TCE & Scaling-Up Infrastructure: A Pakistan Sewage Treatment Plant

Apr 3, 2014 — Neil Boyle

PART ONE: Background


This three part workshop précis examines the application and use of institutional analysis in the preparation and implementation of large scaled-up infrastructure and as case study concentrates on the development of a new sewage treatment plant for the metropolitan area of Karachi, Pakistan by the Karachi Water Supply and Sewerage Board (KWSB).  Institutional analysis is based on Transaction Cost Economics (hereafter referred to as TCE); a sub-field of economics that incorporates economic organization as part of economic analysis.  Part One is Background.  Part Two is Workshop.  Part Three is Subject Matter Details.

KWSB is a semi-autonomous public water authority responsible for the water supply and sanitation of Metropolitan Karachi. The proposed sewage treatment plant is scheduled to be built in three years, but reform to centralize sector sources of funds is expected to take much longer as it will be voluntary. The plant is to treat sewage for a largely underserved metropolitan city that contains 20 million people, serves as Pakistan’s leading financial, industrial, and trading center, and contributes more than 35 percent of GDP.  Population grew at 6 percent per annum over the past decade.  (Wilson Center, 2013)

In 2014, we assess 40 percent of Karachi’s population live in subserviced slums (Katchi Abadis) and on average Karachi residents receive 4 hours of water supply per day. Moreover, nearly half of all sewage remains untreated, dumped into nearby creeks (nallahs) or pumped via sea outfall into the Arabian Sea ruining Pakistan’s southern sea coast.

WSS Sector Utility Providers

Developing a new sewage treatment plant in Pakistan’s water supply and sanitation (WSS) sector offers an opportunity to address both the physical, financial, and political economy issues that are currently constraining the sector.  Actually, sector reform turns out to be the pivot upon which financial sustainability of the treatment plant is based.

In 2014, Karachi’s WSS sector  remains extractive and strained by the imbalance between sector sources and uses of funds, as well as institutional resources.  The result is a maladapted sector that is unlikely to find solutions on its own because vested political interests almost certainly would discourage such effort and neither KWSB nor any of its 16 utilities (8 municipal and 8 cantonments) have sufficient administrative authority and political capital to drive the change process.  (Acemologu and Robinson, 2012)

KWSB has sunk assets and recovers a little less than twice its cash operating costs and only a tiny portion of capital costs.  Pricing is political and likely to remain low given widespread domestic consumption; the negative impact pricing has on the voting constituencies, especially with continued poor quality of delivered services.  Media exacerbates the problem, especially as tariffs are likely to increase, rather than decline, while political capital remains negative. (Levy and Spiller,1994)

Sector strategies are often politicized and typically skewed toward private rather than public interests for a small but wealthy strata of the population leading to higher performing utilities that serve them at little additional cost recovery for the WSS sector overall.  For example, 8 cantonments that pay nominal tariff rates, similar to the other utilities in the sector, for the water supply and sewerage network infrastructure that is built, operated, and maintained by KWSB generate more than 70 percent of household incomes in metropolitan Karachi.

Developing a new project offers opportunity to examine the current context and prepare for a higher performing WSS sector through leveraged reform efforts that address the growing political risks of continued WSS sector underperformance, which almost certainly will include a worsening of economic growth and urban development as productivity succumbs to water borne infectious diseases and further rationing of water supply in an already water scarce country.[1]  Reforms will address the financial and institutional problems facing KWSB, which are profound and  affect the economic organization of the WSS sector of the Karachi Metropolitan area, including the sector’s organization structure, its sources and uses of funds, volumetric tariffs and user charges, planning and accountability, the role and responsibilities of the 16 utilities in the sector, management and reporting relations of the utilities, collection policies, and operations and maintenance (O&M).

Creditworthiness & Sector Reform

Large state owned enterprises (SOEs) such as KWSB that are not yet creditworthy in private capital markets prolong dependence on the public purse and on the incentives that disable public policies, leading to a vicious cycle of mal-adaption. One way to break the grip of fiscal dependence of KWSB on the public purse is for KWSB to achieve creditworthiness through   smart centralization in the WSS sector that would promote economies of scale and scope, the alignment of contracts, and the credible commitment and lock-in of all contractual parties.

Today KWSB is unlikely to become creditworthy because of structural financial imbalance between sector sources and uses of funds.  The costs of the primary and secondary infrastructure that serve Karachi is borne primarily by KWSB.  The sources of funds, on the other hand, are fragmented among several utilities (approximately 16) including KWSB.  Furthermore, sector economies are unavailable to build political capital that will change the political economy of the WSS sector.

. Under reformed sector conditions, KWSB and sectoral creditworthiness are feasible, because Karachi has the basic apparatus in place but it is dysfunctional and maladapted because of the extractive political economy. Under a program designed to centralize WSS sources and uses of funds, Karachi would gain creditworthiness, helping to improve sector performance and political capital long-term

A credibly committed organizational restructuring of the WSS sector would provide economies of scale and scope, and such aggregation would  facilitate transformation of KWSB into a public-private holding company (KWSC) consisting of all existing sector municipal and cantonment utilities.  This centralization of the sources of funds of the sector would take time. Control over the uses of funds would be appropriately decentralized among the utilities into  autonomous corporate divisions of KWSC, much like the US federalized union of states where sector-wide economies are handled by the holding company and individual utility economies by each corporate division thereby apportioning autonomy rationally to all utilities leaving operations and maintenance and civil works in the hands of each corporate division. [2]

Workshop Objectives

Achieving creditworthiness and structural reform is what TCE does best. The TCE component of this workshop will address how to generate the reform and improvements that will help KWSB obtain the creditworthiness needed.  The work will focus on assisting key actors to align sector incentives, develop credibly committed agreements, and draft and supervise contracts that will be designed to lock-in and guide the parties during project implementation.  KWSB will be guided to complete the merger and acquisition of Karachi’s utilities, most importantly the 8 cantonments.

Project work to help a SOE like KWSB achieve creditworthiness will entail achieving smart centralization that entails the best of centralized and decentralized organization.  It involves inserting prudential financial management practices into KWSB and, supporting an inclusive sector political economy.  (Acemologu and Robinson, 2012)  The two must go together and will require a strategic plan that goes beyond the scope of the three year physical construction of the new treatment plant. The focus will be on achieving scale and scope economies, contractual alignment, and credible commitment capabilities, and these contractual features will be designed, implemented, and monitored over the life of the project.

KWSB’s subsequent demonstration of improved management capacity and success over a period of time will increase political support and help the sector shift from an extractive to an inclusive political economy that will benefit all consumers. The improved system will provide economies of scale and scope, realigned incentives, and a graduated program of full volumetric pricing, lifeline support for the poor, and a financially sustainable WSS sector for the largest and most productive metropolis in Pakistan.

PART TWO: Workshop


Participants will work in small groups on clusters of questions picked from the lists below.  The first day will be spent on Institutional Analysis; the second day on Project Preparation; and the third on Project Implementation.  At periodic intervals through each morning and afternoon session, the small groups will be requested to report out.  At the end of each report and intermittently, the trainer followed by brief explanatory handouts, will provide explanatory summary lecturettes that bring consistency to the group reports.

Objective & Subject Matter

The task for the participant is to analyze and understand the contractual relations of the transactions between KWSC and the chain of support transactions, including the private international contractor through each of three major phases of the project cycle. The following questions will be answered in the workshop:

Institutional Analysis

Introduction, Definitions, Concepts

  • Identify the main transaction of the project, its components and their roles;
  • Identify economic organization of the main transaction, its role and functions;
  • Identify production and governance relations of the economic exchange of the main transaction and explain the interplay between the two;
  • Identify the “rules of the game” and the “plays of the game” of the transaction and the relations between the two;
  • How do actions of human actors fit into a working economic organization;
  • Define the problem set of economic organization;
  • Identify constraints to efficient production costs;
  • Identify constraints to efficient transaction costs;
  • Identify constraints to efficient total costs;
  • Identify the main reform agenda of the transaction.

Project Preparation

  • Identify ramifications of bounded rationality;
  • Identify quasi-rents and opportunism and how they come about;
  • Identify incentive ramifications of the specificity of the exchange asset;
  • Identify the main incentives of the transaction,
  • Identify main hurdles of procurement;
  • Identify main hurdles of negotiations;
  • Negotiating credibly committed negotiations;
  • Set the stage for credible commitment and lock-in;
  • Identify main hurdles of contracting;
  • Provisioning contracts with superior institutional arrangements;
  • Writing credibly committed contract clauses.

Project Implementation

  • Describe the actions of actors falling off of the contract curve;
    • Giving and taking credible commitment;
    • Making credible threat a reality;
    • Overcoming hurdles of actors falling off of the contract curve;
    • Paying attention to incentive structures of actors during project monitoring;
    • Describe the action of realigning incentives during project monitoring;
    • Recruiting specialized project monitors; and
    • Discuss hypothesis that a successfully operating and scaled-up WSS program will likely change the political economy of the WSS sector from extractive to inclusive.

PART THREE: Subject Matter Details


As mentioned in Section D, achieving sustainable sector creditworthiness entails 1) prudential financial management; and 2) an inclusive political economy throughout the sector. The five following activity descriptions make up the institutional component of the proposed sewage treatment plant and are the basis from which the workshop subject matter questions have been derived:

a.     the internal incentive structures of the Board are realigned and contractually locked-in so that it functions in accordance with the demands of the job.  Two reforms must take place:  technical assistance is provided to first, corporatize KWSB, and second, to install the M-Form of organizational structure of the new corporation, both of which help KWSC to be fully incentive compatible and inclusive with the aims of the smaller utilities and cantonments and of the WSS sector overall;

b.     external incentives of the transaction are contractually centralized and locked-in under one divisionalized and competitive roof (the holding company) in order to rationalize and reduce the cost of multiple delivery systems (bureaucracy and O&M are high sector costs) that fragment and prevent the efficient division between sources and uses of sector funds. The objective is credibly to align the incentives of the corporatized KWSC with the incentives of each restructured O&M zone in the WSS sector in metro Karachi.  This is done by the holding company KWSC embarking on a program to buy municipal and cantonment utilities to merge with.  Utilities and cantonments that express willingness would be offered a package by KWSC.  In exchange, each utility would yield ownership in return for financial compensation and improved customer service, but more importantly, financial sustainability for the sector;

c.     internal KWSC incentives and external transaction incentives (e.g., for professional, community and NGO associations) are realigned and contractually locked-in so that the large volume and cost of bulk and treated water that had been lost to nonrevenue water (NRW) is reduced to the lowest level of water supply production and distributed and priced volumetrically at full costs throughout the sector; leaving appropriate lifelines for the poor;

d.     internal KWSC incentives and external transaction incentives (e.g., for contractor associations and training institutes) are realigned and contractually locked-in so that the capacity for world class specialization in operations and maintenance (O&M), including energy efficiency for water and sewerage sustainably develops and prospers; and

e.     The logic that the political economy of the sector is linked to the program that operates within its borders is given.  We assert that the causality of the link is circular in nature; it is two-ways.  If it is two ways, then a successful sector reform program is likely to positively influence the sector political economy in two ways:

           a)     the hurdle for extractive decisions are made more difficult by decentralizing the authority for tariff setting among numerous autonomous utilities that experience centralized oversight; and

           b)     the hurdle for inclusive decisions are made easier by strong links between the decentralized utilities and their customer base.

Because nothing works as well as success, the objective of the component is to credibly create the proposed project with its institutional reform components so that the program is contractually and organizationally locked-in and assured to function as planned and that expectations are met and there is a minimum of contract and program instability. Contracts are negotiated, written, and managed with strong credibly committed continuity safeguards built into them.  TCE tells us this is feasible by keeping economic agents incentives aligned to their positions “on the contract curve”, a task that is within KWSC’s capabilities.


 Levy, Brian and Pablo Spiller. 1993. “Regulation, Institutions, and Commitment in Telecommunications: A Comparative Analysis of Five Country Studies.” Unpublished manuscript.

Williamson, Oliver E. 1971b. “The Vertical Integration of Production: Market Failure Considerations.” American Economic Review 61 (May): 112-23.

__________. 1973. “Markets and Hierarchies: Some Elementary Considerations.” American Economic Review 62 (May): 316-25.

__________. 1975. Markets and Hierarchies: Analysis and Antitrust Implications. New York: N.Y. Free Press.

__________. 1976. “Franchise Bidding for Natural Monopolies – In General and with Respect to CATV.” Bell Journal of Economics 7 (Spring): 73-104.

__________. 1979a.  “Assessing Vertical Market Restrictions.” University of Pennsylvania Review 127 (April): 953-93.

__________. 1979b. “Transaction Cost Economics: The Governance of Contractual Relations.” Journal of Law and Economics 22 (October): 233-61.

__________. 1983. “Credible Commitments: Using Hostages to Support Exchange.” American Economic Review 73 (September): 519-40.

__________. 1985. The Economic Institutions of Capitalism. New York: Free Press.

__________. 1987. “Transaction Cost Economics: The Comparative Contracting Perspective.” Journal of Economic Behavior and Organization 8 (December): 617-26.

__________. 1988. “The Logic of Economic Organization.” Journal of Law, Economics, and Organization 4 (Spring): 65-93.

__________. 1996. The Mechanisms of Governance. New York: Oxford                         University Press.

__________. 2002. “The Theory of the Firm as Governance Structure: From                   Choice to Contract”. Berkeley: University of California Press (essay on line).

__________, and Scott E. Masten, eds., 1995. Transaction Cost Economics. Aldershot, Eng.: Edward Elgar.


[1] Pakistan is officially rated internationally as “water scarce” because available water resources per capita are less than 1000 m3 per year.

[2] Called the M-Form of organization structure, the proposed corporate structure for the WSS sector was invented by Alfred Sloan when he headed up General Motors Corporation in the early 1900s when Oldsmobile, Buick, Chevrolet, and Plymouth flourished as autonomous auto manufacturers under the GM holding company.  M-Form became the standard model for large modern (multi-national) corporate structure worldwide.

This article is filed in technicaltools. Start or participate in a discussion below or click here to see more articles in this category.


Please share your thoughts and comments about the article. We look forward to hearing from you. Fields marked with "*" are required: