Institutions, politics, and contracts : the attempt to privatize the water and sanitation utility of Lima, Peru

The main reason Lima failed to implement a concession was geographical: the scarcity of water sources meant high marginal costs, partly for pumping water from deep wells and building adequate storage for dry periods. High extraction costs were compounded by years of neglect; much of the system needed to be replaced. Attracting private investors meant setting prices high enough to recover these high costs and provide a reasonable return on capital. But the government had subsidized costs for years, so a concession would have required a sharp and sudden price increase to cover marginal costs. Moreover, any forward-looking investor would want to slow the pace of future investment by curbing demand through more effective (meter-based) bill collection. And cross-subsidies, which reduce the incentive to conserve water, would also have to be reduced. The ultimate cause of the concession's failure was geographical but the proximate cause was political. Privatizing a utility is politically tricky if it involves higher prices and the controversial ceding of monopoly powers to private parties, especially foreigners. Private participation in water is further hampered by the social importance of water and by the lack of international experience and the technical difficulties in designing privatization reform in the sector. At the same time, water offers fewer benefits than other utlities--few revenues to reward supporters or compensate losers-- and the price increases likely in Peru would especially hurt the urban poor, who were important to the president's support base. After a favorable start, the political equation shifted against privatization. The concession's failure was costly, in access goals not fully met, in adverse effects on health, and in the failure to curb consumption through metering--and hence in continued depletion of the aquifer and its increasing contamination by ocean salt. Peru's institutional weaknesses, especially its lack of an autonomous judiciary, might have limited how much could have been achieved. But considering the net gains from private operation in the much weaker nstitutional settings in Africa, Lima would probably have been better off with a concession.