DIFFERENT REGULATIONS, DIFFERENT IMPACTS WHAT REGULATIONS AFFECT TRADE IN TELECOMMUNICATIONS SERVICES?

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1 OECD Experts Meeting on Telecommunication Services Paris, 10 December 2008 DIFFERENT REGULATIONS, DIFFERENT IMPACTS WHAT REGULATIONS AFFECT TRADE IN TELECOMMUNICATIONS SERVICES? by Margit Molnar Senior Economist, OECD Trade and Agriculture Directorate

2 TABLE OF CONTENTS DIFFERENT REGULATIONS, DIFFERENT IMPACTS - WHAT REGULATIONS AFFECT TRADE IN TELECOMMUNICATIONS SERVICES?... 1 Executive summary... 4 Introduction... 6 Selected features of the telecommunications sector... 6 Telecommunications services as critical inputs to production and delivery of goods and other services.. 6 Is the telecommunications sector a distinctive network industry?... 7 Telecommunications trade has soared during the past two decades... 8 What constitutes trade in telecommunications services?... 8 What can be measured a large gap to gauge Shaping patterns of trade Falling barriers in telecommunications Inducing competition in a network with large fixed and sunk costs Ensuring efficient interconnection Accounting for network externalities Lowering switching costs Managing spectrum efficiently Regulating multiproduct firms Providing universal service Liberalisation and technological progress are bringing down prices and boosting trade in telecommunication services Convergence of services is reshaping telecommunications markets Bringing down roaming tariffs: relying on technological progress or regulation? Assessing competitive pressures in telecommunications markets The top-down approach: from prices to mark-ups The bottom-up approach: picking regulations that may matter Conclusion REFERENCES ANNEX 1. REGRESSION RESULTS ANNEX II. WHY VOIP? Tables Table 1. Turnover of French and US affiliates abroad and foreign affiliates in France and the United States in telecommunications, Table 2. A number of telecommunications markets can potentially be subject to regulation Table 3. Simple elasticities for residential users are higher than for businesses for most years Table 4. Economy-wide regulation and its higher-level components negatively affect trade Table 5. Economy-wide regulation and its higher-level components negatively affect trade (cont.)

3 Annex Tables Annex Table 1. Sector-specific regulations adversely affect trade flows in some model specifications Annex Table 2. Mid-level components of the general PMR have a negative but smaller effect on trade Annex Table 3. Mid-level components of the general PMR have a negative but smaller effect on trade (cont.) Annex Table 4. The impact of the lowest-level PMR indicators on trade is negative but relatively small.. 40 Annex Table 5. The impact of the lowest-level PMR indicators on trade is negative but relatively small (cont.) Annex Table 6. The impact of the lowest-level PMR indicators on trade is negative but relatively small (cont.) Annex Table 7. The impact of the lowest-level PMR indicators on trade is negative but relatively small (cont.) Annex Table 8. Sector-specific regulations are important deterrents of foreign direct investment in telecommunications Annex Table 9. Economy-wide regulations are less important when deciding to invest in telecommunications Annex Table 10.Mid-level PMR indicators do not affect inward FDI in telecommunications except administrative barriers on start-ups Annex Table 11. Some lowest level PMR components have a large negative impact on inward FDI in telecommunications Annex Table 12. Some lowest level PMR components have a large negative impact on inward FDI in telecommunications (cont.) Annex Table 13. General FDI restrictions also affect the telecommunications sector Annex Table 14. FDI restrictions in telecommunications are important deterrents for potential investors in this sector Figures Figure 1. Telecommunications leads productivity growth in services in Spain... 7 Figure 2. The United States is by far the largest initiator of fixed international calls, Figure 3. Along with the United States, Mexico is the largest receiver of fixed international calls, Figure 4. In some countries, more international calls originate from mobile than from fixed phones Figure 5. Some countries receive more international calls from mobile than fixed locations Figure 6. The United Kingdom has taken the lead in branching overseas Figure 7. The United States and the United Kingdom are the largest receivers of telecommunications investment Figure 8. Figure Residential and business telephone charges in OECD have sharply fallen over Figure 9. Average broadband pricing for residential users in USD ppps, Figure 10. Broadband pricing per MB for residential users in USD ppp, Figure 11. Differences in mark-ups are large across countries, Figure 12. Higher barriers to ownership tend to be associated with higher pricing of leased lines in OECD

4 DIFFERENT REGULATIONS, DIFFERENT IMPACTS WHAT REGULATIONS AFFECT TRADE IN TELECOMMUNICATIONS SERVICES? Margit Molnar Executive summary The telecommunications industry is distinct among services industries owing to the crucial role it plays in driving economic growth and the rapid change in some of its key features such as technology and regulatory environment. Productivity growth in the sector fuelled by technological progress, falling regulatory barriers and competition is associated with downward spiralling of telecommunications charges. High price elasticities of demand for telecommunications services imply a substantial boost to traffic when prices fall and underline the importance of creating an economic environment conducive to competition among providers. Telecommunications services are traded in myriads of forms with technological progress continually adding innovative ways to trade this service. In addition to the traditional way of originating telecommunications services in one country and terminating in another, roaming and provision by foreign affiliates have become widespread and most recently, foreign operators provide both international and domestic services even without commercial presence. Telecommunications is also unique among services industries in the sense that a large part of trade in this sector is either not recorded or, even when recorded, not reflected in publicly available data. The only relatively good data, available in time series and in international comparisons, cover the segment comprising outgoing international calls from fixed locations; however, that segment accounts for an evershrinking part of cross-border traffic. Data on investment in the sector are scarce as are data for sales of foreign affiliates. While such serious data limitations inhibit in-depth analyses of trade-related activity in the sector, it is still possible to provide an approximate indication of some developments by drawing on available information, indirect indicators and innovative analytical approaches. Trade in telecommunications services, similarly to other services, appears to be largely affected by domestic regulation. To assess the impact of such regulations, two approaches are applied: assessing the impact of regulations in general without looking at specific measures (i.e. a top-down approach) and assessing the impact of particular regulatory measures on trade (i.e. a bottom up approach). Prices can be a rough indicator of the competitive pressures prevailing in markets. Price comparisons for unit broadband capacities, for instance, provide an indication that Japan, Korea, France, Italy and most Scandinavian countries have relatively competitive markets, while competitive pressures in Senior Economist, Trade and Agriculture Directorate, OECD. T: The author is most grateful to Reka Horvath (at present with Ofcom, previously Consultant, OECD) for her expert input and insightful conversations as well as to Mark van Duijn for his exemplary statistical assistance. 4

5 Turkey, Mexico, Greece and all Central European OECD Member countries appear to be much more limited. Mark-ups, which provide information about competitive pressures taking into account the input costs, indicate that such pressures are in general larger in telecommunications than in other network industries, but smaller than in inherently competitive industries (e.g. retail and wholesale trade, business services etc.). This is not surprising given that the telecommunications sector is no longer considered a natural monopoly like some other network industries (e.g. gas or water supply), although is still retains some characteristics of a network industry in terms of sunk and fixed costs. A rigorous testing of the impact of regulations on trade flows suggests that different regulatory measures affect cross-border trade and foreign direct investment (FDI) in different ways. Most components of the OECD product market regulation (PMR) indicators have a negative impact on cross-border trade in telecommunications services, with larger coefficients on more aggregated indicators. Sector-specific regulation, on the contrary, does not appear to affect cross-border trade in most model specifications; it has a negative impact, however, on FDI. FDI in telecommunications is not much affected by economy-wide product market regulation except, for instance, with respect to some specific components related to state control. FDI restrictions, such as ownership barriers or restrictions on the operations of foreign affiliates have a sizeable negative impact on inward foreign direct investment in telecommunications, in particular if such regulations specifically target the telecommunications sector. 5

6 Introduction The telecommunications sector was selected by the Trade Committee as one of the sectors, along with business services and construction, to be covered in pilot studies aimed at examining the effects of regulations on trade flows. Telecommunications is distinct among services owing to its crucial role in driving economic growth and its rapidly changing technological and regulatory environment. This sector is also unique in that demand for this service is derived demand and that most of the trade in this sector is not recorded. Therefore, trade-related data analysis and conclusions are generally confined to the small segment consisting of fixed-line calls, for which reasonably good data are available. The telecommunications industry is a regulated industry owing to its network characteristics. Different regulations may have different impacts on trade flows and an aim of this report is to identify the ones that may affect trade. Such regulations will be examined from the point of view of their impact on trade, however, they can in principle be put in the GATS context at a later stage. The economics of telecommunications regulation is a science on its own. Here only those regulations will be mentioned that either directly relate to international trade, investment or foreign affiliates or are perceived to have a bearing on trade flows. Selected features of the telecommunications sector Telecommunications services is a broad sector encompassing the transmission of sound, images, or other information by such channels as telephone, telex, telegram, cable, broadcasting, satellite, electronic mail, or facsimile services and including business network services, teleconferencing, and support services. 1 The definition of the category may differ somewhat by country; in the United States, for instance, internet providers do not belong to telecommunications but rather to information services. The importance of the telecommunications sector for the economy is not only reflected in its sheer size of about 3% of GDP in , but even more by its contribution to overall productivity growth, hence to the growth of the economy. Given the telecommunication sector s prominent role as a driver of economic growth, it is crucial to create an economic policy environment that stimulates productivity growth in this sector. Telecommunications services as critical inputs to production and delivery of goods and other services The telecommunications sector is characterised by continuous technological innovation spurring productivity growth in the sector. Given the sector s critical role in producing inputs to the production and delivery of goods and other services, innovation and productivity growth in telecommunications are crucial for the entire economy. Total factor productivity (TFP) estimates using firm-level data in the Amadeus database show that the telecommunications sector has been the fastest growing in Spain (Figure 1). Correa (2006) shows that the telecommunications sector registered above-average productivity growth over the past 34 years in the UK and confirms that other industries have greatly benefited from rapid productivity growth in this sector. This may have emanated from the policy of encouraging infrastructure investment in their production processes. 1. EBOPS (Extended Balance of Payments Services) classification, Manual on Statistics of International Trade in Services, downloaded on April 10, Telecommunications revenue as a percentage of GDP for all OECD countries (OECD, 2007c). 6

7 Figure 13. Telecommunications leads productivity growth in services in Spain 0.45% 0.40% 0.35% 0.30% 0.25% 0.20% 0.15% 0.10% 0.05% 0.00% Average annual compound growth rate of TFP, Note: Total factor productivity was estimated using firm-level data from the Amadeus database. Source: Author s estimation. Is the telecommunications sector a distinctive network industry? Telecommunications is a network industry and stemming from this nature it is characterised by large fixed and sunk costs and network externalities, but it is distinct in a sense that it is no longer considered to be natural monopoly and that its ways of provision of the service have benefitted from the rapid development of technology. Telecommunications is a network industry characterised by large fixed and sunk costs Telecommunications is a network industry with several points or nodes connected by communications pathways. The network layout has some very important implications. The first and most important is that there are large fixed and sunk costs involved in building network infrastructure. This is why, in the past, telecommunications was once considered a natural monopoly. Later, when the importance of competition in telecommunications became obvious, there was an ongoing debate on whether this competition should occur using alternative infrastructure (facilities based competition) or by requiring incumbent operators to share their network (resale competition). In the end, what happened was a mixture of the two: while the last mile (or the local loop), that is the wire from the local telephone switch to the end users was rarely duplicated, alternative infrastructure to connect local switches was often built by new entrants. In fact, technological progress over the last two decades made it possible to use already-existing non-telecommunications infrastructure to connected end-users via alternative communications links even in the last mile: first, the cable television network was upgraded to carry information into both directions (rather than only deliver broadcasting content to the end-user), second, power lines can now be used to carry communications signals to the final users. Finally, Fixed Wireless Access technology can also be deployed to deliver communications services to end-users. In many cases, in order to build the infrastructure, firms have to overcome legal limits and other difficulties. For example, it is often very difficult to obtain rights of way in order to build alternative infrastructure in the last mile (more recently to lay fibre networks). 3 Also, in the case of mobile telephony only entities that have the right to use the radio spectrum can roll out network components. 3 One reason why the pace of fibre investment in the local loop is relatively slow in many OECD countries is the cost associated with network construction, in particular for rights of way and ducts or poles, as well as the 7

8 Still, even when alternative connecting infrastructure exists, competition can be enhanced if companies who do not own infrastructure are also allowed, on a commercial basis, to use existing facilities. and network effects The value of being part of a network increases with the number of people connected to the network. A customer, in his decision of whether or not to join a network, affects not only his own welfare but also that of existing and future participants. Telecommunications services are provided in myriads of ways owing to technological progress The telecommunications industry is one of the industries most often associated with technological change and this is manifest in the myriad ways that telecommunications services are provided. Perhaps one of the most important characteristics of the industry is the way technological progress makes once very important services less important, replacing them with new services. Traditionally, wire-line fixed telephony was the primary service of the industry. Today, mobile communication services and internet service make up an increasing share of the industry. The Ofcom UK Communications Market Review 2008 states: Mobile telephony (including an estimate for messaging) accounted for 40% of the total time spent using telecoms services [in the UK], compared to 25% in However, much of this growth has come about as a result of an increase in the overall number of voice call minutes (from 217 [billion] in 2002 to 247 [billion] in 2007) rather than because of substitution with fixed voice, which still accounted for 148 billion minutes last year, down only 10% from 165 [billion] minutes in As a result of technological progress, continuous renewal of telecoms services infrastructure is a permanent feature of the industry. Therefore, regulation needs to be re-thought on a regular basis. For example, the regulation of VoIP (Voice over Internet Protocol) services (e.g. numbering and number portability) is lacking in several countries even though these services already exist. Similarly, the future regulation of new-generation networks already needs to be addressed even though the new infrastructure is not yet completed. As noted in the European Competitive Telecommunications Association (ECTA) 2007 Regulatory Scorecard: It can cause considerable uncertainty to both dominant firms and those relying on access to bottleneck infrastructure, if the competitive impact of such upgrades is not understood or the regulatory approach is not clearly defined. Continuous service innovation is also a persistent characteristic of the sector. In order not to stifle innovation, care needs to be taken that new services are not regulated in a manner that would interfere with the ability of firms to reap the benefits of their innovation and investment. Telecommunications trade has soared during the past two decades What constitutes trade in telecommunications services? Telecommunications services are now traded in several ways. Telecommunications services originated in one country and terminated in another country are cross-border services under the GATS irrespective of whether the same service provider is present in both countries. Thus, the most basic way of trading in this service is making an international call. Roaming abroad is also part of international trade in associated legal and regulatory difficulties in obtaining permits for access to streets, roads, and other public land. This issue of rights of way in laying fibre in the last mile is a complex legal, managerial, and technological issue where obtaining public rights of way permission, and constructing the required ducts (or poles) is often closely interlinked with national and/or local government legal frameworks and policies. Public rights of way for fibre deployment to the home (OECD 2007c). 8

9 telecommunications services and international trade in telecommunication services is no longer confined to delivering services through networks crossing national boundaries. With the removal of entry barriers to the telecommunications sector worldwide, multinational carriers have created an increasing number of local businesses to provide these services. In addition, according to GATS, international corporate staff transfers in the telecommunications industry and the provision of telecommunication services abroad by self-employed suppliers (e.g. telecommunications engineers) are also considered as international trade. Some of the major ways telecom services cross borders can further be disaggregated according to the network or technology used as media to transmit the service. International calls can be made from a fixed or mobile location, international roaming involves making mobile phone calls or sending text messages when abroad or calling or messaging a mobile phone when it is abroad. Internet-related international trade comprises, for example, accessing the internet in another country or in the same country when routed through a foreign internet exchange point. International calls from a fixed location The most common telecommunications service involving international payments is the provision of international calls. Traditionally, before the liberalisation of telecommunications, most countries had a designated international carrier. International carriers from different countries had interconnection arrangements between them and traffic flowed through settlement routes. Under the accounting rate system, payments were only made at the end of a certain period and only if there was a traffic imbalance: only the country that originated more minutes paid the other country a settlement rate per excess minute. Carriers having relatively lower collection charges (i.e. prices they charged their subscribers) often due to competition from other carriers and a net traffic deficit were dissatisfied with the accounting rate regime; it subsidised high cost monopoly carriers at the expense of lower cost carriers and end-users from competitive regimes. A variant of the accounting rate system still exists, sometimes with more complicated payment structures. Settlement rates are usually higher than national call termination rates, and some country/carrier pairs have higher rates than others. This gives rise to incentives for operators to search for alternative methods to deliver international calls. For example, it might be cheaper to deliver a call from country A to country B via country C if country C has a more favourable settlement rate with country B than country A. Similarly, operators can set up a communications link between two countries, deliver calls from country A to country B via this link, and then send the call from their premises into the network of the national operator thus making it appear as a national call. Finally, an operator can convert the voice signals into data packets and send the call via the internet using VoIP. At the terminating end, the call is again turned into a voice signal and is sent over to the PSTN (public switched telephone network) taking advantage of only having to pay national termination charges. In a liberalised telecommunications market a customer has several ways of making an international call from a fixed location. The most important distinction between these options is whether the call is delivered on traditional settlement routes or is delivered outside the accounting rate system. Dialling an international number from a connection point within the network of the historical operator where the call is routed through the traditional settlement routes is one end of the spectrum of possibilities, while using the services of a fixed-line replacement VoIP company or calling through nomadic VoIP operators like Skype are on the other end. Recently, several fixed line replacement VoIP companies started offering free international calls to fixed phones as part of their basic subscription package. Similarly, internet providers started to bundle calls to international fixed numbers together with broadband and sometimes television services at a fixed price. 9

10 All these developments suggest that calling international fixed numbers is becoming very cheap even though calling mobiles is still comparatively expensive (mostly due to higher mobile national termination charges). International calls from a mobile location Another common channel for international telecommunications traffic concerns international calls from a mobile location. International mobile calls are initiated on a mobile handset but are then routed through the fixed transit network. International roaming International roaming is a service offered by mobile providers allowing their customers to use their mobile phones abroad. International roaming includes two forms of trade: Making mobile phone calls, sending text messages and accessing data services when abroad Calling or messaging a mobile phone when it is abroad When a mobile user switches on her mobile phone in a foreign country most phones, guided by their SIM (subscriber identidy module) card, look for networks of partners with whom the customer s operator has roaming agreements, choosing the one with the strongest signal. The user can also choose a roaming network manually or she may possess a SIM card that is enabled to have a preference for specific networks. International internet connectivity Under this heading there are two main forms of trade: 4 accessing internet content in another country, and accessing internet content in the same country when routed through a foreign internet exchange point. There is a U-shaped relationship between international internet traffic volumes and the development of internet backbone infrastructure (routers and cables). This is due to the fact that unlike in the case of international calls, some of the international internet traffic mostly initiated in developing countries is not efficient. In many cases, it would be more desirable to access content created and hosted locally than using international gateways to access content in another country. Similarly, several developing countries can only access locally hosted content on the network of a different internet service provider (ISP) via international gateways because there are no internet exchange points (IXPs) in the country. 5 Similarly, accessing content in country A from country B sometimes can only be achieved through country C because that is where the single international gateway going from country A leads. The OECD countries are already on the increasing part of the U-shaped curve that relates international internet traffic to internet backbone infrastructure while some developing countries might first decrease their international internet traffic before starting to increase it again. 4. In fact, there is a third form of internet-related trade that is paying for storing internet content on a foreign server, but this is much less economically significant than the other two forms. 5. According to the OECD there were 92 countries in April 2007 which did not have an IXP (Global opportunities for internet access developments, OECD 2007). 10

11 Commercial presence of foreign companies Back in the era when telecommunications were considered to be a natural monopoly telecommunications companies, in most cases, were state-owned. Following liberalisation, some countries fully privatised the incumbent operators without any restrictions on foreign ownership, others fully privatised with some restrictions on foreign ownership, while others retained some state-ownership or strategic position such as the golden share with or without restrictions on foreign ownership in the privatised segment. Even countries that generally welcome foreign investment can maintain restrictions on investment in sensitive sectors such as banking, aviation, airports, shipping, broadcasting, newspapers and telecommunications. Foreign ownership in telecommunications is opposed because first, foreign ownership may make it more difficult for governments to influence investment in infrastructure and technology, which can facilitate the realisation of national economic and development goals; and second, because telecommunications services, if provided by foreign owners could be withdrawn during international disputes to influence the outcome of negotiations. What can be measured a large gap to gauge Measuring telecommunications services trade has become increasingly difficult owing to: (i) the ever larger chunk of traffic not passing over the PSTN but rather transiting via the internet, leased lines or frame-relay networks and (ii) increased cases where a single carrier handles the traffic to the destination country over its circuits. Even when traffic is measurable, data are not publicly available for most forms, especially in international comparisons. Data for international phone calls, for instance, are available for a large number of countries for fixed calls in both outgoing and incoming directions, but only for a limited number of countries for mobile or VoIP calls. Moreover, it is only the volume of such calls is available, not the value. The figures that appear in the Balance of Payments statistics under trade in telecommunication services give little insight into real traffic owing to the variety of settlement systems used. As a result, what can be assessed is only a tiny part of the traceable traffic, which itself is also only a very small share of actual traffic. Data on investment in telecommunications services overseas are also relatively scarce and sales of foreign affiliate are even scarcer. These serious data limitations imply that any results obtained using available data should be interpreted with appropriate care. Shaping patterns of trade As for fixed international calls, by far the largest amount of such calls originates in the United States (Figure 2). While this is not surprising given its size, the number of outgoing calls is disproportionately larger than the size of the economy alone would suggest. Moreover, the size of the economy and population do not seem to be the major determinant of outgoing calls. 11

12 Figure 14. The United States is by far the largest initiator of fixed international calls, International outgoing fixed telephone traffic (billion minutes) Source: ITU World Telecommunications/ICT Indicators Database. The United States is likewise the largest receiver of international calls, although it is closely followed by Mexico (Figure 3). Six of the other G7 countries receive similarly large amounts of international calls (and China s record is of the same magnitude as well). Figure 15. Along with the United States, Mexico is the largest receiver of fixed international calls, International incoming fixed telephone traffic (billion minutes) Source: ITU World Telecommunications/ICT Indicators Database. Information on calls from mobile locations is limited, but what is available suggests that in some countries like Slovenia, more calls originate from mobile than from fixed phones (not including VOIP) (Figure 4). The proportion of calls originating from mobile phones at slightly above 10% in New Zealand is low. 12

13 Figure 16. In some countries, more international calls originate from mobile than from fixed phones Shares of mobile and fixed international calls, 2006 (in %) 100% 90% 80% 70% 50.1% 45.0% 39.2% 28.9% 22.4% 20.5% 10.4% 60% 50% 40% 30% 20% 49.9% 55.0% 60.8% 71.1% 77.6% 79.5% 89.6% 10% 0% International outgoing fixed telephone traffic International outgoing mobile telephone traffic Source: ITU World Telecommunications/ICT Indicators Database. On the reception side, the Slovak Republic and Turkey receive more international calls originating from a mobile phone than from fixed phones (Figure 5). France and Hungary, at the other end of the spectrum, receive a small amount of such calls relative to those coming from fixed locations. Figure 17. Some countries receive more international calls from mobile than fixed locations Share of incoming mobile and fixed international calls, 2006 (in %) 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 10.7% 17.4% 37.6% 55.8% 51.1% 89.3% 82.6% 62.4% 44.2% 48.9% Slovakia Turkey Czech Republic France Hungary* International incoming fixed telephone traffic International incoming mobile telephone traffic Source: ITU World Telecommunications/ICT Indicators Database. The United Kingdom is by far the largest investor overseas in telecommunications (Figure 6); its invested stock is more than 6 times larger than that of second-ranked Germany or third-ranked France. Even Canada, Netherlands and Norway invested more in telecommunications industries overseas than the United States or Japan. The telecommunications sector is very important for UK investors: in 2001, the year for which the most recent data are available, almost a quarter of outward FDI was in telecommunications. The corresponding share for Germany would be slightly above 8%, for France it would be between 3 and 4%. For most other OECD countries, the shares of outward investment in telecommunications would be less than 1%. 13

14 Figure 18. The United Kingdom has taken the lead in branching overseas Outward FDI stock in telecommunications services, most recent available year (in million USD) GBR 2001 DEU 2005 FRA 2005 CAN 2001 NLD 2004 NOR 2005 USA 2005 JPN 2005 DNK 2005 GRC 2004 ITA 1997 KOR 2004 AUS 1996 Source: OECD Foreign Direct Investment Statistics database. The United States and the United Kingdom receive most foreign direct investment in telecommunications among OECD countries (Figure 7). FDI in telecommunications makes up over 7% of total inward FDI stock in the United Kingdom, 3-4% in the United States and 1-2% in France. Figure 19. The United States and the United Kingdom are the largest receivers of telecommunications investment Inward FDI stock in telecommunications services, most recent available year (in million USD) USA 2005 GBR 2001 TUR 2005 JPN 2005 FRA 2005 DEU 2005 GRC 2004 FIN 2005 CZE 2005 POL 2005 CAN 2001 DNK 2005 NLD 2004 Source: OECD Foreign Direct Investment Statistics database. Rather than foreign direct investment statistics, FATS (Foreign Affiliate Trade Statistics) provide a better picture on sales of foreign affiliates in a given country, if available. The OECD FATS database only allows for a very partial tracing of activities of foreign affiliates in the telecommunications sector owing partly to the lack of FATS in many countries and to the high level of aggregation in reporting such statistics (Table 1). The available data suggest that for France, sales in the inward direction (i.e. sales of foreign affiliates in the country) exceeds the outward direction (i.e. sales of French affiliates abroad), while this share in the United States is the reverse with sales of US affiliates abroad being bigger. In terms of their relative importance (i.e. their share in total sales of foreign affiliates in the country and domestic affiliates abroad), for the United States, inward and outward sales shares are of similar magnitude in both countries. 14

15 Table 6. Turnover of French and US affiliates abroad and foreign affiliates in France and the United States in telecommunications, FRANCE, FATS turnover in the telecommunication sector Inward Share of total inward Outward Share of total outward % % % % % % % % % % % % % % % % % % % USA, FATS turnover in the telecommunication sector Inward Share of total inward Outward Share of total outward % % % % % % % % % % % % % % % % % % % % % % Source: OECD FATS database. Falling barriers in telecommunications When regulation is considered, the telecommunications sector can be divided into markets for services or products provided to end users (retail markets), and markets for the inputs which are necessary for operators to provide services and products to end users (wholesale markets) (Table 2). 15

16 Table 7. A number of telecommunications markets can potentially be subject to regulation Retail Fixed Access to the public telecommunications network Publicly available telecommunications services Leased lines Mobile Access to the public mobile telecommunications network Publicly available mobile telecommunications services Wholesale Call origination on the public telecommunications network Termination of national calls on the public telecommunications network Termination of international calls on the public telecommunications network Transit services on the public telecommunications network Wholesale unbundled access Wholesale broadband access Wholesale leased line terminations Provision of wholesale trunk segments of leased lines International circuit for internet connectivity (interconnection of countries with the internet backbone) 16 Call origination on the public mobile telecommunications network Termination of national calls on the public mobile telecommunications network Termination of international calls on the public mobile telecommunications network Wholesale access to the public mobile telecommunications network The wholesale national mobile telecommunications market for international roaming Note: The markets in italics do not fall under the jurisdiction of national regulatory authorities, instead, their prices are usually subject to international negotiations. Regulation tends to be heavy in telecommunications as in network industries in general. Given the nature of telecommunications, in most countries the focus is on how to create effectively competitive markets using regulation. Striking the balance between competition and the level of regulation is a key issue in telecommunications (as is in other network industries) due to the necessity to create a competitive arena to enhance efficiency and to provide sufficient incentives to invest in network infrastructure. The telecom industry has been the fastest among network industries to open up competitive segments to new entrants and now the major issue remains how to prevent the incumbent operator of the network from restricting competition in the competitive segments. Inducing competition in a network with large fixed and sunk costs Large fixed and sunk costs in building telecommunications infrastructure imply that regulators can facilitate the entry of new market players with two sets of measures: first, by reducing the cost of building alternative infrastructure, and second, by making infrastructure sharing possible. by reducing the costs of building alternative infrastructure The cost of deploying copper or fibre in the last mile can be reduced by putting clear, efficient and non-discriminatory rules in place for obtaining rights of way. Similarly, making access to the ducts of the incumbent available also creates a favourable environment for alternative operators to invest in the last mile. and through infrastructure sharing Infrastructure sharing can mean anything from pure resellers (who depend entirely on the incumbent s infrastructure) to companies that use their own transit networks and a fully unbundled local

17 loop to get to the end-user. Resellers might sell only calls to the end-users through indirect (calling cards, dialling a prefix) or direct access. Direct access is also called carrier pre-selection and refers to cases where the customer is billed by the pre-selected operator for the service it provides and by the incumbent for line rental and other services provided. Another possibility is that the provider also buys a wholesale line rental product and offers both line rental and calls to the customer. Alternative providers can also have their own transit network and buy call origination (and call termination) services from the incumbent and again have indirect or direct access to the end-users. Finally, there is one more important option: the alternative provider can buy bitstream access from the incumbent to provide high speed services to customers. 6 Regulatory instruments that make infrastructure sharing viable include carrier pre-selection, full or shared local loop unbundling (LLU), bitstream access, wholesale line rental and requirements to make private partial circuits available, among others. There is, usually, a non-discrimination requirement in the provision of wholesale access products. Non-discrimination means that the incumbent has to provide access on the same terms as it is providing to its downstream operation (in terms of price, quality and speed). The price of the wholesale access products is crucial and is the focus of most national regulatory authorities: if it is too high, entry will not happen; if it is too low, the incumbent is not able to re-coup its investment. It is widely argued by incumbents that network sharing is detrimental to the building of alternative infrastructures. However, evidence seems to suggest that this is not the case: The penetration of LLU is found to be positively, though only moderately, correlated with the penetration of cable. We also find that those countries with some degree of fibre infrastructure or those with well publicised plans for next generation access also have higher levels of LLU penetration. This would appear to cast doubt on the argument that has been put forward by some parties that LLU is damaging to investment in alternative access technologies. 7 Network sharing is also encouraged in mobile telephony: mobile virtual network operators (MVNOs) may buy wholesale access to the public mobile telecommunications networks. In some countries this is already a reality. In others, regulators are seeking to put the necessary regulation in place in order to reduce market concentration and thus prices through the introduction of further competition via MVNOs. A common way to encourage competition has been through the unbundling of the local loop (i.e. allowing competitors to use the incumbent s local network), which has been promoted in most OECD countries. Progress in competition between local networks (i.e. through building competing networks to that of the incumbent operator) has been more limited in most OECD countries, except for example in Australia, Denmark, Korea, United Kingdom and the United States. Intermodal competition, notably by mobile and cable service providers, has been crucial in increasing competition pressures in telecommunications markets. Ensuring efficient interconnection Networks of different countries need to interconnect. Similarly, when there are several transit networks but bottlenecks are shared there is a need for the different sub-networks to interconnect. Fair interconnection agreements are difficult to reach and disputes can be lengthy. Regulation often targets origination and (national) termination charges that can constitute and important barrier to international 6. Bitstream access usually means that the customer still needs to buy line rental from the incumbent. Naked bitstream indicates when this is not necessary. Naked bitstream is the only alternative to the PSTN network for calls-only subscribers by providing voice over broadband Methodology Scorecard, ECTA. 17

18 traffic if there are high. Regulatory intervention can be price regulation (in which case the price-benchmark is often the object of disputes between the regulator and the owner of the infrastructure) or more forward looking structural intervention such as separation of the wholesale and retail operations of the incumbent in order to achieve cost orientation and non-discrimination. The separation can range from accounting separation to operational separation and structural separation. Separation (accounting or management) of the non-competitive segment from competitive segments does not by itself guarantee non-discriminatory third-party access to the trunk network if access prices are not regulated. High access prices have been found to hinder potential competition in e.g. Australia, Finland, Hungary, Iceland, Ireland, Norway and Switzerland (OECD 2007a and various editions of OECD Economic Surveys). Accounting for network externalities By joining a network a user can communicate with all other users on that network and, beyond, on interconnected networks. There can also be said to be an effect in which the network itself becomes more valuable to participants as the number of users, or opportunities for communication, increases (i.e. the network effect). Markets take the network effect into account in the pricing of services hence the development of prepaid cards which enable users to join a network at whatever price they are prepared to pay. This is why the traditional approach to expanding network connections to marginal users, such as through subsidies, is not required. It is why a growing number of countries, including in the developing world, have mobile penetration rates greater than 100%. Lowering switching costs Switching costs are factors that make it more difficult for customers of telecommunications services to change suppliers. These are the actual costs of paying fees to join or install a connection, penalties to pay to the existing operator if breaching an agreement to buy the services for a certain period, the costs of unlocking mobile handsets, or the hard-to-measure costs in terms of effort and time of communicating a new phone number to friends, family and business associates, among other costs. When a rational consumer encounters switching costs, he will not migrate to the network offering the lowest price if the switching costs are greater than the price differential between the two operators. If this happens, the consumer is said to be locked-in to the supplier. Telecommunications providers are able to increase switching costs in order to dampen competition. Mobile operators can artificially lock-in their subscribers by setting on-net and off-net prices differently. If on-net prices are significantly lower than off-net charges it can result in the formation of calling circles when friends and families join the same network. In this case changing operators is particularly costly because this advantageous discount will be lost. Regulators may target some unnecessary, competition-dampening switching costs through number portability requirements. Number portability is now widespread but it is still not uncommon that waiting times to port a number are significant and sometimes the costs of porting a number are unjustified. Similarly, many national regulatory authorities are now addressing the issue of differences in on-net and off-net national call prices as well as the lock-in through long-term contracts. Managing spectrum efficiently The possibility of congestion of the radio spectrum creates a need for regulatory authorities to restrict access to certain frequency bands. For example, infrastructure to exploit the frequency bands of mobile telephony can only be used by operators who bought the rights to these bands. On the other hand, 18

19 there are license-exempt frequency bands that are currently used for services such as Wi-Fi, Bluetooth, cordless phones, and baby monitors, among other local applications. Technological developments and better equipment are constantly freeing up spectrum in that the same frequency bands are less congested than before even with larger volumes of services. Similarly, the same services now might be offered several ways. As spectrum is made available, regulators may therefore seek to ensure that frequency allocation procedures and restrictions do not stifle developments that would sharpen competition and increase welfare. More efficient spectrum use can be achieved by introducing spectrum trading in which spectrum would be transferred to the user that values it most. Regulating multiproduct firms Telecommunications service providers typically offer a range of services. This presents a special regulatory challenge: multiproduct firms may use bundling, cross-subsidisation, and complicated price structures that could dampen competition. Transparency and simplicity may need to be encouraged; leveraging market power from one market to another may need to be prevented. Some level of separation between the wholesale and retail operations of the incumbent appears to be a successful regulatory instrument against cross-subsidisation. Non-discrimination requirements are also aimed at cross-subsidies and uncompetitive bundling. Also, competition between alternative carriers might be facilitated if operators are required to have simple, transparent pricing structures (so that comparisons are possible). Providing universal service Universal Service Obligation (USO) is common OECD-wide, in practice, however, actual providers of universal services are limited to a handful. The others usually pay into a fund to finance these services and the payments are usually determined by their sales. Liberalisation and technological progress are bringing down prices and boosting trade in telecommunication services Opening up the competitive segments of the telecommunications industry to new entrants, together with huge technological progress, have brought about lower telecommunications charges across OECD countries thereby boosting telecommunications traffic. Telephone charges for both businesses and households have sharply fallen in the OECD over the past decade, 8 to a larger extent for the former. This trend masks opposing trends in the two components of overall charges: fixed costs have been rising and usage costs have been declining (Figure 8). Fixed charges, because they were traditionally geographically averaged (and still are in many cases) were set below costs in the monopoly period with call charges above costs. Liberalisation in the market has brought about a rebalancing of prices with call charges falling toward costs and fixed charges moving up. The very recent sharp increase in the fixed component is likely to be related to the proliferation of multiple-play offers OECD-wide. 8. In the European Union, for instance, prices have fallen on average by 30% over the past decade (http://ec.europa.eu/information_society/policy/ecomm/tomorrow/index_en.htm). 19

20 Figure 20. Figure Residential and business telephone charges in OECD have sharply fallen over A. Residential call charges Fixed Usage Total B. Business call charges Fixed Usage Total Note: The charges are in index form with 1990=100 and indicate an average of OECD countries. Source: OECD-Teligen database. Price elasticities of demand for international calls appear to be close to unitary elasticity, indicating that demand for international calls follows prices closely. Agiakloglou and Yannelis (2006) find that the time-varying elasticity of demand for international calls in Greece varies between (Germany) and (Australia). 9 Earlier studies show a large variation in the size of elasticities largely depending on the country and the time period. Simple log-linear elasticity estimates show that demand for international calls (as measured by the volume of calls) is highly dependent on the price of the call (Table 3). The coefficient on these crude elasticity estimates is always significant at the 1% level and the high R-squared statistics indicate that prices explain a large part of demand. The time-varying elasticity estimates of demand for outgoing international calls when show that between their size hovered around one, not surprisingly with households exhibiting higher elasticities than businesses. 9. Agiakloglou and Yannelis (2006) estimate a log-linear demand function with constant and time-varying elasticity and find that the latter has a better fit. They use per minute international call prices and the volume of international calls. 20

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