Privatizing Highways in Latin America: Fixing What Went Wrong
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Privatizing Highways in Latin America:
Fixing What Went Wrong

A revolution in the way highways are provided took place in Latin America in the 1990s, when more than fifty projects, mainly in Argentina, Brazil, Chile, Colombia, and Mexico, were privatized using build-operate-and-transfer (BOT) contracts. The so-called lost decade of the 1980s resulted in low investment in infrastructure and inadequate maintenance, and it created a major highway deficit across Latin America. This deficit, together with chronic budgetary problems, led governments to embrace a scheme in which the private sector financed urgently needed infrastructure investments, thereby freeing up public resources for projects in other priority areas.1

This paper draws some lessons based on the evidence accumulated to date. In particular, we show that policymakers face unpleasant choices when considering how to provide highways in the future. The evidence suggests that private financing of new highways freed up fewer resources than expected. In several cases, public funds were diverted to bail out franchise holders in financial trouble.2 Government guarantees for private highway franchises also added to the fiscal burden-and such guarantees [End Page 129] were paid out mainly during economic downturns, when government budgets were already in deficit.3

Before we proceed, it is useful to clarify what we mean by public and private provision of roads. Under public provision (which we call the traditional approach), the government designs, finances, and operates the road. Private firms may participate in the construction stage and may be selected in competitive auctions, but once the facility is built, the government operates and maintains it. Taxpayers finance the road, and any tolls levied are usually unrelated to construction costs. When roads are privatized, a concessionaire finances, builds, operates, and maintains the facility. The franchise owner collects tolls for a long time-usually between fifteen and thirty years-and when the franchise ends, the road reverts to the government. Such BOT contracts can be awarded either through direct negotiations between the transit authority and an interested firm or through a competitive auction for the franchise of a well-defined project.

Highway privatization promised not only to free up government resources, but also to deliver some of the standard advantages expected from privatization.4 First, a firm that is responsible for construction and maintenance has the right incentives to invest in road quality.5 Second, private firms are better managers than state-owned highway authorities. Third, BOT contracts may be desirable on distributional grounds, since roads are paid for by those who benefit. In particular, cost-based tolls are easier to justify politically when infrastructure providers are private.6 Finally, in contrast with public provision, under BOT, only privately profitable roads will be built, thus using the market mechanism instead of central [End Page 130] planning to screen projects. This reduces the likelihood of building a white elephant, which is a common problem in Latin America.7

Our review of the evidence suggests that the promised benefits of highway privatization failed to materialize. The main reason for the failure was the continuous renegotiation of franchise contracts. In most countries, concessionaires renegotiated their contracts without public scrutiny. This facilitated shifting losses to taxpayers. Such renegotiations negate the public benefits of private highways by giving an advantage to firms with political connections, limiting the risk of losses, and reducing the incentives to be effective and cautious in assessing project profitability.

Opportunistic renegotiations have been pervasive because of two design flaws that are present in all the franchising programs we examined. First, countries have followed a "privatize now, regulate later" approach. In Argentina and Colombia, the lack of a clear contractual structure led to cost overruns and renegotiation of the conditions of the original contract. Moreover, the government agency interested in the success of the franchise program was usually the same agency that supervised the franchise contracts. Since the success of these agencies is often measured by the percentage of the program they succeed in building, they tend to be lax in enforcing compliance with franchise contracts and are inclined to ease the conditions for franchise holders. This is clearly the case in Chile.