TOWARDS A FREE TELECOM MARKET

Paul Beaudry

Istituto Bruno Leoni Mises Conference

October 4, 2008, Sestri Levante

“Many people want the government to protect the consumer. A much more urgent problem is to protect the consumer from the government.”

- Milton Friedman

Introduction

• The Context:the telecom industry as a moving target

• The Goal of the reforms of the 1990s: Promoting a smooth transition to a competitive telecom market by creating incentives for new entrants

• The Means of the reforms: Network sharing and price regulation

• The Shortcomings and anticompetitive effects: Less innovation,more investment in old technology High regulated prices

• The Solution: The recent deregulation

The Regulatory framework

• The Acts Telecommunications Act - sets out policy objectives

• Nine potentially inconsistent policy objectives• objectives (d), (e) and (i) are not intended to enhance

competition

• Overall emphasis on competition, consumer welfare and innovation

Radiocommunications Act - addresses licensing of spectrum and certification of wireless equipment.

The Regulatory framework - cont’d

• The Regulators The CRTC: broad powers

• The CRTC has had ample discretion to regulate because of Governmental inaction in the field

The Government’s residual power to vary, rescind or refer a decision back to the CRTC

The Market structure

• The Former Monopolies - Incumbent Local Exchange Carriers (ILECs). They are regulated by the Telecommunications Act under a system of price cap regulation. (they were previously regulated under a rate of return scheme)

• The « New Entrants » - competitive local exchange carriers (CLECs) They are largely unregulated.

• This market structure was perpetuated by the two-tiered regulatory scheme

The Regulatory Scheme and its shortcomings

• In general: Price cap regulation on bundles of services and additional constraints on some individual services.

• Some important weaknesses: Bundling restrictions Rate de-averaging Win-back rule Foreign ownership restrictions Mandatory unbundling and mandated network access Failure of the stepping stone analysis

• Bundling restrictions – eliminated in 2006 The CRTCs imposed floor price constraints on bundles

of regulated and competitive (unregulated) services. ILECs structured their bundles without regulated local service to avoid the lengthy approval process.

The Regulatory Scheme - cont’d

The Regulatory Scheme - cont’d

• Rate de-averaging – eliminated in 2007 Consumers in the same geographical area or “rate

band” had to be offered the same rates.

The Regulatory Scheme - cont’d

• Win-back rule – eliminated in 2007 ILECs were prohibited from soliciting customers who

had been attracted by competitors for a period of 90 days. The maximum duration of promotions was also limited.

The Regulatory Scheme - cont’d

• Foreign ownership restrictions – still in force Ownership and de facto control: Canadians must own

at least 80% of a telecommunications company’s voting shares and at least 80% of its board of directors must be Canadians.

This position on foreign ownership is one of the most restrictive in the OECD.

The Regulatory Scheme - cont’d

• Mandatory unbundling regulations and essential and near-essential facilities Broad definition of essential and near-essential

facilities Categories of wholesale services and regulated

markups

Failure of the Stepping Stone Hypothesis

• The Rationale: Facilitate entry through mandatory access at regulated

rates Allow CLECs to amass capital to build their own

networks to enhance competition in the long run

• Without the right regulated rate, this hypothesis is deemed to fail.

Stepping Stone Hypothesis - cont’d

• The regulated rate: must reflect the fact that the substantial cost of

obsolescence, the cost of maintaining and upgrading networks and the risk inherent in infrastructure investments is borne only by ILECs

must be constantly adjusted to reflect the entrant’s increasing ability to rely on its own facilities.

must not shield “entrants” from market forces indefinitely and create a reliance on old technology

Stepping Stone Hypothesis - cont’d

• The failure: « The stepping stone hypothesis failed because the

CRTC was unable to set prices at a level low enough to facilitate entrants’ ability to expand their networks and more quickly acquire the customer base that would justify construction of their own facilities but high enough to provide entrants with sufficient incentives to build such facilities.” (TRTP report, 2006).

The unbundling regime slowed down investment and created dependency on unbundled local loops and rent seeking.

RECENT POLICY CHANGES

• Two Factors of Change Maxime Bernier’s tenure as Industry Minister and his

pro-market approach The publication of a report by telecom experts

recommending increased reliance on market mechanisms (TRTP)

The TRTP report

• Canada is losing its edge in telecom innovation because of its regulatory scheme.

• The panel recommends the following:

• Market forces should be relied upon to the maximum extent feasible as the means of achieving Canada's telecommunications policy objectives.

• Regulatory and other government measures should be adopted only where market forces are unlikely to achieve a telecommunications policy objective within a reasonable time frame, and only where the costs of regulation do not outweigh the benefits.

• Regulatory and other government measures should be efficient and proportionate to their purpose and should only minimally interfere with the operation of market forces to meet the objectives.

Three major changes

1. The Policy direction – a pro-market approach

2. Variance of the VOIP decision

3. Variance of the Forbearance decision

1.The Policy direction – a pro-market approach

• Best alternative to a legislative amendment in a minority government context

• The direction:

The CRTC should rely on market forces to the maximum extent feasible to regulate only as a last resort when exercising its powers under the Telecommunications Act.

2. Variance of the VOIP decision

• What is VOIP? Voice Over Internet Protocol: Using the internet

infrastructure and protocol to communicate by phone

• The Issue: Whether VOIP is subject to traditional wireline regulation?

• The CRTC’s original decision: VOIP is merely “another step in the evolution of telecommunications networks” and as such, falls within the purvey of wireline regulation. ILECs providing VOIP will be regulated. (CLECs will not, because they have no market power).

VOIP - cont’d

• The CRTC’s Reaffirmed decision: the decision, sent back by the government in May 2006, was reaffirmed.

• the anomaly of a regulated VOIP: the CRTC decision was unique, making Canada one of the only countries to apply such stringent regulation to VOIP.

• Variance by the Government: distinguish “access dependent” (the provider provides access and service) from “access independent” (different providers for access and service) and forbear “access independent” VOIP.

3. Variance of the Forbearance decision

The Forbearance decision determined the criteria to be met for ILECs to be forborne from regulation in retail local exchange services.

• The CRTC’s test: ILECs must lose a 25% market share in a specific geographic market in order to be forborne from ex ante pricing regulations. ILECs also have to meet wholesale access quality of service requirements for a period of six months before applying for forbearance, and are subject to ninety-day “win-back” rule which prohibits them from contacting customers lost to competitors.

Forbearance - cont’d

• Bernier’s proposal A bright-line facilities-based test: A residential market is competitive

when at least two independent facilities-based carriers, including providers of mobile wireless services, offer llocal exchange services in addition to the former monopoly.

The independently-owned carriers must be able to serve 75% of the number of service lines that the ILEC is capable of serving.

Abolition of win-back restrictions. Streamlining of quality of services requirements for wholesale

access. Consider smaller geographic areas for the purpose of local

forbearance applications. This allows to better target markets where forbearance is not an option and to properly identify competitive markets.

Forbearance - cont’d

• The idea: Competition as rivalry, not market structure. The 75% threshold is not a relevant indicator.

• Under Bernier’s forbearance test, roughly 70% of the Canadian population lived in telecommunication markets that were ripe for deregulation.

Forbearance - cont’d

• Why deregulating the telecom industry makes sense? Rapid deployment of cable telephony by CLECs in the

Canadian market Low barriers to entry into the telephone market for cable

providers High barriers to the entry of incumbent telephone providers

into the video market Control of wireline networks is no longer a good indicator of

market concentration Predatory practices can’t be successful in such a volatile

and innovation-driven industry as telecom

Forbearance - cont’d

• The Varied decision of April 2007: the Government rewrote the forbearance decision and invited ILECs to file forbearance applications.

• The CRTC’s reaction: “the government wants to move quickly toward more reliance on market forces in telecom services, less regulation and smarter regulation. I welcome the clarity and I welcome the variation order.”

• The result: As of June 30, 2008, the CRTC had forborne from regulation over 73% of the residential lines and 65% of the business lines. Further, approximately 80% of local access and revenues were from forborne local services.

Conclusion

• Failure of the two-tier regulatory regime and of mandatory unbundling Misallocation of investment Lagging innovation Rent-seeking to keep the subsidy system in place

• The next step: phasing out mandatory access

• Strong policy leadership can go a long way, even in the absence of legislative change.