Competition and Regulation in the Telecommunications Industry in ...

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Competition and Regulation in Telecommunications• Natural Monopoly: occurs when it is more expensive to have severalcompanies providing the same product than it is to only have one. Publicutilities, such as water and electricity and most other network industries areclassic examples of natural monopoly. Single product monopolists will derivetheir advantage from economies of scale, whereas multi-product naturalmonopolies may also derive their advantages from economies of scope 2 .• Large specific investments and hold-up problems: when private activity investslarge amounts in assets that may only be used for one purpose, there is apotential for the extraction of rents from a contract partner. If a pipelinecompany invests in a pipeline from an oil field to a refinery, this asset is onlygood for transportation between these two points. Once it is built, theinvestment is sunk. The oil field operators might be able to extract the sunkcost from the pipeline builders should they have other possibilities for thetransportation of their oil. Private contracting may be costly in this case andregulation the preferred tool.Regulation must hence be used in sectors where competition is not sustainable dueto one of the three reasons mentioned above. The success of regulation is to bemeasured by the efficiency criteria outlined.2.1.2 Positive Theories for RegulationRegulation does not only exist to correct market failures. This is apparent from thefact that regulation continues to exist in sectors with no natural monopoly features.Regulation also exists because it is a powerful means to redistribute wealth insociety. Regulation can be used to tax one group of consumers and redistribute toanother without imposing a more transparent tax-subsidy approach (Posner 1971).Classic examples in telecommunications are cross subsidisation from long distanceto local calls, from urban areas to rural areas and from business users to domesticusers.An alternative to government using regulation for social welfare-improvingredistribution, is for specific interest groups to capture the regulatory process throughlobbying government. Stigler (1971) observed that companies demand regulation inan attempt to earn abnormal profits at the expense of consumers. Politicians areprone to interest group pressure since single voters are unable to monitor and coercethe policy maker. The successful pressure group in the regulatory game need not becompanies only, but whoever it is they should have low costs of organisation andhigh potential payoffs relative to the competing interest groups. A good example forthis is the success of EU farmers in extracting rents from the rest of the population,whereas consumers with a lower per-head payoff and a much larger membershipfind it difficult to extract benefits from policy makers.The same forces that drive politicians to regulate sectors, may also drive them toderegulate. If interest groups that are being adversely affected by regulation organisemore effectively (or if the cost of the regulation to them increases enough to makethem organise) then they may be able to reduce the level of regulation. Intelecommunications, the advent of the Internet has meant that an inefficient2 When the cost of producing two products together is less than producing them separately18
Competition and Regulation in Telecommunicationsmonopoly has had greater costs to a group of industry users who have becomeharsh critics of the continued monopoly.2.2 Different Types of RegulationHaving identified the different types of factors that create the need for regulation, andthe criteria to judge the success of regulation, the question arises about the ways inwhich regulation is administered. Here we differentiate between theories forsituations when the regulator has perfect information and theories when the firm hasmore information than the regulator.2.2.1 Regulation under Perfect Information• Marginal Cost (MC) pricing: is possible under the case of a weak naturalmonopoly, i.e. one where the average cost is upward sloping over some of thedomain. In this case, MC pricing is possibly efficient• Ramsey Pricing: under strong natural monopoly (i.e. the average cost curve isdownward sloping over the whole domain reflecting high fixed costs and lowmarginal costs), MC pricing will lead to a loss and be unsustainable. Amechanism has to be found by which the distortion is minimised, given cost isbeing covered.o Single Product Ramsey Pricing: set price equal to average cost, hencecovering cost at the minimum possible distortiono Multi-Product Ramsey Pricing: when elasticities of demand differ indifferent markets, setting the same price-cost markup for both marketsis not optimal, since the dead weight loss (DWL) is proportionate to theelasticity of demand. Hence the price-cost mark-up ought to beinversely proportionate to the price elasticity of demand – i.e. theproduct which whose demand is more sensitive to price changes willhave a lower price-cost markup. In telecommunications, it is oftenassumed that access is inelastic and usage is elastic. If this is the case,then access charges should be high enough to cover most of the fixedcosts and usage charges extremely low.Clearly, the implementation problems associated with MC and Ramsey pricing arethose of asymmetric information. The regulator will have less than completeinformation about the cost structure of the regulated firm, making the implementationdifficult. Lastly there may be distributional concerns, as those goods that are inelasticwill have the highest mark-up, but these also tend to be necessities (like basicaccess to a telephone).2.2.2 Regulation under Asymmetric InformationIn reality, MC and Ramsey pricing will suffer from information asymmetries betweenregulators and the firms. Under these circumstances the regulator needs to designregulation that overcomes the information asymmetries to provide effectiveregulation. Two types of regulation have been implemented in practice. These are:• Rate of Return regulation: this is based on the Ramsey idea of having pricesset so that the firm covers its cost and achieves a “fair” return on capital.Hearings are used to determine prices after a test year. The problem with this19
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