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Philippine Institute for Development Studies

Policy Notes May 1999

No. 99-04

Rethinking Government's Role in Urban Infrastructure

billion (Table 1).1 Of this amount, the Philippine investment requirements stand at around US$48 billion.

Gilberto M. Llanto

Unfortunately, investments in basic infrastructure have not been able to match this increased demand. In the Philippines, in particular, the Philippine Medium-Term Development Plan for the periods 1987–1992 and 1993– 1998 and the public infrastructure investments over the period 1990–1996 indicate an overall backlog of P139.42 billion in public infrastructure investments (Table 2). The backlog consists of demand for all types of facilities for transport, telecommunications, energy, water supply and sanitation and other social services and represents about 5.5 percent of gross domestic product.2

With the demand for urban services and facilities, in particular urban infrastructure, continuing to increase through the years, how can the government hope to finance the corresponding investment requirements? This Policy Notes issue looks into this concern by reflecting on a basic philosophy and role of government. Growing demand for infrastructure The rapid economic growth in the ASEAN region in the past decade has spawned a great demand for infrastructure. Said demand is expected to continue as shown in the World Bank estimates for the region's investment requirements in various infrastructure sectors for the period 1995–2004, amounting to as much as US$434

By 2020, it is estimated that more than half of the population of developing countries would be urban-based. The demographic shift implies an increased demand for urban transport, water and wastewater services, basic education and health, sanitation and waste disposal facilities. Clearly, urban growth has further increased the demand for basic infrastructure.

———————— 1 The estimates were done before the onset of the recent Asian financial crisis. 2 Philippine Infrastructure Program, Philippine National Infrastructure Forum, EDSA Plaza Shangri-La, Mandaluyong City, May 22-23, 1997. PIDS Policy Notes are observations/analyses written by PIDS researchers on certain policy issues. The treatise is wholistic in approach, and like the PIDS Executive Memo, it aims to provide useful inputs for decisionmaking. The author is Senior Research Fellow at the Institute and Consultant at the Department of Finance. The views expressed are those of the author and do not necessarily reflect those of PIDS or the Department of Finance.


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Table 1. Investment Requirements for Infrastructure, 1995-2004 (In US$ billion) Power

TelecomTransport munications

Water

Total

Indonesia

82

23

62

25

192

Malaysia

17

6

22

4

49

Philippines

19

7

18

4

48

Thailand

49

29

57

10

145

Source: World Bank, 1996 Infrastructure Development in East Asia and Pacific: Towards a New Public-Private Partnership

Government's new role Traditionally, the national government has been the major provider of infrastructure required by the economy. The rapid population growth and challenge of urbanization, however, have made it necessary to rethink the government's role. This has been brought about by the evidence of urban decay and congestion, the inefficient delivery of public services and the simple lack of basic infrastructure in many municipalities, attesting to the simple fact that government does not have the means to meet the huge task of providing infrastructure. Meanwhile, decentralization has assigned local governments the responsibility of delivering basic goods and services and providing infrastructure at the local level. Devolution has given them the financial and fiscal autonomy to raise resources to finance the growing demand for public goods and services. In this respect, the Local Government Code of 1991 gave local governments the flexibility to use different ways of financing local infrastructure. Local governments can now borrow from private financial institutions without the need to secure prior approval from the Department of Finance. The Code also allows the local governments to enter into build-operatetransfer arrangements with the private

Policy Notes

May 1999

sector to meet local infrastructure demand. Still, the fact remains that even with increased financial and fiscal autonomy, local governments cannot be expected to be major providers of infrastructure given the sheer magnitude of local demand for it. As such, privatization of infrastructure provision has become an alternative method for financing and providing urban infrastructure. For example, the Philippines has given the task of distributing water in Metro Manila to private concessionaires. Build-operate-transfer arrangements have also been tapped to deliver urban infrastructure and to increase power supply in Metro Manila. 3 This indicates a shift in the perceived role of government. From being a major provider of infrastructure, the government is beginning to recognize the importance of playing a coordinating and enabling role wherein the markets can be the ones to provide the financing and ———————— 3 Mandaluyong City used the build-operate-transfer (BOT) arrangement to provide a public market to local residents. In 1990, the Mandaluyong public market burned down. The financially-embattled city government then used the BOT scheme to successfully meet the demand for the reconstruction of a public market.

Table 2. Investments in Public Construction and Backlog in Infrastructure Investments, 1990-1996, Philippines (In P billion) 1990

1991

1992

1993

1994

1995

1996

Gross national product

1,071

1,255

1,375

1,500

1,737

1,959

2,278

Gross domestic product

1,077

1,248

1,352

1,474

1,693

1,906

2,190

Infrastructure program

56.66

79.59

114.84

65.85

79.72

88.41

102.30

Investments in public construction

58.21

47.78

56.61

65.21

65.59

74.18

81.91

1.55

-31.81

-58.23

-0.63

-14.13

-14.23

-20.39

Backlog in public infrastructure investments

Source: Philippine Infrastructure Program, National Economic and Development Authority. All figures are in current prices.


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delivery of urban infrastructure. In part, the Build-Operate-Transfer (BOT) Law 4 is an expression of the government's attitude towards private sector participation. This law indicates areas for private investment, the form and procedure for making the investment as well as the legal basis for different forms of private sector participation in infrastructure, e.g., BOT, privatization of public assets and enterprises, joint ventures, and others.

Clearing the way for an enabling environment The BOT Law, however, is just a starter. For the government to succeed in its refocused role as coordinator and provider of an enabling environment for private sector investment in infrastructure, it must give major attention to the following: Transparent regulatory policies. Clear rules of the game, so to speak, are absolutely necessary if the government wants to encourage private sector participation in infrastructure. The government should have transparent regulator y policies that will safeguard public interest and safety, uphold contractual obligations and ensure efficient delivery of urban services to the population, especially the disadvantaged groups. Regulatory policies should encourage the efficient use of resources through appropriate pricing or tariff policy which covers the full cost of delivering the service and raises resources to finance future investments. Regulatory design should strike a careful balance between the interests of private investors, financiers, consumers and government. This includes the need to have an adequate institutional capacity to regulate, as enunciated by Serafica in her report where she noted that "the technical capabilities of our regulatory institutions (should) be strengthened to ———————— 4 Republic Act 6957 as amended by Republic Act 7718. 5 Ramonette Serafica, "Beyond 2000: An Assessment of Infrastructure Policies." PIDS Discussion Paper Series No. 98-07, Philippine Institute for Development Studies, May 1998. 6 Gilberto M. Llanto and Ma. Cecilia G. Soriano, "Government Guarantees in Infrastructure Projects: A Second, Third Look at the Policy." PIDS Policy Notes No. 97-11, Philippine Institute for Development Studies, October 1997.

No. 99-04

deal effectively with the complex demands of a marketoriented (infrastructure) policy regime."5 Competition policy and privatization. In the rush to privatize in order to cash in on private sector interest in infrastructure provision and delivery, the government runs the risk of not having an appropriate regulatory framework in place that would inhibit monopoly power by private sector providers. This is so because the driving motivation for the government may perhaps not really be the need to have greater efficiency in infrastructure provision and delivery, which may be achieved through privatization, but simply the desire to eliminate the fiscal burden associated with being a major provider of infrastructure. If privatization, however, is to really benefit the consuming public, it is important to introduce elements of competition to bring about efficiency in different infrastructure subsectors, e.g., telecommunications, energy, and water and to provide affordable prices to the endusers. Government guarantees and risk sharing. Comprehensive government guarantees in the power sector have effectively induced private sector participation in that sector. There is, however, a need to review the policy on government guarantees in view of the resultant contingent liabilities that create a potential fiscal problem. In this regard, there seems to be a case for breaking down risks into certain components and assigning them to the parties best able to bear them. For example, commercial risks should be borne by the private investor while government guarantee should be limited to those that are appropriately under the responsibility of government. Guarantee cover could thus be broken down into ] fundamental guarantees covering sovereign and political risks; ] conver tibility guarantee covering foreign exchange convertibility risks; and ] project-specific guarantee covering problem areas such as right-of-way, tariff schedule, and others.6 Developing domestic capital markets. In the ultimate analysis, it is capital markets, not government bud-

Policy Notes


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getary appropriations, which can truly finance infrastructure development. Unfortunately, the domestic debt and equity markets in the country are quite inadequate thereby discouraging private sector participation in infrastructure. While the country might enjoy a stable macroeconomic environment—a basic condition for long-term investments—and while it may eventually succeed in developing a legal and regulatory framework and competition policy that would ensure efficiency in the delivery of service by the private sector providers as well as benefit the public in terms of reduced prices, what remains obvious is the lack of long-term capital needed to finance infrastructure development. To be able to address this, the government should develop, among others, long-term government debt or other benchmarks, the bond market, secondary market facilities for buying and selling longterm debt, and mortgage-backed securities as alternate benchmarks. Decentralization and local infrastructure. Decentralization has transferred to local governments the major responsibility of providing urban services, including infrastructure, to local residents. For example, provision of local water supply, sanitation, sewerage, housing, and land development are part of the decentralization process. If local governments follow tradition, they will assume the role of major providers of infrastructure. However, providing and financing urban infrastructure is a complicated and expensive task, requiring substantial resources and expertise that local government will find difficult to provide. Local governments may have the desire to provide and finance urban infrastructure but limited local resources prevent them from satisfying the increased demand for such. Unless private resources and expertise play a greater role in local infrastructure provision and delivery, there is a slim hope for demand to be satisfied. There will be greater private sector participation in local infrastructure if local governments redefine ———————— 7 Rosario G. Manasan, "Closing the Urban Fiscal Gap: Some Considerations." PIDS Policy Notes No. 99-02, Philippine Institute for Development Studies, March 1999.

Policy Notes

May 1999

their role from being a major local infrastructure provider to a catalytic agent that provides the appropriate policy environment to motivate private sector participation in local infrastructure. The departure from tradition may never be an easy task. Nevertheless, local governments should develop the capacity to play a coordinating and enabling role in their respective jurisdictions. To this end, public-private partnership in local infrastructure development should be promoted. Closing the urban fiscal gap. Finally, local governments should strive for more fiscal autonomy. At present, they are very dependent on national government transfers, e.g., internal revenue allotment, to finance local capital expenditures and their day-to-day operation. In this regard, Manasan observes that urban local government units face a financing problem known as "fiscal gap." This means that perceived ser vice needs and available fiscal resources do not match.7 There is therefore a need to close the gap; otherwise, the delivery of services and public goods to local residents will suffer. As such, policymakers should consider the following recommendations: ] Increase local revenue effort; ] Increase local government taxing authority; and ] Use existing financial resources in service delivery more efficiently. 4

For further information, please contact The Research Information Staff Philippine Institute for Development Studies NEDA sa Makati Building, 106 Amorsolo Street Legaspi Village, Makati City Telephone Nos: 8924059 and 8935705; Fax Nos: 8939589 and 8161091 E-mail: gllanto@pidsnet.pids.gov.ph, jliguton@pidsnet.pids.gov.ph


Rethinking Government's Role in Urban Infrastructure