Transaction Cost Regulation after Expropriation: Argentina's Public Utility Sector

Abstract

With the passing of the Economic Emergency Act in January 2002 which froze all public utility rates and simultaneously devalued the local currency, Argentina entered a period of systematic breaches of the guarantees granted by the government to public utility investors in the early nineties. Such guarantees provided safeguards that managed to substantially reduce expropriation risk in the sector by lowering investors’ cost of capital, thus encouraging foreign capital inflows. The implementation of the Emergency Act in the country also marked the beginning of a period in which rule-based regulation of public utilities was replaced by a mechanism based on government discretion. This paper looks into the governance structure used by the government for the sector in the early nineties when the privatization process was designed and launched, and suggests what that governance structure should be today, more than a decade after the beginning of the contract breaches. Defining governance as the institutional and contractual framework within which public services are provided, the paper concludes that after a decade of systematic contract breaches and expropriations, neither the bilateral governance (i.e., government as regulator with a vertically integrated private company providing the service) adopted by the country in the early nineties nor the one that would be recommended by Williamson's taxonomy (i.e., state-owned vertically integrated companies) would be appropriate, at least in the short- and medium-term. Given that the guarantees provided to investors at the beginning of the nineties failed to prevent the contract violations, a structure that seeks to minimize the risk of a future expropriation should be based on a more market-oriented type of governance, without additional guarantees to investors. The proposed governance structure involves vertically separated companies with the current public utilities acting as OpCos, with network maintenance and commercial obligations only and without the responsibility of network expansions, a task that would be conducted by NetCos under the structure of public-private partnerships (PPP) or Special Purpose Vehicles (SPV) created for this exclusive purpose.