This article uses Paraguay, in Latin America, as a case study in order to examine the difficulties of introducing state reform where the state itself has a long history of control by private interests. It shows how the ‘privatized’ nature of the Paraguayan state is central to an understanding of how it has functioned and responded to recent reform efforts. The article provides an overview of the Paraguayan public sector and identifies several of its peculiar features that are relevant to understanding the state reform process: its small size, high levels of inefficiency and ineffectiveness, rampant politicization and endemic corruption. The article examines the three major components of an externally driven state reform process that began with democratization in 1989: privatization of loss-making state corporations, civil service reform and decentralization. It shows how the ‘privatized’ nature of the state has proved a major obstacle to these efforts and is a major factor in explaining their limited success. The article concludes by offering a pessimistic assessment of the likely prospects for state reform and highlights the danger that Paraguay could descend into a ‘failed state’. Copyright © 2002 John Wiley & Sons, Ltd.