Cost recovery in a project context: Some World Bank experience in tropical Africa

World Development, Vol. 11, No. 6, pp. 503-514, Printed in Great Britain.

1983.

0305-750X/83 $3.00 + 0.00 Pergamon Press Ltd.

Cost Recovery in a Project Context: Some World Bank Experience in Tropical Africa JACOB MEERMAN”

The World Bank, Washington, D.C.

The shortage of government recurrent funding in Africa has led to widespread Summary. deterioration of public services. One reason for this shortage is the substantial consumption of public resources in Africa by parapublic organizations which elsewhere in the world cover costs or generate surpluses. In contrast, the World Bank emphasizes the development of institutions which cover costs either through sale of output or user charges. The Bank’s experience with projects in non-market sectors is also of interest, e.g. primary education in which public subsidies predominate. Another reason for the shortage is that government budgeting - both revenues and expenditures - is rarely forward-looking. Aggregate future expenditure claims arc often underestimated. Hence more attention to forward budgeting is needed. In general governments need to bc far more concerned with getting projects which generate their own finance if broadbased public services arc to become the rule.

1. INTRODUCTION In recent years, there has been a great deal of concern with the ‘recurrent cost’ problem in developing countries, and in particular in SubSaharan Africa. Very briefly, the problem is a result of the fact that existing public organizations are not at all able to produce as designed, in part because governments do not have the funds to buy inputs complementary to capital. Highways, clinics, agricultural extension services, many of these - and other organizations ~ produce useful outputs far below their capacity because of this funding failure.’ The problem has become so pervasive that foreign aid donors to African states in one way or another have broadened their assistance from financing the costs of capital to include covering shares of the recurrent costs attendant on their projects.’ A great deal of analysis has also taken place on this topic. For example, the ‘Report of the Working Group’ (1980) analysed the reasons for the shortage of government recurrent funding in the Sahelian Countries and covered thoroughly the analytical aspects and their policy implications.3 The paper which follows differs from the analysis of the Working Group in approaching the recurrent cost issue largely from the perspective of a multilateral donor. The paper begins with a statement which puts the problem of recurrent cost financing into 503

a general framework. The framework serves to illuminate the following discussion of World Bank experience in tropical Africa with cost recovery - particularly of recurrent costs - in project work in several sectors. The final section is speculative: what are the lessons from this experience for more effective foreign aid and more effective use of financial resources by governments?

2. AN ECONOMIC

FRAMEWORK

A flow of economic outputs implies recurrent costs. Typically capital (buildings, equipment) is combined with current inputs (labour, fuel) to produce an output (kilowatt-hours, tonkilometers, school years, tons of coffee). Since the current inputs are scarce, they have costs. In the most basic perspective, therefore, the recurrent cost problem is that of generating resources to cover these costs. Where outputs are produced and then sold, the proceeds can be used to cover the costs. This solves the problem. In socialist parlance in this ‘productive’ economy, that is the economy where goods are bought and sold, if output

* In this paper, I speak solely for myself and not for the World Bank. I would like to thank Luis de Azcarate and Clive Gray for helpful comments.

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WORLDDEVELOPMENT

does not generate sufficient receipts to cover costs, production of that output ceases. In other words, the ‘community’ or the ‘market’ valued the output at less than its costs to the community. Presumably, this is desirable if there are no externalities making subsidy (or tax) desirable. (If income is very unequally distributed, failure of an output to sell can be interpreted to mean that the rich - a small group with most of the purchasing power - do not want it, rather than rejection by the community.) Government, by definition the non-market economy, is another story.4 In fact, in those sectors which are most basically government defence, police, diplomacy, general administration, legislature - the possibility or desirability of direct payment by the beneficiaries for the sectors’ outputs is out of the question. In addition there are many activities which are not fully government - as national income economists define the government sector - and which may or may not be fully dependent on market sales to cover all their costs and thus survive as economic entities. Such activities are frequently described as parapublic and in order to flourish may acquire government subsidies of one kind or another. (Subsidies may take many forms: regular cash transfers from the government treasury; low interest loans from government or banks; clearly overvalued exchange rates which lower the cost of imported input; secondment of civil servants to an activity; purchase of equity by government in various kinds of enterprises.) The term parapublic is a loose one which covers all of such activities. For the emphasis of this paper, however, it is too vague, since some parapublic entities not only fully cover their costs, but also generate financial surplus. Consequently the taxonomy needs to be taken a step further, and we define as a subset all those parapublic organizations which are also financially dependent on public funds to survive, hereinafter described as financially dependent parapublic organizations (FDPPO). Note that what are FDPPO in one country are producers of surpluses in other countries, and are frequently taxed by governments. Housing authorities, highways5 urban transportation, irrigation networks, agricultural marketing organizations, urban market-places, above all publicly owned enterprises per se, all of these can be either producers which fully cover their costs or FDPPOs. In one fundamental ~ not just a formal or tautological - sense the recurrent cost problem in much of tropical Africa is caused by too many financially dependent parapublic organizations, in other words by production of too

much output which does not recover costs6 Governments have greatly expanded, as FDPPOs, organizations which could be self-financing and in some cases could even generate a surplus which government could tax. As discussed below, some of the problem is also caused by the many heavy financing commitments arising from foreign-aided activities. Consequently, the surplus which government can acquire is smaller and the claims on that surplus larger because of the need to fund FDPPOs. This is the case since the ‘productive’ or market outputs of necessity generate the surplus which is used by government. Note that if there is no surplus, there is neither government nor FDPPOs. The size of the market or productive economy limits the size of governments and FDPPOs. Note also that this is not to deny the sine qua non of public activities (both government and FDPPOs): infrastructure; a framework which provides security of life and property; institutions which organize and foster modernization. In this sense public activities can be very productive. But there is clearly imbalance in resource allocation between government plus FDPPOs and other economic activity in tropical Africa. One obvious, but not necessarily feasible, solution to the recurrent cost problem: take measures so that the market sectors, and therefore GNP, grow rapidly. If the non-government sectors (agriculture, manufacturing, transport, and so on) could grow about 6% annually, government could easily grow 10% annually. Were this to occur, the entire recurrent cost problem could largely disappear. Yet much of this growth would have to come from the parapublic sector itself, because in most African countries it accounts for the majority of all modern activity. There is a vicious circle here: growth is slow in part because the public sector, above all government and FDPPOs, consumes most of the surplus on the development budget and in turn the public sector is starved for funds because growth is so slow. From this perspective increased taxation is not the solution. Most African production is already taxed very heavily. There is substantial evidence that in many countries, agricultural stagnation is in part a consequence of such heavy agricultural taxation. Note, however, that the problem is not simply a consequence of widespread public ownership. Who owns the means of production _ public or individuals - is not crucial. Marketoriented public enterprises can be rapidly growing, self-financing institutions that not only generate surplus for investment but also

COST RECOVERY

IN A PROJECT

play an important role in modernization by developing skilled labour and management. That the majority of them are also FDPPOs which have by and large dismally failed in these respects does not imply that failure is of The above perspective suggests necessity. another solution to the recurrent cost problem: convert the FDPPOs to cost-coverers. A great deal of institutional rehabilitation in Africa has this as a primary goal. As will be seen below, the World Bank has traditionally approached projects from this perspective. This solution would of course also increase the growth of African economies per se.

3. THE WORLD BANK’S APPROACH COST RECOVERY

TO

(a) General The acute shortage of recurrent funding in tropical Africa suggests that the traditional stance of the World Bank on recurrent costs in projects in the productive (market) sectors is sensible. The Bank insists both that such projects should generate more output than they use (have a net rate of return about equal to the opportunity cost of capital in general)’ and in most sectors - that sale of the output from the project should cover at least the recurrent cost of the project by generating sufficient resources to keep it operating, and frequently to cover part or all of capital costs (depreciation plus net return) as well. More recently, the Bank has also been concerned that the costs of producing project outputs do not unduly burden the poorer beneficiaries while suggesting as an additional benefit - in some projects - the direct or indirect use of project outputs as a means to tax better-off beneficiaries and generate a fiscal surplus. The Bank has also traditionally been concerned with efficiency pricing in the economist’s use of the word, that is pricing at long-run marginal costs defined roughly as the cost of additional output when new capacity must be added. This, however, may be inconsistent with financial viability as discussed below. In such situations financial viability usually carries the day. In many situations however, efficiency pricing is a consideration and plays an important role in project design. In non-market sectors, such as primary education or population planning, neither pricing of services provided, nor charges on beneficiaries have traditionally played a significant role. While it would not

CONTEXT

505

be too difficult to devise appropriate charges or taxes, the Bank considers services in these sectors, at least, best financed out of general taxation. So much for the general overview. What has the Bank experienced in tropical Africa with this approach?

(b) Public utilities Nowhere is the Bank’s approach to cost recovery spelled out with greater detail, and perhaps success, than in the public utilities (power, water supply, sewerage and telecommunications). There is no need here to go into the intricate economic analysis in these projects (peak-period pricing, asset valuation, second-best solutions, shadow pricing, financing connecting charges and so forth). For our purposes, a statement of common Bank practice in the sector suffices: The financing of recurrent costs is not a real problem in the public utility sector because each utility is expected to operate with financial autonomy and to recover from revenues operating expenses, debt service, and provide some selffinancing for expansion. This principle is posited because the service is provided to individual consumers who receive most of the benefits. External benefits and social considerations allow for the relaxation of this principle in terms of the degree of self-financing required in the water and sewerage sectors but at no time are revenues planned to be less than sufficient to cover operating expenses and debt service. Rate of return and cash flow covenants are used to ensure this result. Overall revenue requirement covenants do not imply that each component of an operation is entirely self-supporting. Cross subsidization of low income consumers by higher income consumers and rural schemes by urban consumers is a common feature in water supply and power through USC of progressive tariff structures.8

A word on the so-called block tariff (progressive tariff structure) mentioned in the citation is in order. Since consumption by households of public utilities outputs increases rapidly as incomes increase, the so-called ‘block tariff’ exploits this by charging for the initial ‘block’ of consumption at the lowest rate and steadily increasing the rates as consumption increases. As a consequence the average cost per unit to the poor is less than to the better off. Such ‘cross subsidization’ is a common feature in Bank projects for water supply and power.’ One consequence of this approach is a situation where expansion of services is possible to both rich and poor without fiscal subsidy

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because the progressive tariff can insure an adequate rate of financial return to capital. Fiscal authorities usually look with favour on this approach, since service expansion need not bring in train increased claims on government resources. The vicious circle of deficit, shortage of both investible resources and of recurrent cost funding which makes expansion of many other activities impossible in many countries is not inevitable, at least in the production of electricity and urban water. The persistence of substantial inflation has brought a number of changes in the Bank’s financial covenants for power projects in West Africa. Covenants now typically require automatic adjustments of tariffs because of increases in the price of fuel (the fuel adjustment clause) and other costs which experience inflation. A continuing problem here is the reluctance of governments to permit automatic increases of tariffs triggered off by increased prices of fuel and other inputs. Frequent revaluation upwards of fixed assets because of inflation is also a covenant. In contrast, covenants common requiring tariffs which will insure a minimum financial rate of return to fixed assets are falling into disuse in part because of the complexity involved in measuring an adequate rate of return when inflation is substantial, in part also because of resistance by African governments to the use of profitability as a basic measure because of its association with colonial exploitation. Instead covenants are increasingly defined so as to insure cash flow which will cover depreciation plus debt service and finance a substantial share of new investment. In some cases, the latter has been 40% of annual added capacity.

(c) High way maintenance (i) Evolution of the problem In the 1960s World Bank highway loans in West Africa included covenants for earmarking a portion of motor fuel taxes for road funds. One purpose of the road funds was to assure that adequate funding would be available for highway maintenance. However, the funds were mainly used to construct new roads and improve existing ones, usually by using the highway maintenance organization for this purpose as well. In general the Bank did not covenant that the funds be used strictly for maintenance. In appraising projects a persistent concern, however, was that sufficient taxes be generated to cover highway upkeep. If the earmarked funds from the user taxes

- invariably a specific tax of so many units of local currency per gallon or litre - had been reserved for maintenance, then until about 1973 most needed maintenance work could have been financed in both Africa and elsewhere. But the rapid world-wide inflation beginning in 1973 brought about a shortage of maintenance funds as real values of fuel taxes based on invariable specific taxes contracted. In addition in many countries, for example most of those of the Sahel, governments have become so short of funds that they have ceased earmarking for the various road funds in part or total. The bias against maintenance and in recent years the acute shortage of funds has resulted in widespread deterioration in road networks. As a consequence, every country which is a member of the World Bank in West Africa has at least one highway maintenance loan, typically for equipment, spare parts and training. (ii) Remedies The European Development Fund of the Common Market has taken the position that highways should be so designed that the need for maintenance is reduced. The highways may then deteriorate over the years and are rebuilt before deterioration has proceeded to the point where reconstruction becomes very costly (ideally as soon as the discounted present value of future benefits lost because of further deterioration exceeds the present value of the costs of reconstruction). Hitherto, Bank staff have usually assumed, when appraising projects, that whatever maintenance was needed would be forthcoming. They are now also considering the EDF approach which builds upon the expectation of high probability of meagre maintenance. In discussions with governments, the Bank also makes continuing and strong efforts to persuade them to become more ‘economic’ and give first priority to maintenance. Only if maintenance is adequate should new construction be considered. The Bank is meeting with some success on this score. Although the political and administrative impediments to developing adequate maintenance are being reduced, financial constraints have become more acute. As noted, earmarking for road funds continues largely at the same nominal rate in many countries, notwithstanding inflation in the costs of maintenance operations. In many cases these costs now exceed what is going into the road funds in the countries which still have them. The obvious solution is to earmark a larger share of the motor fuel tax or to increase it. Again, governments are reluctant

COST RECOVERY

IN A PROJECT

to increase the earmarked share, because of their traumatic shortage of revenues, particularly in the stagnating economies of the region. At the same time they have been very reluctant to move to a better tax, namely the ad valorem (a tax of a set percentage on the price of motor fuels). Part of this is a reluctance to increase further motor fuel prices after the very painful increases of recent years. Some of it is apparently due to some sort of inertia: governments are reluctant to change from the tried and proven to an unknown tax which will require what appears to be complex administrative changes to be successful.”

(d) Education There is a world-wide consensus that primary education should be universal. But in poor countries the cost of primary education exceeds by far what a poor family can afford. This is illustrated in Table 1. In most of the countries, per capita incomes of the poorest 40% of the population range from a quarter to about three-eighths of the average. Table 1 takes a family of six with per c;pita income equal to and two children in three-eighths of the mean primary school and calculates the public cost of keeping those two children in school as a percentage of family income. The table shows that in most cases such costs would be prohibitively high, a quarter of income or more if the families had to cover them out of their own resources. Consequently, such education must be heavily subsidized if it is to become universal.” The World Bank shares this perspective. In Bank lending for primary education, cost recovery has not been among the most basic considerations, and the Bank has accepted the Table 1. Public costs of primary schooling (two children per family) as % of poor family income, in mid-l 9 70s * Liberia Nigeria Sierra Leone Ivory Coast Senegal

11 16 18 19 30

Niger Upper Volta Mauritania Mali

30 35 39 49

Source: Manuel’ Zymelman, Educational Expenditures in the I9705, World Bank, CPS, processed p. 18. *Six-person family whose total income equals 2.25 mean GNP per capita.

CONTEXT

501

need for overwhelming reliance on the state as the basic source for funding at the primary level. This is not to say that the Bank ignores cost recovery at the primary level. Revolving funds employer-financed technical for textbooks, education, and support to community construction of school buildings have been encouraged by the Bank in various loans. Cost containment is also emphasized. Because teacher costs at the primary level account for anywhere from 75 to 90% of public recurrent costs, the Bank has made suggestions to reduce these costs in several countries by introducing teacher aides or junior teachers whose salaries are low and who would take over an increasing share of the teaching load from the master teachers. The Bank also emphasizes the need for cost-recovery from beneficiaries at the higher levels of education. A typical conclusion by the Bank is that frequently public funding for education is seriously mis-allocated. At the higher levels, and particularly at the universities, the widespread practice in tropical Africa of granting students full fellowships, including in many cases living costs and pocket money, is seen as very wasteful. The Bank proposes that fees be paid by the student or their families, supplemented by educational loans where needed. It believes that financial assistance is best restricted to students who cannot pay. Bank staff occasionally assert that residence halls should be closed and students left to find their own housing while study halls should provide the quiet atmosphere necessary for academic work. The reasons for this approach are close at hand: because financial returns to those receiving higher education are high, while students themselves are, in the majority, from the better-off families, there is every expectation that they or their families could take over a large share of the financing burden themselves, The public resources released as a result of such payments would - ideally - be used to expand the primary system. In some countries such shifting of resources would permit achievement of universal primary education. (Whether resources would indeed shift from the higher to the primary level is a moot question. Government priorities may be very different from those of the World Bank. It is possible that in many countries the actual use of additional resources by governments would be less economically productive than their use in higher education.) The approach has not been successful, Political leaders - whatever their own preferences - have not been able to resist pressures from their constituents to maintain the status

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WORLD DEVELOPMENT

quo. In most of tropical Africa higher level education continues to be free to the user and very expensive to the community. Rarely in tropical Africa have student loan programmes been seriously considered. Nevertheless as shown in Table 2, primary school enrolment is fractional throughout the Sahel. In the entire world, no other region has enrolments at the primary level anywhere near so low. Table 2. Number enrolled in primary school as percentage

Total

Male

Female

44 35 28 17 31 23 26 50 41 50 63 83

51 51 36 21

32 19 20 12

29 34 58 50 58 75 92

17 17 42 32 41 58 63

Source: World Rank, Accelerated Development SubSaharan Africa (1981), Table 38, p. 181.

(e)

(f) Cost recovery

of school age group, 19 78

Gambia Chad Mali Upper Volta Gambia Niger Mauritania Sudan Senegal Uganda Sub-Sahara Africa All low-income countries

for housing construction have been included, these too must be repaid. Consequently, organizations have been developed to invoice clients and handle receipts. Such collections are distinct from those for public utilities (water, electricity) or for municipal taxes. Sanctions site repossession or disconnection of services have to be imposed on clients who do not make payments.

in

Urban Projects

World Bank lending to support the growth of cities has a long history in the public utilities, in transportation and in industry. In 1972, the Bank also started lending to finance housing sites and services and for slum upgrading. Frequently these loans include technical assistance to improve city management and administration, as well as funds to develop community facilities. As with lending in other sectors, from the very beginning the Bank stressed the importance of recovering costs from the beneficiaries of these newer projects. Such cost recovery is badly needed to support future projects, since urban growth is far more rapid than the growth of government resources to finance it. To a large degree, funds thus far recovered have been used to finance additional projects in sites and services or in upgrading. Urban cost recovery involves direct payment by the beneficiaries, typically a monthly payment for the purchasers of the serviced sites or in the case of slum upgrading (improved streets, sanitation, drainage of swamps, new schools and so forth) a tax on the increase in value of property caused by the upgrading.13 If loans

in East African

urban projects

In 1980, the Bank carried out an assessment of its experience in East Africa with cost recovery in urban projects. Six problems were emphasized: political ambivalence, inadequate legislation, delay in granting land tenure, absence of sanctions, weak administration, and unwillingness of beneficiaries to pay. Evidence suggests that the ability, as opposed to willingness, to pay has not been a problem for most slumdwellers. Various studies show that 15-25% of the income of urban households is spent on shelter. Experience, including evaluation of low-income shelter projects, indicates that it is possible to provide acceptable self-help shelter or upgrading at costs of less than 15% of household income, for all except the bottom 10-l 5% of the income distribution. (i) Political ambivalence Delays in starting cost recovery, especially in upgrading components, have often been caused by ambivalence or outright resistance at political levels. Conversely, the countries of successful cost recovery, such as Kenya, have had broad support for cost recovery among political leaders, civil servants, and project beneficiaries. In contrast, in Botswana and Zambia, the lower standards and higher cost recovery of Bank projects (as compared to earlier developments) have been accepted only grudgingly because some people, frequently from higher income received similar services free or of groups, better quality in the past. It is difficult for political leaders and technical people to champion charging the po;t; for public services which the rich receive free. (ii) Legislation Providing individual land titles or occupancy rights usually requires new legislation and is a prior condition to recovering costs in upgrading areas. Developing such legislation may require a long time, even where political support is strong.

COST RECOVERY

IN A PROJECT CONTEXT

(iii) Tenure documents Land tenure documents have to be issued to participating households before collections can begin. Because of weak administration and inappropriate tenure instruments, delivery of tenure documents in East Africa has been slow, particularly in upgrading projects. When a long time elapsed between completion of services and start-up of payments, beneficiaries became accustomed to free services, and frequently refused to pay when collections finally started. (iv) Sanctions Sanctions for non-payment are a major problem in both site and services and upgrading areas. Kenya is the exception; a legal and administrative framework existed prior to the Bank’s first involvement in the sector, which was easily adapted to the project.” In Zambia it took several years to move from legislation, to issuing tenure documents, to collections, and finally to sanctions. In Botswana, normal sanctions did not apply to areas selected for the project, and major modifications were required, which took several years. In general the lack of both adequate legislation and political ambivalence have been major obstructions to repossession of serviced sites. Sometimes an inadequate legislative framework has permitted protracted inaction by governments, presumably because of lack of support by the political leadership. In upgrading projects, finding an effective sanction is difficult. Repossession or eviction are not realistic because (a) the house is privately owned; under such circumstances eviction is frequently not legal; (b) where legal, families know that governments will often not enforce evictions in part because this would create new squatter areas. Zambia attempted a different type of sanction by disconnecting water and power. But families reconnected the services, and where they did not, those who had paid regularly became angry since they were denied the shared service. Many stopped paying. A third possible sanction is group pressure on nonpayers by other beneficiaries of the project. Often recommended, it is not used extensively in East Africa. (v) Administration Because agencies are inexperienced and the novel, weak administration of approaches collections has been the rule. The problem seems to lie less with the basic structure of collection organizations than with their operations. Except in Tanzania, all projects in East Africa use local government institutions for collections. Payments are typically made to the

509

same agency that is responsible for implementing the project. Except in Tanzania, payment location, often cited as a potential problem for beneficiaries in large cities, is always near to or on the site. Opening hours are also designed to be convenient, including evenings and weekends. Payments are monthly - except for Tanzania where they are annual. In practice, collections overwhelm administration. Frequently staff have been too few to handle the large number of accounts. In most projects there has also been an underestimate of the time needed to register houses and issue tenure documents, delaying the start of collections until considerably after the start of services. Once payments began, follow-up has often been poor. In some projects families never signed the loan contract; were never informed where, when and how much to pay; and nothing ever happened when they did not do so. (vi) Willingness to pay Refusal to pay is largely explained in terms of the previous five problems. Families initially willing to pay for services become confused and discouraged because of delays in promised improvements; because of delays in delivery of tenure documents (often due to legislative problems); and because of poor information on amounts due and how payments are to proceed. Conflicting signals from civil servants and politicians contribute to this outcome. Some Zambian candidates for local office discouraged residents in upgraded areas from paying, by assuring them that the government could afford to subsidize the programme.

(g) Agriculture’6 It is more difficult to provide an overview of experience with cost recovery in agricultural projects than in the other sectors. One reason for this is diversity in the sector. In some agricultural projects the output is primarily food, most of which is eaten on the producing farms. Cost recovery in such projects is very different from cost recovery in projects whose output is exported out of the country, such as rubber or coffee. In the latter cases costs can be recovered through taxes or cesses at the points of export. The Bank has usually not emphasized direct cost recovery in projects whose outputs are very diverse and in large part locally consumed. A recent pro’ect in Sierra Leone furnishes a good iI example. Here general farming in an entire

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region is to be improved. The activities can be summarized as follows:

involved

_ Field Services: agriculture extension, soil conservation, seed multiplication and processing, applied research, fruit tree nurseries and farmer and extension staff training; - Commercial Services: supply of farm inputs, credit and coordination of processing and marketing activities; - Accounts: project accounts, procurement, stores, internal audit, and budgetary control; _ Administration: personnel, staff transportation, security and public relations; - &z‘ngineetirzg: road construction and rehabilitation, workshops, well construction, building construction; and _ Livestock: Mara Ranch, livestock extension services, and livestock training services. The project should result in increased outputs in rice (paddy and upland), groundnuts, maize, cassava, tobacco, fruit tree crops, ‘mixed crops’ and cattle, sheep and goats. Cost recovery gets little attention. There is a statement that notwithstanding an increase in indirect taxes resulting from the increased incomes generated by the projects, ‘The government cash flow is negative, which is typical for such a project’. As usual, in such situations the Bank expects that the government will provide the necessary funding in the agricultural budget to maintain services at the desired level. A recent project in Ghana took a similar approach: an estimated 60,000 farm families would benefit by increased production of maize, yams, rice, groundnuts, sorghum, cassava, livestock and fish. ‘The Government cash flow At the end of the project is negative. . . period, GOG (Government of Ghana) will face an increase in recurrent costs of about US $5.5 million per year. This is equivalent to about 0.6 per cent of GOG recurrent budget in 1978/79 and is not expected to be a major burden on GOG finances.‘18 Any problem in providing such funds was assumed to be unlikely. In contrast, in agricultural projects whose output is to be marketed, cost-recovery is frequently ‘internalized’. In some projects, fees for inputs may be the common means of cost recovery: water charges in irrigation, charges for seed and fertilizer. In others, a cess on the output marketed - for example rice or cotton _ is designed to cover recurrent costs and usually a part of capital costs (loan interest and amortization) as well. The experience of countries in covering the costs of inputs by taxing the associated output has been disappointing. Actual collections from irrigation charges, for example, have been far below the amounts

projected. The reasons for this are similar to those for weak cost-recovery in urban projects: political ambivalence, administrative problems, difficult changes in legislation, no tradition of payment for such services. To conclude, most Bank agricultural projects in tropical Africa, at least, do not aim at full cost recovery including capital costs. In diverse general development projects, the only ‘cost recovery’ expected rnfy be in the form of increased general taxes. Even in those projects which best permit cost recovery, recovery of recurrent costs may not be expected during the start-up phase. During this period the Bank loan (or IDA credit) often finances part of such expenses which then become capitalized as government debt.

4. LESSONS (a) Changes

FROM EXPERIENCE in Bank thinking

The above material shows that in several sectors (education, agriculture, health) recurrent costs are not expected to be covered from receipts generated by the project itself. In these, and others, the debt service must also be covered in large part by tax resources not generated by the project. And to the degree that such projects are slow in realizing their potential, the net ongoing claims on government funds to support the projects is larger. Such short and medium run ‘negative cash flow’ also occurs in other sectors such as technical assistance and nonproject loans. (See Table 3 for the sectoral distribution of recent lending in Africa.) This state of affairs has led the parts of the Bank which lend in Sub-Saharan Africa to a great deal of soul-searching on recurrent cost funding in recent years. Much of this concern was stimulated by governments’ failures to fulfill covenants to fund the recurring expenditures of Bank aided projects. It also received a strong push whenever disbursement of loans was delayed because of inability of governments to provide their agreed-on local cost contributions during the implementationof theproject. An early response was to expand Bank lending to include finance of ‘start-up costs’, that is the incremental current expenditures created by a project during its implementation period. Such incremental costs may include salaries and other personnel costs - the category which the Bank traditionally has most unyieldingly refused to fund, precisely because such costs are local, recurrent and for personnel. In some countries this approach might have exacerbated

COST RECOVERY IN A PROJECT CONTEXT Table 3. Recent

511

WorldBank lending in tropicalAfrica,* by sector+

Energy Telecommunications Industry Development finance companies Water supply and sewerage Transportation Small-scale enterprises Urbanization Agriculture and rural development Education Technical assistance Non-project Total of which Bank IDA

Million of US dollars

Percentage

Cumulative percentage

359 15 89 103 60 634 46 54 1145 267 117 470

10.7 0.4 2.6 3.1 1.8 18.9 1.4 1.6 34.1 7.9 3.5 14.0

10.7 11.1 13.7 16.8 18.6 31.5 38.9 40.5 74.6 82.5 86.0 100.0

3359 1448 1911

100

Source: World Bank,Annual Report (1981), pp. 32 and 38. *Botswana, Burundi, Comoros, Ethiopia, Kenya, Lesotho, Madagascar, Malawi, Mauritius, Rwanda, Somalia, Sudan, Swaziland, Tanzania, Uganda, Zaire, Zambia, Zimbabwe, Benin, Cameroon, Central African Republic, Chad, Congo, Gambia, Ghana, Guinea, Guinea-Bissau, Ivory Coast, Liberia, Mali, Mauritania, Niger, Nigeria, Senegal, Sierra Leone, Togo, Upper Volta. tCommitments

- July 1979 to June 1981.

the situation. The increased assistance has permitted increased foreign lending and eventually even greater claims on the government’s limited resources, except for the financially very productive projects which also generate very substantial government revenues. In general the problem persists. And discussion of the issue within the Bank continues. The most radical proposal - and a proposal is all that it is - is to fund certain recurrent costs for long periods of time. Less radical are the suggestions for more adequate fiscal analysis. In the words of one staff member: ‘a more active and vigilant stance towards recurrent cost requirements should be required the cumulative Presumably at appraisal’. requirements of all new activities would be considered in such analysis. To the present, Bank lending practice does not usually reflect this suggestion. In 1978 Bank staff carried out a Malawi Recurrent Expenditure Study which included a set of projections of central government recurrent costs by sector - assuming adequate funding - as well as a set of technical notes explaining the basis of the projection. Since 1978 similar, although less comprehensive, studies have been carried out in other African countries. But these are exceptions rather than the rule. It has also been suggested - with very little response - that recurrent cost require-

ments be shadow-priced at more than one in evaluating the project benefit-cost ratio. Notwithstanding the ferment about these issues, there is not likely to be any radical basic shift in the way the Bank treats them in the near future. Recurrent cost financing is likely to continue to be very controversial, while radical changes in the fiscal context of project analyses are unlikely.

(b) Prescription for foreign aid donors The Bank’s experience, which is not atypical of that of donors as a group, suggests some general conclusions: (i) Part of the problem is that recurrent budgeting is a most underdeveloped art. In practice such budgeting is usually incremental. The finance ministry gives the other ministries what they received last year plus a little more. Yet what is needed is a plan not only for development expenditure but also for the recurrent outlays associated sooner or later with those development expenditures. Donors need to give far more attention to institution building for recurrent budgeting which is also integrated with capital budgeting. (ii) The piecemeal approach to the evaluation and estimation of government financial contri-

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butions to a project involving foreign aid is quite insufficient. During project preparation, a realistic estimate based on the entire picture needs to be made: how many uncommitted fiscal resources will be generated in the next year, and what activities will get them? Will there be enough for this project? (iii) Donor coordination is frequently ad hoc and very general: everyone tells everyone else their plans and adjustments are made as needed. Looking hard at the fiscal implications of the combined set of activities in the context of the general budget situation would give such coordination a focus which would prove very valuable per se and would probably permit improvements in project formulation as suggested in (ii) above. It would be very useful and indeed necessary to work with the finance ministry in any such coordination. (iv) In educational lending, the Bank does not use cost-benefit analysis, nor does it depart radically from its traditional position of not funding recurrent costs: although teacher-wages account for three-quarters or more of total recurrent costs of education they are not usually a cost eligible for Bank financing. Most donors are similar to the Bank in this respect. The exclusion of cost-benefit measurement in education projects is paradoxical in that scarcity of educated people is the most fundamental constraint on growth in Sub-Saharan Africa. To the present, however, techniques for such measurement are controversial perhaps in part because of the very pervasive, subtle, complicated, and long-term ways in which the influence of education on the individual and on groups works itself out. Measurement in a way convincing to the managements of the various donors agencies, if it concluded with very high returns, could play an important role in making donors more willing to fund the recurrent costs of education. It could also be useful in determining the optimal allocation of funds among the different levels and kinds of education. Perhaps of even more pressing importance in many African countries is measurement of the of expenditure for ongoing effectiveness education. The enormous and very impressive expansion in numbers in school has brought in train very low quality education in many countries. In such countries it may be that the economic rate of return in improving existing educational services would be higher than the returns to education expansion. Development of acceptable and feasible measurement of economic benefits from various kinds of educational expenditure could well be undertaken by academic economists, and research

of this kind could make possible more effective educational and other developmental expenditures.21

(c) A word for the governments Increasingly, projects designed with high economic rates of return have become fiscal burdens. Needless to say, in some projects, returns cannot be expected until far in the future; for example, in primary education. In other sectors the paradox remains. There are many reasons for this: the project may look like a fiscal burden, but in reality generates taxes which far exceed its recurrent and other costs. Highways are often in this category. Or, what is potentially a self-financing project fails to do so because of non-support of various kinds from governments; too low fuel taxes is an obvious example. Projects in agriculture and the urban sector may also fit into this latter category. In other cases the project was badly designed or executed and should be eliminated. One point is very clear: if the government has a donor which is adamant in insisting upon cost recovery, it should support it rather than resist it. It is a mistake to see such concern as some sort of donor exploitation of the recipient. Cost recovery as discussed above is very much in the interest of the recipient governments. Those activities which can clearly pay their own way should not be starved of funds either capital or recurrent. Telecommunications, public utilities, highway transport (for roads which already exist) and much of agriculture fit this category. On the one hand they lend themselves very well to concessionary finance of their capital; on the other hand they usually produce outputs which can be sold or taxed in ways to generate substantial surpluses. Consequently it is penny-wise but pound-foolish to let them so deteriorate that they can no longer generate a surplus. In highway transport this may require greater funding to the road maintenance organization. In other sectors it means tariffs which will need frequent increases because of persistent inflation. In terms of the concepts developed at the beginning of the paper, one should avoid as much as possible letting these become financially dependent para-public organizations. As implied earlier, part of the shortage of government recurrent funding is caused by the imbalance between resources for capital formation and resources needed to work with the capital to produce goods and services. In a number of countries, rapid capital formation

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has generated demand for recurrent resources far beyond the country’s capacity. In turn, this apparent myopia results - in part - from the traditional separation of budgeting and planning in two unconnected agencies. In some of the poorest countries a system has evolved in which the ministry of finance allocates domestic resources while ‘Plan’ allocates foreign resources. ‘And never the twain shall meet.’ Obviously in such circumstances development of integrated and forward-looking budgeting would be a step forward. The attempt in Africa to provide public services free to the users has been tragic. Rich countries can afford some of this. Africa cannot. One should salvage, however, as much of the vision as possible: basic goods (nutrition, primary education, medical care, water supply)

should be available to all. The financial dimension of the vision, however, should perhaps be reversed. The recipient will need to pay for the service, unless there is very good reason for not doing so. Often the choice will be between financing the service regressively through a user charge and not providing it at all.” Even with a new vision it will remain to develop techniques of mass-production of such basic services at prices within the reach of the broad masses. In terms of the point of departure of this paper, depending on financially dependent para-public organizations to provide basic goods implies a continuing overwhelming recurrent cost problem; services available to only a small part of the population; and perhaps stunted growth in a too heavily taxed agricultural sector and other surplus producing sectors.

NOTES 1. Deterioration of these organizations is also due to administrative difficulties as well as to various kinds of political processes. These issues are important, but cannot

be treated

in this paper.

2. By 1979 the Development Advisory Committee of the Organization for Economic Cooperation and Development formalized this change in policy in

‘DAC Guidelines on Local and Recurrent Cost Financing’. These were incorporated in Developmenf Cooperation, 1979 Review, Annex III, pp. 175-178. 3. CILSS (ComitC Permanent Inter-Etats dc Luttc Contre la Secheresse dans le Sahel - Permanent Intergovernmental Committee for the Struggle against Drought in the Sahel) and Club du Sahel, Working Group on Recurrent Costs, ‘Recurrent Cost of Development Programs in the Countries of the Sahel’ (August 1980), processed. 4. The national accounts definition of government is used here, namely, the economic sector dependent largely on taxation to function. Government excludes, therefore, the central bank and other public financial intermediaries as well as publicly owned enterprises. These can be described as part of the parapublic sector discussed above. 5. In a number of countries taxes on motor fuel alone cover the total costs of the highway system and provide substantial net government revenues as well. 6. There is a substantial literature supporting this conclusion. A few examples: ‘Failurc of governments to recover costs and extensive subsidization’ are two of the factors underlying ‘the shortage of local recurrent budgetary resources which is a pervasive constraint to rural development programs over time’ (Ume Lele, ‘A revisit to rural development in Eastern Africa’,

Finance and Development

(December 19791, p. 34). ‘Basic reasons for the shortage of recurrent funds’ are ‘government policies conducive to economic stagnation, such as monopolization of functions by inefficient deficit-ridden state enterprises . and inappropriate state-imposed factor prices’ (CILSS and Club du Sahel, op. cit.). ‘Preemption of domestic savings by the state and its agencies is a serious obstacle to economic growth in all the Sahelian countries. Governmentimposed lending rates near zero or negative in real terms stimulate demand for bank credit a proponderant share of which is channelled into state enterprises whose appetites are still far from satiated.’ Clive Gray and Andre Martens, ‘The political economy of the “recurrent cost problem” in the West African Sahel’, Development Discussion Paper No. 128, Harvard Institute for International Development, February 1982 and in World Development, Vol. 11, No. 2 (February 1983). 7. In health and education projects, rate of return calculations are made. 8. Memorandum July 1977.

of E. Gilling

however,

no

to 1. Sebastian,

22

9. It is worth noting that long-run marginal costs of electrical power generation are frequently an increasing function of output as a consequence of moving to less favourable hydroelectric sites and then to thermal power. In a number of countries use of strict long-run marginal cost would bring very dramatic increases in price to consumers and very large financial surplus. In such situations in the face of government resistance, the Bank has frequently agreed to a tariff which generates a reasonable financial rate of return, rather than the far higher price implied by strict scarcity pricing.

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10. The maintenance problem goes beyond finance. Many poorly maintained highways have deteriorated so badly that long-run rehabilitation is necessary. One noteworthy development is increasing reliance on maintenance by private firms, which must perform fairly well or be forced out of business. Contracting for maintenance by road sections is now the practice or is being considered in Mauritania, Ghana, Nigeria and Niger. Usually there is substantial foreign participation in such firms. This solution, however, brings with it additional problems. In some countries the public maintenance organization has, as a consequence, many excess employees. The political ramifications of numerous supernumeraries lead many governments to go very slowly on the approach. Others oppose the exploitation of the profit motive on ideological grounds. 11. Total income of the family is therefore (6).(3/8). (GNP per capita) or (2).(1/4).(GNP per capita). 12. Often the private out-of-pocket costs of such education are also very high. If books, or shoes or supplies, and examination fees are required, they usually exceed 15% of income in the poorest households with two or more children in primary school. 13. In the Ivory Coast this tax (fuxe de plus-value fonciere) per year has been 8% of the increased value for a 20-year period. 14. The Frei Government in Chile developed a pay-as-you-go sites and services programme which was criticized by many and denounced by some because the previous government had provided worker housing with substantial subsidy. Allende - who defeated Frei in the election of 1970 - promised housing to workers largely at state cost. See Joan Nelson, Access to Power: Politics and the Urban Poor in Developing Nations (Princeton University Press, 1979), pp. 350, 364-367. 15. In El Salvador a private foundation operates the site and services programme and largely depends on payments for financial survival. There, sanctions have been regularly exercised. 16. See CILSS, Club du Sahel, Working Group on Recurrent Costs, ‘Recurrent Costs of Development Programs in the Countries of the Sahel’ (August 1980), pp. 72 for a very good discussion of cost recovery in agricultural projects.

DEVELOPMENT

17. Sierra Leone, Northern Integrated Agricultural Development Project II, Staff Appraisal Report No. 3166~SL (World Bank internal document, 27 February 1981). 18. Ghana, Volta Region Agricultural Development Project, Staff Appraisal Report No. 2527-GH (World Bank, internal document, 20 March 1980), p. 12. 19. This is not to deny that in many African countries total taxes borne by the agricultural sector exceed government spending on behalf of the sector and its people. 20. See Owaise Saadat and Francis van Gigch, ‘Lessons from the field: rural development in West Africa’, Finance and Development (December 1981), p. 39. 21. The extensive empirical work on this issue consistently shows very high benefits in the form of increased wages of the educated. This earnings effect persists irrespective of the country’s level of development. (See George Psacharopoulos, ‘Returns to education: an updated international comparison’, Comparative Education. Vol. 17, No. 3. 1981.) Effects on factors of production complementary to or competitive with education have not been measured. There has also been some measurement of the effects of education on farmer efficiency. See Lockheed, Jamison and Lau in ‘Farmer education and farm efficiency: a survey’, Economic Development and Cultural Change, Vol. 29, No. 1 (October 1980). I am unaware of any attempts to measure returns from rehabilitation of existing educational systems. 22. It is interesting to note one approach to primary education when incomes were far lower than now: in England performance contracting for teaching once was common. The contractor was paid when he demonstrated that his charges could read and write. ‘Nineteenth century India had villagers pay one and one half rupees when a child attained proficiency. Payment-by-results was in effect in elementary schools of nineteenth century England and subsequently exported to other parts of the Empire such as Bombay, Malaysia, Canada, Nigeria and Ghana.’ Zymelman, ‘A History of Educational Finance’, unpublished manuscript (1979), p. 19.