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The End of (Traditional) Regulation?

THE END OF (TRADITIONAL) REGULATION? A RESPONSE TO PROFESSOR RICHARD SCHULTZ

Speaking Notes, Philippa Lawson, Public Interest Advocacy Centre

pippa@web.net; http://www.piac.ca

“Breaking the Mould: Reconceiving Telecommunications Regulation” Conference

Faskin Martineau/University of Toronto

February 17, 2000

Richard, let me begin by summarizing your position. I heard you say 6 important things:

  • To the extent there’s any kind of telecom policy in this country, its overriding goal should be competition
  • Competition only works in the absence of regulation. So the CRTC has to go.
  • The way to deliver universal service is through direct government subsidy—so it can be ladled out by MPs just before an election.
  • Anybody, from any country, ought to be able to own Canada’s phone system.
  • Incumbent carriers, who are trying to compete in the new multimedia world of communications with highly vertically integrated international competitors, should be stripped of their long distance businesses
  • Once the competitive Nirvana arrives, we can all relax—general competition law will keep everything running smoothly.

I think you won’t be surprised to hear that I think all of these propositions are a little dubious.

Instead, I’d like to put forward an alternative thesis: that, yes, traditional regulation has run its course, and that new models are needed for the new competitive environment – new models in which pro-competitive specialized regulation complements general competition law. This necessary shift has largely been recognized by the CRTC and is reflected in the dramatic regulatory transformation to which you have referred. But first, let me respond to Richard’s arguments.

Richard has made an impassioned case for establishing competition as the overriding goal of telecommunications policy, to which all other goals are secondary. Competition, for competition’s sake. Ideology substituting for rational, objective thinking informed by economic history – a history that proves the inability of market forces alone to achieve prosperity for anyone other than the corporate elite.

It’s this religious embrace of market forces as the be-all and end-all that leads him into contradictory arguments:

On one hand, we must get rid of the CRTC in order to achieve full competition. On the other hand, we need to keep the CRTC around until competition is sufficiently robust and assured to survive without a specialized regulator.

On one hand, we need to minimize interference with market forces, while on the other hand, we should be actively promoting competition through various interventionist means.

On one hand, we should sit back and let the “creative energies” of the market “forge new corporate alliances”, but on the other hand, we should be wrenching apart those corporations which are only doing what market forces compel them to do.

This fixation on competition, I submit, is precisely what has led to the airline debacle. We forced competition onto an industry which simply could not sustain it.

The fact is that healthy, sustainable competition is not possible in all locations or in all industry sectors. Remnants of natural monopoly, inadequate market forces, and other thorny issues often exacerbated by competition keep rearing their ugly heads.

Even where effective competition is possible, it is rarely achieved in the form that economists promise. Persistent market dominance by the incumbent tends to muddy the clear waters of academic theory. And forcing the incumbent to divest itself of long distance operations won’t provide much relief to local competitors.

Finally, where effective competition is achieved, it will be fragile and vunerable to sabotage by corporate mergers brought about by global forces over which we have little control. Thus, having forborne, the regulator must be ready to step back in if and when the need arises – it must not totally abdicate.

Competition is too elusive, too fragile to be considered our sole end goal. It is, rather, a preferred means to an end. So what is that end?

This is where Richard has left us in the lurch – there’s an unstated assumption in his thesis about what competition will deliver. I can only presume that this ultimate goal is prosperity, a higher standard of living, a better life for all. In other words, competition is secondary to these ultimate goals – it is merely our preferred means of achieving them. So, in fact, Parliament’s error was not in failing to make competition an overriding goal of telecom policy, but rather in giving competition the status of a goal in the first place.

In any case, Parliament has spoken – there are a number of objectives of Canadian telecommunications policy, reflecting a conscious decision to treat telecommunications as a social and economic enabler, not just another utility. Deride these objectives if you wish, but they reflect a national consensus that universal service is a primary goal of telecommunications policy – not just because we want to be nice to poor people, but because we recognize the tremendous positive social and economic externalities that this particular networked industry has the potential to deliver, to the benefit of all Canadians, including our corporate brethren, and to the benefit of Canada as a nation.

Are long term competition and regulation enemies, as Rick suggests? Absolutely not.

Competition can coexist with regulation. Indeed, they must co-exist in order both for competition to thrive and for the other goals of telecom policy to be achieved. A new regulatory model is being developed, one that permits healthy competition, while filling in the gaps that market forces leave behind.

These are difficult issues. It’s no easy task to turn a regulated monopoly into a competitive market, especially when the product in question is an essential service. With difficult issues comes a human tendency to seek out simple answers. And where better to look than economics. Just step out of the way, let those market forces work, and we’ll all be happier for it. Works in theory, right?

It’s reassuring to hear that Rick Schultz does not entirely buy into this long discredited notion – at least he recognizes that taking away regulatory barriers doesn’t guarantee competition. He recognizes that without appropriate regulation the existence of dominant players tends to distort markets and impede the development of competition. That much is obvious to even the most hard core disciples of neoclassical economics.

Beyond this short term, narrowly circumscribed, role, though, the free marketeers seem to me to be astounding naive with respect to the way markets work in practice. They downplay or simply ignore policy goals other than economic efficiency, and they’re blind to the possibilities for more nuanced, sophisticated approaches to complicated problems.

Getting rid of the CRTC will not get rid of the many forces that tend to undermine the development and maintenance of effective competition in a previously monopolized market. It will not make dominant firms any less dominant. It will not get rid of the remnants of natural monopoly in this still highly capital intensive industry. It will not change the fact that consumers – the basis of market forces – in fact often act quite irrationally, contrary to the assumptions of economic theory. It would, in my submission, be disastrous for competition in telecommunications.

It would also be disastrous for Canadians, who have come to rely upon affordable, accessible telecommunications services wherever they live. Which leads me to the question of whether telecommunications is still unique.

Telecommunications is unique in a key respect: it is a networked service, whose value depends upon its universality. Unlike electricity, transportation, housing, or other industries providing essential services, telecommunications is based on connecting people to each other. The value of the network is only as good as its universality. This is what sets telecommunications apart, and what justifies the policy emphasis on universal service.

Richard argues that competition is suffering because of an outdated approach to funding universal service, that we should end the industry contribution scheme once and for all, and leave it to government to deal with the fall-out through the tax system. This is not an unreasonable argument, but it does ignore some important realities.

Let’s just acknowledge, first, what Richard is actually proposing. Under this approach, people living in Iqaluit, for example, would face basic monthly rates of $90. Farmers in Saskatchewan, outport fishermen in Newfoundland, social workers in Yellowknife would have to pay $50 or $60 per month. Some areas would probably be left entirely unserved. What would happen to these communities? What businesses would want to locate there? And who would qualify for subsidized rates? Those on welfare? What about the working poor? Don’t fool yourselves about the efficacy of targeted subsidies – they help some, but not all.

What does Richard’s argument ignore?

It ignores the fact that universal service enhances the value of the network and thereby benefits the industry that provides it. It’s not just taxpayers that benefit from a strong, ubiquitous telecommunications system linking Canadians to each other, it’s also the industry that profits from universal service.

Moreover, while the government may well be at fault for not providing more specific guidance to the CRTC in policy matters such as the extent to which rural and remote areas should be subsidized out of industry-generated funds, it has in fact spoken through the recent amendment to the Telecom Act explicitly providing the CRTC with powers to establish and administer an industry fund through which to “support continuing access by Canadians to basic telecommunications services”. (s.46.5(1))

So it appears the argument we are having is purely academic – the government neither wants nor intends to take over the challenge of ensuring universal service in telecommunications.

It is not uncommon for revolutionaries to ignore thorny problems raised by the new regime they propose. We know all too well the problems with the existing regime. Why are we so naive as to suppose that similarly serious problems won’t result from a new system? Take Rick’s proposal for a government sponsored telecom subsidy – How do you determine eligibility for the subsidy? How do you ensure that it is spent on telephone service and not food? How do you make sure that everyone who needs the subsidy gets it? And that those who don’t need it, don’t get it? The fact is that in programs such as this, people always fall through the cracks, and the result is greater suffering, marginalization, and increased social costs.

This would of course run completely counter to the government’s agenda of “Connecting Canadians”, under which efforts are being made to address the digital divide, to ensure that less privileged Canadians are not only connected by phone, but also have access to the Internet.

Finally, telephone service is not a government sponsored benefit, like OAS or the child tax credit. I doubt that government would want to start using the tax system to dole out money intended for the payment of specific services. The issue here is not income supplementation; it’s affordable service.

Aside from passing the buck on the universal service issue, and making competition an overriding policy goal in the Telecom Act, Richard proposes that we “aggressively promote” competition in two concrete ways:

  • Reduce or eliminate foreign ownership restrictions, and
  • Force the incumbents to divest themselves of their LD (or local) operations.

I’ll leave the issue of foreign ownership to tomorrow’s panel, other than to say that the current restrictions don’t seem to be much of an obstacle to foreign investment in Canadian telecommunications – I suspect that we have more foreign ownership of telecom carriers in Canada than in most other countries.

The divestiture argument, however, does demand a response. I would have agreed with Rick on this five years ago, but the telecom world has been transformed since then. We are now into a new world of global competition, in which the name of the game is corporate merger, so as to combine integrated data, voice, multimedia, and IP-based services. The trend in the US and elsewhere is RE-integration, “one-stop shopping”, providing the full suite of services. We’re way past the local/long distance problem.

Look at AT&T, now hooked up in Canada with Metronet, Rogers and Videotron. It’s become, in the new world, perhaps the ultimate example of a vertically integrated incumbent, providing not just long distance, but local voice in some markets, wireless (Cellular One), Internet (WorldNet), business data and voice services, network outsourcing, web hosting, ecommerce entertainment, and cable (TCI) services.

Divestiture may be an appropriate response to competitive abuses by incumbents, but those who were the incumbents in the old world of telecommunications may not be the incumbents of the new world. I submit that the greater danger that we face in the form of these corporate behemoths is the combining of content and carriage functions under one roof. That’s where divestiture may prove necessary in order to maintain a vibrancy and diversity in the telecommunications marketplace

Finally, I come to Richard’s argument that the CRTC should be dismantled and replaced with, in his words, “a more sophisticated tool-kit of public remedies” including competition law, trade regulation and copyright law. Mindful that these subjects will be addressed by later panels, I wish only to make a few points about the so-called sophistication of competition law, and why it cannot substitute for specialized regulation.

Even our official cheerleader of competition and competition laws, Mr. Von Finkenstein, would be loathe, I suspect, to characterize general competition law as “sophisticated”, especially in comparison with specialized sectoral regulation. It is precisely the unsophisticated nature of competition law that renders it inadequate to safeguard the development of competition in the telecommunications industry.

First, general prohibitions don’t catch all forms of anti-competitive conduct – for example, predatory pricing rules applied under general competition law do not account for the high ratio of fixed to variable costs in the telecom industry, which inhibit entrants from leaving the market during below-cost pricing by a rival. The “revenue recoupment test” does not take account of the strategic benefits to a telecom industry predator of establishing a reputation for toughness and deterring innovation and investment by its rivals.

Second, enforcement of competition law tends to be slow and expensive, whereas specialized regulators can issue directions based on specific regulatory powers in a matter of days, providing a clear signal of the regulator’s view of the conduct in question even if not giving rise to direct liability.

And third, even if general competition laws are successfully invoked, suitable remedies may not be available. A Court, for example, is unlikely to be able to set an appropriate interconnection charge in the way that the regulator can.

We have only to look to New Zealand to see the folly of total reliance on competition laws – millions of dollars and several years were spent in protracted negotiations and lawsuits during which the incumbent carrier was able to delay the introduction of competition and the resolution of competitive disputes. Surely that lesson has been learned.

Australia has attempted to avoid the New Zealand fiasco by empowering its competition authority to act as a specialized telecoms regulator as well. The Australian Competition and Consumer Commission (ACCC) remains in charge of general competition law, but has since 1997 been empowered with specialist knowledge and specific responsibility in respect of telecommunications competition. Telecom staff in charge of carrier competition issues at the old telecom regulator, Austel, were simply transferred to the ACCC. Australia has thus recognized that general competition law and telecoms-specific law are not mutually exclusive choices, but rather, are complementary tools.

This is also recognized by our Commissioner of Competition, who advocates leaving specific regulatory functions regarding interconnection and access with the CRTC. As the Assistant Deputy Commissioner of Competition has emphasized, “competition is not a substitute for regulation”.

So, are facing the end of traditional regulation? Clearly, yes. Traditional quasi-judicial, command and control regulation is not likely to work in an era of rapid change. This has been recognized by the CRTC, and is reflected in its move from hands-on regulator to referee, and from top-down regulation to negotiated rule-making.

Are we facing the end of specialized telecom regulation? No. There will likely always be a role for a specialized telecoms regulator, to deal efficiently and effectively with interconnection disputes, access issues, and universal service subsidization. The CRTC will not go out of business; it will continue to adapt its regulatory approach and procedures to suit the changing marketplace.

But will it adapt appropriately, or sufficiently? A new paradigm of regulation is needed, one which puts more emphasis on cooperation between the CRTC and competition authorities, which focuses on consumer protection, and which takes on a more proactive approach to industry monitoring and consumer information.

My concern is that the CRTC may be too short-sighted and reckless in its desire to please those whose self-interest is in complete forbearance. The Internet of 1999 may not need to be regulated – but who knows about the Internet of 2005? I, for one, am not willing to bet that regulatory intervention in new media will never be needed. The AOL/TimeWarner merger is just a sign of things to come.

I’m also concerned that that CRTC doesn’t appreciate the need for its continued presence not only as a referee of competitive disputes, but also as an information gatherer and distributor, so as to provide consumers with the information they need to make informed choices. We need more regulation by information.

We are in the process of reinventing telecommunications regulation in Canada. What we need is not free market evangelism but rather imaginative and sensible approaches to pro-competitive regulation which are informed by history and guided by a vision of the future in which everyone, not just the corporate elite, benefits.

Thank you.

 

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