Roles of the market and of government in urban service delivery

Assessing the public or private nature of goods and services. Slum-type settlements are evidence of both market failure and of government failure. Where markets have existed, they have often proven inadequate in providing private-type goods sufficiently, such as housing, water and infrastructure, while markets are inherently unable to provide public-type goods (such as street drainage and access roads). Governments have often failed to facilitate the functioning of markets that should exist in the former case, or to act in their place where markets are not possible.

One reason for these failures is that the roles of the public and the private sector in providing slums with services have not been clearly enough defined. A first step is to identify clearly the public or private nature of particular goods or services, thereby determining the relevance of markets and necessary roles for public policy. Private-type goods/services are consumed by individuals, based on their demand at a price that the supplier offers. Examples are end-user water and sanitation systems (e.g. latrines), housing, and solid waste collection. Public-type goods are consumed by the community as a group and have no market mechanism to match demand and supply. They rather require a public choice through a political process or through communal organization. Public-type goods include street lighting, sidewalks and community centers. Yet, there a number of goods and services that are partly public and partly private, or imperfectly private goods, such as piped water supply, piped sewerage, urban roads or sanitary landfill. (See table 1 “Public-to-Private Nature of Urban Goods and Services”)

Other characteristics with implications for public policy. In addition to distinguishing the public, private or mixed nature of urban services, identifying the roles for markets and for governments requires identifying some other important characteristics. (See table 2 “Other Economic Characteristics of Urban Goods and Services”) The first is whether the type of service entails natural monopoly – that is, it can only be provided efficiently by one large-scale producer — or whether other providers would be willing and able to compete. The urban services involving a true natural monopoly are relatively rare (mainly piped water and sewer systems), and where this characteristic prevails a government role in regulation is warranted to protect both producer and consumers.

A second key characteristic is the extent of coordination requirements. Services that are physically networked or technically complex require more coordination in planning, investment and operation, and sharing of information. A third issue is that of externalities (positive or negative impacts on nonusers)–effects such as pollution, noise, or public health and safety implications from the use (or nonuse) of various services. Where externalities exist, private benefits or costs of use are not consistent with the public (social) benefits and costs, and therefore public and private demand are at odds. Such services may require some public financing, regulation, and/or planning of needed levels of investment and operation.

The fourth feature of urban services is the social-political objectives they may entail, whereby society places a special value on availability or consumption of the service as a social benefit. Such objectives may include an emphasis on social equity to ensure that all groups in the society have a minimum level of access, for example to shelter, public transport and health care. How strongly these objectives are felt will vary with each individual society, which will determine the justification for some public financing, regulation and planning to provide the perceived common good for all citizens. As indicated in Table 2, the various types of essential urban services have relatively few claims to natural monopoly, more requirements for coordination, but involve considerable externalities and potentially, social-political claims on a public policy role.

From the foregoing analyses it can be determined in what ways the market or the public sector is better placed to produce and finance each type of good or service. For instance, services that can be used and paid for by individuals and households are best suited to be provided by the private sector. Services with mainly neighborhood-level impacts and local benefits should be chosen and financed by the local community. Services with citywide impacts need to be planned and financed by government or by its metropolitan agencies. The private sector can still be the agent of the community or the government to produce the latter two categories of services under contractual arrangements. At the same time, financial transfers (from the national government to local government, from the latter to community groups, households or individuals) can also be justifiable to correct for elements such as high start-up costs (which constrain potential competition), to counteract negative externalities, or to ensure minimum essential service levels to all households. The level and design of such transfers, or subsidies, must also take account of the need to promote appropriate incentives for users and private providers to fulfill their responsibilities, and to ensure fiscal sustainability.

Thus, in regard to the roles of markets and governments in urban services delivery, it can be concluded that urban services are heterogeneous in their degree of “marketability”, and so a variety of approaches to assess demand and to provide adequate supply is needed. Efficient markets can be formal (following rules of legal contracts), and involve large and small operators, or informal (based on tacit rules of behavior) with mainly small-scale participants. However, a preponderance of informal suppliers often signals that market growth is constrained by poor information and/or by inappropriate government actions—for example, due to onerous tax burdens, government-imposed entry restrictions, or other regulations. Some functions properly assigned to “government” can also be legitimately performed by community-based organizations for their members, for example when neighborhood associations exercise cost-recovery or planning activities in collaboration with municipalities or public utilities, for investments or services in their area (such as local sanitation or sidewalk improvement).

II. Institutional issues in providing infrastructure services to poor urban settlements

Creating sustainable institutional arrangements to provide infrastructure services to low income urban residents and to slum-type settlements requires addressing three issues: i) ensuring adequate incentives for providers, ii) providing technological and service level options to meet households’ demand and affordability, and iii) forming partnerships between utilities, communities and local government.

Conventional public utility approaches. (Brook and Tynan, 1999) The traditional approaches to providing infrastructure (water, sanitation, electricity, public transport and telecommunications) to urban residents, based on experiences in developed countries, has been characterized by strict “command and control” arrangements. Whether executed through public enterprises, private concession contracts or regulated private utilities, such arrangements have typically involved uniform service standards, universal service obligations (statutory requirement of serving all residents), exclusivity provisions (formal protection of one provider’s monopoly) and reliance on subsidies to ensure affordability. The command and control approach implicitly assumes that the infrastructure business is inherently monopolistic and that the single operator can be induced or required to extend service to all who desire it, based on service standards that government should determine.

What happens in practice in many cities of developing countries is that financial and institutional obstacles have hindered or slowed service expansion, thus contributing to the persistence of slums. For example, the utilities are often prepared only to provide modern technologies and high service levels (e.g. piped sewerage with individual house connections), and with user payment procedures that are customary with middle-class households and firms. However, the irregular plot layouts of slum settlements and their lack of legal status or secure tenure for residents often deter utility investments. Even when they receive service from the utility, poor households may be unable to pay monthly bills because of their uneven income stream. At the same time, the official subsidy schemes are typically inadequate to cover the utility’s costs of extending services to a large share of the urban population living in such circumstances. As a result, many of the poor continue to depend on informal, alternative suppliers (or even “black” markets), and they often pay very significant charges for service through these channels.

Making the infrastructure utilities more responsive and effective in reaching poor and irregular urban settlements requires a change in unconventional practices. First, policy should promote and facilitate competition wherever possible, especially through new entry especially in the retail or distribution activities, and in the construction and operation of “secondary” (neighborhood-level) and “tertiary” (on-plot) infrastructure. For example, where physical networks do not exist and are not essential to obtain scale economies, entrepreneurs with tankers or above-ground piping can provide water efficiently and empty septic tank sanitation systems within neighborhoods. (Solo, 1999) “Bulk supply”, whereby an entrepreneur or community group purchases water or electricity from the formal network supplier for distribution within a neighborhood, can be another efficient option.

A second major element of reform is the need to remove the financial constraints on utilities and on users. The traditional “social tariffs” or “life-line tariffs” that are designed to favor low-consumption users often do not reach the poor, create financial disincentives for the utilities to connect those customers, and are not sustainable without monopoly protection to allow cross-subsidies among consumers. Alternative approaches include providing credit to households for initial connection costs, offering these households flexible bill payment options, and targeting any remaining subsidies directly to needy households.

Third, officially-imposed standards of “acceptable” service quality need to be reconsidered to better reflect affordability and demand by poor households. This implies that the regulation of utilities should focus more on outcomes, such as potable water availability, rather than on input requirements, such as the use of particular technologies or investment targets. The fourth important element of reform is to facilitate partnerships. The traditional utilities lack expertise in dealing with slum conditions and with poor households lacking legal tenure. Collaboration with NGOs, community groups and local governments can help the formal utilities and private developers work effectively in irregular settlements. Such partnerships can also ease the interactions between the utilities and nontraditional retailers (for example, to permit interconnection to the network facilities for distribution of bulk supplies). NGOs also can engage the communities in monitoring the performance of both conventional and nonconventional suppliers and participating in formal regulatory processes (for example to create local advisory boards reviewing minimum service quality standards.).