# **Introduction**

Reliable and affordable infrastructure is essential for a well-functioning economy. Today in Europe and Central Asia (ECA) underperforming public utilities impede more rapid economic growth. This working paper raises a constellation of issues—high losses, non-payment of bills, and tariffs set below costrecovery rates—that block progress in the power, natural gas, and water sectors. The paper reviews available data on these sectors and begins to develop a model to quantify the burden on national budgets of infrastructure policy and implementation decisions. The intention is to widen opportunities for overall improvements in allocating scarce budgetary resources by offering policymakers data that will be useful to (a) understand the order of magnitude of current hidden fiscal costs, (b) estimate the costs of current and future policy choices, (c) and reduce the burden on consumers.

Implicit subsidies to public utilities can be considered an illegitimate claim on public resources. Direct subsidies to utilities are formally allocated and formally recorded ‘on the books.’ For a discussion of implicit subsidies and their impact on the quasi fiscal deficit, see Saavalainen and Ten Berge (2004). In contrast, ‘hidden’ costs, although accumulated by utilities, go unrecorded, thereby creating a fiscal burden on the local or national government that amounts to a hidden subsidy. Typically utilities compensate for these hidden costs by reducing investment in maintaining the utility; they may also delay or forego essential maintenance and repairs or reduce the workforce, actions that trigger a downward spiral of significant deterioration in the value of assets, declining service quality, and increasing cost for each unit of service provided. When this happens, losses are increased substantially and abnormally high investment is required to carry out repairs, which is rarely cost effective.

# **The Cost of Policy Choices**

The vicious cycle—that begins with hidden costs and proceeds to hidden subsidies—means that when governments finally absorb accumulated debts, they do so at the cost of adding to the national debt or reducing funding for other programs. This cycle has persisted in part because of difficulties in quantifying the order of magnitude of ‘hidden costs.’ The Hidden Costs Calculator model —developed through collaboration between the World Bank Group and the International Monetary Fund (Saavalainen and Ten Berge, 2006)—was designed to provide a single measure for all implicit subsidies so that policymakers can weigh the price of policy actions (or inactions) that could, but do not, have a fiscal offset. One important criterion for developing the model was to calibrate carefully the tradeoffs between complexity and comprehensiveness on the one hand and ease of use on the other. The major advantage of this model is that—using existing data—it can provide a single measure for hidden costs that can be easily calculated, tracked, and reported; therefore it can monitor and benchmark trends across sectors and countries without extensive or costly data collection.

# **The Hidden Costs Calculator Model**

The model, the Hidden Costs Calculator, is designed to provide insight into three key components of hidden costs affecting ECA infrastructure: poor bill collection rates; excessive losses due to inefficient operations or theft from the network in power, gas or water systems; and tariffs set below cost-recovery rates (i.e., amounts needed for long-run operations and maintenance, investment, and normative losses). This model compares the difference between actual revenues and revenues that could be anticipated in a well-functioning system operating with cost-covering tariffs, bills paid, and losses normative for networks of a certain age and design.

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