One of the basic functions of local governments is to provide public utilities and community services. The proportion of funds allocated to these activities in local government budgets in Central and Eastern Europe varies between 16 percent in Latvia, 18 percent in Hungary, 29 percent in Poland, and 44 percent in Slovakia. Despite the importance of urban services, their share in public expenditures cannot be measured exactly.

The fiscal statistics on local government expenditures often aggregate various "economic" or "environmental" services, and data are not presented in a consolidated format. Their share also depends on local governments’ involvement in providing human services. For instance, Slovak municipalities are not responsible for schools or hospitals.

The primary reason for the lack of specific information on urban services is their mixed character. Despite the public functions of these services, the private sector is deeply involved in their provision. In CEE countries, where the relationship between the public and private sectors is slowly developing, information systems cannot keep up with these changes. Thus the low level of public expenditure on urban services might be because these services have been privatized and outsourced and public expenditure data do not reflect the flow of funds.

Urban utility and community services can be grouped into three categories:

The public nature of services depends on three basic conditions. Ownership matters, but the method of financing is also important, namely, whether services are financed through national and local taxes or user charges. Regulations also have a strong impact on service provision.

Most CEE countries implemented changes in the local utility sector in two major steps (see the table). During the first stage, restructuring, they transferred state-owned property to local governments, combined it with some unbundling of natural monopolies, and transformed budgetary organizations into arms-length corporate entities operating under company law. The next stage was privatization, during which the countries attempted to gain access to foreign or domestic capital through various schemes, including outsourcing, concessions, or the BOT (build, operate, transfer) method.

The speed and character of these processes varied not only by country, but also by service. In the water sector, Hungary and Poland created several hundred service organizations through the extensive fragmentation of formerly state-owned water companies, unlike in Slovakia, which did not adopt this kind of "municipalization." Similarly, most countries transferred solid waste management to local government ownership, but Poland preferred privatization, attracting external capital to assist with this. Romania, meanwhile, created special semipublic service organizations to provide community services.

This diversity is partly explained by differences in policymakers’ motives. In the early 1990s the CEE countries believed strongly that market-based mechanisms were superior to the old rules of service delivery in the public sector. At this time traditional public service organizations were transformed into local, market-oriented entities to increase efficiency and improve the quality of local public utility services. This view has changed recently, with political and public debates on local public utilities turning toward issues of equity and affordability that came to light following privatization.

The restructuring and privatization stages should be supplemented by the development of regulatory mechanisms. Regulation should include the rules governing market entry and define what functions and responsibilities remain with local governments and the financial environment the service organizations operate in.

We propose the following policy actions for successfully managing the transformation of public utilities: