Unlocking Opportunity

Should a private enterprise prosper by providing essential services to the poor?

Consider the case of Sociedad de Aqueducto, Alcantarillado y Aseo (AAA), a company based in Barranquilla, a city of 1.5 million on Colombia’s Atlantic coast. AAA has become one of the fastest-growing water and sanitation companies in Latin America by specializing in the difficult business of expanding or improving service in extremely low-income areas. In Barranquilla, 76 percent of AAA’s customers are in the three lowest of six income segments defined by the Colombian government. Since 1997, when AAA began winning contracts to operate water services in adjacent areas, it has expanded into eight municipalities where more than 95 percent of the population is in the three lowest income segments. Most recently, the company has won contracts to provide service in Ecuador and the Dominican Republic.

AAA is what Colombians call a “mixed capital” company. Around two thirds of its shares are owned by a Spanish public water utility, and the remainder are controlled by the municipality of Barranquilla and private Colombian investors. The arrangement allowed AAA to bring world-class management and technology to a company that was near collapse in the mid-1990s.

The new managers engineered a remarkable turn-around. Ten years ago, 60 percent of Barranquilla’s population either lacked running water or had it intermittently, and most of the city lacked decent sanitation. Today, 99.4 percent of the city has running water and 96.5 has sewer connections—some of the best indicators in all of Latin America. Measured by volume, AAA’s water rate is a small fraction of what informal water truck operators used to charge consumers in Barranquilla’s shantytowns. And because AAA has an excellent bill-collection rate and highly efficient operations, its shareholders are benefiting as well.

Like the other case studies profiled in this issue of ReVista, AAA demonstrates that the private sector can and will respond to the needs of Latin America’s low-income majority, given the right incentives.

Reducing the poverty penalty. This example of social enterprise comes as no surprise to students of market economics. But many specialists in foreign aid and international development still resist the notion that the private sector can be instrumental to alleviating poverty. Some critics argue that such activity undermines the state’s fundamental role as a guarantor of basic services.

In fact, governments that encourage these types of enterprises are not abdicating their responsibility to the majority. Rather, they are recognizing that public spending (and loans from multilateral institutions) will never be sufficient to eliminate poverty. They are also admitting that the poor pay a penalty for their situation—in the form of money spent on trucked water, hours wasted on commuting to distant jobs, and high interest rates paid to loan sharks—and that the private sector can help to reduce that penalty by offering goods and services tailored specifically to low-income consumers.

Since I was elected president of the Inter-American Development Bank last year, I have traveled throughout the region and met with many of its newly elected heads of state. Regardless of their political orientation, these leaders are all asking variations of the same question: What is the quickest and most efficient way to reduce the poverty penalty paid by their citizens? If the public sector can provide the best solution at the lowest cost, so be it. But most of the region’s leaders are also eager to emulate policies that have enabled innovative companies throughout Latin America to produce measurable improvements in the lives of the poor.

These companies recognize that Latin America’s low-income majority represents a vast neglected market. In a study commissioned by the IDB, the World Resources Institute estimated that some 360 million Latin Americans—roughly 70 percent of the region’s population—are at the base of the socio-economic pyramid, defined as living on the purchasing power equivalent of 300 dollars per month or less. Collectively, this population has an annual purchasing power exceeding $510 billion.

Dormant wealth. This estimate does not take into account the dormant assets held by Latin America’s poor. In a separate study for the IDB, Hernando de Soto’s Instituto Libertad y Democracia calculated the wealth that is locked up in assets such as informal businesses or properties and homes that lack legal title—and consequently can’t be easily sold or used as collateral. For the 12 Latin American countries included in the study, this “dead capital” amounted to a staggering $1.2 trillion.

WHAT HAPPENS WHEN LOW-INCOME PEOPLE ARE FINALLY ABLE TO “UNLOCK” THESE ASSETS?

Latin America’s thriving microcredit sector offers a compelling answer. In addition to extending millions of small loans to people shunned by traditional banks, these institutions are now offering savings accounts, debit cards, housing loans and money transfer services to capitalize on the $53.6 billion that Latin American immigrants sent home in remittances in 2005. As a result, hundreds of thousands of entrepreneurs are now able to leverage their modest income and grow businesses that generate personal wealth and jobs. The microfinance market has become so enticing that the region’s big commercial lenders are belatedly “pushing down” into the low-income population with new products and services.

In the housing sector, government programs to promote land and property registration in marginal areas are now yielding fruit, as people with legal titles more easily obtain small loans for incremental home improvements that progressively add value to their property. In Mexico, these efforts have been accompanied by reforms to the mortgage finance industry, creating an unprecedented boom in housing for the poor. More than 1.5 million low-income families have obtained government housing loans since 2001. The loans are bundled and sold to investors in Mexico’s nascent mortgage-backed security market. Homes are then built by private developers who have in turn generated thousands of construction jobs.

Transportation is another sector in which innovative public-private partnerships can quickly reduce the poverty penalty. Following the example set by the Brazilian city of Curitiba, cities such as Bogotá, Quito and Santiago have adopted rapid bus transit systems designed specifically to meet the needs of workers in outlying areas and shantytowns. The systems are administered by municipal governments but operated by private contractors. They have comparatively low start-up and maintenance costs, affordable fares, and immediate positive impacts on pollution and traffic congestion. Most importantly, they dramatically reduce commuting times for low-income workers who cannot afford a car.

The right environment. Today the challenge for governments is to scale up these successful experiences by creating an environment that encourages more public-private partnerships that benefit the majority.

At the most basic level, governments should modernize civil registries so that millions of currently undocumented individuals can claim the rights and opportunities of citizens. Studies have shown that approximately 15 percent of children under five years of age in Latin America and the Caribbean—that is, some 8.5 million children—do not have a birth certificate. Millions of other citizens lack the basic identity documents necessary to access social services, earn a diploma, register a property or obtain a loan or formal job. By giving an official identity to these “invisible citizens,” governments can immediately improve their access to basic services and economic opportunities.

Governments should also take steps to deepen financial democracy, both for individuals and small companies. Despite the growth of microfinance, millions of low-income citizens still lack access to banking and other financial services, and only 6.5 percent of Latin America’s 60 million microenterprises receive credit from a financial institution. Greater competition and regulatory reform can expand the range of financial services available to the poor and lower transaction costs such as those associated with receiving remittances sent by relatives abroad.

The water and sanitation improvements in Barranquilla and other Colombian cities offer a vivid example of how such reforms can translate into concrete benefits for the majority. Starting in the 1980s, Colombia decentralized control of many public services and gave municipal governments both the flexibility and the means to undertake improvements—so long as they showed measurable progress and financial sustainability. The reforms also established clear rules regarding tariff increases and subsidies, a key prerequisite to private sector participation.

The IDB is committed to helping its borrowing member governments appropriate and adapt these successful models in ways that make sense for their own citizens. We recently launched an initiative known as “Building Opportunities for the Majority” that will concentrate our efforts in areas where we believe the Bank can have a measurable impact. We also are in the process of developing new products and lending procedures that will allow us to more rapidly respond to our customers’ needs.

Reducing the poverty penalty and providing essential services to the poor will require new ways of doing business at the IDB. Development work cannot be subject to rigid formulas, but should be periodically charged by new ideas and a willingness to take risks. The people of Latin America and the Caribbean deserve nothing less.