Report No. 14469-AR

ArgentinaTransport Privatization and Regulation:The Next Wave of ChallengesJune 6, 1996

Infrastructure DivisionC-ountrv Department ILatin America and the Caribbean Regional Office

Document of the World Bank

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FISCAL YEAR

January I to December 31

WEIGHTS AND MEASURES

The Metric System is used throughout this report

CURRENCY EQUIVALENTS

Currency Unit - Argentine Peso (A$)US$ = A$1

ACRONYMS

AGP = Administration General de PuertosATAM = Autoridad de Transporte del Area MetropolitanaBA = Buenos AiresBOT = Build Operate and TransferCVF = Consejo Vial FederalDNCPVN = Direcci6n Nacional de Construcciones Portuarias

y Vias NavegablesDNV = Departamento Nacional de VialidadDPV = Direcci6n Provincial de VialidadFA = Ferrocarriles ArgentinosFEMESA = Ferrocarriles Metropolitanos S. A.FONAVI = Fondo Nacional de ViviendaFONDOVIAL Fondo Nacional de VialidadFP = Ferroexpreso PampenoGOA = Government of ArgentinaJNG = Junta Nacional de GranosNRT Net Registered TonsOECD = Organization for Economic Cooperation and

DevelopmentSAP = Sociedad de Administraci6n PortuariaSAR = Staff Appraisal ReportSBASE = Subterraneos de Buenos Aires S. E.SUBTE = The Metropolitan Suburban Rail Services

of Buenos Aires

PREFACE

This report has been prepared by a team led by Antonio Estache (LA1IN) basedon the findings of two missions that visited Argentina in January 9-17, 1995 and January29-February 11, 1995. The first mission included Jose Carbajo (TWUTD), Jose G6mez-Ibanez (Harvard University) and John Meyers (Harvard University). The second includedAntonio Estache (LAIN), Marianne Fay (Young Professional), Walter Garcia-Fontes(Univesitat Pompeu Fabra, Barcelona), Frannie Humplick (PRDEI), and Thomas-OlivierNasser (MIT and Institut d'Economie Industrielle, Toulouse). The report benefited frombackground papers by Javier Cardozo (Consultant), Xavier Freixas (Universitat PompeuFabra, Barcelona), Felix Helou (Consultant), Martin Rodriguez-Pardina (Consultant), andJeff Ruster (PSD). The mission would also like to thank key members of Argentina'stransport sector, Mr. Corcuera Ibanez, Mr. Conejero and Mr. Kohon for their help in thepreparation of this report.

The Peer Reviewers for this report were Messrs. Z. Shalizi (TWUTD), andI. Kessides (PSD).

Background Papers Supporting the Report

Carbajo, J., J. G6mez-Ibanez and J. Meyers (1995), "An Assessment of ArgentinaTransport Reform", mimeo, The World Bank, LA1IN

Cardozo, J., (1994), "Estado de Situaci6n del Transporte en el Area Metropolitana deBuenos Aires", mimeo, The World Bank, LAIIN

Fay, M. (1994), "Infrastructure and Growth in Argentina", mimeo, the World Bank,LAIIN

Fay, M. and A. Estache (1995), "Regional Growth in Argentina: Determinants and PolicyOptions", mimeo, The World Bank, LAlIN

Freixas, X and W. Garcia-Fontes (1995), "Infrastructure Financing for Argentina'sProvinces: Issues and Options", mimeo, The World Bank, LAIIN

Humplick, F. (1995), "Infrastructure Performance in the Provinces of Argentina", mimeo,The World Bank, LAI IN

Hlumplick, F. and T. 0. Nasser (1995), "Risk in Provincial Infrastructure Provision: AnInvestor's Perspective", mimeo, The World Bank, LA1IN

Rodriguez-Pardina, M. and F. Helou (1995), "Comparaci6n de Marcos Regulatorios enArgentina", mimeo, The World Bank, LAIIN

Ruster, J., (1995), "Infrastructure Financing: Options for Brazil's States and Argentina'sProvinces", mimeo, The World Bank, LAIIN

In addition the paper has benefited from two documents prepared in parallel by ourcolleagues of the Government of Argentina.

Kohon, Jorge: "Argentina Railways Case Study" in Kopicki, Ronald & LouisS. Thompson (eds.), Draft report on "Institutional Change and Private SectorDevelopment in Railways". World Bank (forthcoming)

"Diagn6stico del Sector Transportes" Draft report produced for the Government(December 1994) (mimeo)

ARGENTINATRANSPORT PRIVATIZATION AND REGULATION: THE

NEXT WAVE OF CHALLENGES

Table of Contents'

Page No.Executive Summary ....................................................... i

Chapter 1: Introduction and Policy Summary ..................................... 1Reform Needs in the Provinces .......................... .............................. 2Learning from the National Privatization Experience ........................................ 3

Railways and Subways ........................................................ 4Highways ........................................................ 5Ports and Waterways ........................................................ 5

Some Key Issues with Implications for the Provinces ................... ..................6The Role of Subsidies ........................................................ 6Fine-tuning Regulation ......................... .............................. 7The Need for an Integrated Transport Policy Approach .................... 10

Chapter 2: Intercity and Metropolitan Railways ...................................................... 12The Background Before the Reform ....................................................... 12The Strategy of Railway Reform ..................................... .................. 13

How was the Freight Network Unbundled and Privatized? ................ 14How was the Metropolitan Commuter Network Unbundled? ............ 16How were the Intercity Passenger Services Addressed? .......... .......... 18

The First Effects of Rail Privatization ....................................................... 19Impact on Freight Services ................................................. ...... 19Impact on Metropolitan Railways ..................................................... 21Impact on Intercity Passenger Services ............................................. 23Overall Impacts of Rail Privatization ................................................. 24

Lessons and Challenges Ahead ....................................................... 25Lessons learned ....................................................... 25Challenges Ahead ....................................................... 26

Chapter 3: Intercity and Buenos Aires Access Roads .............................................. 30The Background Before the Reform ....................................................... 30The Reform Strategy for Roads ....................................................... 31

First Wave of Concessions: Intercity Roads .................... .................. 32

lThis report was produced under the supervision of Mr. Gobind Nankani, Director, Mr. Asif Faiz,Division Chief, Infrastructure and Urban Development, and Mr. Danny Leipziger, Lead Economist,Country Department I, Latin America and the Caribbean Regional Office. The Peer Reviewers for thisreport were Messrs. Z. Shalizi (TWUTD), and I. Kessides (PSD).

Second Wave of Concessions: Access Roads to Buenos Aires .......... 34The Impacts of the Road Concession Program ............................................. 35Lessons and Challenges ................................................ 38

Lessons Learned ................................................ 38Challenges ahead? ................................................ 38

Chapter 4: Ports and Waterways ...................................................... 41The Situation Before the Reform ...................................................... 41The Strategy of Reform in the Port Sector ................................................... 42

D eregulation ...................................................... 43D ecentralization ...................................................... 43Privatization ...................................................... 43

The Strategy of Reform in Waterways ...................................................... 45The Impacts of the Regulatory Reform of thePorts Sector .......... . ............................................ 46

Lessons learned ....................................................... 47C hallenges A head ...................................................... 48

Chapter 5: Reform Options for Provincial Roads .................................................... 50What is the Demand for Road Services in the Provinces? .............. ............... 50What is the State of the Provincial Supply of Road Services? . ...... I 52How Relevant is the National Experience for the Provinces? ...............A Strategy for the Reform of Provincial Road Management . ........................ 57

Tables

2.1 Summary Features of the Freight Railway Concessions2.2 Bidding Criteria Used in the Railway Freight Concessions2.3 Winning Bids for the Railway Freight Concessions2.4 Summary Features of the Metropolitan Railway Concessions2.5 Winning Bids for the Metropolitan Railway Concessions2.6 Projected vs. Actual Railway Freight Volumes2.7 Metropolitan Railway Performance Shortly After Privatization2.8 Most Recent Performance of Metropolitan Railway Concessions3.1 Summary Features of the Original Intercity Road Concessions3.2 Intercity Road Concessions3.3 Summary Features of the Buenos Aires Access Road Concessions3.4 Buenos Aires Access Road Concessions3.5 Aggregate Traffic Flows for the Intercity Road Concessions3.6 Toll Revenue in the Intercity Road Concessions3.7 Final Price Evolution of Gasoline and Diesel Fuels4.1 Summary Features of the Port Terminal Concessions of Puerto Nuevo, Buenos Aires4.2 Buenos Aires Port Terminals Concessions4.3 Perfornance Indicators of Labor Productivity in the Port Sub-Sector4.4 Argentine External Trade after Port Privatization

5.1 Explaining Deviations From Regional Productivity, 19905.2 Rating Provincial Risk for the Road Sector

Boxes

5.1 How much do Roads Matter to the Private Sector of Santa Fe?5.2 Long-term Options to Attract Private Interest in the Provincial Road Sector

Graphs

5.1 A Comparison of New Road Construction Costs Across Provinces5.2 Unit Costs of Maintenance Contracted out in Selected Provinces

ARGENTINA - TRANSPORT PRIVATIZATION AND REGULATION: THENEXT WAVE OF CHALLENGES

EXECUTIVE SUMMARY

OBJECTIVES OF THE REPORT

The report identifies the main issues the provinces face and options they have incarrying out their new expanded responsibilities in the transport sector. In the process, thereport draws some lessons from the national reforms in railways, roads, ports andwaterways and identifies in these reforms some issues that could not be anticipated at thetime the reforms were originally implemented in view of their novelty.

MAIN GENERAL CONCLUSIONS

The transport sector reforms initiated in 1989 have generally improved efficiency,quality and prices of the major services, but to ensure the sustainability of the successesachieved, the following changes would help:

1. Reform provincial road management andfinancing2. Reassess the role of subsidies in the sector3. Spell out renegotiation rules for contracts4. Streamline the oversight of concessionaires5. Design and explicit integrated transport strategy

o Reform road management in the provinces

- For most provinces, the reform should aim at commercializing the managementand operation of provincial road agencies to cut costs and improveaccountability of managers and workers by relying on multi-year managementcontracts between the road agencies and the provincial government withspecific performance goals and built in minimum levels of service contractswith the private sector;

* In the few cases where it is possible, consider concession contracts with theprivate sector based on minimum subsidy required when traffic levels are toolow to allow profitable private operations;

* Bids for all contracts in the provinces may require revisions of procurementrules;

* Consider innovative financing options for the few high traffic provincial roadsto reduce risks faced by private investors in provincial projects (i.e., theconcessioning of "road packages" covering road networks across provinces toreduce commercial risks); and

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* There may be a market for a "Transport Investment Fund" to finance roadslikely to benefit from increased trade due to MERCOSUR.

* Reassess the role of subsidies to reduce misallocation of traffic between modes:

* To reduce urban congestion and air pollution costs, reduce the implicit subsidyto urban motorists by charging them; otherwise, subsidize explicitly commuterrail;

* Review the apparent implicit subsidy to heavy trucks (i.e., they pay lower fuelstaxes) and charge them for road damage, pollution and congestion they cause;and

* Suppress subsidies to waterway dredging (as in the Parana River) sincecompeting modes or ports are not subsidized, unless the positive externalitiesof this subsidy can been demonstrated.

3 Spell out rules for contract renegotiation:

* Introduce a flexible, fair and transparent mechanism for the renegotiation andmodification of concession contracts, this should facilitate needed contractrevisions in freight railroads, subway and commuter rail; and

* Consider the option of a special arbitration commission independent of theregulators and faster than the court system to settle renegotiations.

* Reduce the number of monitoring agencies and focus their role:

* Concentrate the focus of regulatory authorities on supervision andenforcement, rather than the monitoring of possible monopoly practices; and

* Maintain only one enforcement commission and one arbitration commission tosettle contract disputes between regulator and regulated for the entire sector.

* Design an integrated transport strategy

* a National integrated strategy needed to internalize the impacts of transport onthe environment and on health (to cut the current high rate of traffic accidents)and to better identify sectoral investment needs;

* The instruments of this strategy should include demand management (includinga more explicit recognition of the role of subsidies) and explicit assessments ofthe environmental impact of project and program design; and

* An integrated approach would also take better advantage of multimodaloptions even if much of the initiative is left to t he private sector and of anynew needs resulting from the creation of MERCOSUR.

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SECTOR SPECIFIC ISSUES

* Railways

* Spell out the rules being considered for the revision of the concessioncontracts and the conditions that justify the changes.

* Roads

* Make road user charges more consistent with costs attributable todifferent types of uses and vehicles; and

* Clarify the institutional aspect of decentralization and the rules andconditions of assistance to the provinces.

* Ports and Waterways

3 Finalize quickly the creation of the regulator and of the transfer ofports;

- Accept renegotiation of subsidies and/or fees in demand estimates builtin contracts are found to have been overoptimistic after privateoperators take over operations; and

- Adjust road user charges because containers traffic and thedevelopment of Puerto Madero and of the Retiro Station are all likelyto increase traffic and congestion downtown.

Chapter 1: INTRODUCTION AND POLICY SUMMARY

1.1 Objective of the Report. The report analyzes the reform agenda facing provincialgovernments in the transport sector.' Argentina's provinces inherited many new responsibilities as aresult of the transport reforms started in 1989. To cope with this new role, many are trying to relymore systematically on the private sector. The lessons of the recent experience of transportprivatization at the national level are thus very relevant to any assessment of the provincial options.While drawing these lessons, the report identifies some issues emerging in these early stages of thereform process as both government and private operators are learning more about their respectivenew roles in the sector.

1.2 Main Conclusions. First, the report endorses the decision of many provinces to close mostof the ports and railways they inherited from the national government in view of the modest demandfor these services. Whenever demand is sufficient, however, and when the provinces decide to keepsome of the ports and railways operating, the private sector is often likely to provide the most cost-effective service, a conclusion suggested by national experience. The situation is different for roads,however, where the provinces are slower in adjusting to their new role and the private sector is notshowing much interest due to low traffic. Consequendy, since concessions to private operators arelikely to be the exception rather than the rule, the provinces need to focus on other options. Thereport suggests that in most provinces, cost reductions and improved accountability in roadmanagement could be achieved through management and service contracts-altough thegovernment will have to continue to finance operations, maintenance and investment in most cases.Indeed, where contracting-out is feasible, the concession experience at the national level hasdemonstrated that most users often stand to gainL

1.3 From a more general perspective, the review of the national experience suggests that whilethe reforms, generally, have been very effective so far at improving services and cutting costs andprices, four issues merit the attention of not only the provincial authorities but also the nationalauthorities, namely:

- The importance of implicit subsidies in the sector.* The need to spell out the renegotiation rules for concession contracts.* The importance of a streamlined oversight of the concessionaires.* The potential benefits from an integrated transport poiicy approach.

1.4 Road Map. The remainder of this chapter provides a policy summary of the report andincludes a cross-sectoral view of the issues. Chapters 2 through 4 draw lessons from the nationalreforms of railway, port and waterway and highways, respectively, focusing on the issues mostrelevant to the provincial govemments. Chapter 5 addresses the reform needs of the provinces in themanagement, operation and financing options in the road sector, where the provinces are likely toface their most difficult challenges.

T Ihe focus is on surface Imnsportation modes: railroads, highways, ports, and waterways. The privatizatico of Argeina'snational airline and the status of Argentinars airports are not consideed, neither are buses or other forns of public urbantlm sritation.

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REFORM NEEDS IN THE PROVINCES

1.5 A crucial aspect of the transport reform in Argentina is the devolution of manyresponsibilities in railways, roads and ports from the national to the provincial governments. Issuesare complex as the provinces vary enormously in both needs and resources. The provinces havebeen able to take quick decisions in railways and ports, but are still struggling with the adjustmentneeds in the road sector.

1.6 Most provinces will not have a railways or port problem. Because most intercity railpassenger services offered to the provinces are very lightly used, they have been or are likely to beabandoned without much social cost. All but a handful of the communities apparently can bereached by road and have bus service. The principal loss may be that travelers now must pay higherfares since intercity rail service is heavily subsidized while intercity bus service is not Similarly,many of the ports devolved to the provinces apparently handled no traffic for years and most of thosethat did have traffic are likely to be viable as concessions. There is an excess of small ports on theParana River, for example, and the consolidation of traffic at several financialy self-supportingports probably will cause little hardship. There are a number of fishing ports on the Atlantic Coastsouth of Buenos Aires, and the most important of these are probably financially viable.

1.7 It is taking the provinces much longer to adjust to their new role in roads. Theprovinces' adjustment to their expanded responsibilities in the road sector has been much slowerthan im ports or railways, a clear symptom of problems in the provincial management of the sector.The main issues every provincial road secretary is likely to face are:

* the operation, maintenance and construction of provincial roads cost on average twicewhat they should cost and the local managers are not accountable, and

* the commercial, fiscal and political risks are all too high to attract much private interestin the provincial road sector

1.8 Road costs are too high and provincial managers are not accountable. A snapshot ofthe current state of roads in Argentina's provinces reveals an alarming picture. Only 70 percent ofprovincial roads are regularly maintained and ,on average, maintenance expenditure represents onlyabout 37 percent of total public road expenditure. The most serious issue, however, is the high unitcost of activities in the sector. New road construction, for instance, costs on average about twice asmuch as what might be considered a best practice. Similar observations could be made for patching,graveling, sealing or overlaying. Most often, this reflects a fair amount of cost padding andregulatory restrictions to entry in the bidding of services as well as poor incentives in the overallmanagement of the sector. In a sample of eight provinces (Buenos Aires, C6rdoba, Santa Fe,La Pampa, Neuquen, Corrientes Misiones and Chaco), the World Bank estimates that about$125 million are wasted every year as a result of these inefficiencies. Many provincial governmentsare now aware of the situation and are trying to change the operation of the sector.

1.9 Risks faced by potential private investors are too high in most provinces. The mainrisk pertains to commercial viability. Only a few roads in the wealthier provinces are likely to beable to rely on some forrn of private financing. Santa Fe has already granted a concession to toll,maintain, and improve an existing intercity expressway and C6rdoba, Mendoza, and Santa Fe are inthe process of granting toll-based concessions for the high-volume roads that access their main cities.

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Santa Fe also has plans to grant concessions to toll and maintain some intercity roads that carryrelatively modest volumes (between 1,000 and 2,000 vehicles per day) and to contact withmunicipalities to maintain the provincial and local network of low-volume, earth roads. But for themajority of roads and provinces, the traffic levels simply do not justify much private interest. This isobvious in the less densely populated and poorer provinces. Moreover, the report shows that inmany of these, policy and political risk levels for potential private investors are often much higherthan in the richest provinces. For instance, the fiscal situation in many provinces is so poor that anycontract requiring public sector payment is likely to be a source of concem.

1.10 A solution: contracts to minimize costs and subsidies and rely on benchmarkpricing. In the short to medium run, for most provinces, the best option for reform is probably onein which the provincial government introduces some type of performance or management contract inthe road agencies, with specific targets on pricing of services (based on best practice benchmarkswhen possible), on share of services subcontracted to the private sector and on minimum levels andshares of resources to be allocated to maintenance, as a way of avoiding overinvestment in newroads at the cost of a deterioration of the existing network. In a few cases, the road amin ionsshould be able to bid out to the private operators demanding the lowest subsidy at least some shareof the network. The Province of Buenos Aires, for instance, is planning to bid out at minimumsubsidy cost its roads with light traffic; however, this is likely to be an exception rather than the rulewhen provinces- specific risks are accounted for. Whatever type of contract is adopted, mary of theprovinces may encounter difficulties; then, it will be important for the national government tomnaintain technical assistance to the provinces. Technical assistance, however, is currently much tooweak to be able to have any major impact and will need to be strengthened.

1.11 Increasing the odds of getting private financing in the longer run. Even if roads willhave to be financed mainly by the public sector in the foreseeable future, as provinces improve theirfiscal status, private financing may become available for specific projects. For example, candidatesare commercial projects such as roads from Brazil to Chile which would allow some Brazilian andArgentinean products to be exported through Chile to the West Coast of North America or to EastAsia. The report proposes various options to increase the odds of getting access to private capital.These options essentially try to create funds that reduce transaction costs for investors, easediversification of investments in infrastructure, provide small projects with easier access to capitalmarkets, and contribute to the development of capital market financing of infastructure.

LEARNING FROM THE NATIONAL PRIVATIZATION EXPERIENCE

1.12 Management and service contracts with the pnrvate sector are likely to be the mnaininstrument by which to involve the private sector in provincial transport activities. Concessioncontracts were the main instrument used at the national level. Even if these contracts are not exacyof the same type, the lessons learned from the experience with concession contracts in transport atthe national level is relevant since they show a preference for contract-based regulation in Argentina.Moreover, the national experience, initiated in 1989, is at the forefront of recent efforts to privatizeand deregulate in Latin America Argentina was the first Latin American country to privaize itsintercity railroad, for example. It is the only country outside Japan that has private urban conmnuterrailways. And it is the only country in the world to grant a private concession to operate its subway.Argentina (along with Mexico and Chile) was also among the first in the developing world to grantprivate concessions to build and maintain roads, and is also a leader in efforts to privatize ports and

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waterways. It is thus vital to ensure that the lessons gained from this experience are disseminatedwithin the country as much as outside, since Argentina's reforms are rapidly becoming a model formany other reforms elsewhere. The experience of the three main subsectors are reviewed nextEmphasis is on the design of the reform process (i.e., unbundling, bidding process, and contractcoverage) since it was key to maximizing the gains from the introduction of competition; this is whatmay be most relevant to the provinces--or any other administration attracted to the national reformmodel.

Railways and Subways

1.13 The reform. Ferrocamles Argentinos (FA) was divided into three separate businesses-freight, intercity passenger, and commuter rail--which were privatized or transferred to the provincesin that order. The viable freight network was divided into six separate concessions. The first 20-year concession was offered in early 1990, and by October 1993 five of the six were in privateoperation. All intercity passenger services were offered to the provinces, but most were ultimatelyabandoned (as mentioned earlier). FA's urban commuter railroad services, centered around BuenosAires, were divided into seven separate lines and offered in concession to the private sector. Themunicipally-owned subway system was also placed in a concession jointly with one of the sevencommuter lines. Private operations began on the first concession on January 1, 1994 and by June1995, all the commuter lines had been transferred to the concession winners.

1.14 The outcomes. The outcomes in terms of cost and traffic level and reliability have so farbeen very positive. First; the sector cost much less to the national govenmment since the reforrns andthe need for govemment subsidy has been cut significantly. Throughout the 1 980s, FA required anaverage subsidy of about 0.6 percent of GDP per year--the budgetary transfers to FA was aboutUS$1.5 billion per year in the years immediately preceding concessioning. The intercity freightconcessionaires now receive no subsidies from the national government, while the urban commnuterrailroads and the subway concessionaires are expected to receive a subsidy averaging less than $100million per year over the life of their 12-year concessions, most of which is for capital imnprovements.These changes had a direct impact on the province, since several provinces provide some modestsubsidies for intercity passenger services. Moreover, while the national govemment continues tosubsidize the only "unsold" intercity freight line (Belgrano), one of the options to reduce the burdenof this subsidy is to devolve the line to the provinces and let them decide if they want to continueoperations.

1.15 Second, except for intercity passengers, rail usage is stable or increasing. This suggests thatrail users as a whole are no worse off or are better off under privatization. In many cases, servicequality improved quickly. By 1994, in the case of freight, the concessionaires were carrying aboutthe same tonnage as in the late 1980s. In 1994, the first year in which some urban rail services wereoperated by concessionaires, reported ridership increased 45 percent on urban commuter railservices and 18 percent on the subway compared to 1993. Half or more of the reported increase onthe commuter railroads is thought to be due simply to dramatic reductions in the theft of fare receiptsby train staff; the remainder and most of the reported gain on the subway is thought to be real. Theincreases in freight traffic are due to both increased service reliability and tariff reductions, whileurban passenger growth is largely attributed to additional trains, cleanliness, and security.

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Highways

1.16 The reform. The Government concessioned about a third of the intercity highway system--with average daily traffic volumes of at least 2,000 to 2,500 vehicles--considered most suitable forconcessions. The concessionaires were allowed to collect tolls, but in return were required toundertake a program of maintenance, rehabilitation, and capacity improvements. Twelve separate12-year concessions were offered in 1989 and awarded in early 1990. Next; in 1992, thegovernment organized a system of concessions for improvements to the major access roads ofBuenos Aires. It awarded (in 1994) three 22-year-and-8-month concessions to toll and substantiallyincrease the capacity of the expressways approaching from the north, west, and southeast. Inaddition, the governnent negotiated with the firm that won the concession for the Buenos Aires-Mardel Plata intercity road to upgrade substantially the expressway approaching from the south..

1.17 The outcomes. The improvements in intercity highways have been significant althoughless dramatic and more debatable than in the other two subsectors. On the one hand, according toinformation provided by DNV, the maintenance of the intercity highway system, including theportions concessioned, has improved significantly. In 1989, the proportion of paved roads in badcondition reached about 30 percent. In 1993, it fell to 25 percent and DNV expects it to fall to about10 percent by 1997. Moreover, road usage has apparently increased, while the cost of maintenanceon the concessioned network is no longer a drain on government budgets. On the other hand, thereis no direct evidence that the private sector is maintaining the roads at lower cost than the publicsector did, or even that it is doing better at the same cost. The users now must pay tolls, and thecontinued traffic growth is undoubtedly due in part to the economic recovery and to long-term trendsdtat favor highway modes. The concessions for urban access roads are too recent to offer any firmevidence, but they promise to provide some badly needed increases in urban highway capacity thatthe government might not have built otherwise.

Ports and Waterways.

1.18 The reform. The Government abolished many of the restrictive regulations governingworking practices at ports and on vessels between 1990 and 1993. The seven largest ports operatedby the Administraci6n General de Puertos (AGP) were put in the hands of new port authorities-three in the province of Buenos Aires and two in Santa Fe. These new authorities are govemed byrepresentatives of provincial and local govenmments and shippers and are required to lease theterminals in the ports as concessions. The remaining 60 old AGP ports, which were small, half ofwhich had not served as ports for many years, were transferred to the provinces, which couldcontinue to operate them, lease them to private firms, or abandon operatiorL By 1995, the newauthority for the Puerto Nuevo at Buenos Aires, Argentina's main container port; had awarded andturned over its five terminals to five different concessionaires, and a similar process of concessioningwas underway at the other major ports. Argentina's port approaches and navigable river channelshad been maintained by another public agency, Direcci6n Nacional de Construcciones Portuarias yVias Navegables (DNCPVN). In 1994, the govemment awarded a concession for dredging andmaintaiing the 750km navigation channel from the Atlantic Ocean up the Parana River as far asSanta Fe, including the approaches to the ports of Buenos Aires and Rosario. The concessionaire isexpected to collect a third of the dredging and maintenance costs from tolls.

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1.19 The outcomes. The combination of deregulation and privatization led to dramaticreductions in port charges and in barge and ocean-shipping tariffs. Charges for shipping containersbetween Argentina and Northern Europe declined between 30 and 70 percent between 1991 and1993; the savings for grain and other bulk shipments were around 10 percent. Much of the savingscome from improved labor productivity. At the ports of BA, which handles most of the containersbound to or from Argentina, employment fell from around 8,000 immediately before the reforms to2,500 in 1994. Some of the minor unprofitable ports transferred to the provinces probably will beabandoned; however, these are so lightly used that the benefits lost should be minor relative to thecosts saved.

1.20 Although the Atlantic Ocean-Santa Fe waterway concession has only recently beenawarded, the Argentine Government expects that it will generate similar savings. The public agencyhad been maintaining the channel at a cost of about $70 million per year. The winning concessionbid to maintain it is at $60 rmillion per year, $20 million of which the concessionaire hopes to collectin tolls and $40 million in subsidy from the national government. The savings is greater than thesefigures suggest because the concessionaire is obliged to maintain the channel to a depth greater thanbefore north of Buenos Aires. At the Parana River port of Rosario, one of Argentina's main graimports, bulk grain ships of the Panama design, the standard for world trade, now can load onlypartially fill and must go to the deeper ocean ports of Bahia Blanca (in Argentina) or Santos (inBrazil) to be topped up. The deeper channel will allow Panama ships to leave Rosario fully loaded

SOME KEY ISSUES WITH IMPLICATIONS FOR THE PROVINCES

1.21 In any reformn, there are usually areas in which fine-tuning is necessary. There are threesuch broad areas in which the Government of Argentina may wish to consider some fine-tuning andon which the provincial, and occasionally municipal governments, may wish to :pay particularattention as they cany out their own transport sector reforms:

* Revisiting the cost and benefits of subsidies;* Supervising, coordinating, and streamlining contract-based regulation; and* Integrahtng policies in the sector.

The Role of Subsidies

1.22 Argentina's basic transport strategy since 1989 has been to reduce government subsidiesand privatize wherever possible to allow market forces to be the primary determinant of the servicesprovided. As long as the markets are reasonably competitive, the privatized and unsubsidized firmswill have strong incentives to control their costs, improve their productivity, and tailor their servicesto customer needs. But it is difficult to eliminate subsidies and privatize comprehensively, however;thus, in practice transportation activities will be provided by a mix of subsidized and unsubsidizedpublic and private agencies.

1.23 Explicit versus implicit subsidies to urban commuters. Privatization is compatible withsubsidy, as Argentina's urban rail concessions demonstrate. Moreover, some subsidies may bedesirable because they are needed to offset others, often implicit, that have not been removed.Consider an example relevant to many of Argentina's largest cities, including most provincialcapitals. Urban road use is subsidized in the sense that motorists do not pay for the congestion or

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pollution they impose on others. The best solution would be to charge directly urban motorists forthese costs; the policy of allowing concessionaires to build and toll urban expressways is a step inthis direction. Absent a comprehensive system of urban road charges, however, it may be sensible--as a second best solution--to subsidize urban commuter rail if doing so significantly reduces motorvehicle congestion and pollution.

1.24 No need to subsidize heavy trucks. Continued subsidies to heavy trucks, by contrastseem less defensible--and results in unfair competition for railways--and may have to be removedgradually. Heavy trucks are almost surely not paying for the road damage, pollution, and congestionthey cause since diesel fuels are comparatively only lightly taxed while gasoline is heavily taxed.Rail traffic might increase significantly if trucks were forced to pay their way (and this can be easilydone at tolls for instance), which may lead some provinces to reassess the potential they see imrailways. If so, subsidizing heavy trucks and not subsidizing rail may be causing a senrousmisallocation of traffic between the two modes.

1.25 No need to subsidize waterway dredging. In the Atlantic Ocean-Santa Fe waterwayconcession, it is unclear why the dredging of the Parana River channel should be subsidized sincethe competing modes or ports are not. Without the subsidies, it is conceivable that bulkcommodities might move by rail to the deep-water ports on the Atlantic at Bahia Blanca andQuequen. The Government apparently regards the subsidies as temporary, and hopes eventually tomove to a system that is completely toll financed. The claim, moreover, is that studies show thatdredging the Parana to 32 feet is the cheapest shipping option. In that event, however, shippersshould be willing to finance the dredging thrugh tolls. In short, the waterway subsidies areinconsistent with the overall transportation policy, in that they further depart from more market-oriented traffic pattems.

Fine-tuning Regulation

1.26 The national approach to transport regulation is to rely on a combination of concessioncontracts and specialized commissions charged, with contract enforcement and residual regulatorypowers. Contract-based regulation seems to be a reasonable model for the provinces as wellbecause the system appears to work. However, there are three exceptions or qualifications that weredifficult to anticipate at the beginning of the reform process but could now be corrected with thebenefit of expenrence:

* the need for a mechanism for contract modification;* the need to improve contract enforcement; and* the need to reduce the number of regulatorn commissions

1.27 Contract modifications. Concession contracts, especialy when they are used as aregulatory instrument, can, to some extent, be seen as living documents, because unifreseen andenforceable circumstances often make the concession contract unworkable from the perspective ofeither the govemment, the contractor, or both. Under these circumstances, contract flexibility isgood pub!..L: policy RB.- I.? ensure that the contract is a credible regulatory instrument, the contractmodifatawl-s sho.:'.- bc t;sed . scmne .air aj'd wiordiJe ienegotiation rles base(d on clearlyspelled out jolicy ciwnaa sLu belev. .'lus .sscin has aiready been mtemalized by some of thenational authorities. The Govemment had to renegotiate the intercity road contracts in 1991 because

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of unexpectedly vehement complaints from users that tolls were being collected in advance ofimprovements, and because the Government's emergency decree to peg the new peso to the dollarmade the contracts' tariff-escalation clauses illegal. The solution was to lower allowable tolls and tocompensate concessionaires with both a subsidy and reduced investment requirements. By 1995,even these contracts are seen as inadequate because rapid traffic growth, stimulated by the economicrecovery, has heightened the need for the capacity improvements deleted in the 1991 renegotiations.Similar problems are arising in the case of the freight railroads and in subway and commuter rail.

1.28 But such ad-hoc solutions are not always in the interest of all the parties involved What isneeded is a mechanism forflexibly yet fairly renegotiating concession contracts. With the currentlevel of technical expertise on regulation and of information, and in view of the current tradition ofcommercial law, the best option is to establish a special commission to arbitrate or adjudicateconcession contract disputes using clear but fair rules. The key is to find such rules--otherwise, thearbitration commission confronts the same problems as the standard rate-of-return regulatorycommission Final offer arbitration is a possibility that might work in this context. Under thisscenario, in the event of a negotiating impasse, the arbitrator must chose between the two parties'best and final offers, without modifications. Since no further modifications are possible, both parties(the Government and the concessionaire) would have strong incentives to be reasonable and torecognize each other's legitimate interests. This system has been used successfully with some laborcontracts in the United States, but further research is needed to understand whether it would workwith transport concession contracts in Argentina

1.29 Public Policy Criteria to Test if a Contract Revision is Needed. The contractualrigidities built into the privatization agreements are necessary to close deals and to create bindingcommitments among the participants. However, they make it difficult to adapt when there is a needto resolve emerging problems because many of the actors find adaptation threatening to theprivatization commitments that protect their interests and the whole fabric of reform. Moreover,clearly each franchisee is likely to attempt to interpret most of the contractual ambiguities to its ownadvantage. This is why there is a need to continuously monitor the privatization agreements and toassess any need to adjust them. The option of contract flexibility is a normal feature of a successfullong-term contract, provided that public policy concerns predominate the revision decisions. Theassessment of any modification requirements, however, needs to be based on a good sense of whatwent wrong and on a clear set of public policy criteria

1.30 The sense of what went wrong is necessary for any arbitrator to be able to decide on thedistribution of the costs that may result from the contract change. This starts with a clear sense ofthe performance achieved. It may very well be that the short-run performance is much better interms of service quality and price but that the concessionaires do not meet some of their obligations.Why would these problems arise:

* How realistic were the govenmment requests? Where all the objectives consistent witheach other? Were there trade-off not well identified at the initial stage by either thegovernment or the private bidders who could have asked then for a revision of thespecification of the needs as is taking place in the pnrvatization of the Santa Fe watercompany for instance.

* Was the demand overestimated? This is common. A recent survey of all U. S. urbantransport contracts shows that the estimates of capital and operating costs as well as

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demand built in contracts were systematically too optimistic. But is this due to theformula used in the awarding of a concession or was is due to a mistake by the pnrvateoperator?

* Did the state of the assets deteriorate between the time the bids were made and the timethey were actually transferred? If not, was this due to the weather or to the fact that thepublic operators stopped maintaining these assets? If it is due to the weather, theresponsibility may be shared. In the second case, the private sector may have a fairclaim on a request to revise the contract to allow a revision of some of the terms sinceadditional rehabilitation needs are arising due to a poor protection of his property rightsdunng the transition period.

1.31 But before proceeding with ary change, the policy criteria need to be spelled out They arerequired to ensure a transparent basis for contractual dispute resolution and related policy decisions,as well as to avoid excessively subjective decisions on the need for or nature of contractual changes.These criteria ease the judgment as to whether the maintenance of existing provisions is suboptimalto all parties in view of a fundamental change in external circumstances (e.g., a permanent demandshift), a change in policy priority (e.g., the relative importance of services to the poor increases) or anex-post assessment that the contract is unviable and needs to be restructured. Possible criteriainclude:

* Is the protection of the interests of investors at the baseline levels established in theoriginal terms of privatization guaranteed? Should it be?

* How would the efficiency of the overall operation (flexibility, variety, responsiveness ofoperators, quality of maintenance and of investment strategies) be affected by thechange?

-Would the composition of the financing of the activity be altered? Would it reduce thepublic share in this financing?

* Would the consumer interests be protected?

* What is the nature and source of change in scale of operations in response to demand?

1.32 Discretionary regulatory authority for monopoly control. The second and most easilycorrected issue is that the broad discretionary regulatory authority to guard against monopoly abuse,such as that enjoyed by the rail freight regulator, is probably unnecessary and unwise because mostof the modes already face strong competition. The freight railroads compete fiercely with trucksbecause of the relatively short haul lengths in Argentina, for example, and with one another since thesix rail lines overlap or are within easy trucking distance of each other. Ports compete against oneanother and, within the larger ports, the individual termnials are required to be granted as separateconcessions to further increase competitive pressures. The urban railways face competition frombuses, taxis, and private automobiles, while the urban toll road concessionaires are required to buildparallel and untolled collector roads. Those modes where competition is weaker also have toll ratesand service quality regulated by contract, so that further protection against monopoly abuse seemsunnecessary. The urban toll road concessions were awarded to the bidder who offered the lowesttoll rate, for example, while the urban railroad concessions were granted to the bidder who requestedthe lowest subsidy to provide, at the existing fare, a specified level of train service and program ofcapital improvements.

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1.33 All this suggests that the regulatory authorities should focus on contract enforcement andmonitoring and not be distracted by issues of monopoly. Experience shows that broad grants ofregulatory authority, potential or actual, may be risky as well as unneeded in that they provide anopportunity for the politicization of concession oversight. For example, if the definition of 'just"tariffs is left ambiguous, the regulatory commission may be confused or pressured to substitute itsown judgment for normal commercial considerations. Therefore, it is important to make sure thatthe tariff principles spelled out in the contract are as clear as possible to avoid the temptation ofinterference by the regulatory authority in the details of the tariff structure. These should be left tothe private operator to decide.

1.34 The number of regulatory commissions. A final concem in the area of concessionoversight is the proliferation of regulatory commissions, one for each transport concession program(7 in total). If arbitration commissions are to be used, then they should be independent of theenforcement commissions; otherwise the arbitrator would also be, in effect, one of the two disputingparties to the contract. It seems unlikely, moreover, that Argentina needs a large number of eitherenforcing or arbitrating commissions.

1.35 The case for establishing just one arbitration commission is persuasive. Little specializedindustry knowledge would be required, since the arbitration rule must be simple and clear. A singlecommission might make it easier to pay more and attract commissioners with the extensive businessand govemment experience needed for judging the competing claims. A single commission mightalso better resist capture by industries. There may be gains from a consolidation of enforcementconmmissions as well. Many of the advantages of attracting higher-quality commissioners and staffand resisting specialized interest groups obviously apply to enforcement commissions. Separatecommissions might be required where specialized local concessions were predominant, sinceprovincial or local governments would probably want a strong say in naming commission members.

The Need for An Integrated Transport Policy Approach

1.36 An integrated policy approach in transport is needed for two main reasons: (i) to internalizeefficiently the externalities derived from a rapid increase in motorization; and (ii) to reap theeconomies of scale inherent in multimodal transport. This is just as true at the national as at theprovincial level.

1.37 Coping with increased motorization. The changes brought about by deregulation andprivatization across sectors of the economy, coupled with changes in the structure of the Argentineeconomy, have had a substantial impact on the consumption of transport services. Roads continue totake the lion's share of transport activity, and vehicle fleets are experiencing a very high rate ofgrowth. These developments are bound to have significant impacts on the environment, includingthe public health threat posed by the current disproportionate rate of traffic accidents. An integratedapproach is required to intemalize the extemalities through demand management and explicitassessment of the environmental impacts both in project and program design. At the center of theissue is the need to set efficient road user charges that try to cope with the environmental, congestionand road damage extemalities.

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1.38 An obvious illustration of this point is the metropolitan transport system in Buenos Aires. Itis controlled by different jurisdictions. The national Government is responsible for the main accesshighways, the regulation of all railways, including the underground metro, and two-thirds of busservices; the Government of the province of Buenos Aires is responsible for many primary networkroads and the regulation of 20 percent of bus services; the municipality of Buenos Aires isresponsible for traffic engineering and traffic and street management of the city's most importantarea in terms of economic activity and congestion; and the other 36 municipalities of the Province ofBuenos Aires are responsible for municipal streets and the regulation of 13 percent of bus services.This dispersion of responsibility makes it very difficult to formulate and coordinate an integratedurban transport strategy. A law under consideration in the National Congress would establish theAutoridad de Transporte del Area Metropolitaha (ATAM), which is expected to coordinate, plan,and regulate urban transport in metropolitan Buenos Aires. This authornty would be effective to theextent that its mandate does not focus primarily on the oversight of the metropolitan railwayconcessions, but rather on planning and coordinating effectively the implementation of major policiesand investments--such as transport-related air quality and traffic safety strategies.

1.39 An integrated approach is also necessary to address the financing of investment needs. Forinstance, the concession agreements with the metropolitan railway operators stipulate substantialgovernment investments to modernize the outdated rail infrastructure. This is more evident in theunderground system, where the rehabilitation of line A alone is estimated to cost of US$80 million.If the Government is unable to comply with its investment commitments, the metropolitan railwayprivatization exercise would be seriously undermined. To do so, the Government cannot simply relyon extemal borrowing. It should develop instead an integrated urban transport strategy, includingpricing and regulatory policies to improve cost recovery and the financial sustainability of all urbantransport operators involved

1.40 Takdng advantage of multimodal transport In a likely scenario of increased extemaltrade with the other MERCOSUR countines, Argentina can reap the economies of scale and otheradvantages of multimodal transport if the infrastructure needs of the key export corridors areadequately identified and addressed. The private sector is likely to take much of the initiative indeveloping integrated multimodal transport--especially now that the regulatory barriers anddistorfing subsidies are being reduced. But there may be some worthwhile intermodal facilities, aswell as other large infrastructure investments, which may not be attractive to the private sector intheir first phase of development. Here again is where an integrated approach is necessary to definethe real needs of various transport modes and to raise sufficient financing. The Government has arole to play by planning the allocation of public expenditures destined to capital infrastructure in away that recognizes the advantages of mutlimodal transport Increased participation from transportusers and providers is a prerequisite within an integrated policy approach.

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Chapter 2: INTERCITY AND METROPOLITAN RAILWAYS2

2.1 In 1989 Argentina did not have a well defined policy to re-structure its railways, but couldnot afford the fiscal drain created by the railway deficits. A series of policy decisions adoptedbetween 1989 and 1992 ultimately shaped the railway reform strategy, including the approval in1991 of a railway restructuring program in collaboration with the World Bank. The pattem ofreform used in the railways would also be followed in the highway and port sectors. In essence, thereform has consisted of re-defining the network, identifying the profitable segmnents in each market,through a process of competitive bidding awarding concessions to the private sector, andtransferring a sizable network to the provinces.

2.2 This chapter describes briefly the background and market conditions that existed before therailway reform. It explains the process of reform, the concessioning of freight and metropolitanrailway services to private operators, and gives an indication of the performance of private railoperators to date. Finally, the chapter discusses what remains to be done in the railway privatizationagenda and the issues to be address in the wider context of a multi-sectoral transport policy.

THE BACKGROUND BEFORE THE REFORM

2.3 When the Menem administration set in motion the reform of the railways in 1990,Ferrocarriles Argentinos (FA) operated a national network of about 35,000 kilometers, employed92,000 people and was losing about US$1,400 million annually (1992 dollar values). Of theselosses, approximately $585 million were incurred by the freight services, $350 million by theintercity passenger services, and $465 million by the metropolitan commuter services. These lossesrepresented a major drain to the national Treasury and were the main motivation for the re-structuring of the railways.

2.4 Lack of commercial orientation. Many of the problems experienced by FA were typicalof large national railway companies. FA did not have a clear commercial policy. Managers wereconcemed more with production targets than with satisfying user needs. They were also heavilyinfluenced by the interests of labor unions and equipment suppliers. FA had too many employeesfor the amount of traffic canred; operating practices were outdated, and the maintenance of railwaytrack and rolling stock was deficient.

2.5 The lack of commercially-oriented pricing and investment policies explains many of thedifficulties faced by the Argentinean railways. FA did not have an explicit rates policy, but freightrates were set at about 70 percent the level of the rates offered by truckers. This policy satisfied ademand for low-quality services which was highly costly and conducive to unremunerative behavior.Likewise, FA's investment policy had no commercial rationale. Uneconomic lines were maintainedto accommodate labor unions' requests and provincial political interests. Locomotives wereallocated to uneconomic services which did not generate sufficient funds for maintenance andinvestments.

2 This chapter owes a lot to Kohon (1994).

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2.6 Lack of own resources. As a result of the lack of commercially-oriented policies, FAcould not generate sufficient internal funds to maintain and improve the network adequately, furthercontributing to the deterioration of track and equipment. By 1990, for example, 54 percent of thetotal network had its track either in bad or fair condition, and only 49 percent of a total fleet of 992locomotives were available for service.

2.7 Loss of market share. These conditions lead FA to lose traffic and market shares over theyears and the financial performance of the company deteriorated. Between 1965 and 1990, totaltraffic units (passenger-kilometers and ton-kilometers) declined by 39 percent from 29.6 billion to18.2 billion. Intercity passenger services, an even less profitable business line, experienced thesmallest reduction in traffic with a decline of only 26 percent. Freight services were more adverselyaffected with a drop of 50 percent in traffic during the sarne period, while suburban commuter railtraffic fell by 34 percent. Between 1970 and 1989, the railway share in both the freight and intercitypassenger markets fell to about 8 percent from levels of 14 and 11 percent, respectively.

2.8 High deficits. FA's financial performance continued to deteriorate in the years before1989. For more than 15 years prior to privatization, FA's wage bill alone exceeded its total revenue.During the period 1980-88, the estimated gap between FA's operating revenues and operating andcapital expenditures amounted to an average of US$1,652 million per year (1992 US dollars).

THE STRATEGY OF RAILWAY REFORM

2.9 In 1989, the Menem administration decided to embark on one of the most ambitiousprograms of railway reform and privatization. The first results from privatization are described inthe next section. The main objective of the reforms was to reduce the railway's financial burden.The previous administration of Raul Alfonsin had already considered various strategies to re-structure and privatize the railways. It was particularly interested in separating infrastructure fromoperations (the Swedish model), where freight, intercity passenger and metropolitan commuterservices were to be run by independent operators of mixed public-private ownership. This attemptat re-structuring FA did not succeed because it lacked political support and there were difficulties insetting up the rules of operation for a horizontally integrated railway. Another option, at least intheory, was to offer the whole of FA's operations in a single concession This option was neverpursued because the large amount of finance required and the difficulties inherent in operating aconcession of such a large scale made the chances of finding a willing taker very improbable.

2.10 A two step strategy. A series of policy decisions adopted between 1989 and 1992ultimately conformed a railway reform strategy consisting of two steps. The first step was tounbundle the fully integrated and centralized network by dividing the company into separatebusinesses: freight services, intercity passengers and metropolitan commuter rail. Freight serviceswere partitioned into sub-networks, mainly, but not exclusively, according to geographical (oldprivate railways) and track (gauge width) criteria. To run the suburban passenger services a newstate-owned company Ferrocarriles Metropolitanos S A. (FEMESA), was created, but laterauthorities decided to split its services into seven lines, also according to the old existing privaterailway lines. The Buenos Aires metro (SBASE or more colloquially "Subte') would be included inone of the suburban rail lines. The second step was to offer the operations of the railways to privateconsortia through concessions. As a result of this strategy, most intercity passenger services were

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transferred to the Provinces because they were not commercially attractive. Provincial authoritieswere given the choice between running the passenger service and closing it down.

How Was the Freight Network Unbundled and Privatized?

2.11 The freight network was partitioned into six sub-networks with a total track of 27,000 km.Each of the sub-network was then concessioned to private consortia Freight concessions remainedvertically integrated: each concessionaire had to undertake all of the activities involved in railroadoperations, from the improvement and maintenance of fixed facilities such as stations and rail trackto the dispatching and mnovement of trains as well as marketing and financial control.Concessionaires were given the freedom to introduce new working rules and practices.

2.12 Freight concessions followed the single operator model and granted the concessionaire amonopoly to run the services during the life of the concession. FA would not be allowed to competewith the concessionaire, while concessionaires were not required to run passenger services. Thissingle operator strategy meant that competition would not arise from several operators using thesame track but from several potential operators bidding for the right to provide the service inisolation during the life of the concession. This unbundling strategy was chosen because of thecomplexity found in establishing the rules of operation in the previous attempt to unbundle therailways along horizontal lines. It was not the recommendation of any elaborate and comprehensivestudy of options but the result of historic inertia and political consensus. The political expediencyrequired to carry out the reform was another factor that favored the choice of the vertically integratedoption.

2.13 The main features of the freight concessions are summanzed in Table 2.1. Freightconcessionaires are responsible for all operations and maintenance and for undertaking aninvestment program proposed by them in the bidding documents. Private operators must pay theState a 'fee" for the use of the rail infrastructure as well as a 'tent" for the use of the rolling stock.Operators have the option to run intercity passenger, but must allow access to the track to otherpassenger operators in exchange for a toll. This separation between freight and passenger serviceswas decided because the freight business was not profitable enough to continue cross-subsidizingpassenger operations.

2.14 Bids selection. The process of selecting bids for the freight concession followed a two-envelope system: Envelope 1 contained technical and financial qualification documents. Envelope 2contained information on a set of criteria that would deterrnmine the concession winner among thetechnically and financially qualified bidders. Table 2.2 shows the criteria, and the weights attachedto each criterion, that were used to select the wrining bids in the freight concessions. The Rosario-Bahia Blanca concession, the first freight concession awarded, used slightly different weights withthe same criteria. It served as a test of the remaining concessions that followed. The largestvaluation weight was assigned to the basic investment plan submitted by each bidder, followed by

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Table 2.1: Summary Features of the Freight Railway Concessions

Length 30 years plus an optional 10-year extensionOwnership The State remains the owner of the fixed facilities, including tracks and

stations, and of the rolling stock. The concessionaires have to pay a 'See"for the use of the fixed infrastructure and a 'tent" for the use of the rollingstock received from FA

Labor Concessionaires must hire FA employees but only those considerednecessary; labor redundancy would be financed by the government

Operations and All commercial operations are performed by the concessionaire, who ismaintenance also responsible for the maintenance of track and rolling stock

Pricing Although freight tariffs are deregulated, operators still need to filemaximum rates for each commodity for approval by the Secretary ofTransport

Capital investments The concessionaire would undertake project-specific annual investments asproposed by them in the terms of the concession

Financial performance The government will not subsidize the freight operators irrespective oftheir financial performance

the projected quality of operations and the number of FA staff to be hired by the privateconcessionaire in its new operation. The points awarded for employment of FA personnel reflect apolitical compromise and the limited amount of money available for redundancy payments. Therationale for the last criterion is not straightforward. The emphasis placed on investments raises thensk of non-compliance with the terms of the concession if the operator is not commerciallysuccessful. Table 2.3 summarizes the winning bids in each freight sub-network.

Table 2.2: Bidding Criteria Used in the Railway Freight Concessions

Criteria Points WeightOrganization: Bidder's experience as railway operator; Key personnel;Business plan and profitability I to 10 23Basic investment plan: money and quality of the investment plan I to 10 33Additional investments: proposed by the concessionaire I to 10 5Fee: to be paid to the government and rent for the use of rolling stock I to 10 10Access pricing: Toll level required to allow passenger operations I to 10 5Employment: Number of former FA personnel to be hired I to 10 15Argentine presence: Total interest held by Argentine companies and their I to 10 9decision-naking share in the concessionaire I ISource: Kohon (1994); annex E-l; page 83) Note the weights applied to the Rosario-Bahia Blanca concessionwere different (see Kohon (1994) Table E-l; page 30)

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Table 2.3: Winning Bids for the Railway Freight Concessions

Bid ProposedOffers Canon Investments Demand Projections Personnel

Sub-network Private US$ mill in Year 1 Year 15 (% hiredConcessionaire No. US$ mill. first 15 years mill. tons mill. tons from FA)

Rosario- FerroexpresoBahia Blanca Pampeano (FEPSA) 2 48.4 234 3.4 6.1 1,500(5,163 km) (1-Nov-1991) (85___)Mitre Nuevo Central 2 33.5 386 4.2 7.9 2,322(4,520 km) Argentino (NCA) (78%)

(23-Dec-1992)San Martin Buenos Aires 2 36.4 369 2.9 4.7 2,271(5,493 kin) al Pacifico (BAP) (83%)

(26-Aug-1993)Urquiza Ferrocarril 1 2.8 64 0.9 1.9 1,255(2,751 kIn) Mesopotamico (76%)

(22-Oct-1993)Roca Ferrosur 1 18.0 173 2.7 6.4 1,133(4,791 kim) Roca (86%)

(12-Mar-1993)TOTAL 139.1 1,226 14.1 27.2 6,912(22,781 km) (82%_Source: Kohon (1994) Data are from winning bids when concessions were awarded. Takeover dates appear inparentheses under concessionaire's name.

How Was the Metropolitan Commuter Network Unbundled?

2.15 The metropolitan suburban rail services and Metro (SUBTE) of Buenos Aires followed amodel of unbundling and concessioning similar to the freight concessions. Seven suburban railwayservices were identified according to the different rail networks that existed in the 1940s befbre thecreation of FA: Mitre, Sarmiento, Urquiza, Roca, San Martin, Belgrano Norte and Belgrano Sur.The urban rail service provided by the metro company was placed in a bidding package with theUrquiza line, whose end of line station is physically integrated with the terminal station of the B lineof the underground. These services were then concessioned to the private sector.

2.16 The exercise of concessioning the underground metro service has unique features. There isno precedent in the world of using the concession approach for a loss-making underground masstransit system. The metro network has an extension of 37 km, and the premetro of 7 kms. Themetro was owned by Subterraneos de Buenos Aires S E. (SBASE), a municipal company. Thesystem is old and obsolete. Operations first started in 1913 and by 1950 most of the present networkwas already operating. It has been serving the Buenos Aires urban population which has grownfrom 6.7 million people in 1960 to over 12 million today. Although it steadily lost patronage sincethe early and rnid-1980s, it carried 143 million revenue passengers in 1993, which was the last yearof public operations. When the decision to concession the metro was made, its system was in needof a complete infrastructure rehabilitation, including tracks, communication, signaling systems,escalators and cars. The investment needs were estimated to be around US$400 million.

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2.17 What pnivatization model? The metropolitan railway concessions differ from the freightconcessions in two aspects. First, while freight concessionaires were expected to make a profit andpay their fees and rents to the State, it was accepted from the start that suburban rail operationsmight need public financial support to operate the services, but most importantly, to undertake themuch needed rehabilitation and investments in track and rolling stock. The Govemment identifiedfor each line the amount and type of investments needed and the private operator was expected toundertake such program. Concessionaires would obtain much of their revenue from charging usersan authorized fare and would pay a nominal fee to the Government for the use of the railinfrastructure. Table 2.4 summarizes the main features of the metropolitan railway concessions.

2.18 The second distinctive aspect was the criteria used to award metropolitan railwayconcessions. A three envelope model was used. Envelope 1 contained information about thetechnical and operating experience of the bidder, and was common to all bidders. Envelope 2Acontained a detailed business and operating plan for the railway line in contention. Envelope 2B,also specific to each line, contained the financial proposal for the concession offered by the bidder, inparticular the subsidy required from the Government to run the service. Concessions were thenawarded on the basis of a single parameter: the lowest subsidy requested by the concessionaire tooperate the line and undertake the specified investment and rehabilitation program. The lowestsubsidy is measured as the first ten-year present value of the annual subsidy flow required to operatethe line and undertake the investment plans, net of the annual flow of the fee (or 'banon') offered tobe paid for the use of fixed assets such as track and stations. This method of awarding theconcessions was more transparent, and probably induced a more rational behavior from potentialconcessionaires, than the method used for the railway freight concessions.

Table 2.4: Summary Features of the Metropolitan Railway Concessions

Length 10 years (20 years for the metro) plus optional 10-year extensions indefinitely;Ownership The State remains the owner of the fixed facilities, including track stations,

and rolling stock.Labor Concessionaires will introduce whatever labor practices considered necessary to

increase productivity. Labor redundancy would be financed by the government;Operations and All commercial operations are performed by the concessionaire, who is alsomaintenance responsible for the maintenance of track and rolling stock. The concessionaire

pays a 'fee" for the use of the infrastructure. The government sets servicelevels (minimum frequency of service) and service quality for each concession.

Pricing The government sets maximum fares which are subject to automatic increasesaccording to the service quality achieved. Non-achievement of quality levelsresults in financial penalties;

Capital investments The concessionaire would undertake project-specific annual investments asspecified in the terms of the concession but financed by the government;

Financial performance Each concessionaire bid on the basis of a business plan and annual financialresults. The concessionaires pay a 'fee" to the government and receive asubsidy from the government, or not, depending on the financial outcome oftheir operations, which included a rate of return. Irrespective of the outcomefrom operations the concessionaire would quote the amount of money requiredto execute the investment plan defined by the government.

2.19 The bidding outcome. The characteristics of the successful bids for each sub-urbanrailway line are summarized in Table 2.5. Seven consortia subrmitted bids for each line and various

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packages combining two or more lines. The calls for bids were staggered; first, the Mitre,Sarmiento and Urquiza & SUBTE; second, the Roca and San Martin lines; and finally the BelgranoNone and Belgrano Sur lines. The Metrovias consortia led by a construction company won theconcessions to run the Mitre, Sarmiento, and Urquiza & SUIBTE concessions. The Trainmnetconsortia composed of construction and railway equipment supplier companies, as well as 64 buscompanies won the Roca, San Martin and Belgrano Sur concessions. The Ferrovias consortia, thewinner of the Belgrano Norte concession represents several construction and rail equipment repaircompanies. The total amount of subsidy requested by the winning consortia amounts to slightly overUS$1,000 million (June 1992 dollar value). Most of this amount is intended for capital investmentan system upgrading as opposed to the subsidies received before privatization which tended tofinance operational deficits mostly.

How Were the Intercity Passenger Services Addressed?

2.20 In mid-1989, FA was operating intercity passenger trains with an aggregate level of serviceof approximately 15 million train-km per yeai. A 1991 study that examined the economic viabilityof these intercity passenger services concluded that the only corridor which was commerciallyprofitable was Buenos Aires-Mar del Plata. Although the remaining services were not profitable,the study recommended to maintain services that had small losses but a high social justification.

Table 2.5: Winning Bids for the Metropolitan Railway Concessions

Canon (-or

No. of Subsidy Proposed Expectedbids Investments Demand Personnel

US$ million Year I number ofLine Concessionaire USS mill. in first 15 million people

=_______ years passengerMitre METROVIAS 3 84.1 221.2 57.8 1660(182.1 Iam)Sarniento METROVIAS 3 (177.9) 193.2 93.6 1528(166.6 krn)Urquiza METROVLAS 3 101.7 37.8 24.8 697(25.6 km) (takeover 1-Jan-94)

SUBTE METROVIAS 3 (438.4) 399.2 151.5 2129(44.1 km) (takeover 1 -Jan-94)Roca TRAINMET 4 (70.0) 136.0 120.2 2062(252.4 km.) (takeover l-Jan-95) _

San Martin TRAINET 4 (44.7) 62.7 54.9 867(55.4 km) (takeover 1-Apr-94)Belgano Sur TRAINMET 3 166.1 43.8 13.5 788(58.4 kin) (takeover 1-May-94)Belgrano Norte FERROVIAS 2 196.7 58.7 18.1 830(51.9km) (takeover 1-Apr-94)TOTAL (182.4) 1,152.6 534.4 10561(836.5 km) I _I I _ _ _ _ _ _

Source: Kogan & Thompson (1994) Data are from winning bids when concessions were awardedNote: the canon is the Argentinean label for the fee for the rental of infrastructure owned by the public sector

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2.21 Given that the vast majority of intercity passenger services were not commercially attractiveto the private sector, the Government finally decided in 1992 not to subsidize them any longer andoffered the Provinces the option to continue providing the services but at their own expense. Mostprovinces rejected the Government's invitation. Provinces that agreed to the transfer were BuenosAires, La Pampa, Tucumcin, C6rdoba, Salta, Rio Negro and Chubut. The transfers were done withconcession agreements between the State and the Provinces whereby the State transferred the rollingstock and complementary equipment necessaiy to run the services. The Provinces agreed tosubsidize these operation and run the services over the network concessioned to the freight andmetropolitan private operators, and to pay a fee to these operators

THE FIRST EFFECUS OF RAIL PRIVATIZATION

2.22 It is still early to tell if the private rail operators are more successful than the public operatorswere since it is orny possible to observe their performnance during the first year of operations. Somepreliminary conclusions can be reached however

Impact on Freight Services

2.23 Freight concessions in operation for more than a year, Ferroexpreso Painpeano and NuevoCentral Argentino, have been able to reach the level of tonnage carried by FA in 1990. This trafficrecovery has also been achieved by two of the three other private concessionaires that have been inoperation for only a year: Buenos Aires al Pacifico and Ferrocarril Mesopotamico (see Table 2.6).Only Ferrosur Roca has not been able to reach FA's 1990 level. Despite this traffic recovery, thelevel of traffic realized is considerably below the level of traffic projected with the only exception ofFerrocarril Mesopotamico. In addition, the oldest concession, Ferroexpreso Pampeano has notbeen able to improve much and has been finding difficulties associated with floodings and adversemarket conditions. As a whole, the private operators are reaching an average 70 percent of theprojected traffic and according to some estimates, actual revenues may be between 50 and 60percent of expected levels.

2.24 What caused under-performance? The under-performance of freight operators is partlydue to the strong competition from trucks. FA foUlowed the practice of setting the rates at 70 percentof the trucking rates. Private freight rail operators assumed that their improved service would allowhigher rates without fully anticipating the likely response from truckers and the possibility that thedemand would not materialize as expected. Ferroexpreso Pampeno (Rosario-Bahia Blancaconcession), for example, has had losses during its first three years of operation due, among otherreasons, to increased competition from trucks, delays in the privatization of the port of BahiaBlanca, and a drop in the international pnrce of grains. Even though the resurgence of theArgentinean economy is said to be changing substantially the pattem of production, the type ofproducts carried by private rail operators does not seem to differ substantially from that carriedbefore privatization.

2.25 The optimism in projecting demand levels, possibly induced by the bidding cnrteria used toaward the concessions, may bear some responsibility for the gap between realized and expectedtraffic levels. For the freight concessions, the private consortia did not have to accept a pre-specifiedprogram of investments, unlike in the bid for the metropolitan railways. Instead, they had to identifyinvestment needs and propose an investment program for the first 5 years. This would be

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compulsory to fulfill, but could be modified from the sixth year of operations if demand conditionswarranted it. Nevertheless, the size of the net present value of the investment flow during the first15 years of the concession had a weight of 0.35 in the bid evaluation criteria This criterion ofselection undoubtedly may have induced the concessionaires to make demand projections andassociated investment promises that were unrealistic but helped them obtain the concession.

Table 2.6: Projected vs. Actual Railway Freight Volumes(in thousand tons)

Ferrocarriles Argentinos Private concessionaireRailway (ach al) (Projected vs. actual)

1990 1991 Year 1 Year 2 Year 3

Ferroexpreso Pampeano 2,143 1,263 3,410 3,601 3,793(takeover I -Nov-1 991) 1,804 2,351 2,479

(52.9%) (65.2%) (65.3o%)

Nuevo Central Argentbno 3,310 2,533 4,214 4,542 4,870(takeover 23-Dec-1992) 2,832 3,435

(67.2°%) (75.5%)

FeuTosur Roca 2,143 1,263 2,711 3,142 3.573(takeover 12-Mar-1993) 1,695

(62. 5%)

Buenos Aires al Pacfico 2,419 1,484 2,959 3,340 3,840(takeover 26-Aug-1993) 2,456

(83%)FerrocarrilMesopotimico 987 814 903 1,056 1,210(takeover 22-{ct-1993) 1,107________________________ ____________ ___________ (122.5% )

Source: Comisi6n Nacional de Transporte Ferroviario

2.26 What should be the regulator's response? The consequence of lower than expectedmarket results is that freight concessionaires are not fulfilling their promised investments. For nowthe Comision Nacional de Transporte Ferroviario, the regulatory agency which oversees the freightconcessions, is filing the associated penalties, but has problems enforcing payment and investmentimplementation. The amount of investments prorised by the freight concessionaires amounts toabout of US$1.2 billion during the next 15 years. No information is available of how muchconcessionaires have invested thus far. Due to the difficulties experienced by FerroexpresoPampeno, for example, the concessionaire has asked the Government for a change in thespecifications of the contract, requesting a reduction of the investments and a deferment of itsimplementation. The response of the Government to the lack of compliance with the investmentprogram and to the FP request will set a precedent and thus is closely monitored by the rest of theconcessionaires.

2.27 The Government is faced with the following dilemma: if it enforces the letter of theconcession contract and the private concessionaire is forced to undertake the promised investments,

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the concessionaire may go bankrupt and eventually go out of business, ceasing all service provision.If, instead, the Government does not enforce the concession contract, it loses credibility, sets aprecedent and, therefore, incurs a reputation cost not only with the freight concessionaires, but withother concessionaires within and outside the transport sector.

2.28 It is not clear which social cost is larger, that of bankruptcy and service interruption, or lossof credibility by the Govemment. Even if the private concessionaire could afford compliance withthe contract, to make the private concessionaires undertake investments which otherwise arecommercially unnecessary, is questionable from an economic perspective because it would be amisallocation of resources. Instead, what seems to be needed is a mechanism for flexibly yet fairlyrenegotiating concession contracts. This mechanism must have enough flexibility to accommodate awide range of disputes or conflicts, since the type of reforms needed will be difficult to anticipate.Yet it must be fair enough to achieve a balance between concessionaire and public interests. Inparticular, it cannot be so lenient that it undermines the incentives of potential concessionaires to bidhonestly but it also cannot be so strict or unpredictable that it drives potential private investors away.

Impact on Metropolitan Railways

2.29 The metropolitan rail operations under private control started in January 1994. It is veryearly, therefore, to draw definitive conclusions regarding the performance of the metropolitanrailway concessions. There is information available only for a few months. Yet, data for the revenuepassengers camed indicate an impressive growth rate over the traffic levels experienced byFEMESA during the same period a year earlier, in particular for the Beigrano Sur line (seeTable 2.7) An important reason for this immediate improvement has been the anti-fare evasionmeasures adopted by all private operators, including access controls at the turnstiles, for example, inthe SUBTE. The gain in traffic has been also fostered by the improvements in customer services,security and safety, particularly at stations as illustrated, for example, by the Belgrano Norteexpenence

2.30 The level of service performance is mixed when measured by car-kilometers run, theindicator of the output of the supplier. On the one hand, the 92.9 percent growth in car-lcm run bythe Beigrano Sur line must have contributed substantially to the 171 percent increase in patronage.On the other hand, a reduction in the level of service for the San Martin line may have been causedby the difficulties encountered with the rolling stock and the availability of locomotives when theprivate operators took over the line.

2.31 Cautious optimism. In line with the experience of the freight concessions, most suburbanrail operators are still an estimated 30 percent level below the projected demand estimates submittedin their winning proposals. This gap has many sources, among them overly optimistic demandprojections as well as market difficulties arising from a proliferation of bus services covering themetropolitan area and competing for patronage. The Belgrano Sur concession shows a very oddresult because the winning consortia projected a first year demand at least twelve-fold previouspatronage.

2.32 Table 2.7 shows the revenue-passenger and car-kilometers performance of the privateconcessionaire (for the first few months of operation for which comparable data was available)compared with the same penrod a year earlier, when operations were still carried out by the public

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company.) For all private concessionaires, both indicators increased with the exception of the SanMartin line which shoed an almost 12 percent decrease in the car-kilometers. The Urquiza line forinstance showed a 34 percent increase in revenue-passenger with just a 7 percent increase in car-kilometers run.

Table 2.7: Metropolitan Railway Performance Shortly After Privatization

Performance indicatorsRevenue passengers (1) Car-kilometers (2)

(million) (million) (1)/(2)FEMESA PRIVATE FEMESA PRIVATEJan-Oct 93 Jan-Oct 94 %A Jan-Oct 93 Jan-Oct 94 %6A %A

SBASE(Metro) 118.6 140.1 18.2

(151.5)

Urquiza 13.8 18.5 34.1 7.0 7.5 7.0 25.3%(24.8)

|_____ |Apr-Oct 93 Apr-Ocd 94 Apr-Oct 93 Apr-Oct 94San Martin

12.6 18.0 42.6 8.1 7.1 -11.8% 61.6%(54.9) %

BelgranoNorte 9.2 36.8 4.8 5.3 10.6% 23. 7%

6.7 (18.1) %May-Oct 93 MayO-t 94 May-Oct 93 MayOCd 94

BelgranoSur 0.8 2.3 171% 0.9 1.3 40.5% 92.9%

= _________ =___________ (23.2)

Source: Concesiones Ferroviarias de la Region Metropolitana de Buenos Aires. Informe Operativo Octubre1994. Unidad de Coordinaci6n del Programa de Reestructuraci6n Ferroviaria. Buenos Aires. November1994. (N.B.: The figures in parentheses in the second column are the projected traffic projected by the winningconcessions during the first complete year of the concession. The expected first year traffic of 151 millionpassenger revenue for SUBTE has been calculated by subtracting the 24.8 million for Urquiza line from the totalof Urquiza and SUBTE of 176.3 million; see Kogan, PW Financing, January 1994, p. 9).

2.33 Most recent traffic data reinforces the growth trend of the first months after privatization.Table 2.8 compares the performance of the metropolitan railway lines (including the undergroundsystem, SUBTE) during the June November periods of years 1993 to 1995. Excluding SUBTE, themetropolitan railway concessions show on average a healthy 75 percent increase in passenger traffic.Car-kldometers increased on average only 25 percent, which points towards a more effectiveufilization of available capacity.

2.34 The SUBTE in turn has experienced a growth in the number of passengers transported of 28percent. Overall, the traffic recovery in the SUBTE, may have been also aided by the rapid growthin car ownership experienced by the Buenos Aires metropolitan region since 1991. Approximately750,000 vehicles entered the metropolitan vehicle fleet over the last three years. This rapid increasein motorization has contributed to traffic congestion and to a reduction in the commercial speed ofbuses, developments which in turn have raised the attractiveness of the metro.

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Table 2.8: Most Recent Performance of Metropolitan Railway Concessions(Data for June-November period of ever year; bold figures correspond to private management)

1995/1993(all units in million) 1993 1994 1995 %^Passengers 79.69 94.32 102.24 28%

SUBTECar-los 10. 23. 12.13. 13.46. 32%.Passengers 17.93 19.99 31.13 74.%

NitreCar-Aks 7.98 8.92 8.54 7%Passengers 8.89 11.99 12.13 36%

UrquizaCar-Ions 4.28 4.75 4.95 16%Passengers 34.00 42.05 62.21 83%

RocaCar-kons 13.24 10.87 10.93 45%Passengers 10.85 16.09 19.94 64%

San MartinCar-mns 681 632 7.61 12%Passengers 5.56 8.45 13.52 143%

Belgrano NorteCar-Ions 3.88 4.48 5.43 40%Passengers 0.89 2.58 4.52 408%

Belgrano SurCar-Ios 0.98 1.37 2.51 156%Passengers 108.76 134.22 189.85 69%

Total mninus SUBTETo__minus_SUB_ Car-Ins 47.25 54.78 59.17 18%

Source: Unidad de Coordinacion del Prograrna de Reestructurac6n Ferroviaria

Impact on Intercity Passenger Services

2.35 There is little available information on how the intercity passenger services run by theProvinces are doing. There are two sets of issues:

(i) how much subsidy are these services receiving from the Provinces, and do theyrepresent value for money or are they very costly and what are the alternatives; and

(ii) what is the interaction of these services, if any, with the freight concessions whocontrol and maintain the track (passenger services need more maintenance thanfreight trains and freight concessionaires are not reportedly doing a particularly goodjob of maintaining the track at stipulated standards). The access fee that freightconcessionaires charge the passenger trains may be too high as compared tointemational standards and could be an issue to be dealt with by the regulatoryagency.

2.36 The likelihood of private sector involvement in the only potentially profitable passenger line:Buenos Aires-Mar del Plata also needs to be determined. In theory, the Buenos Aires-Mar delPlata passenger line is profitable enough to be concessioned to the private sector. This, however,

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was attempted without success. The line is now operated by the Province of Buenos Aires and itscurrent management are allegedly preparing it for concession. There is a timing issue too in that aparallel intercity toll road could be a powerful competitor when is completed in two years.

Overal Impacts of Rail Privatization

2.37 The motivation for privatization was to minimnize or eliminate the fiscal drain that railwaydeficits were creating for the Argentinean treasury. The expectations were to reduce the subsidies totheir minimum possible level by inducing the private sector to take over the operations of theprofitable segments of the freight market, but also the metropolitan railway lines in exchange of thelowest minimum subsidy that could be bid for. In addition, enough number of bidders competingfor the right to operate the service monopoly concession would ensure that any subsidies from theState to the concessionaire would be kept at a minimum. Control of operations and maintenance bythe private sector was expected to bring improvements in productive efficiency and service quality

2.38 Has competition for the market worked? More specifically, was competition for themarket sufficient to substitute for competition in the market? In theory, only two bidders are neededto dissipate all rents except for those that reflect a retum for commercial risks. It is difficult to tell ifthis was the case in the freight concessions where there were at most two bidders for four of theconcessions, and in two cases the concession was awarded to the only submitted bid.. Even in thecontext of such few bids, it is potentially confusing because implicit valuation of trade-offs must bemade in the case of an award based on scores. For example, in the event that two technicallyqualified bids reach the same total valuation but have different points for different criteria, then adiscretionary choice is necessary if a second round of bids is to be avoided.3

2.39 Subsidy reduction. The need for Government subsidy to support the railways has been cutsignificantly. Ferrocarries Argentinos required an average subsidy of $ 1,407 million per year (in1992 pesos) throughout the 1980s--mostly to finance operation deficits-- and comparable levelswere observed in the Buenos Aires subway in the years immediately preceding the concessions.The intercity freight concessionaires now receive no subsidies from the national Government whilethe urban commuter railroads and the subway concessionaires are to receive a subsidy averagingless than $100 million per year over the life of their 12 year concessions, most of which is for capitalimprovements. In addition, several provinces (mainly Buenos Aires) provide some modestsubsidies for intercity passenger services while the national Govemrnment continues to subsidize theone intercity freight line (the Beigrano) that did not attract any private bids.

2.40 Efficiency gains. The savings in railroad subsidies appear to have been achieved throughincreased labor productivity and the suppression of lightly used services and lines. The reduction inemployment on the services previously operated by Ferrocarmiles Argentinos is particularlydramatic. Ferrocarriles Argentinos employed 92,500 persons in June 1989, while the privateconcessionaires and the public authorities that had assumed responsibility for FA's services togetheremployed only 19,682 persons in June 1994. Of the 19,682 employees, moreover, only 7,603worked for the private concessionaires that had taken over most freight and urban passenger services

3 The assessment of the success of competition for the market in this specific case is a hard one. With so few bids, it isreasonable to wonder if the full benefits of competition have been obtained The answer is in part hidden by the scoringsystem. A more transparent system wvuld have scored the qualifications first and then award on the price basis.

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while the remaining 12,079 worked for the remnant national agencies operating the three commuterlines then awaiting transfer to a concessionaire (7,485 employees), operating the one remainingpublic freight line (1,274), or supervising the remaining FA assets (1,500) or to provincial agenciesoperating intercity passenger services (1,820) Presumably labor requirements will decline evenfurther as some of these services are turned over to the private sector. On the Buenos Aires subway,labor requirements were reportedly reduced by approximately half from about 2000 to 1000workers

2.41 Probably no more than half of these labor savings were achieved by cutting services. Themost significant cuts were in intercity passenger services, where the number of train kilometersoperated fell by approximately three-quarters and the number of passengers carried fell by perhapstwo-thirds. In addition, some of the intercity freight concessionaires are apparently not maintainingall the rights-of-way in their concessions to very high standards. The reduction in intercity servicesprobably accounts for less than a third of the labor savings, however, since intercity passengerservices were thought to account for about a third of pre-reform employment and some of the mostheavily used of these lines were maintained. The freight lines that are effectively being abandonedare also lightly used, and thus probably did not contribute greatly to pre-reform labor needs.

2.42 The discussion of the efficiency gains achieved from labor reductions may appear somewhatcold-blooded but the Government Argentina was in fact very careful to protect the interest of theworkers and ensured that a severance pay would ease the layoffs. With the support of a World Bankloan financing the voluntary retirement of 30,000 rail employees, a severance pay equivalent toroughly two years of salary was paid to each retired employee, Auditors certified that severancepayments were made only to staff whose labor contracts were terminated and that paymentsconformed to labor laws and were consistent with severance pay in other sectors. Measures topercent reemployment were also put in place. This effort paved the way for subsequentemployment-reduction cycles financed from govenmment sources.

LESSONS AND CHALLENGES AHEAD

2.43 There are lessons that can de drawn from the strategy of rail privatization and from theprocess that has been followed thus far. Also, there are challenges that lie ahead and need to beaddressed, especially associated with the unfinished privatization agenda

Lessons Learned

2.44 Three main lessons can be drawn from Argentina's experience in railway reform thus far:

Focus on a single bidding criterion. One lesson is the need to be very careful with thechoice of bidding criteria to award the concession contracts. The Argentinean authorities learnedfrom the freight concession experience and simplified substantially the method of bid selectionapplied to the metropolitan commuter railways. Trying to select the wining bid through numerouscumbersome criteria with discretional weights is more likely to reduce the efficiency of the biddingprocess than to improve it. Instead, the terms of the concession should be made clear and known toall potential bidders and bidding should take place on the basis of a single parameter, whichencompasses the economic assumptions made by the bidders in relation to the terms of theconcession. In the case of the metropolitan railways concession, for instance, each concessionaire

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calculated the expected value of the expected revenue from operations, compared them to the capitalinvestment programs and finally estimated the subsidy amount to be requested from theGovenunent. This subsidy estimate thus reflects his/her own best estimate of the expected return onthe operation. The objective is to make the bidding process and the final selection as transparent aspossible and not to induce exaggerated or misleading assumptions.

Make Flexible contracts. A second lesson is the need to devise contracts which areinherently flexible enough to incorporate unforeseen circumstances. Many freight concessionairesare reportedly not meeting the investment promises they made in their bids and are essentiallydisinvesting in the network they were provided by not maintaining their lightly used lines. Althoughsome question whether the bids were honest from the start, there are logical reasons why theseinvestments may not now be needed. In the first place, the truckers responded to improved railservice by reducing their rates more sharply than expected, thereby reducing both rail traffic and railprofitability. In any event, strictly enforcing some of these contracts is not necessarily in the public'sinterest. In the case of rail, wasteful, unneeded investments would be made or the concessionaireforced into bankruptcy, disrupting service until a replacement could be found.

Make the transfer of assets quick The third lesson is related to the process ofprivatization rather than to the regulatory instrument or contract design. It suggests the need toshorten to a minimum the time between pre-awarding the concession and start of operations. Thepoor state of the assets, including track, rolling stock, locomotives, and spare parts, when they aretransferred to the concessionaire from FEMESA is a common complaint across concessionaires.There appears to be a gap between what is recorded in the books and in the concession agreementsin terms of quantity and quality of assets before take over and what is transferred afterwards to theprivate operator. Given the lack of incentives to maintain and do proper inventory purchases on thepart of FEMESA, the longer it takes for the transfer to take place, the poorer the state of these assets,and the more difficult it is for the private operator to start operations adequately.

Challenges Ahead

2.45 As expected from a complex and challenging exercise, the railway privatization still has anunfinished agenda that needs to be addressed. In the freight market, the future of the Belgrano lineneeds to be setded In the metropolitan services market, two lines still need to be transferred to theconcessionaire and any remaining obstacles must be eliminated. Finally, there remains the overallissue of the regulatory structure to be put in place and the related issue of the contractual strategy tobe pursued if concessionaires do not comply with the stipulations of their concession agreements.

2.46 The Belgrano freight network The Belgrano railway remains probably the mostimportant item in the unfinished agenda of the entire railway privatization exercise. The Belgranodid not make it through the first concessioning exercise and the Government has decided to pump inUS$165 nillion (90 million in the first two years and to improve the traction problem and 25 millionfor the following three years) with the idea to try its privatization later on. The problems of theBeigrano are the excess capacity it creates by having two main lines that compete with each otherand the critical maintenance state of its bridges. It has recently suffered a severe drop in trafficfalling from 4.8 million tons in 1984 to slightly over 1 million currently. It has 250 locomotives butonly 50 are in operating condition and due to the lack of traffic most of the stations are closed.

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2.47 If after considenrng the rehabilitation improvements planned by the Government theBelgrano proves to be under no circumstances attractive to the private sector as the other freightrailway lines were, it should be either offered as a concession against the lowest subsidy bid(following the model of the metropolitan railway concessions) or transferred to the Provinces forwhich it provides a vital service. Even though the Belgrano railway passes through 13 provinces,only in 6 of them is it the only available railway: Chaco, Formosa, Salta, Jujuy, La Rioja andCatamarca; however, the most important provinces in terrns of traffic are Salta and Jujuy

2.48 What Regulation Is Needed? The single operator strategy adopted in the rail privatizationmeans that competition does not arise from several operators using the same track but from severalpotential operators bidding for the right to provide the service in isolation during the life of theconcession. This model shifts the burden to preserve effective competition to the rules of thecontract and the supervisory role of the regulator. Price competition, for example, is preserved in theterms of the concession by setting limits to the possibility of exercising monopoly power, and theregulatory function consists of supervising that the terms of the concession are fulfilled.Altematively, outside competition can exercise a similar limiting role as is the case in the freightmarket if there is deregulated trucking industry that keeps downward pressure on rates. Also, manyof the different private freight lines are close to one another and in some instances overlap, creatingintramodal as well as intermodal competition. If anything, railway operators may be at adisadvantage since they have to publish their rates --there are maximum allowed rates thatapply to all operators and commodities-- while truck operators negotiate their rates privatelywith the knowledge of the prices charged by their rail competitors.

2.49 Once the concessionaire is selected, a specialized regulatory agency is responsible for anyfinal contract negotiations, for contract enforcement, and, in some cases, for other regulatory powers.The freight railroad concession contracts are supervised and enforced by the Commission NacionalTransporte Ferroviario, for example, which also has broad powers to determine whether freight ratesare unjust and to resolve disputes between the freight concessionaires and provincial authorities whowant to run intercity passenger trains over freight tracks.4 The urban railroads and subway aresupervised by the Unidad de Coordinaci6n of the Programa de Restructuraci6n Ferroviaria withinthe Ministry of the Economy, although the Govemment hopes to create a new regulatory body tosupervise all modes of urban transport within the Buenos Aires metropolitan area

2.50 Contract enforcement and monopoly control. This system appears to work reasonablywell with three qualifications. The first, and most easily corrected, is that broad grants ofdiscretionary regulatory authority to guard against monopoly abuse, such as that enjoyed by the railfreight regulator, are probably unnecessary and unwise. The comrnissions should focus exclusivelyon contract enforcement and monitoring and not be distracted by issues of monopoly. One reasonfor doing so is that most of the modes already face strong competition. The freight railroadscompete fiercely with trucks because of the relatively short lengths of haul in Argentina, forexample, and with one another since the six rail lines overlap or are within easy trucking distance ofone another.

4 The government currently plans a second regulatory body to take over the disputes betwveen passenger and freightoperators, but the Cornisi6n Nacional has that responsibility.

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2.51 An issue that the regulatofy authority will very likely need to address is the closure of somesegments or entire railway lines. If and when the private rail operators start their investmentprograms, they are going to find that some lines do not have enough traffic to Justify rehabilitation oreven maintenance investmnents. Thus, the regulatory authority will need to develop criteria toevaluate and process the requests for rail closures.

2.52 Contract modifications. The second problem, which is at least as important but far moredifficult to solve, is how to cope with the need to periodically renegotiate or modify the concessioncontracts. The idea of renegotiations or modifications may seem antithetical to the whole idea ofconcession contracting. The hope of the contract system is to protect both the public and theconcessionaire from abuse by specifying all the terms of the concession in advance. The publicseems protected because the contract is bid competitively, so that the services specified are providedat the lowest price. The concessionaire seems protected in that his obligations are clear from thestart, so that there is no possibility that officials can change the rules after he has committed hiscapital and energy to the project The prospect of renegotiation threatens to undermine the potentialconcessionaire's incentives to bid honestly and to open the door for political interference.

2.53 Regulatory economists have long debated whether one can design concession contracts thatneed minimal renegotiation A key lesson from Argentina's transport concessions, however, is that itis probably imnpossible to specify all the conditions in advance, especially in an economicemvironment changing as rapidly as Argentina's, and thus the contracts must be seen as livingdocuments. Even carefully drawn contracts may become obsolete because the world often changesquickly and in unexpected ways.

2.54 Part of the problem may be that the contracts were poorly drawn. The rail freight biddingspecifications imposed so many unrealistic requirements, for example, that some allege that theyencouraged dishonest bidding. But in many ways the obsolescence of the contracts is a product ofthe unexpected success of the economic reforms. Between 1989 and 1991, when the intercityhighway contracts were first put out to bid and then renegotiated, for example, the economy was insuch a weakened state that maintenance seemed a far more pressing need than capacityimprovements (as discussed in greater detail in the next chapter).

2.55 A possibility may be a U. S.- or British-style regulatory commission with the discretion tomake fairly broad changes in the terms of the concession as long as the concessionaire is allowed toeam rate of return on its investments similar to that earned in comparable private but unregulatedindustries.5 This option is often criticized both because the technical tasks (most notably,determining the right rate of return and investment base) are difficult and because the commissionscan be captured by various interest groups and politicized. These dangers might be even greater inArgentina if it has no tradition of commission regulation and regulatory case law to draw on.

2.56 A very different option would be to rely on normal commercial contract law and theincentives and opportunities it creates for the voluntary renegotiation of contracts that no longer servethe interests of either party. In the United States at least, contract law is focused on enforcement and

The U. S. and British approwches differ in several important ways but both ultimately require a pziodic review of rates bya commission with a fair rate of reum as the primary criterion for the review.

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the judges and courts are reluctant to get iMvolved with issues of renegotiation. Enforcement isusually a fairly blunt threat or incentive for renegotiation, moreover, especially in cases such as thesewhere it is in neither party's interest to have the contract enforced as is. Argentinas contract lawprobably has similar limitations.

2.57 An intermediate option is to establish a special commission to arbitrate or adjudicateconcession contract disputes using clear but fair rules The key is to find such rules--otherwise thearbitration commission faces all the same problems as the standard rate-of-return regulatorycommission. One possibility which might work in this context, for example, is a rule that in theevent of a negotiating impasse the arbitrator must pick between the two parties' best and final offers,without modifications. Since no further modifications are possible, both parties (the Governmentand the concessionaire) would have strong incentives to be reasonable and to recognize each other'slegitimate interests. This system has been used successfully with some labor contracts in the UnitedStates. Furthermore, where it hasn't worked well, the reasons have had little analogy to theArgentinean situation. Further research is needed to understand whether it would work withtransport concession contracts in Argentina

2.58 The number of regulatory commissions. A final concem is the proliferation of regulatorycommissions, one for each transport concession program. If arbitration comnmissions are to be usedthen they should be independent from the enforcement commissions since otherwise the arbitratorwould also be, in effect, one of the two disputing parties to the contract. It seems unlikely, however,that Argentina needs a large number of either enforcing or arbitrating commissions.

2.59 The case for establishing just one arbitration commission is fairly clear. Little specializedindustry knowledge would be required since the arbitration rule must be fairly simple and clear. Asingle commission might make it easier to pay more and attract commissioners with the extensivebusiness and Government experience helpful in judging the competing claims. A single commissionmight also better resist capture by specialized industry groups.

2.60 There may be advantages to cut the number of enforcement comrmissions as well. Many ofthe same advantages of attracting higher quality commissioners and staff and resisting specializedinterest groups obviously apply to enforcement commissions as well. Separate commnissions mightbe required where specialized local concessions were predominant, however, since provincial orlocal governments would probably want a strong say in narnming commission members.

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Chapter 3: INTERCITY AND BUENOS AIRES ACCESS ROADS

3.1 This chapter describes the state of the road network and financial difficulties experienced bythe sector before the current administration set in motion its road privatization program. It alsodescribes the reform strategy pursued and its effects. It ends with a discussion of the lessons learnedand the challenges that lie ahead, especially for the Provinces.

THE BACKGROUND BEFORE THE REFORM

3.2 Argentina has a mature, well connected but poorly maintained road network. Excluding themunicipal and feeder road network, there are about 59,000 kilometers of paved roads, 41,000kilometers of gravel roads and about 100,000 kilometers of earth roads. Of the paved network28,000 kilometers belong to the national network The rest belongs to the provincial network.

3.3 About 57 percent of the national road network carries approximately 75 percent of thevehicle-kilometers traveled. There exists a large concentration of traffic in the vicinity of majornodes, such as Buenos Aires, and to a lesser extent Rosario and C6rdoba, which are served bymulti-lane roads and freeways. The traffic in the remaining two-lane roads is moderate to low.Traffic congestion has become a problem, especially in Buenos Aires. Traffic volumes decreasedsubstantially during the 1980s to peak strongly again in 1991-92.

3.4 When the intercity road concession program started in 1990, the road network was in verybad shape. Only 40 percent of the national paved network was in good condition, while 25 percentwas in fair condition and 29 percent was in bad condition.

3.5 What caused the deterioration of the road network? Three factors contributed to thedeterioration of the road network:

* the intensive use of the road network;* the gradual loss of public funds for road maintenance, and* the inefficient institutional set-up of the sector.

3.6 Intensive road use. In 1950, 68 percent of passenger traffic and 32 percent of freighttraffic used the roads; by 1990, those percentages were 92 and 85, respectively. This modal shifttowards roads was caused by the relatively low input costs faced by road users compared wit'h therailways and by the deteriorating and increasingly inefficient service provided by the railways priorto concessioning. The diesel fuel used by trucks was not or hardly taxed and the structure of fixedand variable charges on medium and heavy trucks for road use does not discriminate well accordingto the relative axle-load damage caused by each type of vehicle. In addition, vehicle over-loading iscommon. The gap between maximum loads of between 8 and 10 tons per axle assumed in roaddesign and the actual axle-loads of 14 tons, which are found on average in Argentina, shorten theeconomic life of the pavements and increase the financial requirements that are necessary to restorethe pavement to its designed level of service. Part of the blame lies in the lack of public oversightand control.

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3.7 Lack of financing. The gradual loss of financial resources destined to road maintenanceand investments also contributed to the deterioration of the network. While in 1950 the fuel taxearmnarked for roads --as a proportion of the fuel sale price-- was 25 percent, in 1990 it had fallen to8 percent. This gradual loss of fuel tax revenues earmarked for roads accelerated in 1985 as aconsequence of reducing earmarked funds so as to contribute more to covering the public sectorfiscal deficit.

3.8 Inefficient service provision. Recurrent changes in design or changes in time schedulewere conducive to cost-plus type contracts and tended to promote so-called '"old-plating" orinflation of the cost base. This, coupled with the inherent inefficiency of the public sector tomaintain, administer and manage the road system, produced a situation characterized by costinflation and rent-seeking behavior.

3.9 Until 1991, all major technical functions of the national highway network were the exclusiveresponsibility of the Direccion Nacional de Vialidad (DNV). They included planning, design,construction and maintenance. The Direcciones Provinciales de Vialidad (DPVs) performed thesame functions in the Provinces. The coordination between the DPVs and DNV was carried out bythe Consejo Vial Federal (CVF). An inefficient duplication of activities between DNV and theDPVs resulted in inadequate planning, sub-optimal production, and costly administration, largelythrough lack of a modem system for administering the resources destined to maintenance activities.

THE REFORM STRATEGY FOR ROADS

3.10 Given the situation, the primary objectives of the Argentine reform program in the roadsector were understandably the reconstruction and maintenance of existing roads and the reductionin the amount of public finance required by the road sector. The participation of the private sector inroad rehabilitation and maintenance in exchange for the right to toll users was seen both as a way toshifi the financial burden associated with maintaining roads from the public budget to the users, butalso as a means to maintain roads more efficiently.

3.11 The privatization approach adopted by the Menem administration was preceded by a reformpackage that the prior administration tried to implement in 1988 without success. That reformpackage contemplated the creation of mixed public/private partnerships, with a majority of privatecapital, to take care of interurban roads and access roads with high traffic levels in exchange for atoll. Concessions would be given to these partnerships for a period of between 10 and 15 years afteran agreed set of investments had been carried out. The Direcci6n Nacional de Vialidad would playa dual role as minority partner and as regulator. This attempt at reform of the intercity road sectornever found enough political backing.

3.12 The reform of the public sector initiated by the Menem administration took the form of adecree which contemplated concessioning the rehabilitation and maintenance of roads to the privatesector and re-defining the role of DNV. The Decree differed from the attempt of the previousadministration in two important respects: road concessions of the build-operate-and-transfer (BOT)type would be awarded through competitive bidding, and there would not be mixed public/privatepartnerships; instead all concessionaires would be totally private.

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3.13 On the institutional front, the idea was to transform DNV into a national plamning andcoordinating agency while the management and control of road wvorks was transferred to theProvinces. An objective of the reform program was to strengthen the five regional offices of DNV.Another presidential decree gave the role of allocating and auditing the financial resources fornational highways to DNV, as well as the technical and financial supervision of the roadconcessions. DNV thereby becomes their regulator as well as an administrator.

First Wave of Concessions: Intercity Roads

3.14 In September 1990, the Government awarded about 9,800 km of the intercity paved roadnetwork (27 percent of the national network) accounting fbr 57 percent of total traffic. Only about36 percent were in good condition, but the weighted average daily traffic of 3,400 vehicles (rangingfrom 2,500 vehicles in some sections to 7,500 vehicles in others) was profitable enough to attract theprivate sector. The main features of the intercity road concessions dealt with the toll structure,quality levels, and the obligations of the concessionaire; these are summarized in Table 3.1.

Table 3.1: Summary Features of the Original Intercity Road Concessions

Length 12 years;

Ownership The State remains the owner of the road infrastuctfe. The concessioriaire has topay a "canon" or fee to the State during the life of the concession; the canon waseliminated after the original contracts were re-negotiated

Operations and All rehabilitation, improvement and maintenance operations are performed by themaintenance concessionaire, who is legally responsible for anry accident caused by the

inadequate condition of the road

Pricing. The Government sets a uniform basic tariff for all vehicles and all concessions.The uniform basic tariff is subject to indexation

Investment obligations The concessionaire would carry out specific works before starting to charge tollsand other works throughout the life of the concession. The pavement conditionmust reach certain index in the third year of the concession, a higher index in the10th year and maintain it until the end of the concession. The concessionairemust also repave the road at least once during the life of the concession

Financial performance The concessionaire's revenues are derived exclusively from tolls; The govemunentdoes not guarantee minimum traffic levels and does not provide any otherguarantees. The govermnent agreed to pay a subsidy related to VATcontributions after the original contract was re-negotiated.

3.15 ToDls. The toll structure was subject to price-cap regulation and defined by a uniform valueper kilometer and vehicle type and set equal at all concessions. The basic toll for cars, for example,was US$1.5 per 100 kms (November 1989 dollar value.) The maximum toll is five times the basictoil and depends on vehicle size, number of axles, and distance traveled between toil booths. Toprotect the concessionaire's revenues against inflation, tolls would be updated according to aformula that gave roughly similar weights to the cost of living index, the wholesale price index andthe value of the US dollar.

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3.16 Service quality. The levels of service were technically defined with the objective ofrecovering past levels of service as measured by an index of road serviceability that varies between 1and 10 and reflects the state of the pavement. The targets varied according to a time scheduledivided into three periods. Dunrng the first three years, the objective was to reach the 1988 level ofservice of 6.38, which had fallen to 4.63 in 1991; in the following seven-year period the index was toimprove to 8; and during the last two years of the concession it could not fall below a 7.5 score.

3.17 Investments. The obligations of the concessionaire included investments to be undertakenbefore concessionaires were allowed to toll users, such as resolving the most serious deficiencies inthe pavement and vertical signaling, and other investments to be undertaken during the length of theconcession in order to achieve the pre-specified serviceability indices. Although the biddingdocuments did not specify the volume of investments required to reach the serviceability indices, itwas estimated that at least 50 percent of the network had to be repaved during the first three yearsand another full repavement would be necessary during the remaining nine years of the concession.

3.18 The concessionaires were also initially obliged to pay a fee (or '"anon') to the State duringthe life of the concession and take legal responsibility for the accidents caused by the bad conditionof the roads. The Government would not provide any traffic revenue guarantees to theconcessionaires.

3.19 The intercity road concessions were awarded in twelve simultaneous bidding contests thatincluded 38 route segments in 20 corridors, belonging to 15 different Provinces. A pre-selection of97 companies identified 88 as adequate. The 88 companies selected formed 38 consortia, fromwhich 29 were chosen comprising 77 individual companies. During the first half of 1990, 147 bidswere submitted and the road concessions were finally awarded to 13 consortia formed by 46 privatecompanies. The canon to be paid to the State by these 13 consortia, which was the key criterion inthe selection of bids amounted to US$890 million (September 1990 dollar value.) The results aresummarized in Table 3.2.

3.20 Breakdown and renegotiations. The intercity road concessions were in operation duringfive months, from September 1990 to February 1991, when the Govemment decided to suspendthe contracts and re-negotiate them with the concessionaires. Two developments were mainlyresponsible for such a decision. First, toll indexation raised the basic tariff by 53 percent fromUS$1.5/100 km. to US$2.3/100 krm; second, many concessionaires started to toll users beforeundertaking the investments that were stipulated in the concession agreements. In addition, tollbooths were located either at a relative short distance from each other or near urban centers in orderto capture suburban trips (lack of access alternatives created captive traffic) There were publicprotests and a strong pressure to reduce the level of tolls. The Govemment decided to suspend thetoll, to review the existing concession agreements, and to re-negotiate the contracts.

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Table 3.2: Intercity Road Concessions

Total Basic toil rangeLength Nov. 1994

Concessionaire Coridor (km) Toil booths (US S/100an)1 665 3 2.6 - 3.3

Semacar S. A.2 297 2 1.8-1.93 508 3 2.1-2.5

Caminos del Oeste S. A.4 697 3 2.5 - 3.1

Nuevas Rutas S. A. 5 421 2 2.6Covico U.T.E. 6 479 3 1.2 -3.4

7 242 2 2.5-2.6

Servicios Viales S. A. 8 694 3 1.9 -2.5

9 298 2 1.5Covicentro S. A. 10 332 2 1.9 -2.1CovinorteS. A. 11 714 3 2.6-3.1Concanor S. A. 12 481 3 2.1Virgen de Itati S. A. 13 946 6 1.2 -3.3Rutas del Valle S. A. 14 280 2 1.8Canino del Abra S. A. 16 404 3 1.2 -2.4Nuevas Rutas S. A. 17 540 3 2.2 -2.3CamninosdelRioUruguayS. A. 18 618 4 1.6-4.1Red Vial Centro S. A. 20 309 4 1.0 - 1.6

3.21 The changes introduced in the concession agreements represented a major overhaul of thedesign of the concession. Tolls were cut backtoUS$1/100 kn, which meant areductionofover 50percent from the indexed value of US$2.3. More importantly, not only was the canon thatconcessionaires had to pay the State eliminated but the Government granted concessionaires anannual subsidy of US$57 million to be distributed among concessionaires according to their VATcontributions, which amounts to a shadow toll because VAT contributions are directly related totraffic levels. The location of the toll booths and the road work commitments and time scheduleswere also re-negotiated

Second Wave of Concessions: Access Roads to Buenos Aires

3.22 The second wave of road concessions encompassing the access roads to Buenos Aires alsohad to be re-negotiated In 1990, the access road network of Buenos Aires was pre-awarded to asingle consortia. The conditions established that the concessionaire had to finance the needed roadwork with the toll .evenue, but did not have to undertake any major improvements before tollingusers. This pre-awarding was eventually canceled and a new scheme developed.

3.23 Thus, in 1992 the Government initiated a second wave of road concessions for themaintenance, operation and improvement of three existing strategic access highways radiating fromBuenos Aires: Acceso Norte (including the expansion and maintenance of Avenida General Pazwhere no toll will be charged), Acceso Oeste, Acceso Ricchien and its extension to Cafluelas,

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totaling US$868 million. With the aim of harmonizing the procedures and regulations regardingurban road concessions, a new contract was signed with the concessionaire of La Plata-BuenosAires highway and two other road segments, for public works that have been awarded in 1979 withthe modality of concessions with Government subsidy. A sum of about US$200 million has alreadybeen invested of a total of US$600 million.

Table 3.3: Summary Features of the Buenos Aires Access Road Concessions

Length 22 years and 8 months;

Ownership The State remains the owner of the road infrastructure.

Operations and All new construction, rehabilitation, improvement and maintenancemaintenance operations are performed by the concessionaire, who is legally responsible for

any accident caused by the inadequate condition of the road

Pricing The basic tariff is the one bid by the concessionaire. This uniform basic tariffis subject to indexation according to the US consumer price index.

Investment obligations The concessionaire would carry out specific works before starting to chargetoUls and other works throughout the life of the concession. Theconcessionaire must transfer the roads in perfect maintenance conditions atthe end of the concession

Financial performance The concessionaire's revenues are derived from tols and revenues from thecommercial exploitation of service areas authorized by the Organo de Control;The government does not guarantee minimum traffic levels and does notprovide any other guarantees..

3.24 Benefiting from the intercity concessions experience, the terms of the concession and thebidding criteria for the Buenos Aires access roads were designed to be simple and straightforwardBidders were provided with a detailed and comprehensive concession agreement indicating thequantity and time schedule of the investments required, the level of service to be provided and therisk sharing arrangements between government and concessionaire. The need for alternative accessroads was specified, mainly collector streets. The bidding criteria was reduced to one vanrable:concessions would be awarded to the bid with the lowest toll.

3.25 The terms of the concession allocated the bulk of the project risk to the privateconcessionaire by requiring a minimum level of equity for the project company and not allowing anyrevenue or traffic guarantee, or any other guarantee or financial support, from the Government. Inaddition, concessionaires were responsible for the land expropriations that were pending. The mainfeatures of the Buenos Aires access roads concession operations are summarized in Table 3.4.

THE IMPACTS OF THE ROAD CONCESSION PROGRAM

3.26 The improvements in intercity highways are less dramatic and more debatable but probablystill significant when compared with the other modes. On the one hand, the condition of the roads

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under concession has improved significantly, the cost of maintenance is no longer a drain ongovernment budgets, and road usage has increased. On the other hand, there is no direct evidencethat the private sector is maintaining the roads at lower cost than the public sector did, but the usersmust now pay tolls. 6

Table 3.4: Buenos Aires Access Road Concessions

Acccso La Plata-Norte Acces Buenos Aires

(incl. Avd. Acceso Ricchieri HighwayGral Paz) Oeste

Length (kn) 118.3 55.9 57.3 63Toll (US$/100km) $1.00 $1.00 $0.60 n.a.Toll booths (number) 1 2 2 n.a.Traffic forecast (ADT vehicles) 250,000 90,000 100,000 110,000First 2-year investment (US$ million) $300 $130 $95 $200Expropriation costs (US$ million) $2 $19.7 $9 n.a.Total Investment (US$ rnillion) $495 $215 $158 $608

Source: specific concession contracts

3.27 The estimation for the intercity concession program was that at least 50 percent of the roadnetwork had to be repaved during the first three years of the concessions. This calculation wasbased on the serviceability index that the roads had to achieve during that initial period. However,according to the Organo de Control de Concesiones, between 1991 and 1993 only 32.22 percent ofthe concessioned road network was rehabilitated. Only 19.5 percent of the total investrnent valueexpected during the life of the concession had been invested at the end of 1993, the last year forwhich data is available.

3.28 Between 1991 and 1993 the total volume of traffic using the concessioned network hasdoubled (see table 3.5). This continued traffic growth is due in part to the economic recovery and tolong-term trends that favor the highway modes. The traffic growth has resulted in a substantialincrease in toll revenues, which were almost US$60 million in 1991 and by 1993 were aboutUS$207 million (see Table 3.6). Most concessions have experienced a sustained increase in toilrevenues while few have had negative toll revenue growth in 1993 compared to 1992. The averagegrowth in toll revenues in 1993 for the 10 concessions that reported positive revenue growth was6.26 percent; while the average decrease in revenues in the same year for the 4 concessions withreported negative revenue growth was 9.2 percent.

6 Although the standards of maintenance of the govemment were much lower than those being asked from theconessonaio s and the odds must thus be in favor of the new model.

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Table 3.5: Aggregate Traffic Flows for the Intercity Road Concessions(in thousand euivalent technical uts

Intercity Year I Year 2 Year 3 (3) - (2)Coidors Kms (1) (3) %A

I &2 962 6,200.4 10,129.5 11,162.9 10.2%3 &4 1,205 3,278.8 11,826.0 12,712.3 7.4%

5 421 2,,362.4 4,853.5 4,890.6 0.70/o6 479 1,122.3 2,501.6 2,748.1 9.8%

7,8 & 9 1,234 2,386.9 18,666.8 21,792.1 16.7%10 332 3,341.7 6,591.4 7,070.7 7.2%11 714 0.0 1,244.8 4,057.8 225.90/o12 481 410.7 5,756.8 4,893.1 -15.00/o13 946 3,614.3 7,250.7 8,420.4 16.1%14 280 610.2 3,162.6 3,639.3 15.0%16 404 3,079.5 4,787.5 5,555.0 16.0%17 540 2,445.7 5,715.9 6,000.3 4.90/o18 618 4,491.5 10,953.4 11,891.1 8.5%20 309 3,077.1 3,460.1 5,550.5 60.4%

Total 36,421.9 96,00.6 110.384.4Source: Organo de Control de Concesiones. Direccion Nacional de Vialidad. n.d.

3.29 As shown in chapter 6 of this report, road rehabilitation and maintenance in Argentina canbe a source of substantial savings if more efficient practices were adopted. In the absence of anymechanism to translate cost reductions --due, for example, to improved productive efficiency-- intolower tolls, any gains derived from more cost-effective road maintenance activities will translatedirectly into higher profits for the concessionaire. Reduced vehicle operating costs, including traveltime savings, will still remain the main source of user benefits even though this source will erodeover time as traffic increases and traffic congestion an'ses --unless capacity improvements are timelyallowed. Current contract specifications, however, are very rigid as explained next.

Table 3.6: Toil Revenue in the Interdty Road Concessions(in thousand US dollars; current values

Intercity (1) (2) (3) (3) - (2)Corridon Kms 1991 1992 1993 %A

1 &2 962 9,481.4 17,587.9 21,812.2 24.0%3&4 1,205 6,506.7 22,826.1 25,955.4 13.7%

5 421 5,701.2 10,069.1 10,987.2 9.1%6 479 1,378.4 3,547.6 4,131.2 16.4%

7,8 & 9 1,234 4,756.9 36,468.1 41,873.8 14.8%10 332 5,189.1 10,181.2 11,877.2 16.6%11 714 - 2,277.6 10,899.2 378.5%12 481 708.0 8,682.3 9,384.2 8.0%13 946 6,680.3 12,647.7 14,652.2 15.8%14 280 938.9 4,910.4 5,579.9 13.6%16 404 2,722.7 5,619.3 6,631.0 18.0%17 540 4,237.5 10,196.2 11,423.1 12.0%18 618 8,994.5 19,054.8 26,261.0 37.8%20 309 2,560.1 3,767.7 5,717.6 51.7%

Total 59,905.8 167,836.9 207,185.4Source: Organo de Control de Concesiones. Direcci6n Nacional de Vialidad. n. d.

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LESSONS AND CHALLENGES

Lessons Learned

3.30 Flexible contracts. The lesson regarding the need to have flexible contracts is alsoapparent with the intercity highway program. The Government had to renegotiate the contracts in1991 because of a combination of unexpectedly fierce complaints from users that tolls were beingcollected in advance of improvements and because the govemmenfs emergency decree to peg thenew peso to the dollar made the contracts' tariff escalation clauses illegal. The solution was to lowerallowable tolls and to compensate concessionaires with a combination of subsidy and reducedinvestment requirements. 7

3.31 By 1995, even the intercity road concession contracts are seen as inadequate. Theinadequacy has to do with how the conditions of the re-negotiated contracts affect the incentivestructure of the concessionaire, these relate to the timing of the major rehabilitation components ofthe road work in the event of an unforeseen rapid growth in demand. Assuming a given steadytraffic demand with a low level of traffic growth, the toll level and the timing of the majorrehabilitation work in the life of the concession were linked so that the concessionaire couldreasonably afford the rehabilitation work needed for that traffic level. The reduction of the toll levelfollowing contract re-negotiation postponed the optimal timing of the major rehabilitation workmaking it closer to the end of the concession; however, given the rapid build-up in traffic, it is in theinterest of the concessionaire to advance the timing of the rehabilitation work because of theassociated increase in toll collection, but the contract specification do not allow it. In addition, rapidtraffic growth, stimulated by the economic recovery, has heightened the need for the capacityimprovements deleted in the 1991 renegotiations.

3.32 A straightforward bidding criterion and thorough preparation. As in the railwayconcessions, a lesson can be drawn from the highway concession experience regarding theimportance of the preparatory work that goes into the bidding documents before the concessions areawarded and the advantages of compn'sing all relevant information in a single, straightforwardcriterion. The potential concessionaires for intercity road concessions had to bid according to the feeto be paid to the State, after the technical and financial credential were accepted. By contrast, thecriterion used in the Buenos Aires access road concessions was the lowest toll. But the conditionsregarding investment obligations, for example, were discussed and determined before their inclusionin the bidding documents. The use of a single, unmistakable criterion not only provides transparencyto the awarding process but also avoids unnecessary complications derived from the existence ofpotential trade-offs between the characteristcs of competing bids. Moreover, preparatory work withpotential bidders before the actual bidding takes place ensured unambiguous concession rules.

Challenges Ahead

3.33 A few challenges still lie ahead: at the national level, the need to develop an efficient systemof road user charges and to consolidate and coordinate the institutional decentralization process, as

7 This is of course a difficult lesson to leam. In deed, the degree of desirable flexibility varies. It could easily be argued thatIn Argentina's political context, the need for speed in decisions is what mattered to ensure quick high short-term gains. Itmay be that the longer the decisionniakers take to prepare, the less flexible they have to be!

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well as its regulatory structure. There is also a need to establish a strategy to reform themanagement of the provincial road network. This strategy is discussed in Chapter 5.

3.34 Road user charges. Road user charges in Argentina consist of the traditional indirectcharges, such as fuel and vehicle taxes, and the less traditional direct charges, such as the tolls paidin the road network under concession. Road user taxes are mainly fuel taxes, and taxes on tires,lubricants, vehicle sales, import duties, and vehicle registration fees. The tax component in the priceof unleaded gasoline, for example, is very high reaching currently over 55 percent of the finalconsumer price; by contrast, the tax component in the price of diesel is only about 15 percent (seeTable 3.7)

Table 3.7: Final Price Evolution of Gasoline and Diesel Fuels(all data at December of eve year in US$Aitre)

Gasoline fuel (NAFTA) Diesel fuelBefore VAT tax Other Final Before VAT tax Other Finaltaxes taxes price taxes taxes price

1990 0.168 0.026 0.199 0.393 0.119 0.019 - 0.1381991 0.248 0.039 0.273 0.561 0.184 0.029 - 0.2131992 0.235 0.042 0.273 0.550 0.193 0.035 - 0.2281993 0.238 0.043 0.288 0.569 0.216 0.039 - 0.2551994 0.270 0.049 0.288 0.606 n.a. n.a. - n.a

Source:?

3.35 Before 1990, the financing of road maintenalce consisted of the distribution of earmarkedtaxes between the Direcci6n Nacional de Vialidad (DNV) and the Direcciones Provinciales deVialidad (DPVs). Then, 10 percent of fuel taxes, 57 percent of tire taxes, 50 percent of lubricanttaxes and 100 percent of taxes on vehicle registration and sales went to DNV; the percentages ofrevenues from the same taxes received by the DPVs were 9, 29, 27 and zero, respectively.

3.36 Since 1990, all earmarked revenues assigned to DNV have gradually been eliminatecd Thisdecision was intended to restore the flexibility needed in the macroeconomic management of theeconomy at a time of structural adjustments. As part of the economic reform policy initiated in1990, tax revenues from taxes on tires and lubricants were transferred directly to the Treasury andthe earmarking of tax revenues derived from taxes on vehicle registration fees and sales waseliminated. The result has been a drastic change in revenue channels for the maintenance of roads.While in 1990, earmarked taxes represented 70 percent of DNV's income and only 1.9 percent wasprovided by the Treasury, in 1992 the proportions were zero and 96.5 percent respectively.

3.37 The structure of road user charges has to be reassessed on several grounds. First, theexistence of tolls for the use of the portion of the road network most heavily traveled makes itrelatively important fo, the rens-i.Pn;;, road user charges. such as fuel and vehicle taxes, to capturethe components of the road us .. Osts attibutable to dMterent type of vehicles currently not capturedby the toll structure. flhe cu0 u ( . -o {ends on vehicle size, numnber of axles, and distance traveledbetween toll booths. Second, tnere is an implicit subsidization of trucks and buses at the expense ofcars to the extent that gasoline is heavily taxed compared to diesel fuel. This fuel tax structure needsto be reconsidered in light of the privatization policy which has eliminated all subsidies in competingmodes, such as the railways. Third, the potential road damage caused by the different axle load

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configuration of vehicles may be only partially captured by the vehicle taxes and other fixed chargessuch as vehicle registration fees.

3.38 Finally, it is not clear the extent in which the current structure of road user charges does notreflect or incorporate well either the costs of congestion, accidents and air pollution caused by privateautomobiles and public transport vehicles. These transport extemalities are causing increasingdamage to the environment and public health, particularly in urban areas, but above all inmetropolitan Buenos Aires. Over 8,100 deaths per year have been caused by traffic-relatedaccidents in Argentina in 1993 and 1994, a very large figure compared with the 42,000 fatalaccidents per year in the United States, 10,000 in France or 7,000 in Spain. The number of fatalaccidents per million vehicles in Argentina was 1,475 in 1993 and 1,570 in 1994, compared to 230in the United States, 388 in France, and 503 in Spain (all 1993 figures). In addition, air quality inmetropolitan Buenos Aires is worsening due to the rapid increase in motorization and increasingtraffic congestion.

3.39 Dealing with future concessions. Regarding future concessions, the challenge remains totranslate the reduction in costs achieved by the concessionaires due to their higher efficiency intoroad user savings and to structure the contract so as to provide the right incentives and flexibility toadapt to new circumstances.,. In the current concession schemes, it is not clear the extent in whichthe efficiency gains achieved by private sector involvement are translated into user savings either viaoperating cost savings or time savings. For now, the Organo de Control de Concesiones in DNVrelies on the toll operators for the traffic and toll revenue information. It should probably develop astronger capacity to check and audit the results submitted by the concessionaires. This regulatoryfunction will become even more necessary in the future if the likely flexibilization of the contractsallows not only for capacity increases as argued above but also for a mechanism to translate some ofthe gains into, for example, lower tolls or to help cross-subsidize the provincial roads that have lesstraffic but act as feeders to the intercity links

3.40 Institutional decentralization and coordination With the road decentralization processthat is accompanying the road pnvatization strategy, the Direcci6n Nacional de Vialidad (DNV) is tobe transformed into a planning, coordinating as well as regulatory agency which will undertake thetechnical and financial supervision of the road concessions. In the context of the decentralizationprogram, the interaction between DNV and the DPVs needs to be improved. The DPVs areexpected to gradually become responsible for managing the contracted works in the segments of thenational road network located in each province. Some provinces are already responsible through apilot scheme for maintaining national roads, as is the case of Santa Cruz and La Pampa.Consequently, cooperation and the transfer of technology between the national and provincial roadagencies needs to be made more systematic and less ad-hoc. This cooperation will largely dependon the needs and capacity of each Province.

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Chapter 4: PORTS AND WATERWAYS

4.1 Before 1990, Argenfina's ports were characterized by outdated facilities, excessiveregulation (e.g., excessive minimum staffing requirements for cabotage,...), high costs, crosssubsidies, inadequate levels of investment and maintenance, and declining traffic. The Menemadministration reform strategy was similar to that adopted for railways and roads, namely, acombination of privatization, deregulation, and decentralization to the provinces. The overallobjective was to make the port sector and port-related operations more efficient by reducing costsand increasing productivity. Following the pattem of chapters two and three, this chapter describesthe port sub-sector before its regulatory reform was undertaken, the reform strategy adopted by theMenem administration, the immediate impacts on market performance and productivity, and thechallenges for the sub-sector that lie ahead.

THE SITUATION BEFORE THE REFORM

4.2 In 1989, five public entities administered certain aspects of port operations with overlappingresponsibilities. The Administraci6n General de Puertos (AGP), was responsible for 37 portsacross Argentina, including the six major ports of Santa Fe, Rosario, Buenos Aires, Quequen,Bahia Blanca and Ushuaia. AGP's administration of the ports was highly centralized. TheDireccion Nacional de Construcciones Portuarias y Vhas Navegables (DNCPVN) and AGP weremainly responsible for investments and provision of port services, including waterways dredging,but also had secondary functions as port authorities. In addition, the Capitania General de Puertos,Prefectura Naval Argentina, and Administraci6n Nacional de Aduanas also regulated portoperations with either police or customs responsibilities. The official facilities for grain handlingbelonged to the Junta Nacional de Granos (JNG), which in 1989 concentrated a large proportion ofgrain and sub-product cargo handling and set its own tariff structure. JNGs operating practices andregulations were too a source of inefficiency and high cost.

4.3 Dedcliing cargo movement. Total cargo moved in the ports of Argentina fell 10 percentbetween 1970 and 1989 from 83 to 75.1 million tons. All of this loss was in cabotage traffic whichfell from 58.2 to 40.8 million tons due to a strong modal shift towards road transport and an increasein the transport of oil through pipelines. External trade cargo actually grew during the same periodfrom 25 to 34.3 million tons..

4.4 The port of Buenos Aires alone experienced a remarkable 52 percent reduction im thevolume of cargo movement falling from 26.9 to 12.7 million tons. Several factors caused thereduction of movement in the port of Buenos Aires. In the general cargo market, years of economicrecession, the growth in road transport --particularly to Brazil, Chile and Patagonia--, and thecompetition exercised by the ports of Chile contributed to the loss of market share. In the agriculturegrains market, since 1970, but especially after 1978, the San Martin-San Lorenzo zone with itsprivate grain facilities experienced traffic growth at the expense of the port of Buenos Aires, whichoperated according to the regulations of the JNG.

4.5 High tariffs. Argentina's port tariffs and charges increased steadily, so that right before thereforms, Argentina reportedly had among the highest port charges in the world. Between 1980 and

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1991 stevedoring fees increased im real terms by 250 percent In some instances, the operations ofan official grain elevator of JNG could be 55 percent more expensive than operating a privateelevator because of tariff components added by JNG regulations such as the item "servicios a lascargas" The high charges were due to a combination of restrictions, working practices, high payrates, outdated equipment and overly centralized administration.

4.6 Contrary to economic logic, tariffs and practices at the port of Buenos Aires were used anorms for the rest of public ports. Rent equipment charges or stevedores salaries, for example,would be agreed upon for the port of Buenos Aires and then adopted by the other national ports.This caused a higher level of user costs across the port system because the costs of the port ofBuenos Aires were high due to several factors including the need for routine dredging and therequirement to have the pilotage and towage services, which represented over 65 percent of the totalcost faced by a ship. In addition, the lack of adequate infrastructure investments which made theport of Buenos Aires facilities obsolete, as well as its 'bpen port" characteristic, in contrast with aterminal-based port, induced inefficient operating practices and unnecessary costs associated withcargo handling and storage.

4.7 Subsidies. Despite its high operating costs, the revenues from the port of Buenos Aireshelped cross-subsidize most of remaining public ports. Between 1988 and 1990, for example, theport of Buenos Aires enjoyed an average operating surplus of US$26.7 million per year, while therest of the port system as a whole had an average operating deficit of US$19 million. Whencompared with average total expenditures of only US$23.4 million per year over the same period,the conclusion is that capital infrastructure investments in the port of Buenos Aires must have beenneglected or postponed during the period's fiscal adjustment process. Indirect subsidies were alsoprovided by the Fondo Nacional de la Marina Mercante, a sectoral fund that financed the nationalshipping business, which derived its income from taxes imposed on both imports and exports.

4.8 Insufficient and inappropriate investment. Inadequate investments in port infrastructurewas not an exclusive feature of the port of Buenos Aires before the reform. Infrastructureinvestments in ports and dredging of waterways, but from the early 1980s onwards the levels ofinvestment and maintenance in port infrastructure decreased considerably. AGP increased heavilyinvestment in cranes and port superstructure equipment but it was never fully efficiently utilized. Inaddition, investments AGP made were often inadequately maintained and consequently facilitiesdeteriorated deteriorated by the late 1 980s. In the ports of Rosario, Buenos Aires and La Plata, forexample, docks collapsed into the water. Also, with the exception of the access to the port of BahiaBlanca, waterways are now less deep than they were during the 1970s. The situation in the AGPports contrasted sharply with that in the private terminals for grain handling; these private terminalsexperienced a relatively high concentration of investments, especially after the grains law passed in1978 virtually eliminated the state monopoly in grain port handling.

THE STRATEGY OF REFORM IN THE PORT SECTOR

4.9 The Menem administration strategy consisted of a combination of devolving many portresponsibilities to the provinces, privatization, and deregulation. Decentralization was pursued at alarger scale than with intercity passenger railway or provincial roads since only the port of BuenosAires, and not even all facilities within that port, remained under national jurisdiction. The rest of theport infrastructure network was transferred to the provinces. In addition, a substantial ingredient of

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the reform was the abolition of outdated labor practices and deregulation of maritime transport andother port-related services.

Deregulation

4.10 The Govemment initiated a series of regulatory reforms to reduce maritime transport andport costs. In 1991, national shipowners were allowed to temporary 'butflag" their ships, therebyachieving substantial reductions in crew manriing and costs. The major port reforms wereimplemented under Decree 817 in 1992. The decree liberalized all contractual arrangements withstevedoring companies, deregulated the piotage and towage services, gave complete freedom toestablish tariffs, allowed foreign ships to practice cabotage, and abolished previous labor agreementsand norms that were hampering productivity in port operations. The decree also initiated the processof privatization and transfer of ports to the provinces and eliminated the Capitania General dePuertos.

Decentralization

4.11 The law that would regulate the ports (Ley de Puertos) was passed in 1993 and establishedthe decentralization of the national ports to the Provinces and the municipality of Buenos Aires. Thetransfer system consisted of two stages. Small ports were transferred directly to the ProvincialGovemnuents. Major ports, such as Buenos Aires, Bahia Blanca, Quequen, Rosario and Santa Fewould also be transferred to the Provinces but subject to the creation of Sociedades deAdministraci6n Portuaria (SAP). These port administration entities would be non-profitorganizations charged with the maintenance of the port's infrastructure and common use areas,including waterways and access areas. The SAP would receive fees from the concessionaires andtariffs for the use of the infrastructure. Any profits would have to be invested in the port.

4.12 The port of BA was divided into three areas with different functions and administrations.The area called Dock Sud was transferred to the province of BA as a port specialized in liquid bulks,especially petrochemical products. The area called Puerto Nuevo remained under nationaljurisdiction and was split into six terminals which would compete among each other and would beconcessioned for operations to the private sector. The area called Puerto Sur, still to be developed,would be concessioned to the private sector for new construction and development.

Privadzation

4.13 The legal framework for the privatization/concessioning of ports and waterway dredgingwas provided by the Ley de Puertos (1993). Port privatization intended to improve port operationsby fostering competition both between ports and within ports, as in the port of Buenos Aires whereall terminals compete for cargo movement and handling. The law affected not only the portsbelonging to AGT but also the grain elevators that belonged to JNG. The ports law clarified thelegal status of private ports and port terminals that were operating with incomplete authorization. Italso gave the option to private interests to build, administer and operate ports for private or publicuse and exempted the ships operating in those ports from paying the State nominal fees for portsservices that the State does not effectively provide.

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4.14 The privatization of Puerto Nuevo. The port of Buenos Aires, known as Puerto Nuevo,which handles rost of the nation's container traffic, was left under national Government overseeingbut was required to be offered in concessions to the private sector. The port was divided into its sixterminals that operate general cargo and containers, including four terminals that belonged to JNG.All terminals were offered to the private sector as concessions in a bidding open to intemationalinvestors. Bid prequalification was based on financial solvency, business capacity and technicalfeasibility of the proposed investments. Bidders submitted two envelopes. Envelope 1 had adetailed technical proposal. Envelope 2 contained the financial bid which was linked to expectedtraffic for the terminal in question. The bid guaranteeing the highest level of payment to theGovemrnment would win the concession. Bidders were allowed to bid for mnore than one terminal,but had to express a preference and could be awarded only one temiinal. Terminals I and 2 wouldeventually be awarded jointly. At the end of March 1994 the winning concessionaires for the sixterminals of Puerto Nuevo were selected. Tables 4.1 and 4.2 present a sumnrnary of the concessionsand of the winning bids and private consortia, respectively

Table 4.1: Summary Features of the Port TerminalConcessions of Puerto Nuevo, Buenos Aires

Length 25 years for terminals 1,2 and 3; 24 years for terminals 4 and 6; and 18 yearsfor terminal 5.

Ownership State remains the oviner. Concessionaires only acquire right to mnaintain anduse infrastructure and equipment received by the State

Labor Concessionaires must employ 1,350 people from Encoggar and AGP(Administraci6n General de Puertos) or present an equivalent number ofredundancy agreements;

Operations and All commercial operations are performed by the concessionaire. Themaintenance concessionaire pays a "fee" for the use of the infrastructurePricing The government sets entry and exit tariffs for each vessel, initially at US$0.30

per net registered ton. The govermment also sets the maximun cargo chargesCapital investments The concessionaire would undertake project annual investments as specified in

the terms of the concession; The SAP (Sociedad Administradora del Puerto)will contribute with a fixed sum for the infrastructure rehabilitation works. TheSAP wil supervise these works, which must be done by specific stages andtimetable

Financial performance Each concessionaire bid on the basis of a business plan and annual financialresults.

4.15 Terminal 1 &2 were originally awarded to an intemational consortia headed by P&OAustralia (P&O) in partnership with Fasce, a local stevedore company, and Maruba, an Argentineshipping line. Their bid offered a "canon"of US$13.5 million. The second highest bid for US$9.6million came from a consortium formed by Murchison and Roman Maritima. Murchison is themain and long established Argentine operator at the port of Buenos Aires with a 60-year history ofstevedoring and investment in the port and 70 percent share of traffic before privatization. After anappeal from Murchison on the grounds that P&O's partner Fasce did not have enough equity, theGovernment disqualified the winners and formally awarded terminals 1&2 to Murchison-Romandespite repeated appeals from the P&O consortium. Nevertheless, the Govemment urged bothparties to agree on a deal and P&O and Maruba agreed to acquire a 49 percent share in Murchison-Roman and form a new company to operate the terminals.

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4.16 Terminal 3 was awarded to Terminales Portuarias Argentinas, a consortium headed by theU. S. crane and truck manufacturer Mi-Jack which offered a US$5.1 million annual canon.Terminal 4 was awarded to Gabriel & Cia, a local consortium offering a canon of US$1.1 million.Although the P&O consortium also subnitted a bid for Terminal 5, since they were originallyawarded terminals 1&2, terminal 5 was awarded to the second highest bidder Buenos AiresContainer Terminal Services, an intemational consortium headed by the Manila-based intemationaloperator Internatonal Container Terminal Services Inc. with local stevedore H Bouzas andBemberg Investments, an Argentine brewing conglomerate, which offered a canon of US$8.8million. Finally terminal 6 was awarded to Terminal Portuaria Intefema de Buenos Aires for acanon of US$8.2 million. Thus, in total, six terminals of Puerto Nuevo were awarded for a total ofabout US$32.5 million per year.

Table 4.2: Buenos Aires Port Terminals Concessions

Terminal

1&2 3 4 5 6

Total Area (hectare) 27.5 15 7 21.5 21Docks Area (meters) 1,813 1,397 449 n.a. 2,085"Sitios de atraque" (#) 11 8 2 5 6Canon bid (US$ million/year) 9.6 5.1 1.1 8.9 8.2Target volume after 4 years (milhon tons) 2.4 1.27 0.28 2.21 2.06

THE STRATEGY OF REFORM IN WATERWAYS

4.17 In waterway dredging and maintenance, the Government is following a phased approachthat will allow it to gradually decrease its activity while the private sector takes over. The overallstrategy consists of restructuring Direcci6n Nacional de Canales, Puertos y Vias Navegables , thepublic entity in charge of waterways and port access and decentralizing the responsibility for muchof its activities to the provinces. This strategy still maintain State subsidies for the dredging ofwaterways. In the case of the Santa Fe-Ocean waterway the State subsidies will be combined with aconcession to the private sector to modernize, rehabilitate and operate the navigation channelinvolved. Also, the Government intends to make a concession for Bahia Blanca eventually.

4.18 Santa Fe-Atlantic Ocean waterway concession. The canal-dredging project in the SantaFe waterway involves deepening to 32 feet a 465-mile stretch from the Atlantic Ocean to BuenosAires, Rosario and Santa Fe. The total cost of the project amounts to US$650 million, but theGovernment will subsidize the project with 395 million partially disbursed over the 10-year life ofthe concession. The concessionaire is allowed to charge a toll for vessels of more than 15 feet,which will depend on the vessel's net registered tons (NRT) and the segment of the waterway used.The maximum basic toll bid by the winning concessionaire amounts to US$0.97/NRT, which willbe applied depending upon the segment of the waterway being traversed: 44.44 percent of the basictoil between the Atlantic Ocean-and La Plata; 61.50 percent between La Plata and San Pedro; and100 percent between San Pedro and San Martin port. At the end of 1994, a consortium led by thecompany Jan de Nul was selected as the concessionaire and started working in May 1995. Since

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then, significant improvements have been achieved: in may 1996, the deepening of the waterwayhad reached 28 feet already.

THE IMPACTS OF THE REGULATORY REFORM OF THE PORTS SECTOR

4.19 Although it is early to draw lasting conclusions on the impacts of the reforms in the portsector, there is some evidence of the changes in labor productivity and tariffs.

4.20 Labor productivity. Table 4.3 shows the changes in labor productivity, between 1989 and1993 in the activities carried out by AGP, the port of Buenos Aires and the public entity in charge ofwaterway dredging. In all three types of activity, labor productivity increased significantly as theworkforce has declined while the level of output in the sector increased. In AGP staff was reducedfrom 3,712 in 1989 to only 1,100 in 1993. In AGP's central administration, employment was alsoreduced from a level of 470 to 180 people. The liberalization of operating rules has drasticallyreduced the number of stevedores in the port of Buenos Aires: in 1991 there were 3,200 while at theend of 1994 there were around 1,300. Although exact data is not available, the elimination of theCapitania General de Puertos and the privatizafion of JNG has reduced the number of staffemployed in their associated activities. And progress is continuing, the most recent data shows thatlabor productivity has more tripled between 1991 and 1995 in the BA port.

Table 4.3: Performance Indicators of Labor Productivity in the Port Sub-sector

_ _ _ _ _ __ 1989 1993 A%Adtinistraci6n General de PuertosCargo movement (thousand tons) 19,673 23,461 19.2%Staff (number of employees) 3,712 1,100 -70.3%Productivity index (tons per employee) 5,300 21,328 302.4%

Port of Buenos AiresCargo movement (thousand tons) 12,400 14,100 13.7%Staff (number of employees) 7,400 3,000 -59.4%Productivity index (tons per employee) 1,670 4,700 181.4%

DirecciJn Nacional de Canales, Puertos y ViasNavegablesVolume dredged (thousand cubic meters) 8,073 9,158 13.4%Staff (number of employees) 2,000 1,375 -31.2%Productivity index (volume per employee) 4,036 6,660 65.0%

Source: DST (page 133)

4.21 Tariffs. Tariffs also declined, the amount of savings varying according to the type ofservice, port, and ship size. In the port of Buenos Aires, for example, towage tariffs have decreasedaround 40 percent following flag changes and increased competition. Pilotage tariffs havedecreased, the extent depending on the ports and the areas of service. Stevedore tarifWM havereportedly also decreased and are expected to decrease even more when the privatization process iscomplete. Maritime tariffs have decreased up to 30 and 40 percent in cargo movements that werepreviously reserved exclusively for Argentine-flag ships.

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Table 4.4: Argentine External Trade after Port Privatization

1989 1990 1991 1992 1993ExpotsTraffic (thousand tons) 25,596 36,817 36,841 39,961 38,032Total tariff (thousand US$) 1,624,800 1,915,100 2,106,400 1,815,900 1,826,500Average tariff (US$/ton) 63.48 52.02 57.18 45.44 48.03

IMpoilTraffic (thousand tons) 7,44 0 5,865 6,869 10,746 10,831Total tariff (thousand US$) 227,500 227,300 421,200 698,600 718,800Average tariff (US$/ton) 30.58 38.76 61.32 65.01 66.37

Source: DST (page 132)

4.22 The joint impact on extemal trade of deregulation and privatization of port and maritimetransport and of the other major economic reforms undertaken by the Menem administration hasbeen considerable. The participation of maritime transport in the extemal trade of Argentina hasremained very high. During the period 1989-1993 it represented around 94 percent of total exportsand 75 percent of total imports by volume. Table 4.4 shows the evolution of extemal trade andaverage tariffs in the period 1989-1993. There has been a reduction of the average tariff for exports,but an increase in the average tarifffor imports over the period. Changes in intemational tarifflevelsand in the product composition of extemal trade should explain these average tariff variations, butthere is no information available to explain the reasons for the asymmetry

4.23 By then end of 1994, govemment estimates show an overall cost savings of about US$156million a year as a result of port deregulation and privatization. This figure consists of 50 percentcost savings in general cargo (or US$60 million), a 60 percent cost saving in bulk grain shipments(or US$82 million) and a 70 percent cost saving in fishing cargo activity, mainly in Patagonia region(or US$14 million)

Lessons Learned

4.24 At least two lessons can be derived from the Argentine experience in the regulatory reformof its ports. One lesson results from the advantages of an integrated policy approach towardsreform. The other lesson derives from the experience of awarding the terminal 1&2 concession.

4.25 Advantages of an integrated policy approach. Although it is difficult to quantify, muchof the benefits achieved so far would not have occurred without the integrated policy approach thathas been followed. The privatization of the port sector has been accompanied by a substantialderegulation of port operations as well as the reform of cargo reservation in the maritime sector.Equally the abolition of JNG and the privatization of its grain elevators helped by eliminatingunnecessary restrictive practices.

4.26 Flexibility is better with rules. The concession of terminal 1&2 offers a cautionary lessonregarding the process of awarding concessions. In retrospect, the Govemment was right in seekingan agreement between the two consortia which were claiming the right to operate the terminals; and

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than the original result would have done. Had the P&O consortium be formally awarded terminals1&2, it is likely that Murchison would have taken all of its equipment as well as its considerableclient base, including 50 percent of all container traffic. On the other hand, Murchison can nowbenefit from the intemational expertise brought by P&O. However, the original winner wasdisqualified by the Govemment prior to a court judgment that eventually cleared the P&O's partnerfrom any wrongdoing or misrepresentation. In the process of awarding concessions there is nosubstitute for clear rules and the application of straightforward criteria.

Challenges Ahead

4.27 Unfinished agenda. The regulatory reform process is still incomplete. The organization ofa National Port Authority that would act as the regulator and monitor the concessions is still pending.Similarly, there is a need to complete the transfer of the ports that still remain under the control ofAGP and liquidate the entity. Since March 1996, the AGP is now working with a consultativecouncil made of private managers and is supposed to soon be liquidated as a public entity. Finally,further concession arrangements and institutional changes regarding DNCPVN are required toproceed to the full privatization of the activities associated with the dredging and signaling ofnavigation channels.

4.28 Risks of non-compliance. As in the case of the freight railways there is a risk of non-compliance by the concessionaires regarding the terms of the concession and a risk of bankruptcy ashappened at the end of 1995 with Terminal 6. The risk stems from the optimism about the port'seffective market potential as reflected in the combined total for all the bids or US$32.5 million/year.This amount equates to a total cargo volume of 8.1 million tons or a 55 percent increase in thecurrent volume. Given the strong competition for cargo that has likely develop between terminals,even if a mild economic recession were to develop and traffic volumes were to drop, theGovernment may find itself in a position similar to the freight railway operations where port terminalconcessionaires will seek a renegotiation of their concession contracts. Again, a flexible buttransparent procedural approach towards contract renegotiations should be sought and developed.So far the renegociation has followed that road and as of May 1996, after adjustment in both prices(a 25 percent price cut) and volumes, the total market represents now about US$24 million/year.

4.29 Urban growth and the port of Buenos Aires. The potential traffic problems created byport and urban development concessions in the center of downtown Buenos Aires may worsen overtime. Virtually all of the containers destined to or from Argentina pass through Puerto Nuevo,which is right next to downtown, and the concessionaires of the five privatized terninals areplanning major capacity expansions to accommodate rapid expected traffic growth. At the sametime, the Government has granted a private real estate developer the rights to redevelop theneighboring obsolete old port (Puerto Madero) and plans to grant another developer rights todevelop the unused parts of large downtown rail yards at Retiro Station.

4.30 These three major projects, all involving concessions, are likely to lead to major increases indowntown traffic. Most of the containers move to and from the port by truck, for example, and theredevelopment projects are likely to include auto-oriented luxury housing and offices. If urban roaduse were properly priced, the concessionaires (or their tenants) would have considered the full socialcosts of their activities. Because urban road use is subsidized, however, the result will be excessive

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congestion and pollution. In this context it might have made sense to focus port development andport concessions somewhere else or not to grant one of the redevelopment concessions.

4.31 Why subsidize waterways? Although the Atlantic Ocean-Santa Fe waterway concessionhas only recently been awarded, the Argentine Government expects it to generate large savings. Thepublic agency had been maintaining the channel at a cost of about $70 million per year, but thewinning concession bid is to maintain it at $60 million per year, $20-25 million of which theconcessionaire hopes to collect in tolls and the rest in subsidy from the national Government.Although it is not clear that the externalities justify this kind of subsidy, the fiscal gains from the'privatization of waterways are quite significant for Argentina, since total subsidies in this sectorhave been cut from over $100-120 million/year to around $80 million/year. The savings is greaterthan these figures suggest, moreover. For instance, the concessionaire is obliged to maintain thechannel to a greater depth north of Buenos Aires. At the Parana River port of Rosario, one ofArgentina's main grain ports, bulk grain ships of the Panamax design, the standard for world trade,now can load only partially full and must go to the deeper ocean ports of Bahia Blanca (inArgentina) or Santos (in Brazil) to be topped up. The deeper channel will allow Panamax ships toleave Rosario fully loaded.

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Chapter 5: REFORM OPTIONS FOR PROVINCIAL ROADS

5.1 This chapter proposes a strategy to reform provincial road management in the interest ofcost effectiveness and responsiveness to user needs. The focus is on the road sector because this iswhere the provinces have so far been less successful at coping with their newly expandedresponsibility. Chapters 2 and 4 showed that ports and railways are unlikely to represent a rmajorconcem for the provinces. The provinces have used their increased responsibility in transportinfrastructure to close many of the smaller regional ports, and to start working on passing onprogressively to private operators the few large competitive ports such as Santa Fe and Rosario. Inrailways, most provinces also have decided to close operations, although a few provinces ultimatelymay face tough decisions if the National Govemment decides to leave it up to them whether or notthey want to maintain the Belgrano line. As discussed earlier, this is likely to be a separate issuerather a general matter requiring a major restructuring in the sector.

5.2 The chapter is organized as follows. The implicit demand for road services in Argentina'sprovinces is assessed by examining the importance of road services as an impediment to provincialgrowth. The supply side is then considered which reveals an alarming picture in terms of costs,quality of services, and financing options. The following section shows that the privatization strategyfollowed by the National Government will find only limited direct application in the provincial roadsector. The retums to investment in roads and the levels of commercial, fiscal, and political risks inmost provinces are too high to attract much financing from the private sector. But the final sectionshows that the lessons of the national experience are relevant to the provinces. Competition formanagement responsibilities can convey many of the equivalent benefits brought about byprivatization at the national level. The chapter concludes with the presentation of a strategy to lowercosts and improve user responsiveness in the management and operation of the provincial roadsector.

WHAT IS THE DEMAND FOR ROAD SERVICES IN THE PROVINCES?

5.3 Between 1950 and 1990, in large OECD countries, the growth rates of regions withincountries converged towards a common long-term average national growth rate at a velocity ofabout 2 percent a year (with a range of 1 percent in the 20 regions of Italy and 3 percent for the 11regions of the UK). Initial differences in access to infrastructure in general and to road networks inparticular were critical determinants of disparities across regions. Moreover, improvements in theoverall human and physical infrastructure contributes to accelerate the convergence of regions.8

5.4 A background paper to this report finds that the general conclusions are just as relevant toArgentina. Although the convergence rate is somewhat higher in Argentina, at about 4 percent, thepolicy implications are the same; namely, road sector deficiencies have been an impediment togrowth for many provinces.9 Table 5.1 reveals the relative importance of human and infrastructure

8 Barro, R. and X. Sala-i-Martin (1992), "Convergence", Journal of Political Economy, 100, 2, pp. 223-51 and Sala-i-Martin (1994), "Cross-Sectional Regressions and the Empirics of Economic Growth", Economic Working Paper Series,Universita Pompeu Fabra, No.79, May.9 Fay, M and A Estache (1995), "Regional Growth in Argentina: Deterninants and Policy Options", mimeo, The WorldBank (LAlIN) which replicates a detailed assessrnent of the convergence of regions in Spain: Vives, X. and A. de la Fuente(1995), "Regional Convergence in Spain", Economic Policy, forthcoming.

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capital, in particular roads, as a source of provincial growth in Argentina The first column is thetotal deviation from mean income per worker. If the deviation is positive, then the province didbetter than average; if it is negative, it did worse. The second column represents "explaineddeviation," or the share of total deviation the model can explain. The other three columns show theamount of deviation explained by each of the three variables. Columns (3) to (5) sum to theexplained deviation. Take the Province of La Pampa as an example. The model could "explain"21.5 of the 28.5 percent above the mean income per worker level. This 21.5 percent better-than-average performance was due to 26.2 percent to a better than average performance in the road sectorand 4.5 percent in the sewerage sector and was offset by a 9.1 percent below average performancein the education sector (21.5=26.2 + 4.5 - 9.1 including the rounding error).

Table 5.1. Expahing Deviations From Regional Productivity, 1990

(GDP per worker)

Total Deviation Importance of Importance of Importance ofdeviation explained by the education in roads in explaining access to sewers in

from national model explaining the the deviation explaining theproductivity average deviation deviation

(1) (2) (3) (4) (5)AdvancedBuenos Aires 0.167 0.079 0.351 -0.324 0.052Cordoba -0.144 -0.069 0.197 -0.131 -0.135Mendoza -0.330 0.065 0.042 -0.081 0.105Santa Fe -0.019 -0.025 0.142 -0.160 -0.007

Low DenityChubut 0.602 0.407 0.112 0.160 0.135La Panmpa 0.285 0.215 -0.091 0.262 0.045Neuquen 0.477 0.244 0.155 0.051 0.038Rio Negro 0.033 0.153 0.020 0.088 0.045Santa Cruz 0.649 0.780 0.345 0.347 0.088Tiena del Fuego 1.191 1.150 0.674 0.261 0.215

IntermediateEntre Rios 0.014 -0.085 -0.098 -0.065 0.077Salta -0.299 -0.039 -0.069 -0.090 0.120San Juan -0.263 -0.139 0.036 0.005 -0.180San Luis 0.848 0.285 0.133 0.142 0.009Tucunman -0.319 -0.255 0.022 -0.261 -0.016

UnderdevelopedCatamrca -0.025 0.056 0.064 0.077 -0.085Chaco -0.858 -0.826 -0.547 -0.144 -0.135Coffientes -0.013 -0.307 -0.293 -0.059 0.045Formosa -0.572 -0.474 -0.390 -0.031 -0.053Jujuy -0.109 -0.164 -0.144 -0.108 0.088La Rioja 0.012 0.304 0.186 0.191 -0.074Misiones -0.535 -0.867 -0.423 -0.163 -0.281Santiago del Estero -0.790 -0.487 -0.424 0.033 -0.096

5.5 In the case of the road sector, Table 5.1 shows that the provinces in which a lack of roadsslows growth include: Buenos Aires (-32%), Tucuman (-26%), Misiones and Santa Fe (-16%),Chaco (-14%), Cordoba (-13%), Jujuy (-10%), Salta (-9%), and Mendoza (-8%). The results forSanta Fe are confirmed in a recent survey of the infrastructure needs of a representative sample ofmanufacturing firms (see Box 5.1). Note that Misiones and Chaco (the two poorest provinces,along with Santiago and Formosa) suffer from serious deficiencies in all categories. This is clearly a

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first-order approximation and does not substitute for a detailed analysis. An obvious omission forinstance is the fact that railways are an important substitute in BA Province, which may explain thehuge estimated contribution here. But in most of the other provinces there are few such substitutes,and hence the results appear more robust. A more general omission is the importance of the newopportunities for market diversification offered by MERCOSUR in the demand for road services.These will probably further increase the demand from the export sector."0

Box 5.1: How much do Roads Matter to the Private Sector of Santa Fe?Lessons from Consultation with 76 Flrms in the Province.

A survey of the private manufacturing sector infrastructure needs in the Province of Santa Feconfirms these results from a demand-side perspective. The survey, prepared in the context of thisreport, and carried out by the Santa Fe's Statistical Office, is based on a questionnaire sent to arepresentative sample of 250 firms. At this time, 76 replies are available. All except one firmmainly rely on trucks to transport their product; 99 percent sell in Argentina, 38 percent sell in otherMERCOSUR countries, and 28 percent export elsewhere.

The survey suggests that roads matter to the private sector and that manufacturing firms need moreand better roads. Specifically, 31 percent of the firmns ranked the proximity of key roads as one ofthe top three factors in the selection of their current location. Moreover, 23 percent would placeroad access at the top of their list of criteria in selecting a new location. In fact, one in two has thisfactor as one of the top 4 in selecting a new location. In Santa Fe, only 43 percent are very satisfiedwith the current access to the road network and only 16 percent are very satisfied with the currentquality of roads. The others are either moderately satisfied (60%) or dissatisfied (24%) with thequality of roads. When asked about their level of satisfaction with the railway situation, unhappinessis much more obvious, with 64 percent of the firms expressing dissatisfaction with the quality ofrailways and 20 percent with access to railways. Although no specific question addressed the portsituation, many indicated the importance of access to waterways and ports for the success of theirbusiness.

WHAT IS THE STATE OF THE PROVINCIAL SUPPLY OF ROAD SERVICES?

5.6 A snapshot of the current state of road management in the provinces reveals an alarmingpicture. The most obvious issue is the high unit cost of any activity (Graph 5.1). For instance, newroad construction costs on average US$300,000/km in a range going from US$170,000 in LaPampa to US$530,000 in Entre Rios, road reconstruction costs vary from US$50,000/km inChubut to US$260,000 in Chaco, with an average of US$114,000. Similarly high averages andlarge dispersions are observed for the cost of patching, graveling, sealing or overlaying.

1 ° These conclusions are not new to the GOA. DNV is cunrently reviewing and redefining the national road network torecomnmend how the national and provincial networks should be financed and other govemment units are working on theeffects of MERCOSUR for the country.

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Graph 5.1: A Comparison of New Road Construction Costs Across Provinces($000/ki)

Entre R ios - Wg. .

Buens Aires l 2 | 'l ...

ant~~~~~~~~~~~~~~~~~~~~~~~~. Cru . . .. . - . - . :..

corrl nte -. -.. .. ~~~~~~~~~~~~~~~~~~~~...:.. .. . ..:

Formosa - .- . . .:

Juuuy ~~~~~~~~~~~~~~~~~~~~~~~. .-. ...-. .... . .:

Rio Negro

La Pam a | | g lll} :: | : ~. ---. :. . . . . . . . . .

AVERAGE P

Santa Fe .........

Santa Cruz.': ~ ~

Jujuy * :.. *a::~ ..

La PampaM

0 100 200 300 400 500 600BEST PRACTICE AVERAGE

Source: Questionnaire Filled by the Provincial Road AgenciesNote: The best practice mentioned is the national one in 1993 for the sample covered here. It is only indicative asdifferences in geographical characteristics and other sources of non-limearities may lead to some v~riation in costsacross provinces.

5.7 In many cases, the high costs reflect overdesign based on 'technical" optimnization at theproject level with no regard to budget constraints, instead of optirmization at the network level withinescapable budget restrictions. For example, the cost of rehabilitation considered by localconsultants is typically twice the cost of the optimal solution recommended by the Bank. These highcosts often reflect a fair amount of cost padding and restrictions to entry in the bids. In many others,they appear to reflect implicit or informal agreements between civil servants or politicians andprivate construction companies made possible by complex and opaque procurement rules that boildown to preestablished short lists of candidates eligible to deliver public works. The lack ofdocumentation on these rules at the provincial level is representative of the lack of transparency andaccountability in which provincial administrators are often conducting activities in this sector. Inaddition to the high costs of services, the main indicators of the costs of this lack of accountability arein the composition (maintenance vs. investment) and quality of service delivered and the poormonitoring of the overall road system. With the exception of the provinces of La Pampa and SantaFe, which have some network monitoring systems in place, the rest of the provinces have litfleinformation available regarding traffic volumes, axle weights and road surface conditions. This

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technical information is necessary not only to establish priorities and prepare multiyear maintenanceand investment plans but also for the design of effective road user charges." 1

5.8 Another important indicator of the road management problem is that only about 70 percentof provincial road networks are regularly maintained. This figure however masks a wide dispersion.About 12 percent of the provinces maintain 100 percent of their network, while 20 percent maintainless than 40 percent of their network. On average, maintenance represents about 37 percent of totalexpenditure on roads. In some provinces such as Entre Rios, Catamarca, Jujuy or Chubut, itappears to be less than 20 percent. In many of these, a share of 50 percent would often be moreappropriate. But even when the allocation for maintenance is reasonable, there is a wide variety ofexperiences. It tums out that provinces that rely more substantially on the private sector formaintenance work tend to conduct these activities at lower cost, thus allowing a larger share of thenetwork to be maintained for a fixed budget. Moreover, there also is a clear correlation between theproductivity of public workers and the increased reliance on the private sector for some services.

5.9 A final illustration of the problems on the supply side is that there appears to be nocorrelation between personnel capacity and respective length of network There are wide disparitiesassociated with the size of the network that each province is required to manage. Some provinceshave a total length of network of between 20,000 and 30,000 km, while others have as little asbetween 1,000 and 3,000 km and the average range lies between 4,000 and 7,000 km. Yet there isno consistency between the needs revealed by the network and the staffing policies. Some provincesappear to have excessive amount of staff while other provinces have few. The provinces ofCatamarca, Formosa, Misiones and Tucuman, for example, vary between 300 and 700 employeesper 1 000 km of network--most of these employees need training--while the province of Cordoba, forexample, only has 10 employees per km. A reasonable number would be in around 50 to 80employees per 1000 km of network..

5.10 The outcome of this poor management is obvious in a recent survey conducted by theWorld Bank in 10 provinces. Only about 42 percent of the network is in good condition, while 37percent and 18 percent, respectively, are in fair and bad condition. This means that the provinceswill need to increase their maintenance outlays to improve their network. An important qualification,however, is that since unit costs could be cut significantly, the provinces could meet theseexpenditure requirements without much increase in the current dollar allocation to maintenance.This is important given the difficult state of provincial public finances.

5.11 The maintenance needs for the provincial road network in the next five years are estimatedto be US$500 million per year, including routine and periodic maintenance. On the resource side,the total share of provincial governments in fuel tax revenue will be gradually increased from 13percent in mid-1992 to an expected 26 percent after 1996 to account for the proposeddecentralization of responsibilities. The Provincial Road Agencies only get 60 percent of the totalprovincial allocation according to critef a that include population, fuel consumption and resourcesspent on roads (the other 40 percent is distributed to two electricity and public infrastructure funds).

"In the context of a the preparation of a proposed provincial road project to be financed by the World Bank,most provinces are currently preparing this inventory. As of June 1995, a third have completed the monitoring oftheir road network, and are starting to carrv out the analysis to identify adequate strategies and priorities as weakas a multiannual maintenance program.

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While these resources are not enough to cover global investment needs, they should be sufficient tocover the maintenance and rehabilitation needs. But this will require proper pricing andmanagement of scarce resources.

HOW RELEVANT IS THE NATIONAL EXPERIENCE FOR THE PROVINCES?

5.12 Few provinces will be able to rely on concession contracts similar to those signed by theNational Govemment. Only those with roads with enough traffic potential and these already havebeen concessioned or are nearly ready to be concessioned in the portions of their network that couldattract private operators. Santa Fe has plready granted a concession to toll, maintain, and improvean existing intercity expressway and C6rdoba, Mendoza, and Santa Fe are in the process ofgranting, or have already granted, toll-based concessions for the high-volume roads that access theirmain cities. Santa Fe also has plans to grant concessions to toll and maintain some intercity roadsthat carry relatively modest volumes (between 1,000 and 2,000 vehicles per day) and to contractwith municipalities to maintain the provincial and local network of low-volume earth roads.

5.13 Theoretically, even for some low traffic roads, concessions may be attractive when bid outto the pnvate operator who needs the lowest subsidy. The road network of a province for instancecan be subdivided into various subnetworks to be contracted out and include a prescribed share ofhigh traffic roads and another of low traffic roads. The province of BA is following a similarstrategy in the reform of its road management. But few other provinces will be able to do thisbecause, as shown below, few could convince pnrvate operators that the risks they would face wouldbe minor and that the subsidy the concession contract promises will be paid.

5.14 What exactly are the risks faced by the private sector? While it is difficult to spell out theserisks in much detail, it is useful to provide a brief overview of the way private investors look atpotential road projects. The approach is clearly 'back-of-the-envelope"with modest ambitions and agood deal of subjectivity; however, it does provide some important insights to any province lookinginto private financing options for roads.

5.15 A project sponsor/developer faces four main types of risk: (i) currency/financial risk due tointerest rate fluctuations/refinancing; (ii) commercial (which includes production costs and demandaspects); (iii) provincial (associated mostly with the fiscal and overall economic situation of theprovince); and (iv) political (which include sector-specific risks, such as the risk that the contracts orthe regulatory environments will be renegotiated). The first risk element is something the provincescan do little about. The provinces should not do anything about the commercial risk, but should beaware of it when assessing their chances of attracting private investors. The last two risk elementsare largely under their control.

5.16 The information readily available (for 1993) to any investor is organized in Table 5.2 tolhighlight the commnercial, provincial, and political risks in the road sector in each province. Each riskis quoted as L (low risk), M ( medium risk) or H (high risk). These levels are assessed in terms ofdeviations from a benchmark, defined here as the best practice in Argentina for each individualindicator. If the value of an indicator is close to or far from the benchmark value the provincerepresents a low or high nrsk with respect to that specific indicator. To obtain an overall risk rating, avalue of 1 is assigned to low risk, 2 to a medium nrsk and 3 to a high risk. The last column of Table5.2 gives the overall risk rating.

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Table 5.2: Rating Provincial Risk for the Road Sector

Commercial Risk Provincial Risk Political Risk Overall Risk

Provinces Istaffing l|technol. Hdemand IIGDP/N I|Def. Ed. lRE. IME. JM. ICE. RF.Advanced

I BuenosAires** M M L M H L L L . H L 1.702 Cordoba M M L H H L H L L H L 1.913 Mendoza . . L H H L M . . . L 1.834 Santa Fe M M L M H L L L L M L 1.55

Low Density5 Chubut M . H M H H M H . . M 2.56 La Pampa M M H M H L M M L L M 1.737 Neuquen M . M M H H L H . L M 2.228 RioNegro M M M H H M H L . M 2.339 SantaCruz M L H M H H L L L H M 2.010 TierradelFuego M M H L H H M L L L L 1.82

Internediatei 1 Entre Rios M . L H H L M H . L L 1.6712 Salta M M L H H H M M L H M 2.1813 SanJuan M M L H H L M L L H M 1.7314 SanLuis M . M M H L . . . M 1.6715 Tucuman L L L H H L L L L M H 1.45

Underdeveloped16 Catamarca M M M H H H L L L H M 2.0917 Chaco M M L H H L H L L M M 1.7318 Correntes M M L H H M M L L L M 1.7319 Formosa M L L H H L L L L H M 1.5520 Jujuy M M L H H H L L L L M 1.8221 La Rioja M . M H H H . . . . M 2.3322 Misiones M M L H H L L L L L L 1.3623 Santago delEstero M M L H H L H M H L L 1.82

Note: GDP/N = Gross Domestic Product per Capita; Def=Deficit; Ed= education level; RE, total expenditure onroads; ME=expenditure on road maintenance; M share of the network maintained annually, CE share of the budget contractedout; RF = amount collected for the road fund; Low risk =1; medium nsk-2, high risk = 3.

5. 17 The main risk factors specific to roads are approximated as follows: 12

commercial: the number of employees per 1000 km of roads approximates the margin toimprove labor productivity, unit cost of road maintenance to approxirnate current localtechnologies, provincial population density to approximate potential demand--the higher thevalues observed, the lower the risk and the more attractive a province is to an investorbecause it is easier to improve labor productivity--.

12 The numerical value of the indicators are from Humplick (1995, forthcoming), 'Infrastructure Performance in theProvinces of Argentina", World Bank Discussion Paper; Humplick provides a thorough analysis of three sectors.

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provincial: the Provincial Gross Domestic Product per capita (GDP)--the higher the GDP,the better the rating--; the Pubhic Provincial Deficit (Def)-the higher Def, the worse therating--; and the education level (Ed)--the higher Ed, the higher the qualification of theworkforce and the better the rating.

political: the total expenditure on roads, per km (RE); it signals the provincial commitmentto roads--the higher RE, the lower the risk--; the expenditure on road maintenance per km(ME)--the higher ME, the lower the risk because the strongest the commitment tomaintenance--; the share of the network maintained annually (M)-- the higher M is, thelower the risk since it is another sign of commitment--; the share of maintenance budgetcontracted out (CE) signals the level of experience in contracting out--the lower CE, thehigher the nrsk--; the (average over the last three years) amount collected for the road fund(RF) signals commitment to road investrnents--the higher RF, the lower the risk

5.18 The last column of Table 5.2 provides an aggregate risk indicator. The average is 1.93 andonly Chubut, La Rioja, Rio Negro, Neuquen, Salta, Catamarca and Santa Cruz represent an aboveaverage risk to potential private investors in this sector according to the data used here.. But themost interesting information comes from the specific sources of risk Table 5.2 shows that thegreatest nsks tend to be from the economic/fiscal conditions in the province and to some extent thelack of demand. 13 The fiscal risk has only got worse according to the prelimninary data available for1994 and this probably mean that for most provinces the overall risk rating would deteriorate. Toaddress the commercial risk revealed in the lack of demand, the only realistic option is to build insubsidies in the contract with the private operator. However, for the commitment to a subsidy to becredible, most provinces would have to demonstrate a much better fiscal situation than they currentlycan. This implies it will take some time before most provinces have the opportunity to rely in anymajor way on concession contracts with subsidies built in. Private operators are likely to expectprovincial governments to build a track record of good fiscal performance before committingthemselves to the large sunk costs that road construction often entails. This means that in the short tomedium run, the provinces will have to come up with a reform strategy for their road sector thatdoes not rely heavily on concession contracts. Alternatively, a strategy of commercialization of roadsector management should yield benefits similar to those generated for users by the competitionoriented strategy adopted by the National Government in roads, rails, and, ports.

A STRATEGY FOR THE REFORM OF PROVINCIAL ROAD MANAGEMENT

5.19 This overview makes it clear that the provincial governments have the long-term problemmany governments face: most of the financing to meet network expansion requirements will have tobe financed from public sources other than road user charges as these essentially cover the recurrentexpenditure needs only. The discussion below provides a few options drawing in more pnrvatefinancing in the long run; however, this will only represent a modest contribution to the likely needsof the sector. In addition to this long-term problem, provincial authorities have two short-term issuesto address in their reform of provincial road management and operations: (i) cost effectiveness innew construction and maintenance (see Graph 5.1), and (ii) responsiveness to users' needs (see

13 The impact of the high employment levels is more difficult to assess. On the one hand, the excessive level of employmentin the sector suggests that it should not be too difficult to improve labor productivity and cut cost as was done in the railwaysector by reducing employment. On the other hand, the political accountability and cost of labor reductions may be muchhigher at the provincial level and are then less likely to be authorized -even as part of a privatization effort.

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Box 5.1). The first of these two issues is particularly important as it can contribute significantly toreduce the financing requirements by lowering the cost of expenditures needed to cover maintenanceand investment needs of the sector.

5.20 The long-term problem. With the current technologies and with the current levels ofdemand, the provincial road sector has the least chance of attracting private financing among allinfrastructure sectors. Private investors and operators are only attracted by reasonable combinationsof rates of return and risk and in the short run, with few exceptions, the returns to provincial roadsare expected to be low and the matching risk levels too high. In the longer run, with the help ofinnovative and diverse financing techniques for specific stand-alone projects (such as'MERCOSUR highways'), a few opportunities may appear, but these also will be very limited interms of the total financing needs of the sector. Two such innovations are described in Box 5.2. Forthe foreseeable future, however, the public sector will have to remain the main source of financingfor most provincial roads. In this context, the best short-term option available is to minimizefinancing requirement by minimizing costs. The main elements of a strategy that can achieve theseshort-term goals are discussed next.

5.21 Focusing on the short-term issues. A key reason why many provincial road agencieshave failed in achieving cost effectiveness and responsiveness to users is that their managers havelacked the incentive to minimize costs or to focus on the user's needs. To have these incentives,when assets cannot be sold or concessioned to private operators, the best solution is tocommercialize the management and operation of the sector. This means that the management of theroad agencies can be concessioned with clear and coherent goals spelled out. Once the contract isawarded, the managers enjoy autonomy and financial independence in their decisions (i.e., the roadmaintenance and investment strategies should be insulated as much as possible from politicalconsiderations). This commercialization ensures many of the benefits of competition by requiringthat individual managers, operators or workers in the sector (whether public or private) competewith each other for the privilege of operating or servicing all or some of the provincial roads.

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Box 5.2: Long-term Options to Attract Private Interest in the Provincial Road Sector

The guiding principle for the long-term options for financing specific road projects in the provinces should be aclear concern to minimize and allocate nsks faced by pnvate investors. This ensures that incentives are in place to controlnsks whAle all information pertaining to the nature and level of the nsk is effectively used. Two models deserveconsideration in the context of Argentina's provinces: (i) a revolving fund; and (ii) a discrete fhnd. There are more optionsand, in practice, given the vast differences that exist among projects and provinces, a case-by-case approach should beconsidered when targeting fLnding products to specific projects. Both options, however, require some degree of provincialinvolvement, financial participation, and exposure to different risks. 14

How would a Revolving Fund work?

Objective: This fhnd can be used to provide either guarantees or direct financing to road builders. Its main purposewould be to stimulate private involvement in roads with average traffic in provinces, in which only modest guarantees orsomewhat longer-term borrowing opportunities would be enough to be able to delegate a fair share of responsibilities toprivate operators.

Mechanism: The find is initiated with grant money (which could come from FONAVI or FONVIAL, or fromtempomry surcharge on road users), and can be complemented vith debt or equity-that could be provided by some of theusers with a stake in the road (say the rrilk producers in the milk producing regions). The original equity paymnents into thefind can be staggered but are in general limited. Sustainability is based on the fact that it relies on recycled loans forsuccessive generations of projects A prudent leveraging of the find is generally the best option when the equity is notsufficient to meet most of the needs. As soon as the find becomes leveraged, subsidized rates should be avoided. These tendto erode the size of the fund.

Assessment: the main advantage of the fund is that it operates without any need to borrow, since the initial paymentcan be made with grants. Its major disadvantage is that if for too many projects the internal rates of return do not pass somequalifying (hurdle) test, and a large share of the loans involve subsidized rates. Unless the grants keep flowing in, the size ofthe fund will be eroded. On balance, it seems it can be very effective. It has been an effective way of maximizing the capitalavailable for highway infrastructure in the US since 1949. Most fully-funded revolving loan programs in the US providedirect loans at below market rates or make loans to less than credit-worthy jurisdictions, often becoming a lender of last resortfor these jurisdictions. Paybacks on loans usually occur over 7 to 12 years.

How would a Discrete Fund work?

Objective: This find is intended to finance a one-time poohng of clearly identified projects; its m,ain attractivenesswould be in the context of development of transport infrastructure aimed at meeting new needs resulting from the newopportunities offered by MERCOSUR. Consider for instance the construction of a four-lane highway between Brazil andChile going through, say Cormientes, Santa Fe, Cordoba, and San Juan or Mendoza. Such a highway probably could veryeffectively provide access to new markets across the Pacific Ocean to many Argentinean, Brazilian and Uruguayan products.If any of the four provinces in the example rejects the idea of a four-lane highway, it is likely to reduce the commercial valueof the venture, and hence increase the commercial risk of private investment in any of the provinces. If instead, the fourprovinces can come up with an agreement to coordinate their request for bidding and jointly to commit to the overall project,(which the Constitution now allows), the overall commercial and political risks of the venture would be lower than the samerisks for separate projects in each one of the four provinces.

Mechanism: In general, these funds work through the earmarking of some resources to the financing of the fhnd.The revenue earmarked (say form the tolls or any other road user charge) can be used to immediately pay the investors theirdue according to terms specified in the contract.

Assessment: This approach provides investors with a reasonably predictable revenue stream and provides theprovince with access to funding sufficient for investment purposes. The short-term prospects for this kind of fund arecurrently limited as there is still much uncertainty about the commitment to reform of many provinces, and as many of thedetails of a NERCOSUR transport policy remain to be spelled out. The attractiveness of such a find however is likely to beenhanced by a bunching of province since many of the roads likely to be attractive to the private sector go through severalstates, the coordination of provincial government in the management of these roads is likely to increase their market value.On balance, the fhnd seems to be attractive to many as it is being considered or implemented in many countries in East Asia.

14Details on the specific design of these finds can be found in Ruster, F. (1995), 'Infrastructure Financing: Options forArgentina's Provinces', The World Bank, mimeo and US Department of Transportation (1994), 'Perspective on the CurrentRole of Bonds in Highway Capital Program: Designing Debt Policy and Selecting Bond Instruments', mimeo, July.

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5.22 The short-term reform strategy. The main specific elements of this strategy are asfollows:

* unbundle the key tasks in the sector: Few provinces wilU have opportunities to rely oncompetition through bids for toll roads and to get a private operator to take over fullresponsibility for a highway, since traffic levels are generally too low. This implies that thefirst step to make the most out of competitive options is to desegregate the key inputs in thedelivery of road services into the financing, management, and execution of the tasks of thesector. This unbundling is needed to make the most of the opportunities to introducecompetition in the components. It is clear that for the construction of most roads, as well asfor their maintenance, most of the financing will have to come from the public sector. It isless clear that the actual work and the management of these roads have to remain in thepublic sector. This is not to say that these should be privatized; but the mere fact that publicmanagers and workers know that they could be replaced by private substitutes increasestheir incentive to perform.

* imNose performance targets on managers. A key to cost effectiveness is an increasedaccountability of the managers of road agencies. Currently, whether a manager makes surethat the roads are according to needs or not does not make a difference in terms of his/heremployment status (i.e., whether he performs or not, he/she may keep his/her job for a longtime). This manager would become more accountable the management of the agency wascommercialized. This can done with public managers through performance contracts orwith private operators through management contracts, tailored to the preferences of theprovincial government in terms of degree of private sector involvement. This involvesassigning clear responsibility for operations and maintenance and performance reviews byan impartial entity. It also means designing a system of road user charges (as discussed inchapter 3) that establishes a clearer link between users' payments and maintenanceexpenditures (to increase accountability of road agencies to users), and finally a mechanismfor users to influence road authorities. Many of these objectives can actually be built into aperformance contract if the Government decides to maintain the management in publichands or in a management contract with a private operator.

* bid out maintenance and construction services. Most provinces are already contracting outsome share of their maintenance. Santa Fe and Cordoba, for instance, are contracting outover 70 percent of their maintenance work. But many provinces with high unit costs, suchas Neuquen, could contract out much more. The provincial govemors could ensure this byincluding a target imposing a minimum share of maintenance work to be contracted out.This has been done by some govemors in the south of Brazil with very effective results:maintenance cost were cut by more 25 percent with no change in quality. Similar resultswhere achieved in Chile, where 80 percent of all maintenance work is contracted out

15 Although the international experience reviewed in chapter 2 of the 1994 World Development Report clearlyshows that management contracts tend to be more effective than performance contracts.

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Graph 5 2: Unit Costs of Maintenance Contracted out in Selected Provinces(000$/km)

C haco .......... .. . . .......................... ........... ..... 1........ .: ....... . . . . . .. -... :.E:: |:

Neuquen I ................ .................... .....

Co r h o1 ..... 1. . - - -7:

AV E R AG E . . .. . . ... ..

Santa Fe - ... ... - - - - - .......

..... .R X1.... - ------. . . . -......... - .. -....

S d Estero -:

Neqe .:..,....., -,- : " ' -:.'-"."'""""",:'

_ 7 .-.... ~~~~~~~~~~~~~~~.......... 1 1 _

Cornentes .. . ...

.. .. u ... ..Juluy :~~~~~ .... :-. -:.-::| 4:... .. .. .. ................. .. ::- .. : .::::: .. ..: :--.-: . :: . :: . ... -. :.. :. : . -::.::::::-..:. -. :..-..- . :....- . .: . . .:- . . .. . ...-.: ..,, '''. .................. ' '. . .....

Catamarca . . .... . ...... . . .. 14.

..... .. :...

, ~~~~~~~BEST PRACTICE AVE AGE

Souirce Questioiuiaire l leld hv t.hc lrovinicial Road AgenciLsNote: The best practice mentioned IS the national one in 1993 for the sample covered here. It is onlyindicative as differences in yeographical chlaractenstics and other sources of non-linearities mav lead tosome variation in costs across provinces.

* ensure that all bidding and procurement rules facilitate competition. A main differencebetween Chile, and Argentina's provinces, however, is that the bidding of contracts is donecompetitively in Chile. This may be why pricmng in Chile is much more consistent with best

ractice benchmarks than in Argentina s. 6 Graph 5 2 shows that even services contractedout are very expensive by international standards and highly variable across provinces. InChaco, for instance, where 59 percent of maintenance is contracted out, the unit cost ofmaintenance work is $301,000/km. This is about twice the price of 'best practice"in thecountry and cannot be explained by factors such as geography and the condition of the roadbefore maintenance. In many provinces, such differences often reflect cost padding andexcessive regulatory restrictions n entry to the bidding process (often not very transparent oropen to negotiations). Competition in the sector really begin in the design of the biddingmechanism as observed in the discussion of national experience.

* rely on benchmark pncing. Using intemational best practice as an indicator of how servicesshould be priced is often an underestimated complementary approach to minimize road-related services costs. It could be a very effective way to reduce the gap between financingneeds and sources In most provtnces. since many have extremely high prices in the sector

16 There is no reason wvhy public employces cotuld not participate in the bidding. Thex' max' need to getorganized as small firms to bid and may actually be highly competitive, in terms of prices and quality. Allowvingthem to bid for serxice contracts can be an effective xxa! to address the redundancy problem in the public sector.

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that are unjustified by their physical characteristics. While the most effective approach is torely on benchmark pnrcing based on the best intematonal practice, the imposition of the bestnational practice could quickly reduce financing requirements significantly in mostprovinces in Argentina For instance, if in 1993 every province had priced its new pavingactivities at the national best practice price, collectively they could have saved at leastUS$10 billion. The provinces with the largest potential for realizing such savings are EntreRios, Cordoba and Chaco. For many, these savings would represent between 10 and 15percent of their total current expenditure.

* keep the regulatory institutions in the sector to a minimum. The main instrument tointroduce incentive-based regulaton in the proposed strategy is the contract: whether thecontract covers the performance of public managers, private operators or contractors, theirsupervision is a key to the success of the reform. There is no need to have one regulator foreach contract or group of contracts. The point is to make sure that the staff are qualified,empowered, and free from any political interference from the Govemment. Only in thisfashion can they ensure that the gains from competition will be realized, instead oftransformed into rents captured by the managers, politicians or contractors at the expense ofroad users and the provincial taxpayers.

5.23 Sequencing of provincial reforms The discussion has made it clear that there are manychanges the provinces can undertake. There is, however, a natural sequence to these changes.Provincial governments should focus first on improving the operaton of the sector. This is wheremanagement and perfornance contracts are likely to achieve the most in the short run. But the short-run gains from such contracts are not their only payoff They are also the first step in establishingthe commitment to change as well as the credibility of any reform in the road sector that catches theeyes of private investors in any province. This has large potential payoffs in the longer run. Oncethe administration is locked into transparent, efficiency-oriented contracts, then some privatefinancing through infrastructure funds can become a realistic option for the provinces.

5.24 Summing up. The prospects for a successful implementation of this reform strategy in thesequence recommended are good. The current public policy debate--including the dialogue with theBank on the reform needs and options for the management of the provincial road sector--isencouraging and consistent with the proposed strategy that aims at introducing competition andaccountability in the provincial road sector. The ongoing review by DNV of the provincial financingoptions provides a good opportunity to assess the various opbons for redesigning the current roadfunds in order to create a new type of fund more likely to attract private financing and progressivelyreduce the public sector contribution--although it should be clear that the public sector will remainthe key financier of the road sector, one way or another, for the foreseeable future. Finally, the birthof MERCOSUR is likely to create new opportunities for tolls road as the demand from national andregional exporters for road services increases, although these opportunities are for the longer run.

IMAGING

ReprtNO; 14469A AR

TyPe: SR