REGULATION IN TELECOMMUNICATIONS INDUSTRIES: Why, What and How to Regulate?

Graduate School of International Corporate Strategy, Hitotsubashi
University
Asian Tax and Public Policy Program

Economic Analysis of Regulation and Public Enterprise

REGULATION IN

TELECOMMUNICATIONS INDUSTRIES:

Why, What and How to Regulate?

Bakhodir Mardonov IM0313

February 20, 2001
Recent empirical studies have showed that national indicators correspond
closely to the degree of competition in telecommunications markets. Greater
competition has generated greater innovation, investment and spin-offs for
the economy as a whole. However, many governments have found that
competition in telecommunications can bear good results only if appropriate
regulatory institutions are functioning effectively. Consideration of
advantages and disadvantages of specific regulatory policies raises
questions on why regulate, what to regulate and how to regulate.

Why Regulate Telecommunications?

There are different approaches trying to answer this question, but
basically they are split into two views: whether government should regulate
actively or intervene only in case of “market failure”.

Public policy goals: Even though the ultimate goals are the same, the
relative priority given to different goals may vary. For example, in
developing countries with a limited access to telecommunications services,
the policy goal to make them universally accessible is especially
important. While, in developed countries, the priority goals may be to
raise the efficiency of telecommunications and maintain a basic telephone
service.

Market failure: General goals such as “universal accessibility” cannot be
enough to justify regulatory intervention when the prevailing view relies
on market forces to promote efficiency and innovations. In this case, the
strongest justification takes the form of “market failures” and the
regulator may intervene in order to facilitate competitive entry, combat
abuse of market power and redistribute benefit.

Actually, the nature of the problems addressed depends on the structure of
the telecom services industry, the general economic, political and social
situation and the prevailing set of fundamental telecommunications
policies, particularly those concerning the roles of monopoly and
competition. Accordingly, we may consider three groups of countries: (i)
full monopoly, (ii) partial monopoly and (ii) full market system.

As some countries have moved from one of these groups into another, the
major problems to be solved by regulators have changed. For example, as
Mexico introduced competition in cellular services and privatised its
former state telephone monopoly, Telmex, it has faced controversial issues
concerning the interconnection of different carriers' networks. In the
United States, the evolution of the telecommunication industry since the
1950s illustrates a gradual transition from the first group via second to
the last one: if in the beginning, the regulatory policy concern was to
assure the universal availability of telecommunications services with
reasonable rates, over the years, as competition has developed, regulators
become more confident about the provision of different telecommunications
services. Thus, a gradual relaxation and withdrawal of some forms of
regulation (notably controls on the pricing of services to end-users) has
been introduced. At the same time, new forms of regulation have arisen from
the need to solve new kinds of problems, concerning for example, the terms
of interconnection between different carriers' networks, or control of the
numbering plan in a multi-carrier environment.

In spite of variations of the regulator’s mandate across each group of
countries, some of his basic missions can be defined as following:
1) Promotion of “universal service” targeting low-income households, users
in remote geographical areas, or disabled persons. For example, in
Argentina, this was done through setting goals for the expansion of PTO
networks; in the United Kingdom and U.S., through imposing “lifeline”
tariffs for low-income users.
2) Protection of user interests.
3) Change in the industry structure. The desired change is usually towards
a more competitive industry structure, but this mission can be far from
'deregulation'. For example, in Japan, the Ministry of Posts and
Telecommunications caused NTT to maintain high charges between Tokyo,
Osaka and some other major locations for the initial period of
competitive entry, to help new entrants gain a foothold.
4) Movement towards a “no discrimination policy” or “level playing field”.
However, in this case, the concern on the need to discriminate in favor
of new entrants has to be addressed (mission 3).
5) Supervision of the dominant PTO in case of limited or absent
competition. This can be done, for example, through applying price-cap
regulation like in Mexico.
6) Stimulation of innovations. In many countries, the regulator is seen to
anticipate opportunities for innovations and creating a favourable
environment for their timely exploitation. For example, in the United
Kingdom the pioneering action of OFTEL in granting licenses for the
Personal Communications Network (PCN) and Telepoint (CT2); in France,
current activity by DRG on PCN licensing; in the U.S., policy of granting
'pioneer's preference' in the licensing of radio frequencies to companies
pioneering new service concepts and technologies.
7) Management of common resources effectively.
8) Stimulation of investments in the public network.
9) Network interconnection. Open entry requires interconnection. It is
important to create favourable environment for interconnection of new
network operators and other providers of telecom services. However, the
more innovative the services of the new entrant, the tougher the problem
may become for the dominant carrier. This subject requires considerable
study and analysis, since it lies at the heart of the challenge of
finding economically efficient means of facilitating entry and promoting
competition.

In practice, the regulator’s mandate represents a mixture of these
different concepts. Not only does the 'mix' vary from country to country,
it also evolves over time. For example, in Canada, telecom regulation has
traditionally followed the mission of supervising the dominant PTO. More
recently, the mission of changing the industry structure has emerged as a
major thrust of Canadian telecom regulation policies. A cellular duopoly
was established and a second long-distance carrier, now known as Unitel,
was granted operating and interconnection rights to the local telephone
companies' networks. This consent was initially given only for leased-line
and packet-switched service, and not for switched telephony, but Unitel is
now licensed to provide a full range of long-distance services, including
voice services.

What to regulate?

The provision and use of telecommunications services may be regulated in
the following ways:
1) licensing carriers;
2) establishing and supervising technical and operational standards and
practices for network operations by carriers;
3) overseeing the quality of service provided by carriers;
4) regulating the pricing of telecom services, either by controlling
telecom operators' rates (tariffs) in detail or by applying some more
general form of control such as a price-cap;
5) setting the terms (administrative, financial and technical) for the
interconnection of different carriers' networks, including the 'access'
pricing charged by one carrier to another, where there are multiple
carriers and one carrier needs to interconnect with another's network;
6) controlling type approval of customer premises equipment (CPE) and its
attachment to the public network;
7) controlling the numbering plan and related matters.

The decision on 'what to regulate' has substantially varied in various
countries since it depends on what outcomes are to be achieved. For
example, in “full monopoly group” countries (e.g. Spain, Italy and the
majority of developing countries), the regulator's goals will imply that:
. supervision of the monopoly PTO's technical standards and practices may
be unnecessary;
. price regulation will be necessary and important;
. licensing new carriers and regulation of network interconnection is not
relevant.
At the other extreme, in a highly competitive group countries (e.g. U.S.
long-distance telephone service), the regulator’s goals will imply:
. regulatory control of some technical and operational matters is
essential since effective competition requires extensive interconnection
of different carriers' networks;
. price regulation may become unnecessary, at least in some segments of
the industry;
. licensing function may be unnecessary or minimal;
. rules concerning the interconnection of different carriers' networks are
of critical importance.

But what if a government chooses not to regulate at all? Experience
suggests that this decision is too illusory: in the unregulated or self-
regulated monopoly, someone must determine whether or not the monopoly is
acting in the public interest, and intervene if it is not.

These considerations, among others, have led the countries of the European
Community to collectively enact EC legislation requiring the establishment
in each country of an explicit regulatory process for telecommunications
and a regulatory body to implement that process which is separate from
operational PTO organisations, even in those countries where national
legislators have chosen to maintain a monopoly of basic fixed voice
services.

How to regulate?

Regulator with a defined mission can fulfil it using widely differing
regulatory approaches. Actually, there are basically two kinds of choices
that must be made to define regulatory approaches:
1. How far the regulator will exercise control, and how far the regulator
will act 'by exception.' To what extent will certain matters (e.g.
'access charges' for interconnecting) be controlled by the regulator, or
will the regulator only intervene 'by exception' when a particular
regulatory case requires this? In the case of access charges, for
example, U.S. practice involves continuous and mandatory control of
access charges for fixed-service carriers. In the United Kingdom, by
contrast, the regulator does not automatically exercise control over
these charges, but may exercise the power to determine the charges if
the various carriers fail to reach agreement.
2. How far the regulator controls outcomes directly, or indirectly. For
example, if one goal of regulation is low prices for service, will the
regulator control prices directly, or seek to influence prices
indirectly by promoting an industry structure that is considered to be
favourable to achieving low prices? Or, to take another example, will
the regulator directly impose particular targets for network expansion
and modernisation, or rely on the effect of a general framework of
incentives designed to encourage carriers to pursue these goals?

In this context, let’s consider one of the most fundamental issues about
whether or not the regulator should intervene to promote innovation. There
are three different views on this matter:
1. “Regulator as Patron”: the regulator identifies the promising
innovation, and takes steps to ensure that the organisation most likely
to implement it is not only authorised, but have priority access to the
resources necessary to implement the innovation.
2. 'Pro-active Removing of Obstacles': the regulator does not 'pick
winners' in this way, but nevertheless actively seeks to ensure that
regulation itself does not impede promising innovations and to act pro-
actively to provide an environment that is favourable for innovation.
3. “Arm's Length Approach”: the regulator’s role is minimised in decision-
making about innovation, and the regulator will respond to innovation
initiatives from the PTO or other interested parties (e.g.
telecommunications users, resellers or providers of value-added
services). This may occur if the innovation needs the regulator to take
specific actions before it can proceed.

Although these approaches are different, they are not clear-cut
alternatives. There are many intermediate approaches between them. In table
1, the main advantages and disadvantages of these tree alternatives are
presented.

Concluding all above, we can say that establishing proper regulatory
institutions is an important precondition for successfully restructuring
the telecommunications sector and increasing the involvement of private
initiatives and market forces. Three basic questions are to be addressed at
the outset - why, what and how to regulate – in order to settle the main
two principal issues: how to ensure a proper interface between the
regulated and competitive parts of the telecommunications, and how to
encourage the innovative forces in the sector.

Table 1 Advantages and Disadvantages of the Broad Regulatory Alternatives
Concerning Innovation