Franchising and privatization
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Source: rru.worldbank.org
Competition through bidding ensures minimum selling prices because the winning
franchisee will lower prices until revenues just cover costs.
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PriPvUBLaIC tPOeLICY FOR THE sector The World Bank March 1995 Note No. 40 Franchising and Privatization Antony W. Dnes Increasing private sector participation to improve the efficiency of infrastructure services is a growing trend around the world. This trend reflects dissatisfaction with state solutions, ever- tightening government budgets, technical change, and policy innovation. One approach to in- creasing private participation that is attracting much interest is franchise bidding schemes. Improved understanding of franchise contracting techniques could foster the successful revival and development of Sir Edwin Chadwick’s idea of competition for the field. Competition for the field the most attractive terms—for example, the lowest price to consumers. Competition Some elements of most infrastructure activities through bidding ensures minimum selling exhibit “natural monopoly” characteristics, prices because the winning franchisee will meaning that one or more services or products lower prices until revenues just cover costs. can be produced most cheaply by a single firm. Franchising schemes also may avoid pitfalls Examples include electricity transmission and associated with traditional regulation of such distribution and gas and water pipelines. This industries or with their nationalization. raises the issue of organizing an infrastructure industry so as to gain the advantages of pro- Letting monopoly franchises has a long his- duction by a single firm, without encouraging tory: France and Spain, for example, have been monopolistic conduct. Happily, not all elements letting water concessions for over one hundred of infrastructure exhibit natural monopoly char- years. With the recently increasing interest in acteristics. Market competition is both possible private participation in infrastructure, franchis- and highly desirable in many activities, such ing has taken root in power, solid waste, tele- as electricity generation and long-distance and communications, and water enterprises in cellular telephony. developing countries as diverse as China, Guinea, Hungary, and Mexico. In a recent case Sir Edwin Chadwick, a Victorian social re- closely resembling the Chadwick/Demsetz pro- former, proposed a franchise solution to prob- posal, Buenos Aires awarded a water conces- lems of natural monopoly, an approach later sion to the company offering the lowest promoted by Harold Demsetz in the United evaluated price, which was notably 20 percent States.1 Chadwick distinguished between com- or more below the price previously charged petition “within the field” and “competition by the state-owned water company. for the field.” Where competition is not pos- sible within an industry, Chadwick surmised, Natural monopoly competition for the right to be the natural monopolist may be an adequate substitute. To examine natural monopoly at its most un- The essential idea is that monopoly franchises adorned, consider an industry in which de- could be auctioned off to the bidder offering creasing cost gives rise to natural monopoly. Private Sector Development Department ▪ Vice Presidency for Finance and Private Sector Development
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