July 14, 2011

The maximising city

Our cities do not need more government spending—they need more autonomy, privatisation and deregulation.

Indian cities face seemingly insurmountable problems of congestion, water availability, garbage and sewage disposal. A recent New York Times article “In India, dynamism wrestles with dysfunction” on Gurgaon triggered off a healthy debate on this issue. On the Marginal Revolution blog, Alex Tabarrok, a professor of economics at George Mason University, describes Gurgaon as a collection of “private oases” where the private sector has provided, inter alia, “transportation, utilities, security” but between such oases lie the “government desert”. He acknowledges that economies of scale would mean that some services could be better provided by the government, but it would have been better had even those responsibilities been privatised early on as far as possible, rather than assigned to the Haryana Urban Development Authority, the relevant government body that turned out to be incompetent.

Gulzar Natrajan on the other hand sees this as a cautionary tale, and argues that Indian cities need massive—and direct—government investments (see previous article). Residents should get ready to pay up higher user fees and taxes, while the poor will have to be subsidised by the government. While charging higher user fees is indeed required, higher taxes unless accompanied by structural reforms like smaller municipalities, fiscal autonomy and direct mayoral elections will be detrimental to cities in a country which already has an anti-urban policy bias. He is sceptical of Private Public Partnerships (PPPs)—and given our recent experience with crony capitalism, rightly so.

But the solution is not rejecting the approach completely. Instead a more open, competitive approach to PPPs is needed with no retroactive contractual changes. Private players need to move from a “cost-plus” mindset to a more entrepreneurial one—we should insist on greater contractual clarity early on. If a private player then has cost overruns in building, say, an airport, then the government should not, and should not be expected to, bail the former out.

A further move towards longer-term contracts is also needed—perhaps, potholes would not develop in our roads every monsoon when the same contractor is liable for maintaining a baseline quality (as opposed to a periodic tender system, where sub-standard roads are actually incentivised as they increase the number of contracts next year). It is true that infrastructure in many leading global cities was indeed built directly by governments over the last two centuries. Today private companies like Hindustan Construction Company (HCC) have built from scratch mid-sized cities like Lavasa—drains, roads and all. Even massive projects like the Bandra-Worli Sea Link (also built by HCC) need not require tons of taxpayer cash up front, because the receivables (tolls) can be completely securitised. Indebted American cities have used this technique, with partial success.

Of course a Tabarrok-ian wholesale privatisation is not feasible anytime soon for existing cities. But calling for general-tax-revenue-financed direct government spending and building is the wrong way to go. If this means strengthening the “vicious” loop of mistrust about government leading to an underfunded, dysfunctional and hence mistrusted government, perhaps we need not see this as cynicism but realism, and propose alternative solutions wherever possible.

Let us therefore examine specific problems. Regarding traffic jams, we need congestion tolls and tariffs, not necessarily more public transport [See How to un-jam our cities, Pragati, July 2010]. We need to cut various automobile taxes to bring autos more in line with other goods, and make the transition revenue-neutral. We need to deregulate our bus, taxi and three-wheeler services rather than make them more expensive by restricting their numbers through licencing. Some of the cost savings there can then be channeled towards tighter emission norms—surface public transport is more polluting than urban private transport in India. Moreover, inane requirements like three-wheelers not being allowed to cross state boundaries need to go. Metro rail cannot be a solution in all towns and cities. In Gurgaon, it made sense to extend Delhi’s network. In many other mid-sized cities, such rail lines will not be viable. Also, congestion can be further reduced by competitively selling parking spots to collection agents—this will increase the fees, but surely not many poor are parking their sedans there?

Garbage collection—most Indian municipal governments waste a lot of money on unionised garbage collectors, and other such sinecures (for some, garbage collection, park cleaning or night policing are indeed plum government jobs as they do not have to turn up for work, and knowing that, many local Resident Welfare Associations have hired private alternatives anyway). Instead, dumping of garbage should be heavily fined, and more PPPs (if not outright privatisation) should be encouraged for collection. Rahm Emanuel,the new mayor of Chicago, broke with his union allies in following the footsteps of other cities and introducing “managed competition” in the city’s services. This is likely to save $65 million in garbage collection alone. Even though government departments are still likely to win the majority of the bids initially, the competition will force them to be more efficient.

In the case of drinking water supply, sewage collection, and electricity distribution there are some obvious positive network externalities (and potential risks of local private monopolies), therefore government does have a role to play here. But does that mean that investments of “billions of dollars” are required? Privatisation of distribution has already substantially reduced electricity theft in cities like Delhi, and citizen-customers have multiple distributors to choose from. Other Indian cities need to follow this model. Moreover, private electricity networks, connected to generators through a national “smart” grid, can be further extended if they are suitably incentivised by allowing further pricing flexibility. Similarly, when it comes to supply of potable water supply, we should follow a diversified policy toolkit of using higher charges after a certain usage, encouraging rainwater collection and, again, encouraging PPPs on the distribution side to minimise “losses”.

While “private islands” sourcing their own supplies may indeed be sub-optimal, such a market failure pales against the government failure where the poor de facto have to rely on much more expensive drinking water than the middle-class. When it comes to sewage collection, governments should concentrate on pubic health benefits like anti-malarial campaigns by spending money on suitably spraying chlorine oxides and have a limited mandate of inter-linking existing private sewers, rather than “crowding out” work done and attempting to build a house-to-house network on their own.

But assume for a moment that tariffs for government services cannot be raised for political reasons, and that the “be slow and appear honest rather than accept PPP imperfections” mood gets entrenched from our defense ministry to our municipalities, then indeed the cities have to rely on greater grants from New Delhi. While reformist schemes like the Jawaharlal Nehru National Urban Renewal Mission (JNNURM)  and recent proposals to have a certain percentage of central revenue be earmarked for cities by law may be important initial steps, they foster greater centralisation and lower flexibility of policy responses to unique problems in different cities.

If instead of grants, more fiscal autonomy was granted to cities they would compete to preserve (and expand) their tax bases by ameliorating counter-productive regulations like low floor area ratios (FAR) and floor space indices (FSI)  that keep our cities dispersed and create the need for more transportation, a policy is especially harmful in a emerging economy like India’s. Autonomous municipalities with powerful executives would be forced to reduce real-estate transaction taxes (something which would actually increase tax revenues, given our current rates) and do away with inefficient departments if they knew they would not be bailed out “from above”. Moreover, so long as they are not allowed to levy distortionary taxes like octroi, local governments would get to keep any surplus and invest in parks and city development projects.

Central spending cannot seed the cities of the future. Direct spending cannot nurture existing cities. Despite all the problems of Gurgaon, millions have voted for the city with their feet because the private sector has stepped in where the government has failed. The solution is not to grow rent-seeking public works departments in such cities and assume that by forcing elites to buy a “stake” in public services, the situation will somehow work tomorrow. Even many first-world cities are bankrupt today because of the political economy of government unions; Indian cities needs to be ahead of the curve and embrace pragmatic privatisation.

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