budget deficits, posing also a formidable challenge in term of fiscal policies and macroeconomic stability in developing countries.

Equity goals include ensuring universal access to services by, if necessary, charging tariffs below costs or extending service into unprofitable areas. SOEs are given additional developmental objectives, such as ensuring employment, creating necessary infrastructure for economic development, and so forth.<sup>**7**</sup> All over the world, but particularly in developing countries, prices have not been seen just as an instrument to reach purely allocative aims. Redistributive aims are often present especially with the aim of protecting the poor. Many economists would argue against the use of pricing to redistribute income, and consider progressive income taxation and welfare subsidies more effective means to redistribute incomes. Redistributive price distortions can, to some extent, damage the efficiency of the overall economic system.

Even if in principle all such objectives can be captured in the definition of social welfare and developmental goals, if goals cannot be clearly quantified specified, a good performance cannot be distinguished from a bad one. More importantly, SOE managers cannot be rewarded on the basis of performance. The problem is further complicated by the fact that SOE management does not face any credible threats for non‐performance from the _external_ environment in which it operates. Hence, we cannot limit to consider internal governance factors leading to SOE inefficiency, but we also need to take into account additional external governance factors. The threat of takeover or bankruptcy as an _ex ante_ performance and monitoring instrument is non‐existent. Barriers to exit have insulated the management of SOEs. Continued state‐directed credit, equity injection and finance deficits have created perverse incentives for managers of SOEs and perpetuated soft‐budget constraints.<sup>**8**</sup> This leads us to consider how to improve the **_performance evaluation_ and** **_monitoring_** of SOEs. In the absence of a robust performance evaluation it is hard, if not impossible, to provide incentives or delegate autonomy for SOEs. The problem with defining performance criteria for SOEs is due to the fact that some objectives (notably the developmental ones) are difficult to be quantified and that in many cases agreement is difficult to be reached on the tradeoffs. However, governments may want to consider evaluating a public enterprise in a similar way to a private one. Conventional _profit_ measures risk being unfair as they fail to capture the additional equity objectives that the SOEs are asked to fulfill. The second best solution would be to revaluate the accounts using shadow pricing.<sup>**9**</sup> However, _shadow prices_ are complex to be defined in practice. Governments can still consider following some simple guidelines. First of all, it is desirable for the performance evaluation to focus 7 In general the literature distinguishes between commercial and non‐commercial goals, assuming implicitly that the commercial goals pursued by the private sector always lead to productive and allocative efficiency. As noted in the discussion above this may not necessarily be the case, unless we face a perfectly competitive market structure, a case that is not particularly relevant in the case of infrastructure. Here, to avoid any _ad hoc_ assumptions on intrinsic efficiency connected to ownership, we find it more useful to distinguish between efficiency and equity goals.

8 The relevance of soft budget constraints has been highlighted in the seminal contribution by Kornai. For a comprehensive survey of the issue see Kornai _et al._ (2003). Recent empirical studies attempted to disentangle the contribution of internal and external governance factor in driving SOE inefficiency in a number of developed countries. See Bartel and Harrison (2005) and Bertero and Rondi (2002), in the case of the US and Italy respectively.

> 9 For a definition of public and private sector discount rates see Grout (2003).

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