which were supplied with water by private companies) by 100%, by the same amount in Argentina (province of Tucuman); in France in the period between 1984 and 1997 by 300%; in the Philippines (Manila) in five years by 300%. Maybe the most drastic case of water price rising was recorded in Bolivia (Chochabamba, third largest city in Bolivia) where the prices rose in 2000 only by 200% which led to mass demonstrations (and also deaths of several demonstrators) after which the concession agreement was cancelled with a concessionaire compensation claim in the amount of 40 million dollars.- clearly a sizeable attack on the living standards of the population! This rise in prices showed that after privatisation, the average worker had to allocate one fourth of his or her monthly income to cover the expenses of household water consumption. Also in Manila, the poor population spends more than 10% of their income to buy adequate quantities of drinking water of suspicious quality.

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increased efficiency of the collection system by excluding from the network, those users who could not pay for their services. The goal of facilitating access to water for poorest strata of the population turned is thus into its very opposite. Due to high prices and disconnections from the network, the poor were denied a basic human right, the right to access to drinking water. The consequences for human health, infant protection are clearly negative30. Some cities recorded mass illegal connections and theft of this life-critical resource. Often Governments are caught in a trap of paying for subsidies for the poor population paying the funds that they received form privatisation back to the private company, as a result of increased prices.

Experience of Developed Countries


The countries of Western Europe have followed various paths to water privatisation, which in the main preserved the existing privatisation model where water supply and sewerage services remain vertically integrated and publicly owned monopolies. Exceptions from this model are Great Britain (excluding Scotland) and France, where private companies dominate the sector. Recently, Spain has also been rapidly privatising its water supply sector. Opposing this trend are the remaining countries of Western Europe, which either did not accept privatisation at all (Denmark, Greece, Ireland, Luxembourg, Holland and Austria), or have a relatively low share of private capital in the structure of the

overall ownership (Belgium, Germany, Italy, Portugal, Finland and Sweden); this is illustrated figure 1. The view of the Dutch Government articulated in 1999, is indicative of the general stance adopted, which concluded in the course of the discussion on privatisation of the water supply sector that it is a 'vulnerable and valuable public good, which is not to be played with'. The majority of Western Europe countries prefer a model where it is not necessary to carry out the privatisation of this important and sensitive sector. They quote the following advantages of the state or public ownership in this field: 1) responsibility, where the companies operating in this field are responsible to publicly elected local or national governments, which, test via the electoral process their success in managing this sector; 2) transparency and openness of company operations which have to present their business results publicly and cannot hide behind so called 'commercial and business confidentiality'; 3) responsibility to citizens, where the water supply and sewerage sectors perform a basic public functions and therefore they should be responsible to citizens and not to stockholders; and 4) costs of operations are lower which also makes the price paid by the end user lower, since the goal of the business is not profit or dividends, which would be paid to owners of the private company and/ or transferred abroad31. A similar model is adopted in the countries of North America, both the USA and Canada, the public sector dominates with a 95% share, where water supply and sewerage are generally owned

Figure 1: Percentage of population supplied with water, by the type of the company operating this business, 1996.

Source: Eureau: Management Systems of Drinking Water Production and Distribution Services in the EU Member states, according to: Hall, David, Water in public hands - the alternative to privatisation and globalization, Helvetas conference on water, Zurich, March, 2003.

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After commercialisation of the water supply in South Africa (in cities in the region of the Dolphin Coast), in 1988, the local population was forced to pay the full price of drinking water. Two years after that, cholera broke out in those parts of Africa which infected over 25,000 people, of whom 300 died, before the disease was contained. For instance, in Bolivia, capital returns at a rate of 16% are guaranteed by the concession agreement to the concessionaire (consortium led by the International Water company).

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by municipalities. Funding these needs in the USA is realised by way of revolving credits from the central government.

Experiences from the region


Two approaches to managing and developing utility sector (water supply and sewerage) infrastructure can be seen in Central and Eastern Europe, privatisation and restructuring. Privatisation has mainly been realised through concession agreements with leading foreign private multinational companies. Recent assessments show that about 4% of the water supply and sewerage networks are privatized in this region. Some of the countries that have selected privatisation as an approach are; the Czech Republic, where more than 50% of this sector was privatised to multinational companies (Prague, Brno, Osrava, Karlsbad, South and North Bohemia, Pilsen, Sumperk); Hungary (Budapest, Kaposvar, Szeged, Pech); Poland (Gdansk); Estonia (Tallin); Romania (Bucharest, Ploiesti, Timisoara); Slovenia (Maribor); Croatia (Zagreb - waste water systems); Bulgaria (Sofia); Albania (Tirana, Elbasan); Armenia (Yerevan-management agreement). Among the countries which did not accept privatisation, but opted for restructuring of the current municipal utility companies are: Poland (Poland (Lodz, Szezecin, Torun, Zywiec, Krakow, Bydgoszez), Hungary (Debrecen), Moldova (Chisinau), Latvia (Riga), Lithuania (Kaunas, Vilnius), and Russia (St. Petersburg and Kaliningrad)32. After brief analysis of the mentioned approaches to managing and developing utility infrastructure in the region, we can conclude restructuring the existing utility companies

represents a viable and sound alternative to the privatisation process. It is also observed that the restructuring process was supported by EBRD the European Bank for Reconstruction and Development and by EIB - The European Investment Bank, by long-term and favorable credits, which were not conditioned by guarantees of municipal and city government structures.

The Situation in BiH


Bosnia and Herzegovina annually receives about 1250l/m2 of rain, which represents a total of 64 billion m3 of precipitation. About 57% of the total precipitation flows away from the area of BiH, of this 62.5% down the Sava River basin to the Black Sea and 37.5% down rivers flowing to the Adriatic Sea. The quantity of precipitation, in temporal and spatial terms, is not equally distributed. Average consumption of drinking water in BiH amounts to about 420 liters per capita per day, of which 32% is used by households, 35% by industry, while the remainder represents so-called 'non-chargeable' water, which is lost in the network or is used for public purposes. About 89% of the drinking water is drawn from underground sources, 10.2% from waterways and only 0.8% from natural lakes and impounded reservoirs33. Even with the unfavorable spatial and temporal distribution of water, BiH has enough drinking water to meet its needs in the medium and long term. According to results of the living standards measurement survey conducted in BiH (LSMS) in 2001, 94.4% of urban households, 89.8% of semiurban households, and 75.4% of rural households

Figure 2: Percentages of population in BiH which have drinking water, by areas and entities

Source: BiH Statistics Agency, Federation Bureau of Statistics, RS Bureau of Statistics, Living Standards Measurement Survey in BiH (LSMS), 2001. 32

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For more details on each of these projects, see: Lobina Emanuele, Water privatisation and restructuring in Central and Eastern Europe, 2000, Public Services International Research Unit (PSIRU), School of Computing and Mathematical Sciences, University of Greenwich, London, U.K., 2001. Mrden Damir, Water and Sanitation in Post Conflict Areas - Bosnia and Herzegovina, World bank Water Forum, 2002.

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were supplied with drinking water. By entity, the situation in urban and semi-urban areas of the FBiH was more favorable than in the RS, while the situation is reversed for households in rural areas (see Figure 2). The situation is far less satisfactory in the case of the sewerage network. According to the results from the same survey, 76.2% of households in urban areas, 46.7% in semi-urban areas, and 24.5% in rural areas use the public sewerage network. The situation is much more favorable in urban and semi-urban areas in the FBiH. Referring to figure 3, on average, 78.4% of households in BiH have a bathroom with toilet, 82.7% in the FBiH and 71.2% in the RS. The situation is more favorable, for households in urban areas in both entities. Public utility companies, organized at the level of municipalities, cities or cantons are responsible for supplying drinking water to the population and the regulation and disposal of waste water. These companies are owned by municipalities or cities or cantons and are accountable to their respective assemblies. Yet equally, the age of the water supply and sewage infrastructure in some areas does not meet the needs of the users, neither in terms of the quantity or quality of the water. Most parts of the water supply systems were damaged during the war and are worn out to a lesser or higher degree. This particularly refers to the distribution networks in urban areas, where water losses are particularly high34. Preparations for the privatisation of public utility companies began between 1999 and 2000. These companies were obligated to submit their privatisation programs to the responsible cantonal privatisation agencies, which were required to be drawn up using the same methodology which was applied to other business companies. Considering that these are significant public companies of a large value and special (even political) importance for municipalities and cantons, it was concluded that their privatisation could not be conducted following the models which used for other businesses. In the search for an adequate model, their privatisation was practically abandoned and (for now) permanently postponed. In terms of the position of the public to the privatisation of this sector, the results of a public

survey35 at the level of BiH, shows 53% of respondents have a negative view of privatisation and one third of that number has a 'very negative' view. Consequently, 27.9% view privatisation positively, while only 11.3% had a 'very positive' view. Subdividing the sample; 59.3% of examinees from urban areas have a negative view of privatisation, while only 23.5% of respondents think it is positive. Further more, than two thirds of respondents (68.5%) support citizen participation in the privatisation of electricity, telecom and the water supply sector. After privatisation, 49.2% of examinees expect the quality of services to remain at the same level, and 16.9% believe the quality will worsen. With regards to the prices of services, 39.6% of examinees believe that prices will rise after privatisation, 17.9% expect them to remain at the
Figure 3: Structure of sewerage provision by urban households in BiH

Source: BiH Statistics Agency, Federation Bureau of Statistics, RS Bureau of Statistics, Living Standards Measurement Survey in BiH (LSMS), 2001.

same level, while 26.5% expect a decrease. Negative effects are expected with regard to living standards and employment. Research conducted for the purpose of this Report clearly shows that the citizens are much more interested in taking an active part in the privatisation of the existing public companies. Future research should perhaps concentrate only on the privatisation of water supply and sewerage as a separate utility sector. It is interesting to note that the Living Standard Measurement Survey in BiH, as well as

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Framework water management basis of BiH, JVP Vodoprivreda BiH, Sarajevo, Zavod za vodoprivredu (Water Management Institute), Sarajevo, 1994, according to: PRSP - BiH Poverty Reduction Strategy Paper, Second Proposal, Council of Ministers of BiH, Ministry of Foreign Trade and Economic Relations, Office of the PRSP Coordinator for BiH, Sarajevo, 2003. . Public survey for UNDP - Privatisation of Natural Monopolies, PRISM Research, September 2003.

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official statistics, do not include water consumption in the structure of household expenditures, whilst, on the other hand, they do deal with issues such as the consumption of brandy liqueurs wine, and beer. The average consumption of alcoholic and soft drinks is known, while we can only speculate about the consumption of water. This attitude perfectly depicts the view of BiH society regarding this important life-giving resource, because if this were not the case, Sarajevo streets would surely not be washed and city greenery would not be watered from the city mains.

Recommendations
There are numerous examples of negative effects arising as a consequence of the entrance of large multinational companies into the water supply and waste water treatment sector in undeveloped and developing countries. An alternative to privatisation can be restructuring by means of external, expert-based consultorts and by managerial improvement of the organization, the available resources, infrastructure, and of the price determination system and revenue collection. There are also experiences around the world of a successful application of the concept of the so-called 'public partnerships' in the forms of various models: for example, Public-Public Partnerships36 (PUPs), Participatory Water Management37, Consumers Cooperatives38, and Trade Union Co-operatives39. We can recognize parts of these models in the earlier practice adopted in this field in BiH, when development of water supply infrastructure was funded with various types of self-contribution, funding and cofunding by future users. In selecting a method of privatisation of water supply systems one needs to answer the question whether the public interest

could be satisfied by a system driven by the interests of profit-motivated companies. Opponents of privatisation have a predominant view that managing water as a strategic and irreplaceable resource should be guided by public rather than private interests. Of course, we are not here recommending retention of the status quo in this important field. We believe it can be considerably improved even without privatisation of this sector by improving the organisation, management and efficiency of the existing utility companies, and through facilitating, access to credit support by international financial and development institutions. In order for this to be realised, it is necessary to think about the creation of conditions for moderate increase of prices for these services although unpopular with the public (and politicians), would create the conditions for investing in the rehabilitation and reconstruction of the existing network and the building of a new system, as well as developing new capacities for exploitation and delivery of drinking water and treatment of waste water. Current local experience with development of local water supply and sewerage networks indicates that the possibilities for improvement via this model have not been exhausted. Finally, if the local public companies employed a commercial approach and charged their services at prices which cover their expenses with the improvements in efficiency, internal organization and management - any talk of their privatisation would be superfluous. Such restructuring would surely support not only their current position but also development goals, given by the guaranteed supply of the population with sufficient quantities of high quality drinking water and adequate treatment of waste water.

36

37

38

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Meaning another company or other companies in the public sector, which have the required experience and capacities, in the utility sector, implement projects for the improvement of utility infrastructure. These companies can be local and/or foreign. This model was successfully applied in Baltic States (Estonia, Latvia and Lithuania), but also in semi-rural areas of the North West Province in South Africa. A project (Kaunas) is being realized in Lithuania in cooperation with the Finnish State Environment Institute, whilst other countries of this region cooperate with Swedish municipal companies which have more experience in implementation of similar projects. The quoted model of "participatory management" has been successfully used in Brazil for fifteen years in the water supply of the city of Porto Alegre with 1.4 million inhabitants of whom 99.5% have access to drinking water. The Departemento Municipal de Agua e Esgoto (DMAE) Company represents a state, non-profit, self-financing company, financially independent from the state, which offers to users high quality services at prices which are among the lowest in Brazil. The "consumer cooperative" model has been applied in Bolivia (Santa Cruz) since 1979 and is considered to be very successful for urban centres. All consumers are jointly members of the Cooperativa de Servicios Publicos Santa Cruz Ltda (SAGUAPAC) and take part in the election of the members of the assembly. In the period between 1988 and 1999, the percentage of population connected to the water supply system rose from 70 to 94%. The "trade union cooperative" model has been successfully implemented in the capital city of Bangladesh (Dacca) which has over 10 million inhabitants.

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5. CHARTING A WAY FORWARD: CONCLUSIONS AND RECOMMENDATIONS


The evidence reviewed draws us to a mixed conclusion on the role privatisation has to play in the future strategic management of natural monopolies within BiH, and in securing a successful transition to a modern European market economy. Global experience, from both developed and developing worlds, and particularly progress and practice in the ex-socialist transitional countries, demonstrates that the great potential offered by privatisation is tempered and limited by a series of risks, pitfalls and negative socio-economic spin offs. Above all privatisation is not some 'breakthrough medicine' which will solve all of the problems of these crucial sectors of the economy, but merely a tool to be used within a wider transition strategy alongside liberalisation and effective regulation. Some of the numerous examples of the negative effects arising from large multinational companies entering the natural monopoly sectors in developing countries mentioned above, provide empirical real world evidence that privatisation in these areas should be well thought-out and conducted carefully. It is important to emphasize that after signing long-term concession agreements or purchasing the enterprises, the strategic investor moves forward in four main stages/phases: 1) Improvements in organisation and management, with the objective of increasing in the efficiency of utility companies, and almost inevitably, reducing staffing levels; 2) Increasing prices to levels which fully cover business expenses and create conditions for the return of future loans and ensuring a projected profit for the multinational company; 3) Ensuring and realising favorable long-term investment credits from international financial and development institutions and implementing reconstruction projects, rehabilitation and/or development of infrastructure; and 4) Managing the whole system until the total investment is returned and the concession agreement expires with the sale or return of the whole system to the State in its capacity as the substantive owner. Preparation and processes issues have a particular importance; privatisation with undue

haste and without proper consideration and foresight of the social economic political dimensions is likely to do more harm than good. Overall therefore we caution against the dash for privatisation advocated by certain sections of the international community, and we call instead for a debate and the building of a consensus within BIH on this necessarily sensitive issue. In essence that debate needs to address the four topic areas listed below, and we summarize our thoughts on each: First, the definition of the strategic goals of privatisation of natural monopolies and what the linkages with the wider social and economic agenda. This is in essence a question of efficiency versus equity, and the trade-off between the two. Our analysis and the polling carried out for this study leads us to believe BiH citizens view both as being important, but would define the concept of efficiency more widely than short term economic gain. This implies there should be no blanket application of privatisation. A pr ope r ly phas e d and we ll r e gulat e d pr oc e s s comes a close second in the list of priorities. Indeed, all of the empirical evidence and a growing body of theory indicate that privatisation is not something to be rushed into. Questions about market and ownership structures, service obligations and regulation need to be addressed at the outset. Reforms need to be sequenced and the mechanisms for transferring assets (sales versus vouchers, versus assignment) need effective governance and oversight. The 'shape' of the ownership structures to be adopted provides our third area of consideration. All of the evidence presented above calls for an eclectic approach to these questions governed by an appraisal of the economic and political realities of each sector and locality. An early task would be an examination of which enterprises form 'pure' natural monopolies and which do not, and hence the need for retention in state ownership or sale and the extent of regulation required. Compelling political and social considerations are also pertinent to the eventual structures to be adopted. Finally, the issues of regulation, ownership and accountability have to be considered. These raise perhaps the most serious political concerns. The sale of national assets which deliver what amount to essential services is necessarily a sensitive issue. And contrary to the pronouncements of some voices within 35

the International Financial Institutions, the case for public ownership of some sectors and sub-sectors, particularly in the case of natural monopoly is more than merely ideology. Strong and accountable regulation of business entities is essential in any industry which displays natural monopoly characteristics and in many others where a strong public interest exists. In essence we argue for a balanced approach to the issue of privatisation, which recognizes some of inadequacies of the status quo, and the potential that privatisation offers, but also is aware of the dangers and risks - and what is politically and socially achievable. The above assessment will certainly disappoint those who anticipate considerable budget inflow on the basis of 'privatisation' of these important sectors. An alternative to privatisation can be restructuring through external, expert-based, managerial improvement of the organization, available resources, infrastructure, and also improvement of price setting and bill collection system. Also, if the Government played a more responsible role in addressing the difficult issues within the sectors as opposed to waiting for private investors to address them, the restructuring and management capabilities of these companies would be much better. Many strategic alternatives exist to the generic 'full blown' models of privatisation including: Restructuring and cultural change through the external, managerial improvement of organizations, coupled with better revenue collection and commercialization of operations. Successful application of Public-Public Partnerships (PuPPs); which includes initiatives like Participatory Management, Consumers Cooperatives and Trade Union Co-operatives. These models are useful not least because they are recognisable in the pre-existing practices in BiH. Establishment of public and local corporations, facilitating access to credit support from local and international financial and development institutions, and allowing industries moderate increases in prices for services. In selecting a method of privatising the natural monopolies one needs to answer the question of whether the public interest is inevitably different to the interests of the profit-

motivated companies. Opponents of privatisation have a predominant view that managing natural recourses as a strategic and irreplaceable resource should be guided by public rather than private interests. Of course, suggesting retaining the status quo in this important field is not the best solution. The situation can be considerably improved even without the privatisation of these sectors by improving organization, management and efficiency in the existing utility companies. In order for this to be realised, it is necessary to think about the creation of conditions for moderate price increases, for some of the services (for example in local fixed line telephony) and most definitely reducing prices of international calls or electricity prices for large electricity-driven companies. Although unpopular with the public and politicians, this would create conditions for better investment management and rehabilitation and restructuring of companies making them more competitive and efficient. Finally, a conclusion can be drawn that, except for those who believe in the strictest form of capitalism, based exclusively on private ownership, the privatisation of natural monopolies is not a remedy, nor is it the primary objective. The privatisation, or partial privatisation, of natural monopolies should be viewed as a means of achieving other goals, such as: Facilitating the introducing of competition into a market which was monopolized; Clearly separating the regulatory role from the role of company management and care for operative business; Creating a more dynamic professional environment; Creating stronger motives and incentives to company leadership; and Reducing trade union influence. The privatisation of natural monopolies is not the only and exclusive way to realize the mentioned objectives. Similar effects can be achieved in other ways, too, such as, for instance, transforming state administrations into a company with a public holding40, changing the way of appointing senior managers in such companies, breaking up large companies and creating subsidiary companies, or by eliminating the legal basis which ensures the privileged monopoly position of the company.

40

Like Deutsche, France, British and many other European telecoms

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The introducing competition is potentially a more important instrument of economic policy to achieve the commercialisation of infrastructure services which were rendered before by public monopolies. Competition policies ensure the rules of the game and resolve the objective aspect of market development. Competition makes it possible for improvements made with regard to efficiency at the company level to be translated into lower prices for end users and achieve a more efficient allocation of resources in the economy as a whole. In a narrow economic sense privatisation is indisputably an effective policy. It ensures companies have the necessary profit maximisation motivations and access to financial markets. But again to deliver these benefits, privatisation has to be accompanied by the potential for effective competition. In the case of natural monopolies this may well be illusory in the short run and inefficient in the longer term. Drawing on our sectoral analysis given above, we recommend: For the Electricity Sector, restructuring of the industry into three component parts; generation, transmission and distribution. This to be followed by the privatisation, using a mixture of methods, of the distribution companies as regional concessions, following the consent of local stakeholders, fully recognising that some may remain in public ownership. As for the generation as a sub-sector (power stations and unused potential) retention of state ownership should be viewed as strategic export resource. Privatisation of unexploited potential should be done on concession base and time limited. The current and potential electric-generating capacity of BiH should be strategically analyzed and addressed. BiH has the potential to be regional suppler of electricity, especially renewable and clean sources of electricity, and this should be one of the strategic imperatives of the Government's long-term agenda. The transmission mechanism, which represents a 'pure' natural monopoly to remain as a state owned but arms-length managed entity. A powerful a regulator acting as an overseeing mechanism for each of the economic entities and sub sectors should be set up prior to any

privatisation measures. Its brief would be both to foster efficiency in the sector and ensure consumers share equitably in the resulting gains. In the case of the Telecommunications we acknowledge that technological advances have done much to mitigate the strictures of natural monopoly permitting competition and creating a dynamic commercial environment. Thus we conclude in favour of a more liberal approach in this sector, and we can see no benefit for retaining the existing companies wholly in state hands, save for the need to ensure access to the fixed line networks they operate. Since this is one of the most profitable sectors in BiH retaining a majority of state share of the equity is probably the best way forward41. Proceeding with liberalisation should be seen as one of the priorities and this is to be accompanied with the strengthening the powers of the Communication Regulatory Agency. The Agency should be tasked with acting both as a champion for end-consumers and a manager of the market place to secure both the gains, and avoid the costs, of competition in a fully liberalised market place. In contrast, with respect to Water Services in BIH, we find in favor of retaining much of the industry in public or municipal hands. We consider that this, of all the sectors examined, presents the clearest example of natural monopoly and the scope for useful competitive pressure is necessarily constrained. We also consider that social and political issues mean that the transfer of the sector out of the publicly accountable sphere would present unjustifiable risks. We do however acknowledge that this sector, like the others, would benefit from the introduction of modern and commercial management practices; and that there is a desperate need to make substantial new investment in the water supply infrastructure, something which as yet the public agencies (Entity, Cantonal and Municipal) are neither not able nor prepared to make. Thus we recognise that there may be some score to develop management contracts along the lines of the public partnerships discussed above.

41

Privatisation directly to the citizens, preferably within the Stock Market, should continue and would probably have positive effects both on the company itself and on the financial markets of BiH.

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Finally, it is vital that proper attention is given, throughout the reform process, to the political and institutional dimensions. This is especially vital in the context of BiH and its fractured governance structures. It is not only about pursuing the right policy but securing support, with the right dynamics, and at the right time, which yields successful outcomes for each of the industries under consideration. Policies in these sectors must be developed in cooperation with both national and international experts, and be open for debate by the BiH population, since they are the users and the true owners of the assets to be privatised.

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