In the mid-1990s, Brazil began restructuring its electricity sector with its primary objectives to establish competition in the generation and commercialization segments, regulate natural monopoly activities, and, perhaps most importantly, attract private investment. However, the expected private capital has not materialized, forcing the government to intervene and invest through its government agencies and its federal and state-owned companies. Furthermore, the electricity shortage the country experienced in June 2001 renewed debate and concerns over the economic efficiency on whether or not the existing arrangements in the Brazilian electricity market were sustainable in the long term. In response, the Government of Brazil created a special committee to recommend proposals to correct the current dysfunctions and propose improvements for the electricity sector model.

The committee produced three papers under this mandate. The first identified the main areas where improvement was needed in the operation of the electricity market. The second report then identified 33 flawed areas that needed to be remedied in order to enhance the competitiveness and reliability of the electricity sector. In their third report, the committee analyzed 11 of the 33 measures outlined in its previous report and issued specific proposals for each. In this article, the authors critically review these proposals, paying special attention to four interrelated topics that particularly bear on the economic efficiency of the market and the development of independent generators. The authors advise that when policymakers endeavor to restructure an industry, they must identify the existing inefficiencies of the sector being restructured and work to correct them; in the electricity industry, the authors argue that cross-subsidies are one of the inefficiencies that need to be addressed because they distort economic choices and erect barriers to effective competition and are therefore inconsistent with a competitive market.

In Brazil, the cross-subsidized tariff is a problem that has been present for years without a clear solution. Yet, far from offering such a solution, the tariff realignment measure in the committee’s third report seems to justify cross-subsidies. The authors conclude that only the elimination of cross-subsidies will push customers towards the market-oriented outcomes that were intended in the reform of the Brazilian electricity sector.

This article was published in the December 2002 issue of The Electricity Journal and can be purchased from Elsevier Science.