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Graduate School of International Corporate Strategy, Hitotsubashi


Asian Tax and Public Policy Program

Economic Analysis of Regulation and Public Enterprise



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


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


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


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


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


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

| |Advantages |Disadvantages |

|Regulator as |May stimulate important innovations not |Regulatory complexity and cost. |

|Patron |previously foreseen. |Blurs the line between regulatory and |

| |May significantly increase the rate of |commercial decision-making. |

| |innovation. | |

|Pro-Active Removal|Maintains dividing line between regulatory|A country with this approach may in some |

|of Obstacles |and commercial decision-making. |cases become follower of a country with |

| |May still significantly increase the rate |the “regulator as patron” model. |

| |of innovation. | |

|Arm's Length |Simplicity and low cost for the regulator.|May result in slower rate of innovation. |

|Approach | |May entail significant delays since the |

| |Maximises the clarity of the dividing line|regulator needs to undertake new policy |

| |between regulatory and commercial |development efforts, after initiatives are|

| |decision-making. |received, before he can respond. |