The Business of the State

“NOBODY KNOWS WITH CERTAINTY how the universe came into being but if God had said `let there be light’ while in Colombia, He would not have had enough money left for the rest of creation. Because the truth is that in a country where there are projects which have cost a lot, few have cost as much as the expansion of the electric sector during the last ten years.”

So began an article entitled “The Black Hole,” in Semana, Colombia’s Time magazine. Electricity expansion plans accounted for close to 30 per cent of Colombia’s debt. As the Minister of Mines, Oscar Meija, put it, “the electric sector became a kilowatt carnival.” All over the Third World, kilowatt carnivals were sucking in billions of dollars of foreign loans.

The conduits for these electricity investments, as with most other Third World investments, were state enterprises. Treating development as a product to be assembled, Third World governments set up a myriad of state corporations to invest in the component parts: energy projects; the steel industry; bauxite mines and aluminum plants; agricultural marketing boards; railways, airlines, roads, and bridges; paper plants; textile companies; computer companies; marble and tinted glass operations. Next to governments themselves, state enterprises became the Third World’s largest accumulators of foreign debt.

Of these, the state electricity companies throughout the Third World borrowed the most. The electric companies favored huge plants, but these took decades to build, piling up enormous financing costs before generating any revenue. Assuming that a growing economy required a growing energy supply, and knowing no bounds, Latin American countries planned to double their electricity supply every eight years.

The most costly light in Colombia’s kilowatt carnival was the Guavio dam. Delays due to collapsing tunnels and other technical problems, and stubborn landowners who refused to evacuate their homes to make way for the dam, doubled Guavio’s cost to over $2 billion. The cost overruns equaled the cost of building a subway system for the capital city of Bogota, half of the country’s annual coffee exports, or half of the country’s social spending.

In Brazil the story was much the same. A fabulously expensive electricity expansion program contributed over $25 billion to the country’s foreign debt. Record-breaking dams — the world’s largest and the first in the rainforest — proved unnecessary. By 1983, electricity capacity exceeded demand and Brazilians were admitting that they had over-indulged. While “many countries over-consumed,” they said, “Brazil over-invested.”

Despite shaky financial estimates touting many of Brazil’s dams, electric power utilities had little trouble raising construction money. One syndicated loan for the Itaipu dam aimed to raise $50 million. The Western banks offered $103 million, and the Brazilians took it. In the end, Itaipu’s cost overruns came close to 400 per cent.

Zaire’s equivalent of Itaipu was the Inga-Shaba hydroelectric project and power transmission line, the longest in the world. Originally estimated at $450 million, it ended up costing over $1 billion — equal to 20 per cent of Zaire’s debt. U.S. Export-Import Bank loans and guarantees to commercial banks covered the initial bill, while commercial banks covered cost overruns, as the project fell further behind. “It’s taking so long that a lot of the equipment they’re putting at the two ends is deteriorating,” one U.S. embassy official noted. When the project was finally completed, the power — destined for Zaire’s rich copper mines — was no longer needed: the Belgians, who were running the mines for the Zaire government, had tapped their own sources of external finance as well as locally available hydroelectric power to keep themselves afloat.

Nuclear power investments, like more conventional electricity investments, also turned into financial quicksand.

Brazil’s nuclear power program was eviscerated, with only two of nine reactors likely to be completed. Mexico’s only experience with nuclear power — two reactors at Laguna Verde near the ancient port city of Veracruz — were finished in 1990 after an on-again, off-again construction schedule that stretched over two decades. Laguna Verde’s costs, originally projected at $1 billion, eventually amounted to almost $4 billion.

Vying in popularity with state electricity utilities in attracting loans were other state energy companies, particularly oil companies, which lenders viewed as blue-chip borrowers. Next to the Mexican government itself, Pemex, the country’s state oil monopoly, was considered Mexico’s best credit risk, despite its notorious inefficiency, with production costs nearly twice the industry average. (The Mexican government even used Pemex to borrow money for general government purposes.) By 1982, Pemex accounted for about one-third of Mexico’s public sector medium-term debt.

Like Pemex, other national oil companies, such as Pertamina in Indonesia and Petrobrás in Brazil, frequently went to international capital markets, racking up debts the government would eventually assume, and political obligations that destined financial disaster.

Petrobrás was created in the 1950s, when “public sector” became an economic catch-phrase and state-run enterprises promised industrial growth without pain. It became Latin America’s largest corporation, and one of Brazil’s largest losers, politically obliged to charge low prices for its oil, one-third of which is imported.

Compounding its woes, Petrobrás became an infirmary for sick ventures of various kinds and a development agency for government programs. In addition to petroleum, Petrobrás counts among its products sugar-cane alcohol (at a cumulative investment cost of about $650 million), naphtha (at an annual loss of about $500 million), and even lobster exports to the U.S. (at an unknown cost). Unpaid oil bills by other state entities come to about $600 million.

Taken together, oil and electricity state enterprises often accounted for half of a nation’s foreign debts. Close behind were the national steel companies.

No country, according to conventional wisdom, could be modern without a steel industry. The Pearson Commission considered steel consumption “one of the basic indicators of industrialization.” Third World governments and their financiers, in an attempt to assemble developed economies, created Sicartsas everywhere.

Like other state enterprises around the world, in Mexico Sicartsa became a metaphor for nationalism, touted to the public as a protector from self-serving private interests, whether foreign or national. Yet Sicartsa, again like other state enterprises, became another state vanity project and a costly folly for all Mexicans. The Sicartsa complex remains unfinished: Mexico can no longer pay to put it in place. Completion would cost billions more, and the completed plant would then only lose money. Mothballing the complex for a more propitious time would cost $2.1 billion. Shutting down for good would cost $1.4 billion. Sicartsa’s functioning Phase I has debt obligations that consume more than 30 per cent of its revenues, preventing it from showing a profit. To keep up with the debt, the government replaces old loans with new. The government would like to privatize it, but negotiations with buyers have been difficult — Sicartsa’s production costs are twice those of South Korean steel mills.

The Sicartsa experience occurred in other Third World countries. In Brazil, Siderbrás’s Açominas steel plant in Minas Gerais, built in the late 1970s at a cost of more than $2.5 billion, was financed almost entirely with external borrowing. Within a few years that cost had escalated to $5 billion and the plant was idle.

Siderbrás, “once the jewel in the caps of ruling generals,” according to Euromoney, “has fallen deepest into the mire.” With estimated debts of $13.5 billion, the group of steel-making companies posted losses of over $7 billion in 1988 to make it the Third World’s heaviest-losing company, with almost nine times the losses of British Coal, also state-owned. Companhia Siderurgica Nacional, one of the group, lost $7 billion during the 1970s by selling its product to Brazilian industry at 40 per cent below world steel prices. Brazil’s state steel companies share responsibility with the nation’s state electricity and oil companies, Eletrobrás and Petrobrás, for the bulk of Brazil’s public indebtedness.

Venezuela’s state steel company, SIDOR, is in similar dire straits. Estimated to have cost more than $6.5 billion, by the end of the 1980s SIDOR was reckoned to be “technically bankrupt”: it had a market value of $600 million and debts amounting to $1.5 billion.

In Togo, after the state steel company built a mill with West German financing, the Togolese government realized that no iron ore was available to start up production. It ordered the German technicians to dismantle an iron pier located at the port — a pier that had been constructed by Germany prior to World War I and still functioned well. Once the steel mill had exhausted the pier as a feedstock, it closed down.

Nigeria also purchased an integrated steel complex from Germany, financed by a combination of export credits and a $350 million term loan syndicated by German commercial banks. According to former banker Richard Lombardi of the First National Bank of Chicago: “The steel plant was originally conceived to utilize on-site, relatively low grade iron ore deposits. But Nigeria typically was sold — and bought — at the top of the line. With subsequent add-ons, the steel plant became increasingly sophisticated.” In fact, so sophisticated that the Nigerian government was forced to import higher quality ore. Even ignoring the cost of having to purchase the higher grade ore, the cost of the steel complex will exceed $1 billion. That works out to be approximately $12 for every Nigerian man, woman and child, the equivalent of one-tenth of their average income for a steel mill. And this amount covers only the loan principal — not interest, commissions, nor front-end fees, nor the cost of refinancing.

The iron and steel complex and copper refinery for which Zaire’s Inga-Shaba power line was built met the same ill fate. The Maluku steel plant, as it was known, never operated at more than 10 per cent of its capacity; its steel is of poor quality and costs three or four times as much as imported steel; it employs 1,000 people instead of the 10,000 promised.

Throughout all these financial debacles in country after country, foreign financiers showed no interest in avoiding bad projects. One study found an unusual number of boondoggles in countries which, having enjoyed large and sudden windfalls from sharp commodity price increases, subsequently enjoyed another windfall in the form of abundant loans from “impressionable and over-enthusiastic international bankers.” A study sampling 1,600 state vanity projects in seven oil-exporting countries found them to have been plagued with frequent cost escalations, completion delays, and postponements or suspensions: almost half of the projects over $1 billion went wrong in one way or another, with the average cost escalation being 109 per cent. In general, the larger the project, the greater the waste. Even those that were completed as expected often turned out to be economic albatrosses. A sugar project in Trinidad completed in 1983 was saddled with production costs five times above those of efficient world-scale producers, even though the latter sometimes had far higher labor costs.

To Argentineans, the country’s state-owned enterprises — which first started under the government of Juan Perón — are the culprits of Argentina’s economic collapse. One former secretary for growth promotion from the 1980s explains the problem: “The largest 12 of them account for 80 per cent of the fiscal deficit. National railroads lose about $5 million a day. Aerolineas Argentinas loses close to $1 million daily.” The losses are not difficult to explain, according to Hector Zanelli, Executive Vice President of Ferrocarriles Argentinos, a state-owned railway company with a bloated payroll of 95,000. “Our salaries cost us about $500 million, and our sales are about $300 million, so you can see where our problems start.” One consultant involved in the discussions over possible privatization of the state-owned railway estimated that half of Ferrocarriles’ employees could be cut from the payroll without a diminution of service.

State enterprises throughout Latin America borrowed so much from foreign sources that they soon accounted for an unprecedented proportion of the country’s total investment. With enormous debt repayment commitments exacerbated by outdated, inefficient production methods and a requirement that state enterprises sell goods at below cost, they drove public sector deficits. In the mid-1970s, state enterprises in the seven largest Latin American economies accounted for one-quarter of the public sector deficit. That rose to about one-half by the early 1980s. Brazil’s state enterprises by 1990 accounted for roughly half of its foreign debt. In Mexico, where public expenditures accounted for almost half of the nation’s economic activity, state enterprises were responsible for half of that.

Most large enterprises touched by state hands suffered from incredible cost overruns, excessive foreign borrowing, and levels of economic inefficiency so great that they have often assumed comical proportions.

In the Republic of the Ivory Coast, a $60 million sugar plantation and mill, discouraged by the World Bank, was later financed, along with five other complexes, by the export credit agencies of Belgium, Canada, Holland, the U.S., and France, for an overall cost exceeding $1 billion. When the plants started producing sugar in the late 1970s, production costs for a pound of sugar averaged nearly 300 per cent of the world price. In all six cases, investment expenditures surpassed original estimates by more than 200 per cent. According to former banker Lombardi, “The entire sugar program, including original feasibility studies, down payments, front-end fees, and early interest payments, were funded on borrowed money, that is, through a combination of export credits and associated commercial bank loans.” The vignette ends, Lombardi explains, “with the picture of an Ivory Coast farmhand spraying unwanted molasses on a dirt road in order to keep the dust down.”

State enterprises depended on state guarantees to finance their expansion. They then depended on other state subsidies to make their operations seem viable.

So numerous were the subsidies, so twisted were the tasks assigned them, so unrealistic were the prices set by fiat, that centrally planned economic chaos was inevitable. Ghana’s State Fishing Corporation was forced to sell fish at the same price everywhere in the country, regardless of costs. Brazil’s regional utilities were prohibited from making more than a 10 per cent profit — anything over that figure was to be handed over to Eletrobrás, the national utility. The regional utilities, to keep profits in their own enterprise, built more electricity plants regardless of need. Egypt’s electricity utilities subsidized 87 per cent of industry’s electricity cost, accounting for 70 per cent of the government’s budget deficit.

State enterprises dominate the debt landscape in countries large and small, in governments of all political stripes. When Malawi became independent in 1964, its unabashedly capitalist president Hastings Kamuzu Banda announced a development policy based on the “acquisitive instincts of the people.” But driven in part by fears of domination by foreign companies, Banda set up three state firms to promote agriculture, industry, and local entrepreneurs, which came to account for one-third of the country’s GDP.

Sources and Further Commentary

For an excellent review of the costs of the Colombian electricity sector, for the quotation opening the chapter, and for specific information on the Guavio dam, see “El agujero negro” and “Un elefante llamado Guavio”, both in Semana, Colombia, April 4, 1989. Also see International Water Power & Dam Construction, U.K., July 1987, February 1988, and May 1990 for further information on the Guavio dam. In addition to funding from the Inter-American Development Bank, Guavio was also funded by the Canadian International Development Agency and the Canadian Export Development Corporation.

Sources for the estimates of how much of the Third World’s debt was accounted for by electric utilities and state energy companies include Economic and Social Progress in Latin America, 1989 Report published by the Inter-American Development Bank, 1989; Latin American Debt by Pedro-Pablo Kuczynski, The Johns Hopkins University Press, Baltimore, 1988.

For Brazil, in particular, data on the debt accumulated by Brazilian state enterprises comes from “Extracting Power From The Amazon Basin” by John A. Adam, IEEE Spectrum, August 1988; “Too Big, Too Bad” in The Economist, U.K., March 12, 1983; “Losses Grow As Payrolls Blossom” in A Supplement to Euromoney, U.K., September, 1989. For details on Itaipu’s borrowings see “Hydro project is to receive $103 million” in The Globe and Mail, Toronto, June 1, 1984; “Itaipu celebrates completion amidst financial crisis” in The Financial Times, U.K., May 7, 1991; “Brazil: Itaipu dam has `critical problem,’ says official” in Gazeta Mercantil; Swaps: The Newsletter of New Financial Instruments, vol. 3, no. 8, Washington, D.C., August 1989.

For more information on Zaire’s Inga-Shaba hydroelectric project, see Debt Trap by Richard Lombardi, Praeger, New York, 1985; A Fate Worse Than Debt by Susan George, Penguin Books, London, 1988.

Details on Brazil’s nuclear power program can be found in “Datafile: Brazil” in Nuclear Engineering International, U.K., April 1990, and Impacts of Great Energy Projects in Brazil by Luiz Pinguelli Rosa and Otávio Mielnik, International Development Research Centre, Ottawa, August 1988. On Mexico’s nuclear power program see “Mexico’s Nuclear Paradox” by Michael Redclift in Energy Policy, February 1989; “Mexico: Nuclear Debaters Fired” in IFDA dossier 74, Switzerland, November/December 1989; “Storm gathers over Mexico A-plant” in The New York Times, May 2, 1987.

For details on Pemex see Latin American Debt by Kuczynski; “Well of nationalism: oil’s role in Mexico raises tricky issues for a free-trade pact” by Matt Moffet in The New York Times, November 26, 1990. For information on Petrobrás see “Latin paradox: lofty crude-oil prices drive Brazil’s producer deeper into the hole” by Thomas Kamm in The Wall Street Journal, October 25, 1990. In a special advertising supplement in The Wall Street Journal entitled “Petrobrás: a catalyst for Brazil’s development,” March 21, 1986, Helio Beltrao, president of Petrobrás, said: “Brazil’s debt problem doesn’t affect Petrobrás credit and operations. All the important banks extend credit to us. As a matter of fact, we can’t use all the credit we are offered.”

The detail on Mexico’s Sicartsa steel plant comes from “Paths to growth: a steel plant shows how U.S. and Mexico differ on development” by Mary Williams Walsh in The Wall Street Journal, May 2, 1986 especially. A description of the reach of the public sector into Mexico’s economy, primarily as a result of the bank nationalization in September 1982, appears in “Disposing of banks’ holdings a problem for Mexico” in The Globe and Mail, Toronto, September 17, 1982.

On the steel industry see “Losses Grow As Payrolls Blossom” in A Supplement to Euromoney, U.K., September, 1989; Latin American Debt by Kuczynski; “What Brazil’s new president will face” in The Globe and Mail, Toronto, November 15, 1989; “Brazil to sell state-owned CSN once it’s pulled out of the red” by James Brooke in The Globe and Mail, Toronto, June 4, 1990; “Debt-burdened Venezuela set to sell off investment offspring” by Simon Fisher in The Globe and Mail, Toronto, December 26, 1989. Details of Togo and Nigeria’s steel saga are from Debt Trap by Richard Lombardi (as above). About Zaire’s Maluku steel facility see A Fate Worse Than Debt by Susan George (as above).

Sources on the dismal record of state vanity projects include The Debt Threat by Tim Congdon, Basil Blackwell, London, 1988. See also Oil Windfalls: Blessing or Curse? by Alan Gelb and associates, published for the World Bank by Oxford University Press, 1988.

Information on the expense of Argentina’s state enterprises comes from “Argentina trains, economy spin wheels” by Roger Cohen in The Wall Street Journal, March 2, 1989; “Will reality force the hand of Argentina’s Peronists?” by Manuel Tanoira in The Wall Street Journal, June 9, 1989; “Privatization campaign in Argentina bogs down” by Thomas Kamm in The Wall Street Journal, October 25, 1990; “Argentina: Menem Ditches the Dogma” in A Supplement to Euromoney, September 1990.

For the total economic costs of state enterprises in Latin American economies see Latin American Debt by Kuczynski; “Brazil may lay off 400,000 to curb government costs” in The Globe and Mail, Toronto, May 10, 1990; “Billions come and go” in The Globe and Mail, Toronto, October 6, 1986.

Information on the Ivory Coast’s sugar complex comes from Debt Trap by Lombardi. Details on Ghana’s, Egypt’s, and Malawi’s state enterprises come from “African Privatization: How’s It Going?” by Colleen Lowe Morna in Development Forum, vol. 18, no. 6, New York, November-December 1990; A Special Supplement to Euromoney, U.K., September 1990. See also “Blame Africa’s own leaders for `black elephant’ aid” by George B.N. Ayittey in The Globe and Mail, Toronto, August 4, 1988; “African leaders put power first says Conable” by Peter Riddell in The Financial Times, U.K., April 26, 1990; Industrialization in Sub-Saharan Africa: Strategies and Performance by William F. Steel and Jonathan W. Evans, World Bank Technical Paper no. 25, The World Bank, 1984.

One of the main reasons for privatizing state enterprises is to reduce the state deficits. For further information see “Privatization Fever Hits Latin America” by Lenny Glynn, in Global Finance, New York, March 1990; “Privatization, Venezuelan style” by Carlos Ball, in The Wall Street Journal, June 1, 1990; “The Future Looks Brighter” in The IDB, Inter-American Development Bank, November 1990; Privatization and Public Enterprises, by Richard Hemming and Ali M. Mansoor, IMF, January 1988; “Privatisation Can Be A Complicated Process” in Euromoney, U.K., September 1990; Privatization: An Overview of Worldwide Experience With Implications For The Electric Utility Industry In The United States, by Russell L. Klepper, for the Power Supply Policy Group, Edison Electric Institute, Washington, D.C., 1989; “Privatization in Honduras Called Lesson for Latins” in World Bank Watch, U.S., February 26, 1990; address by Miss Zélia Cardoso de Mello, Minister of the Economy, Finance and Planning, Brazilian governor to the Inter-American Development Bank Annual Meeting, Montreal, April 2, 1990; Privatizing the World: A Study of International Privatisation in Theory and Practice by Oliver Letwin, Cassell, London, 1988; “Caribbean & Central America Give Privatization Bandwagon a Push” by Richard C. Schroeder, in Annual Meeting News, Washington, D.C., September 25, 1989.