Local Public Enterprises -- OECD Report

Executive Summary Local public enterprises have an important role in public service provision. Local public enterprises (LPE) represent a popular mode of public service delivery in OECD countries. In Europe, where the use of LPEs is particularly pronounced, local governments use not only public enterprises integrated into the administration but also 16,000 legally independent organizations, which they own at least partially. The use of LPEs varies, however, greatly between countries and is largely determined by the allocation of public service delivery between public and private sector as well as the functional decentralization in federal systems. In Japan, for example, 9,000 LPEs are active in public service delivery whereas only 300 LPEs exist in South Korea. LPEs are active in a wide range of services, very often in basic infrastructure services where market failures or high transaction costs are present. Typical areas of operation for LPEs are classic public services like water and sewage, waste collection, electricity distribution but also urban planning and development. The former, especially, are signified by high transaction costs, natural monopolies, and general market failures. Despite this general tendency, there are large differences between countries. For example, while water provision is largely public in many countries, private companies can be used to replace LPEs. In France municipalities often contract the service out while in the UK a central authority regulates private regional providers. From an organizational governance perspective we can distinguish 1) directly managed LPEs, 2) corporatized LPEs, 3) intermunicipal cooperation, and 4) mixed public private LPEs. Although country-specific differences in the actual design of LPEs exist and make comparisons difficult, a comprehensive taxonomy of LPEs can be developed along three criteria. First, directly managed LPEs are characterized by the fact that the government retains decision rights. Alternative governance types require the creation of a legally separate organization, where the government has to surrender decision rights at least partially. Consequently, corporatized LPEs represent the second 3 type of LPE, which is owned exclusively by the local government but decision rights lie with the firm’s management. If the government further gives up exclusive control and ownership, partnerships with public or private partners become possible. The third and fourth types of LPEs are therefore intermunicipal cooperations and mixed public private partnerships, where the latter involves a private share in ownership. The main trends among LPEs relate to efforts of public sector reform and the adoption of alternatives to direct provision—corporatization, private sector involvement, and cooperation among local government. In the search for efficiency, a number of governance alternatives to directly managed LPEs have become popular with local governments. Instead of real privatization, most municipalities have separated enterprise operations from the administrative body, either remaining sole owner of the enterprise or bringing in a partner. In the former case, i.e. corporatization, governments simply spin off tasks or whole departments into a publicly owned company. This trend of agentification is possibly the single most important trend for LPEs and has affected virtually all OECD countries. For this purpose a number of countries, for example Italy, France, and Japan adapted their legal framework to allow for corporatized firms. Associated with this, given the increased interest in private sector participation in LPEs, is the fact that the regulations regarding mixed ownership have been subject to change. Not surprisingly, public private partnerships in their institutionalized form have consequently been another popular alternative provision mode. While some countries already have long experience of such arrangements, recent trends have also led to the adoption of mixed public private LPEs in countries where in the past public provision was the norm. Finally, instead of simply private partnerships, partnerships between local governments have also gained in importance in recent years. Local governments choose different types of LPEs for pragmatic reasons. Political and institutional factors, however, also play a role. Reviewing the empirical studies comparing the efficiency of different types of LPEs, no clear picture arises and the evidence points toward no clear efficiency advantage of one over the other. This is consistent with the idea of transaction cost economics suggesting that governance types are chosen deliberately in order to reduce transaction costs. Organizational decisions by local governments are largely based on transaction costs related to task-specific contracting difficulties. More complicated 4 tasks are typically not contracted out but, rather, provided through a LPE. The more discretion and control the government deems necessary, the more likely it is that more integrated LPEs are chosen. Partnerships with public or private partners are envisaged if limitations of purely local provision exist or in the search for external capacities, for example for finance and skills. On the other hand, political factors also play a role and may potentially prevent the adoption of cost economizing governance types. Although alternatives to directly managed LPEs solve some institutional challenges for local governments, new challenges are created by their adoption. Directly managed LPEs are faced with a number of challenges, such as territorial restrictions or resource restrictions in terms of finance and skill. The trends of corporatization, private sector involvement, and intermunicipal cooperation, are specific responses to these challenges. These types of public sector reform lead, however, to new institutional challenges for the local government. In partnerships, especially with private partners, different objectives may hamper operations. Removing an LPE from the direct political discretion of the local government also raises questions of accountability. Finally, steering these types of LPEs also requires the municipality to acquire contracting abilities to manage the relations with the legally independent LPE, giving rise to potential accountability problems. Despite the fact that different types of LPEs represent a trade-off between different institutional risks, the prevalence of these risks is strongly related to the capacities of the local government. As a result of the different possible allocation of decision rights, property rights, and fragmentation of control, LPE types vary in how prone they are to various different types of risks and institutional challenges. When decision rights are with the government, the risks of political capture and risks of a soft budget constraint are elevated. Conversely, when decision rights are transferred from the government to an independent LPE management (for example under corporatized firms or mixed public private arrangements), risks to financial integrity increase along with potential risks for accountability. Similar trade-offs arise when control over an LPE is fragmented because risks for coordination increase with multiple principals who have potentially heterogeneous objectives, while political capture is less of a problem in this case. Involving private partners (mixed public private property rights) acts as an amplifier to the existing trade-off because it further increases risks to 5 financial integrity and accountability, while at the same time representing a more credible gatekeeper against the risk of soft budget constraints. Despite this characterization of LPEs as a collection of pros and cons, it does not automatically follow that the choice of LPE alone determines the eventual risk for public service provision. How strongly the various risks actually affect public service provision also depends crucially on the institutional capacities of the local government. The risk potential is not exogenously given but varies according to the risk management capacities of the respective municipality. Various types of capacities as checks and balances but also more governance capacities can help to reduce and even neutralize the harmful effects of such risks. Capacity building in terms of LPE governance should, consequently, be emphasized both by local governments themselves but also with support from the regional and national level.