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Distortions in pricing of public services

Vagaries of Consciousness

  • Prices are not right, supply chain faces frequent disruptions

Nothing injures economic development more than the existence of distortions in the pricing of public services. Let us first explain the theory. Production of any good or service entails costs, and unless those costs are recovered, continued production or supply would be impossible. In fact, it is not just the recovery of the cost; to meet the growing demand, further investment in enhancing production capacity would also be required, which would be priced in the provision of good or service.

This principle is strictly applicable in the case of what is a pure private good, defined as one whose consumption is rival (the cake that I eat cannot be eaten by other) and market can exclude users (by asking for a price). There could be non-rival goods (such as movies and plane ride) but markets can still exclude through pricing. Goods could be rival but not excludable, such as sub-soil water or fishing (exclusion could be possible through licensing). Finally, there are goods which are pure public goods, such as defense and policing), which is neither rival nor excludable. For pure public good, since market does not function, it is provided by the government through taxation.

Ideally, the government should only confine itself in the production and supply of pure public goods. Yet we find the government engaged in almost all infrastructure projects like power, gas, railways, highways, seaport, airports, aviation, shipping and some manufacturing activities. Most of these activities, despite being non-rival conform to the principle of excludability, which means a market in their provision can be allowed to function. If a market is allowed to emerge, with adequate regulatory safeguards, market efficiency would be significantly higher than under government ownership, which would mean lower prices and reliability of supplies. Numerous distortions that emerge because of public ownership would also disappear.

We would explain the above principles within the context of two key public services namely electricity and gas, where government ownership and undesirable interventions have brought these sectors at the verge of collapse.

Ideally, the government should only confine itself in the production and supply of pure public goods

Let’s first discuss the power sector. A decision in principle to divest power wing of the erstwhile WAPDA was taken as far back as in 1988. However, powerful interest groups constantly impeded such plans, with the result that even after three long decades, the plan has not succeeded. What is more, the portion of the plan partially implemented (such as induction of private sector in power generation) has created distortions of its own, as other parts of the plan remained unimplemented and consequences of such induction (like initial increase in pricing) was not passed on to the consumers leading to accumulation of huge receivables. It should be noted that the decision to induct private power was not based on any ideological considerations. It was a response to the fact that future investments were not forthcoming to meet the rising demand. Initially, the cost of private power was to be higher but with economies of scale it would have fallen.

However, when the initial higher cost was not passed to consumer for political reasons, receivables started accumulating, despite an understanding with the IPPs that payments would be made through opening of local LCs. The so-called accountability drive during the second PML-N government (1997-99) had already scared the investors, and hence no one objected to a default on LCs but IPPs discontinued payment to fuel suppliers, who in turn, refused payments to some of their local suppliers (gas companies and refineries) and hence a notion of circular debt (CD), unheard previously, emerged in our lexicon.

CD is a product of failing to set the tariffs at cost recovery level as well as setting tariffs as if there were many private producers in the field and thus require individual pricing. The reality is that there is a single owner, the government of Pakistan, who is boxed in a corner to charge a price (explained later) that results in a large subsidy, which occasionally is not paid on time.

After private power, which was taught a lesson so that it would never return to Pakistan, the process of deregulation was stopped. However, each time a World Bank loan was needed, government would do enough to get the loan released and return to its familiar ways of indifference, soon thereafter. Two major reforms were the establishment of power sector regulator, NEPRA, and a big push for corporatisation of the power wing into 8 distribution companies (Discos) three generation companies (Gencos) and one transmission company (NTDC). Both these decisions were taken in 1997 but it took ten years to complete the exercise, during which time the sector was running essentially on power added under policies of 1994 and 2002 (all by local investors as foreign investors shied away) and it was proving insufficient to meet the growing demand.

After corporatisation, another major policy mis-step was to allow NEPRA to determine tariff for each Disco separately. When eight tariffs were determined, the question was whether to implement NEPRA determined tariffs (NDT) for each Disco or charge a uniform tariff. Here again, politics became the main consideration for decision making. It was decided to apply a uniform tariff. Legally the only tariff that could be applied uniformly was the lowest or minimum determined tariff (MDT). This was done, but it created huge differential between actual Disco tariffs and MDTs. Since this was a policy decision, government had to bear the differential cost. A new word was coined in public finance, tariff differential subsidy (TDS), which would wreck the fiscal system over the next decade, and continues to do so to this day. While doing so, nobody cared who would foot the bill. Whenever the politicians would be reminded that such subsidies are unsustainable they would frown at the very suggestion of increasing the tariff. Except once in 2013, when prime minister Nawaz Sharif, fresh from his electoral victory, agreed to increase tariff by more than 50pc, which was a prior action to clinch the Fund program. In fact he would repeat it several times during the Fund program to ensure it was not derailed.

The TDS has been brought down to a reasonable a limit at present. But the real challenge is the CD, which is holding the entire power sector hostage and with it poses an unbearable thereat to country’s finances.

Also, since investments were not made after 2002 policy, shortages started to emerge resulting in massive public protests in the summer of 2013 when elections were held. The PML-N government made end-of-load-shedding its main slogan. During the last five years they have added more than 5000 MW to the national grid while a similar amount is in the pipeline.

In the meanwhile CD has soared to an unbelievable level of Rs.1.2 trillion or 3-3.5pc of GDP. One is puzzled to realise that policy-makers are not spending sleepless nights over this calamity. We are sitting over a ticking bomb which if exploded could lead to a complete unraveling of the fiscal system. There is plenty of power available but it cannot be produced for want of liquidity and availability of a commensurate infrastructure of transmission and distribution (T&D) that can dispatch it to consumers. The T&D infrastructure is woefully inadequate, incurs phenomenal losses, and adds to the cost of power by not allowing capacity payments to decline with the rising sales of energy.

This then is the state of distortions in the provision of electricity. Prices are not right, supply chain faces frequent disruptions, huge accumulation of receivables across the supply chain, inadequate investments to meet growing demand and uncertainty regarding future prospects in the sector. Three decades have passed since the government had decided to create a market for production, transmission and distribution of power and also appointed a regulator. We only have less-than-half the job done without having a road-map to guide us for the future. And these are only macro issues that we have focused on. There is a litany of other distortions when it comes to operational problems. Getting an electricity connection is as difficult today as it ever was and if there is a need for some repair, transfer of meter, change of its location, reconfiguration etc. you would be lucky if it’s attended in a timely manner. [To be continued]

Waqar Masood Khan

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Waqar Masood Khan

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