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The Effects of Privatization in Electricity Sector: The Case of Southeast European

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 The Effects of Privatization in Electricity Sector:
The Case of Southeast European Countries1

Nela Vlahinić-Dizdarević*

1. Introduction

During the 1990s all transition countries started with economic reforms in
infrastructure services, changed the centralized organization of monopolistic
infrastructure utilities and introduced market-oriented structures and public
regulation. The reform programmes for the electricity sector in transition
countries were similar and focused toward three main elements: restructuring in
order to enable competition, introduction of the new regulatory framework with
the establishment of an independent regulator and privatization process. The
choice of the privatization model, timing and sequencing of privatization
process became crucial economic issues because these irreversible policy
decisions strongly determined the economic growth.
While theoretical and empirical studies suggest that there is a positive
relationship between privatization and improved performance in industries
operating in competitive markets, the evidence is less clear for industries
operating in non-competitive markets or as natural monopolies. Still, the
international financial institutions, mostly the World Bank and International
Monetary Fund, have made the pressure on transition and developing economies
during the 90s to conduct privatisation in electricity sector with the main aim to
improve efficiency. It has become more evident over the years that changes in
ownership may not be sufficient to improve sector performance, particularly in
electricity sector. Moreover, privatizing loss-making state-owned enterprise may
improve microeconomic efficiency but may result in output losses and increased
unemployment.
The paper focuses the hypothesis that the privatization in electricity sector
does not necessarily generate economic gains, while its success depends on the
regulatory framework, which in turn is affected by political and social norms
and standards. Therefore the aim of the paper is to analyse the economic effects
of privatization within the context of wider economic reforms in electricity
* Prof., PhD; Faculty of Economics, University of Rijeka, Croatia
1
The presented results are part of the research project (Economic impacts of regulatory reforms in electricity
sector, No. 081-0361557-1455) supported by the Ministry of Science, Education and Sports of the Republic of
Croatia.

1
sector, particularly in transition economies of Southeast Europe and to relate
these effects with their regulatory quality.

2. Theoretical and empirical background

The issue of privatization has been an important economic policy topic,

though politically controversial in some cases, like privatization of natural
monopolies. The modern idea of privatization was born in Germany in 1957
when the government sold its majority stake of Volkswagen to private investors,
but the privatization has been usually related to transition processes in countries
of Central and East, as well as Southeast Europe and former Soviet Union. At
the beginning of 1990s, privatization was recognised as an effective way to
create incentives to improve economic efficiency, increase investment and
implement new technologies.
The theoretical background of privatization is largely connected with the
concept of property rights. A strong theoretical impetus came from North2, who
asserts that “the inability of societies to develop effective, low-cost enforcement
of contracts is the most important source of both historical stagnation and
contemporary underdevelopment in the Third World”3. The reason for this is
that the kind of market essential for economic development requires
“nonsimultaneous transactions, in which the quid is needed at one time, or place
and the quo at another”4. De Soto5 concluded that the lack of formal property
rights is “the missing ingredient” keeping underdeveloped countries from
sustaining long-term growth. Furthermore, the lack of property rights limits the
amount of goods and services that can be exchanged in the market. According to
Clague et.al.6, the gains from trade cannot be realized unless the parties expect
their contracts to be carried out. Of equal importance is a guarantee that the
fruits of such transactions are not at some later time point expropriated by the
state7. The privatization process can be an effective way to induce structural
changes by formalizing and establishing property rights which create individual
incentives. Along with creating strong incentives that boost productivity,
privatization is usually seen as a way to improve economic efficiency.

2
North, Institutions, Institutional Change and Economic Performance, Cambridge: Cambridge
University Press, 1990
3
North, supra note 2, p. 54
4
Clague et.al., Contract-Intensive Money: Contract Enforcement, Property Rights, and Economic
Performance, in: Journal of Economic Growth 4 (2), 1999, p. 186
5
De Soto, The Missing Ingredient: What Poor Countries Will Need to Make Their Markets Work, in:
Anderson and Hill (Eds), The Privatization Process, Rowman&Littlefield Publishers, Inc., 1996
6
Clague et.al., supra note 4
7
Rothstein/Teorell, What is Quality of Government? A Theory of Impartial Political Institutions,
Working Paper Series 6, The Quality of Government Institute, Göteborg University, 2005, p. 24

2
 Efficiency gains from privatization have been widely recognised in the
literature. However, the concept of efficiency can be very broad and empirical
covering is not precise. A firm could be “inefficient” because it fails to choose
the appropriate capital/labour ratio given technological opportunities and given
relative factor prices. It could also be “inefficient” because it uses more inputs
than it is necessary to produce a given level of output, or equivalently, because it
produces less output than it could for a given level of input use. A firm could
also be “inefficient” because it overpays for the inputs it uses8. Many studies
equated efficiency with productivity and profitability and failed to measure
efficiency separately. These categories are not synonymous because rise in
productivity can be the result of different reasons other than efficiency
(technical progress, scale economies), while profitability can, in case of
monopolistic market power, rise without any efficiency improvements.
Sheshinski and Lopez-Calva9 proved that increase in profitability is usually an
equivalent to increase in efficiency, but only in competitive markets.
There have been many empirical studies on the relationship between
privatization and performance of firm or industry. Most of these studies that
have been done for competitive markets argue that micro-economic evidence
supports the assumption that privatised firms improve profitability after their
sale. Some comprehensive reviews of empirical studies on privatization and
performance have been also done with similar results. Kikeri and Nellis10
reviewed 60 studies of privatization in competitive sectors and concluded that
there is a strong relationship between privatization and financial and operating
performance improvements. Similar results have been achieved by Megginson
and Netter11. They have found that the change of ownership in many different
countries matters because almost all privatizations improved performance
measured in many different ways.
Contrary to the previous studies, the results of the studies that have focused
on monopolistic markets are ambiguous. Shirley and Walsh12 showed that 6
studies found better performance associated with private ownership, 5 studies
are neutral and 5 studies report superior performance for publicly owned
enterprises. They concluded that private ownership and competition are

8
Bradburd, Privatization of natural monopoly public enterprises: The regulation issue, in: Review of
Industrial Organization, Vol. 10, No. 3, 1995
9
Sheshinski/Lopez-Calva, Privatisation and its benefits: theory and evidence, HIID Discussion Paper
No. 698, Harvard University, Boston, MA, 1999
10
Kikeri/Nellis, Privatisation in competitive sectors: the record to date, World Bank Policy Research
Report, No. 2860, 2002
11
Megginson/Netter, From state to market: a survey of empirical studies on privatization, in: Journal
of Economic Literature, Vol. 39, No. June, 2001
12
Shirley/Walsh, Public versus private ownership: the current state of the debate, World Bank,
Washington, DC, Working Paper No. 2420, 2000

3
complements. Saal and Parker13 in their study of UK water and sewerage
companies found that efficiency (measured as total factor productivity) declined
after the privatization and concluded that performance improvements resulted
from increased regulation rather than privatization itself. In a review of many of
these studies, Parker14 connected such mixed performance results with two
factors: the degree of competition or market structure of the industries
concerned, and the regulatory incentives in place for management to pursue
efficiency gains. A recent study15 offers the econometric assessment of the
effects of privatization, competition and regulation on the performance of the
electricity generation industry using panel data for 36 developing and transition
countries over the period 1985-2003. They have also confirmed the
overwhelming importance of increasing competition to promote improved
performance in monopolistic markets. Even more, the competition is dominating
as the explanation of performance in electricity generation. Wallsten16 found that
competition is beneficial for economic performance, but the privatization is
beneficial only when coupled with the existence of and independent regulator.
Cross-country studies show that profitability increases more and productivity
less in markets that are less regulated and less competitive. The introduction of
competition enhances productivity gains17. According to theoretical and above
mentioned empirical results, it seems that the relationship between privatisation
and improved performance is clear for industries operating in competitive
markets, but the evidence is ambiguous for natural monopolies that are operating
in non-competitive markets.
Previous analysis has focused the privatization effects on efficiency of firms
and industries and it has not included the macroeconomic impacts that should be
the most important for policy makers. Theoretical studies argue that
privatization reduces the size of government (and, consequently, bureaucracy)
which is not strongly motivated to maximize allocative efficiency. By
privatizing, the role of the government in the economy is reduced, thus there is
less chance for the government to negatively impact the economy18.
Privatization can improve country’s fiscal position and therefore make

13
Saal/Parker, Productivity and price performance in the privatised water and sewage companies of
England and Wales, in: Journal of Regulatory Economics, Vol. 20, No. 1, 2001
14
Parker, Performance, risk and strategy in privatised, regulated industries, in: International Journal of
Public Sector Management, Vol. 16, No. 1, 2003
15
Zhang/Parker/Kirkpatrick, Electricity sector reform in developing countries: an econometric
assessment of the effects of privatization, competition and regulation, in: Journal of regulatory
Economics, 33, 2008
16
Wallsten, An Econometric Analysis of Telecom Competition, Privatization and Regulation
in African and Latin America, in: The Journal of Industrial Economics, 49, 2001
17
Domney/Wilson/Chen, Natural monopoly privatisation under different regulatory regimes,
in: International Journal of Public Sector Management, Vol. 18, No. 3, 2005, p. 276
18
Poole, Privatization for Economic Development, in: Anderson/Hill (Eds.) The Privatization
Process, Rowman & Littlefield Publishers, Inc., 1996.

4
environment to reduce interest rates and raise the level of investment. According
to World Bank19, privatization also induces foreign direct investment that can
boost economic growth because of the “positive spillovers of improved
technology, better management skills and access to international production
networks”. Empirical studies showed that methods of privatization matter much
more than privatization per se. Gouret20 concluded that transition countries that
have conducted gradual privatization reached higher level of output in
comparison with those countries with massive and speedy privatization process.
Contrary to the theory and previous studies, Cook and Uchida21 argued that there
is a robust negative correlation between privatization and economic growth,
although some authors explained it by the lack in model specifications and the
lack of appropriate government reforms22.
The level of development is also an element that should be taken into
consideration when assessing the macroeconomic effects of privatization.
According to the “big push” model by Murphy, Shleifer and Vishny23, it is
predicted that the effect of transferring public infrastructure stocks to private
investors, who aim to maximize their own profits, may be non-linearly
correlated with the level of economic development. This implies that developing
countries might not be able to expect the same effects of private sector
involvement on performance improvements as developed countries, regardless
of the above-mentioned worldwide privatization trend. They may result in a
form of under-investment equilibrium. This is not only because of a deficiency
in appropriate governance and legal structures but also because of lower
aggregate income per se24.
It is worthwhile mentioning the idea stressed in some studies that “big”
government can be seen as a problem. For example Tanzi25 argued that in order
to reduce corruption, it is necessary to reduce the size of government and its
control over the economy and privatize. The “small is better” argument was also
stressed as a part of the “shock-therapy” argument for massive and quick

19
World Bank, The First Ten Years: Analysis and Lessons for Eastern Europe and the Former
Soviet Union, Washington, D.C., 2002
20
Gouret, Privatization and output behavior during the transition: Methods matter, in: Journal
of Comparative Economics, Mar2007, Vol. 35 Issue 1, 2007
21
Cook/Uchida, Privatization and Economic Growth in Developing Countries, in: The Journal of
Development Studies, Vol.39, No.6, August 2003
22
Filipovic, Impact of Privatization on Economic Growth, in: Issues in Political Economy,
Vol 14, August 2005
23
Murphy/Shleifer/Vishny, Industrialization and the Big Push, in: Journal of Political Economy, 97,
1989
24
Iimi, Rethinking Privatization and Economic Development: A Sampling of Evidence, JBICI
Working Paper No. 9, Japan Bank for International Cooperation, 2003
25
Tanzi, Policies, Institutions and the Dark Side of Economics, Northampton, Edward Elgar, 2000

5
privatizations in transition economies. A group of economists26 in an early paper
in this field used data from between 49 and 212 countries and concluded that the
size of government or how extensive its policies are has little or nothing to do
with the quality of government. They found that the better performing
governments are larger and collect higher taxes, while poorly performing
governments, in contrast, are smaller and collect fewer taxes.
In recent years the issue of privatisation of natural monopolies has become
controversial because of these mixed or even deteriorating macroeconomic
results of privatisation. In many countries it turned out that possible improved
microeconomic efficiency brings benefits (profit) only for their owners. The
question whether the prices to consumers gone down to reflect these cost
savings has been explored in several studies. There have been concerns about
such issues in newly liberalized electricity markets all around the world.
Newbery and Pollit27 concluded that such concerns were well founded: they
found that nearly all the benefits had gone to producers, and virtually none to
customers. Fiorio et.al.28, Florio and Doronzo (2007) explored the effects of
privatization in electricity sector on electricity prices and customers’ satisfaction
in EU members. Their main findings are the following: first, panel estimation of
prices tend to reject the prediction that privatization per se leads to lower
electricity prices, after controlling for other reforms, and other industry and
country-specific variables; second, customer satisfaction about prices and
quality of services is higher with public ownership than under private
ownership. The case of Nordic countries shows that highly competitive national
markets and a regionally integrated transboundary market are well supported by
an industry structure where public ownership plays a significant role. According
to Fiorio et.al., the fact that electricity generators are often owned by
municipalities can be seen as an intrinsic constraint to anti-competitive mergers
and acquisitions, that are often motivated not by economies of scale in
production, but by the desire to influence prices. The same reasoning may apply
to a public sector owned firm exposed to competition.
As it has been the case in some countries, increased economic efficiency of
electricity companies can go together with low growth or recession. Therefore
public sensitivity about privatization of “family silver” and strategically
important sectors like energy sector has induced different opinions on this issue,
especially in times of energy crisis and costly energy resources. Privatization

26
La Porta et.al., The Quality of Government, in: Journal of Law, Economics and
Organization, Vol. 15, No.1, 1999
27
Newbery/Pollitt, The Restructuring and Privatisation of the CEGB: Was It Worth It?,
Cambridge Working Papers in Economics, Faculty of Economics, University of Cambridge,
1996
28
Fiorio et.al., The Electricity Industry Reform Paradigm in the European Union: Testing the Impact
on Consumers, Working paper No. 23, Universita degli Studi di Milano, 2007

6
accompanied with liberalization and deregulation was policies preferred by the
World Bank and International Monetary Fund in transition and developing
countries and such neoliberal doctrine has been known as “Washington
Consensus”. The problem was that the view of Washington Consensus focused
too much on structural measures aimed at improving efficiency at a
microeconomic level and on the belief that liberalized markets and privatised
companies automatically create competitiveness and growth. As it has already
been discussed, it has become clearer over the years that changes in ownership
may not be sufficient to improve sector performance. Moreover, privatizing
loss-making state-owned enterprise may improve microeconomic efficiency but
may result in output losses and increased unemployment with high economic
and social costs.
During the 1990s the role of institutions has been introduced in economics
and many economists argued that Washington Consensus doctrine did not
involve enough social and institutional dimensions of development.
»Augmented Washington Consensus« was proposed, which added ten further
»commandments« underscoring the role of institutions and good governance.
The Augmented Washington Consensus added some important elements,
especially the social dimension of development and the important role of
institutions, but privatization and abolishment of national monopolies have still
been the central parts of the adjustment programmes supported by international
financial institutions. According to Rodrik29, the Augmented Washington
Consensus is very broad, undifferentiated agenda of institutional reform that is
too insensitive to local context and needs and it describes what “advanced”
economies look like, rather than proscribing a practical, feasible path of getting
there. However, during the last decade these issues induced a considerable
growth in research on “good governance”, the quality of government institutions
and their impact on reforms and economic growth. This growing body of
research started by empirical findings among economists that institutions can be
considered as the key to understanding economic growth in developing
countries30. Consequently, the neoclassical economic thought has been expanded
and incorporated such new ideas. New institutional economics has been
29
Rodrik, After a Neoliberalism, What?, Paper presented at the Alternatives to Neoliberalism
Conference sponsored by the New Rules for Global Finance Coalition, May 23-24, 2002
30
See Acemoglu/Johnson/Robinson, The Colonial Origins of Comparative Development: An
Empirical Investigation, in: The American Economic Review, Vol. 91, No. 5, 2001;
Acemoglu/Johnson/Robinson, Reversal of Fortune: Geography and Institutions in the Making of the
Modern Income Distribution, in: The Quarterly Journal of Econometrics, Vol. 118, 2002; Easterly,
The Elusive Quest for Growth: Economists' Adventures and Misadventures in the Tropics, Cambridge,
Mass.: The MIT Press, 2001; Easterly/Levine, Tropics, germs, and crops: how endowments influence
economic development, in: Journal of Monetary Economic, Vol. 50, 2003;
Rodrik/Subramanian/Trebbi, Institutions Rule: The Primacy of Institutions Over Geography and
Integration in Economic Development, in: Journal of Economic Growth, Vol. 9, 2004

7
developed and provided with new evidence of the role of institutions in market
economies. The importance of institutional framework is crucial for sustainable
growth in output and efficiency in utility service industries like electricity.

3. Economic reforms in transition countries' electricity sector

3.1. Key reforms steps and sequence of reforms

There are considerable differences in individual reform speed and

sequencing that depend on different country and sector characteristics, as well as
achieved level of development. However, the so-called “standard prescription”31
(Hunt, 2002, 15) in developed countries has been transmitted to transition and
other non-OECD economies. This model generally involves the following steps:

• Corporatisation of state-owned companies

Corporatisation is the first step and it means the separation of the utility from the
Ministry that involves at least the creation of clear accounting framework and
separation of accounts for different parts of the business. Separation of accounts
has been achieved in all Southeast European countries, although most
governments have retained the final authority to set prices.
• Enactment of an electricity reform law (Energy law)
Electricity or energy law is generally recognised as a formal precondition for
regulatory reforms and establishment of a formally independent regulatory
agency. It represents a legal basis for all further steps and signals a country’s
commitment to implement reforms. It also reduces the uncertainty and risks that
are related to issues such are property rights and conflict resolution procedures.
This step has been done in all SEECs.
• Implementation of regulatory reforms
Regulatory reforms are often considered as the most important element of the
economic reforms in electricity sector. In developed countries it is widely agreed
that the effective regulatory practice requires the independent regulator whose
regulatory function is clear and removed from the Ministry. This regulator
should set entry and exit terms, as well as tariffs for those parts of the industry
that remain a monopoly. However, SEE countries are faced with the lack of
regulatory resources and regulatory experience. In most countries there is a
shortage of qualified human resources to staff the new regulatory agencies and
in many cases, the economic and political institutions necessary for well
functioning of regulators are weak. Governments still play the important role
and have the most important influence on final price setting.

31
Hunt, Making competition work in electricity, New York, Wiley, 2002

8
 • Restructuring
Restructuring involves the unbundling of network operation from the
competitive activities. Unbundling should start with the separation of
distribution business from the generation and transmission activities because
much of the inefficiencies in the electricity sector arise from distribution and it
often suffers from high technical and commercial losses. Distribution should be
subjected to regulation and experience shows that incentive regulation can result
in significant efficiency improvements. After the distribution, the transmission
activities should be separated from generation and the separate entity should be
established. A clear division of transmission and generation is a precondition for
effective competition in the generation segment. Similar to distribution,
transmission should be also subject to incentive regulation.
• Establishment of a competitive wholesale generation market
The breaking of the monopoly in generation involves some form of competition
so the generators have to compete with each other to sell their electricity. This
experience seemed to show that independent generators could often provide
power more cheaply than traditional utilities and seemed to show benefits in
breaking the absolute generation monopoly of traditional generation utilities32.
The critical issue in establishing a competitive wholesale electricity market is to
create sufficient number of firms. Although this step seems efficient in
developed countries, it has become dubious in case of small transition
economies such are SEE countries. Their electricity systems are in fact too small
to be divided up into several competing firms and the limited size of market
participants can even further reduce the already small number of potential
investors.
• Privatisation
Privatisation of state owned utility is final, although the least common step of
electricity reforms and it is not necessarily connected to liberalization process.
Norway is a successful example that a state and locally owned electricity sector
can be efficient and implement necessary reforms. Where privatization is
feasible, it should start with distribution, while privatization of generation can
take place after the regulation and ownership of distribution companies are
settled. Privatization of transmission is less common due to its strategic
importance for the national economy.

3.2. Progress in electricity reforms

In order to evaluate the progress in electricity reforms achieved by

transition countries, the reform indexes made by European Bank for

32
Thomas/Hall, GATS and the Electricity and Water Sectors, PSIRU, Business School. London:
University of Greenwich, 2006, p. 18

9
Reconstruction and Development (EBRD) have been used. These indicators
cover issues as commercialization, tariff reform, the quality of the regulatory
framework and involvement of the private sector. They range from 1 to 4+, with
1 representing little or no change from a rigid centrally planned economy and 4+
representing the standards of an industrialized market economy.33
Table 1 shows the reform indicators in electricity sector for Southeast
European countries (SEECs) in comparison with Central and East European
countries (CEECs) and Baltic states that have become EU members. SEE
countries are in different stages of accession process, but they are all reforming
their economies in accordance with EU Acquis. Although Bulgaria and Romania
are EU member states, they are usually considered as SEE countries. The
analysis focuses period after 2000 because this year was the turning point of
progress in SEE countries after a decade of war, political instability and
economic recession.

Table 1 Progress in reforms in electricity sector, 2000-2008

Country 2000 2001 2002 2003 2004 2005 2006 2007 2008
SEECs
Albania 2,33 2,33 2,33 2,33 2,67 2,67 2,67 2,67 2,67
B&H 2,33 2,33 3,00 3,00 3,00 3,00 3,00 3,00 3,00
Bulgaria 3,33 3,33 3,33 3,33 3,67 3,67 3,67 3,67 3,67
Croatia 2,33 3,00 3,00 3,00 3,00 3,00 3,00 3,00 3,00
Macedonia 2,33 2,33 2,33 2,33 2,33 2,67 3,00 3,00 3,00
Montenegro 1,00 1,00 1,00 1,67 2,00 2,33 2,33 2,33 2,33
Romania 3,00 3,00 3,00 3,00 3,33 3,33 3,33 3,67 3,67
Serbia 2,00 2,00 2,00 2,33 2,33 2,33 2,33 2,33 2,33
CEECs and Baltic states
Estonia 3,67 3,67 3,00 3,00 3,00 3,00 3,33 3,33 3,33
Hungary 4,00 4,00 4,00 4,00 4,00 4,00 4,00 4,00 4,00
Latvia 3,00 3,00 3,00 3,00 3,33 3,33 3,33 3,33 3,33
Lithuania 3,00 3,00 3,00 3,00 3,33 3,33 3,33 3,33 3,33

33
1 - Power sector operates as government department with few commercial freedoms or
pressures. Average prices well below costs, with extensive cross-subsidies. Monolithic
structure, with no separation of different parts of the business. 2 - Power company distanced
from government, but there is still political interference. Some attempt to harden budget
constraints, but effective tariffs are low. Weak management incentives for efficient
performance. Little institutional reform and minimal, if any, private sector involvement. 3 -
Law passed providing for full-scale restructuring of industry, including vertical unbundling
through account separation and set-up of regulator. Some tariff reform and improvements in
revenue collection. Some private sector involvement. 4 - Separation of generation,
transmission and distribution. Independent regulator set up. Rules for cost-reflective tariff-
setting formulated and implemented. Substantial private sector involvement in distribution
and/or generation. Some degree of liberalisation. 4+ Tariffs cost-reflective and provide
adequate incentives for efficiency improvements. Large-scale private sector involvement in
the unbundled and well-regulated sector. Fully liberalised sector with well-functioning
arrangements for network access and full competition in generation.

10
Poland 3,00 3,00 3,33 3,33 3,33 3,33 3,33 3,33 3,33
Slovak
2,00 3,00 4,00 4,00 4,00 4,00 4,00 4,00 4,00
Republic
Slovenia 3,00 3,00 3,00 3,00 3,00 3,00 3,00 3,00 3,00
Source: http://www.ebrd.com/country/sector/econo/stats/tis.xls

Generally, Southeast European countries have made a progress in

electricity reforms, but compared with more advanced Central and East
European countries, small countries in the Southeast Europe face significant
economic constraints that are related to their limited market size and capacity.
These constraints can be divided as systemic and regulatory ones. The systemic
aspect is related to the physical size of the electricity systems in these countries
because they are too small to be divided up into several competing firms. In
addition, there is a trade-off between having a sufficient number of competing
generators and economies of scale of the plants. The issue is whether the
efficiency gains from several small competing units out-weights diseconomies
of scale and increased transaction costs of an unbundled system34. In addition to
the systemic issues, these small transition countries are faced with the lack of
institutional and regulatory resources. Their institutional settings are
characterised by high corruption, the lack of judicial independence and
credibility and highly interventionist governments, which makes the necessary
reforms much slower.
In comparison with progress achieved in other fields, it seems that
electricity reforms have lagged behind other areas of transition. Most countries
have made small improvements in 2008 in comparison with 2000 regarding
regulatory reforms and restructuring. Macroeconomic environment in most SEE
countries has been burden with serious problems and disbalances such are
budget and current account deficits and, as a consequence, high external debts.
Many macroeconomic problems have slowed down the pace of reforms in
electricity sector, and these problems have become even bigger during the
recession in 2009 and 2010. According to presented data, Serbia, Montenegro
and Albania have been marked by lowest grades, while Bulgaria and Romania
as two EU member states have reached the highest grades. At the same time,
these countries have completely privatized their electricity distribution and
opened their electricity markets.
Generally speaking, CEE countries have reached higher grades, especially
Hungary and Slovak Republic, but there have been no improvements in
implementing economic reforms in electricity sector since they joined EU. The
case of Slovenia shows that low progress in reforms according to EBRD
methodology does not necessarily imply the low efficiency of the sector. The
34
Jamasb, Between the state and market: Electricity sector reform in developing countries, in: Utilities
Policy, No. 14, 2006

11
critics of EBRD approach in benchmarking the progress of reforms argue that
low grades (like in case of Slovenia) do not necessarily reflect low progress in
implementing and conducting overall reforms in electricity sector, but may be
the result of the aversion to privatize and deregulate electricity market. Having
in mind this ambiguity in explaining reform results by international financial
institutions, the further analysis will introduce the regulatory quality since the
quality of regulatory framework has been widely recognised as the crucial factor
for the success of economic reforms in electricity sector.

3.3. The results of privatization in electricity sector of Southeast

European countries

Privatization in electricity sector of Southeast European countries has

been undertaken in a variety of manners but with the same goal to encourage
foreign direct investment into the sector and to allow market liberalization and
increasing competition. A lack of past investments into the electricity network in
many countries of the region has resulted in inefficient electricity industry,
inadequate electricity supply and non-compliance with EU environmental
standards. As it has turned out, the success of electricity privatization is mostly
dependent upon the prior sector restructuring, a transparent and effective
regulatory framework and appropriate market conditions for investors to enter
the market.
In all SEE countries the transmission networks are sill not privatized and
are kept fully in state ownership to ensure non-discriminatory third-party access
and security of supply. Privatization of the transmission system network is
regarded as politically undesirable because of its strategic importance for the
national economy. Therefore the Transmission System Operator in each country
is owned directly or indirectly by the government. The situation is different in
the case of distribution. Distribution companies (Distribution System Operators)
in some countries (Albania, Bulgaria, Romania, Macedonia and Montenegro)
have been separated from the dominant market player and sold to strategic
investors.
The privatization experience worldwide shows that the optimal
sequencing of privatization in electricity sector is first to privatize distribution
and then generation, while privatization of transmission network is often
considered as economically and politically undesirable step. The most important
reasons for privatization of distribution are the reduction of technical losses due
to new investments and the reduction of commercial losses. A more independent
distribution company should collect from state owned industries and non-paying
residential customers and reduce commercial losses. In that way the strong
distributor that has sufficient collection rates and an efficient distribution
network increases the value of generation assets. These were the crucial reasons

12
for the distribution privatization in Bulgaria, Romania and Macedonia where
privatization is seen as the implementation of a stable revenue stream to fund
generation investment.
Croatia, Serbia and Bosnia and Herzegovina are still in the initial phases of
the privatization process. In Croatia electricity distribution is operated
exclusively by state-owned company Hrvatska Elektroprivreda, while in Serbia
the 100% state-owned JP Elektroprivreda Srbije is the dominant vertically
integrated utility dealing with electricity production, distribution and supply. In
Bosnia and Herzegovina there are three dominant vertically integrated electricity
companies that are almost 100% state-owned. Regarding electricity generation
in these three countries, the sector is still mainly state owned. In Croatia, state
ownership is 95% (exception is RWE which has 50% stake in thermal power
plant TE Plomin) and in other countries the generation sector is fully owned by
the state or by state-owned enterprises. Generally, the privatization of the
generation sector has been conducted in some SEE countries, but to a lesser
extent than in the case of distribution system. The majority of generation assets
are still owned by the incumbent market player, although the privatization of
electricity generation is evolving quickly and a significant amount of generation
assets are expected to be privatized in the short and medium term. Countries in
the region have taken very different approaches to addressing the privatization
of the generation sector with some countries maintaining a strong domestic
utility and others seeking high levels of foreign investment through the sale of
the majority of their domestic generation assets.

4. Regulation and regulatory quality in electricity sector of transition

countries

Regulation is crucial in the extreme case of imperfect market structures or

natural monopoly (such is electricity). Natural monopoly is characterised by a
single seller, a unique product and impossible entry into the market. In the case
of electricity, there are extremely high barriers for new firms to enter the market
that are related to economies of scale. Economic literature agrees that in
situation when increasing returns to scale cause monopoly to form, regulation is
the adequate government policy. The underlying economic issue for utility
regulation is that governments, particularly in certain times, have a strong
incentive to behave in a short-sighted and populist manner that reduces welfare
over a medium- to long-term period35. Economic regulation is necessary to
modify market behaviour when market failures cause markets to behave less

35
Cubbin/Stern, The Impact of Regulatory Governance and Privatization on Electricity Industry
Generation Capacity in Developing Economies, in: The World Bank Economic Review, Vol. 20, No.
1, 2006

13
efficiently than in the case of perfect competition. Because of its social costs,
regulation prevents natural monopolies to accumulate excessive amounts of
monopolistic power. In fact, regulators induce firms in non-competitive markets
to act in a way that is compatible with social goals. Regulatory mechanisms
must be established in order to induce firms to produce the optimal output with
the optimal inputs.
As it has been already pointed out, the success of conducting electricity reforms
strongly depends on the regulatory framework. Building effective regulatory
structures in transition economies is much more complex issue than just the right
choice of regulatory instruments because this process depends on the efficiency
of regulatory institution, quality of regulatory framework and overall
institutional capacity. The importance of institutional environment and
regulatory quality is especially important for utility service industries like
electricity. According to Kirkpatrick and Parker36, institution building, including
building a good regulatory regime, is one of the most difficult problems facing
transition economies at the present time.
Although theory strongly confirms the positive impact of regulatory
quality on the quantity and quality of electricity generation and overall
electricity outcomes, there is a limited number of empirical studies focusing this
issue and most of them are dealing only with the electricity generation. The
recent study from Zhang, Parker and Kirkpatrick37 finds that regulatory reform
per se is not sufficient to increase the availability of electricity in their sample of
developing and transition countries. Even more, their results show that
regulatory reform, when not accompanied with other reforms, may actually
reduce electricity output. When considering the interactive effect of regulation
and privatization together, the regression results imply that private involvement
in electricity generation together with regulatory reforms is associated with an
increase in electricity generation per capita, labour productivity and capacity
utilization. Still, the most important factor in improving performance in
electricity generation is increased competition. A study from Vlahinić-
Dizdarević and Prša38 analyses the impact of regulatory quality and government
effectiveness on the success of conducting electricity reforms in transition
countries and found that the effect of government effectiveness on the reform
success after the introduction of the regulatory quality as a mediator in the
model becomes statistically insignificant comparing with the effect before
having the mediation model. These results confirm the mediation hypothesis that
regulatory quality completely mediates the effects of government effectiveness

36
Kirkpatrick/Parker, Regulatory impact assessment and regulatory governance in developing
countries, in: Public Administration and Development, Vol. 24, No. 4, 2004
37
Zhang/Parker/Kirkpatrick, supra note 15
38
Vlahinić-Dizdarević/Prša, Quality of Governance and Electricity Reforms: The Case of Energy
Community in Southeast Europe, paper presented at International Conference Odyssey, Faculty of
Economics, Zagreb, 2010

14
on the success in implementing reforms in electricity sector of transition
countries.
In order to analyse the regulatory regime one should have the appropriate
measure. The mostly used methodology is the one from the World Bank39 where
all governance indicators, including regulatory quality index, are based on
subjective or perceptions-based data reflecting the views of a diverse range of
informed stakeholders like households, firms, experts working for the private
sector, NGOs and public sector agencies. Although such methodology obviously
reflects the subjective judgments and perceptions, the perceptions are important
because agents base their actions on their perceptions, impression, and views.
Despite above mentioned limitations, this composite indicator is widely used
and represents a useful tool for broad cross-country comparisons and for
evaluating broad trends over time, having in mind the particular country context.
Graph 1 shows the comparison between regulatory quality in Southeast and
Central and East European countries in 2008.

Regulatory quality in SEECs and CEECs in 2008

1,6
1,4
1,2
1
0,8
Value 0,6
0,4
0,2
0
-0,2
-0,4
AL B&H BUL CRO KOS MAC MN ROM SERB CZH EST HUN LAT LIT POL SLVK SLO

Countries

Source: The World Bank, 2009

As expected, Southeast European countries have much lower level of

regulatory quality, which is their huge competitive disadvantage and important
reason for the slower pace of economic reforms in all areas, including electricity
sector. At the same time, the appropriate level of institutional resources and
institutional and regulatory quality are crucial for transition countries in order to
benefit from the reforms in electricity sector. Findings that the regulatory quality
is a crucial condition for the success in implementing electricity reforms in
transition countries induce a dilemma for the policy-makers in SEE countries
weather the EU electricity model is appropriate at this stage. The EU reform
model in electricity sector needs certain institutional resources that are still

39
Kaufmann/Kraay/Mastruzzi, Governance Matters VIII: Aggregate and Individual Governance
Indicators, 1996-2008, The World Bank Policy Research Working Paper 4978, The World Bank, 2009

15
missing in SEE countries. The question weather the well designed reform model
can be successfully implemented regardless of the specific political and
economic system, institutional capacity or development stage of a country and
industry, has become a controversial issue in times of global economic and
energy crisis.

5. Concluding remarks

Privatization in transition countries’ electricity sector has been conducted as

a part of much wider transition processes and structural adjustment reforms with
the goal of achieving higher level of economic and social development.
Privatization is the final reform step that is not necessarily connected to the
liberalization process and the most controversial one due to the huge economic
and strategic importance of electricity sector for a national economy. The
relevance of this topic has induced a number of papers dealing with the impacts
of privatization. Their results show that the relationship between privatization
and improved performance is clear for industries operating in competitive
markets, but the evidence is ambiguous for natural monopolies like electricity
that operate in non-competitive markets. In many developing and transition
countries it turned out that improved microeconomic efficiency brings benefits
only for their owners. Transition countries with high budget deficits, high public
and external debts decided to privatize loss-making electricity enterprises in
order to decrease imbalances, but it resulted with output losses, increased
unemployment and high economic and social costs.
Privatization in electricity sector of Southeast European countries has
been undertaken in a variety of manners but with the same goal to encourage
foreign direct investment into the sector and to allow market liberalization and
increasing competition. The success of electricity privatization is mostly
dependent upon the prior sector restructuring, a transparent and effective
regulatory framework and appropriate market conditions for investors to enter
the market. Bulgaria, Romania and Macedonia have privatized complete
distribution network, while Croatia, Serbia and Bosnia and Herzegovina are still
in the initial phases of the privatization process. All these Southeast European
countries are small economies (Romania is the only exception) and they face
significant economic constraints that are related to their limited market size and
capacity. The systemic constraints are related to the physical size of their
electricity systems because they are too small to be divided up into several
competing firms. In addition to the systemic issues, these countries are faced
with the lack of institutional and regulatory resources as well. The EU reform
model which has been implemented in all SEE countries needs certain
institutional resources that are still missing. It has become the biggest obstacle in
the process of full implementation of electricity reforms and privatization

16
because appropriate level of institutional environment and regulatory quality are
crucial for SEE countries in order to benefit from the reforms.

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