Capitalizing On A Window Of Opportunity For Reform Of Telecommunications Regulation In The Russian Republic ~ Part 1

These changes in the public sector have been driven in large measure by two forces. The first is the rapid pace of change and innovation in the private sector. During 1996, wireline telephone networks added over 50 million new lines worldwide, while the number of mobile cellular subscribers similarly increased by over 50 million. According to the World Bank, the development and modernization of global telecommunications infrastructure over the last five years required investment totaling $60 billion, while investment over the next five years will require approximately $60 billion each year. Increased liberalization and competition around the world have led to an explosion of new and innovative services, the rise of new operators, and reductions in costs.

The second force prompting reform in telecommunications regulation is a growing appreciation for the fact that a modern and effective telecommunications system is one of the most important ingredients for economic development. Information, and the facilities for accessing, processing, and disseminating it in electronic form, have become important strategic resources. A healthy telecommunications industry attracts foreign investment and creates jobs. By allowing people to communicate effectively and efficiently across large geographic regions, it also can facilitate growth across all sectors of an economy and across all regions of a country. Clearly, any country seeking economic growth and modernization must develop and maintain a modern telecommunications infrastructure. It is likely, however, that as more and more nations seek to upgrade their telecommunications capabilities to international standards those that fail to implement a stable and predictable regulatory environment conducive to long-range planning will be unable to attract the necessary expertise and capital investment.

Although there is no single way to foster this modernization, experience across the world has revealed certain "best practices" that lead to successful development. Drawing on the experience of various countries, this paper seeks to identify those practices, and to explore their potential application in the Russian Republic. The first part of the paper outlines general conclusions and recommendations. The attached appendices detail the experiences in four countries -- the United States, France, India, and Chile -- as well as recent multilateral approaches to developing a bustling telecommunications industry. These studies provide illustrative examples of some of the successes and some of the perils involved in fostering a modern telecommunications system.

Many of the recommendations set out in this paper follow the outline of a Reference Paper adopted in whole or in part by sixty-five of the signatories to the WTO Agreement. (Of the countries discussed in this paper, the U.S., France, and Chile adopted all of the Reference Paper’s principles while India made a partial commitment.) Although it is not yet a member of the WTO, the Russian Republic can use these recognized principles as a template for devising a regulatory framework capable of crafting and implementing rules and policies that will promote the transformation of its telecommunications systems by promoting fair, open, and honest competition for all participants in the market.

Drawing upon the Reference Paper, and the comparative analysis of the four countries discussed herein, we recommend that the Russian Republic create a regulatory structure that incorporates six principal elements: (1) an independent regulator with open and transparent processes; (2) fair competition and competitive conditions; (3) detailed rules for interconnecting networks; (4) centralized spectrum oversight; (5) privatization and liberal foreign investment; and (6) requirements for a minimum level of service available to all potential users. Establishing such a regime has presented and continues to present a challenge in virtually every country, but overcoming monopoly control and other outmoded ways of thinking about and overseeing telecommunications systems is a necessary step toward achieving the kind of infrastructure and capabilities needed to unleash the full potential not only of the telecommunications industry itself but also of the overall national economy.

It is also worth noting briefly what is not addressed in this paper. Regulation of broadcasting and other content delivery systems introduces complex issues well beyond the scope of this paper. The Internet also is poised to raise a host of questions precisely because it does not fit neatly into any of the traditional categories used for regulation, and the issues are likely to get more complex still as the technology continues to advance. In order to give this paper an analytical framework, we have organized the discussion around platforms (wireline, wireless, and satellite). But as the process of convergence blurs or even obliterates distinctions between technologies (e.g., circuit switched vs. packet switched networks) and the uses of a given platform (e.g., for voice, video, or data), this framework will have to be revised to reflect the new reality. Accordingly, any new regulatory regime should be designed with sufficient flexibility to respond to unforeseen challenges that inevitably will arise through both technological advances and geopolitical developments.

The process of transition from a monopoly provider (or series of monopolies) to competition and privatization is not easy, nor is there a single recognized method for accomplishing that goal. Along the way, regulation must be skillfully applied to provide incentives normally provided by competition. The regulatory practices in the four countries surveyed in the Appendices demonstrate varying approaches taken to achieve similar goals, as well as varying degrees of success. For example, in both the U.S. and Chile the government took aggressive action to dismantle monopoly providers and, despite stiff initial resistance, have been able to improve service and lower prices through competition. The Indian experience shows that the success of regulatory and market reforms depends upon consistent and long-term commitment to the process, since unkept promises are likely to undermine the investor confidence necessary to attract and retain private capital for major infrastructure projects. While the French market is only in the earliest stages of transition, it has certainly committed to the requisite actions for development of a competitive and fairly regulated telecom market.

Although no perfect model emerges from the experience observed in these and other countries, certain common characteristics of successful regulatory regimes do appear, as reflected in the Reference Paper to the WTO Agreement. These are:

• an independent regulator separate from and not accountable to any operator or service provider;
• an open and transparent regulatory process;
• introduction of competition, including safeguards to ensure that service providers who, alone or together, have significant market power do not exploit their position to engage in anti-competitive behavior;
• assured ability to interconnect to other telecommunications networks at any technically feasible point in the network at fair prices and under non-discriminatory terms;
• centralized control over spectrum allocation within the country and coordination of spectrum use internationally;
• privatization and liberal rules regarding foreign investment; and
• appropriate universal service requirements.

Implementation of such a regulatory framework in the Russian Republic is a necessary step toward ushering in an era of improved telecommunications capabilities, innovative services, and lower prices. To be lasting, the transition from state-controlled monopoly to competition among private providers should be implemented incrementally. Competition works best, at least when it is just starting to develop, with a supporting framework of pro-competitive laws and independent government oversight. It is best to establish the regulatory framework first by creating an independent regulator to oversee the relationship between the incumbent provider and its new competitors. The elements of this framework, and other details of the recommended regulatory regime, are discussed in more detail below.

At the outset, a legitimate question arises as to whether a regulator for the telecommunications sector is really necessary. We believe that such a regulator is crucial at this stage in the development of virtually every market. At a minimum, some governmental entity must perform the administrative tasks of issuing and tracking licenses and other authorizations. So long as spectrum is scarce and interference continues to pose a concern, some form of regulation is necessary. At a more fundamental level, however, a regulator with expertise in the industry can serve a vital role in paving the way for the transition from a market structure dominated by one or a few firms to one in which competition is the rule. In November 1995, over 95% of the world's telecom revenues (excluding the U.S.) went to monopoly or dominant carriers. Only once all sectors of the industry are truly open and competitive will the question of whether to have any regulator specific to the sector take on real-world significance.

Effort should be made to insulate the regulator from the financial pressures of running a state-owned enterprise, and the political pressures of either facing election or having to rely on political leaders to make or enforce its decisions. Decisions to allocate scarce resources or manage the competitive market should turn neither on the government's desire to promote its proprietary interests nor on political influence. In other words, the Russian Republic should strive to establish a regulator that can independently follow rules of law in the manner of a court when such rules exist, and independently pursue what it regards as the public interest when such rules are either absent or left to its discretion. A stronger market will develop only if participants feel confident that the regulator does not face significant conflicts of interest -- that its decisions are either mandated by pre-existing law, or are made to further a legitimate public interest.

The independent regulatory bodies in the U.S., France, and India share certain common characteristics. For example, each has established a commission with from three to five members, including a Chairman, with power over appointments split between the executive and legislative branches. Of these countries, however, only India has adopted the additional strategy of making the body self-funding. SUBTEL, the Chilean regulator, is an exception that proves the general rule. Although it is part of a Ministry, it has proven itself time and again to be an effective and independent entity, so much so that periodic proposals to create a completely independent regulator have repeatedly been rebuffed as unnecessary. SUBTEL's independence may be explained in large measure by the fact that the state does not have an economic stake in any telecommunications operator, which greatly decreases the potential for conflicts of interest.

We would envision a system in which a government agency, most likely at the ministerial level to demonstrate the importance of the sector, is responsible for making broad outlines of telecommunications policy and handling international negotiations. A separate and independent regulator would be charged with implementing that policy by adopting rules and regulations, processing licensing applications and awarding licenses, allocating spectrum, handling disputes among service providers or complaints from the public, ensuring compliance with licensing terms and conditions, and setting standards for and approving equipment specifications. In order to enhance the independence of this regulator from other branches of the government, its operations should be funded to the extent possible out of its own fees and auction revenues.

This recommendation implicitly assumes that the new regulator will have available to it sufficient expertise to deal with the complex and often novel issues confronting it. At least initially, however, most of the personnel with such expertise will be drawn from the regime being left behind, and the new bureaucratic and incentive structures will be forced to coexist with perhaps incompatible aspects of that old regime for some time. The transition will take a long term and public commitment to the process. Anything less could impede reform by giving hope to those with vested interests in the current regime who might seek to stymie change.

The huge investments necessary to build telecommunications infrastructure require many years to recover, and thus operators will be reluctant to make such investments in the absence of a stable regulatory structure. One key to establishing the necessary stability in the telecommunications industry is a regulatory process that is fair, transparent, and predictable. At a minimum, such a process must include notice of any proposed action and an opportunity for interested parties to comment on the proposal. All applications and petitions must be subject to public scrutiny, and any submissions in an ongoing proceeding must also be publicly available in the interest of full participation in and disclosure of the matters affecting the final decision. The process must also include written and publicly available explanations of the basis for all regulatory decisions, and the availability of judicial review as a further check on regulatory fiat.

Equitable regulation of the telecommunications industry requires that operators know what to expect. If two or more companies seek a license to provide a service, the process by which that license is granted or denied should be both fair and predictable for all applicants. All of the licensing criteria and the terms and conditions of the individual licenses should be made publicly available before the process begins. Once initiated, the process should be transparent: each company should be able to follow the process and understand why its application was granted or denied, and the same basic process should apply to applicants in the future. Such processes create confidence in the system which is a prerequisite for future development.

One issue that has continually plagued regulators in telecommunications is the problem of capture -- when regulators do the bidding of those they are supposed to regulate. Telecommunications policy is meant to promote the needs of the public -- to enhance consumer welfare. Too often, however, regulators hear only from large operators with large sums of money at stake, and lose sight of the needs of the public at large, or of other players in the industry who have not taken the initiative to make themselves heard. To combat this problem, a regulator should encourage public participation in the decision-making process by offering proposed rulemakings for public comment and simplifying the process of providing input to the regulator. It should also actively solicit input from industry and end users of telecommunications services to stay abreast of developments and ensure that regulation is achieving its intended goals. Such constant evaluation of practices and recalibration of policies is especially necessary as the pace of developments in the market continues to accelerate. Fortunately, the technology itself may present enhanced opportunities for such participation. For example, the FCC has established a site on the Internet where most of its orders and many of the comments filed in its proceedings are published and downloadable from any location, and it is currently in the process of adopting rules that will enable interested parties to file documents electronically as well. By increasing the avenues for participation, a regulator can avoid the tunnel vision of becoming captive to the views of just a small segment of those affected by its decision.

In most countries, a small number of firms dominate the telecommunications markets and therefore may have both the incentive and ability to act alone or in coordination to stifle competition and deny entry to new competitors through predatory pricing, cross-subsidization, and similar tactics. Any country that allows those anticompetitive actions to go unchecked will never realize the promise of a robust telecommunications sector. It is perhaps ironic, though nonetheless true, that strong pro-competitive regulation is necessary in order for competitive forces to succeed in replacing regulation.

There is no single standard repository for responsibility over enforcing competitive safeguards. Obvious choices include the independent industry regulator, a law enforcement agency, or a trade agency. The former brings a special appreciation of the telecommunications market, while the latter two are probably better suited to the pure analysis of competitive conditions. In the United States, this responsibility is spread across all three types of agencies -- the Federal Communications Commission, Department of Justice, and Federal Trade Commission. While this system brings to bear both industry- and competition-specific expertise, it also complicates the process and has the potential for introducing turf battles. France, Chile, and India have taken a different approach, placing primary responsibility in an agency dedicated to competition issues. Chile's AMC played a key role in bringing competition to the market, for example by forcing Telefonica's divestiture of ENTEL. This would appear to be a preferable approach, especially if the regulator stands ready to lend its expertise to competition authorities where necessary.

For a variety of reasons, it may be desirable to retain a limited or transitional form of monopoly for voice services over wireline networks. In such a case, the dominant provider should be prohibited from investing in competing technologies until the market has become fully competitive, and should also be required to make its facilities available for resale by others. Moreover, the regulatory authorities should establish firm dates for transition to full competition and clear rules for operation of the network in the interim. During the transition period, competing carriers should be able to resell the dominant carrier's services as a way to generate income and secure customers while they build out their own facilities. The resale regime should not, however, be viewed as a long-term alternative to encouraging construction of alternative network infrastructure. Only the rise of additional facilities-based providers will ultimately lead to a truly competitive market and eliminate the need for regulatory oversight.

Regardless of the timetable for introducing competition in such traditional core services, however, comparable services offered by means of new wireless and satellite technologies can and should be permitted to offer an immediate competitive alternative. Wireless and satellite services can provide substantial network capacity relatively inexpensively and, especially when interconnected with existing wireline facilities, may well present the greatest potential for increasing the level of service available to all customers. This has been the case in Chile, where cellular service is a preferred alternative to wireline carriers, and may soon become the case in the U.S. as companies such as AT&T seek to bypass the dominant local providers by introducing wireless local loop technologies.

More competition leads to lower prices and more innovative services for consumers. Few people appreciate, however, that it often also leads to increases in profits for all competitors, both incumbents and new entrants. For example, for years AT&T enjoyed a monopoly on long distance wireline service in the U.S., and vigorously resisted entry by new operators. However, in the 12 years since MCI first began offering a competitive service, AT&T's profitability has grown even though its share of the market has fallen from 100% to 60%, because the size of the market grew as prices went down and service went up. Interconnection is likely to be a particularly good example of this phenomenon. In the long run, interconnection is in the interest of incumbent firms because it increases the value of communications services to consumers which increases their demand and in turn increases the size of the market, to the benefit of all competitors. The same can be expected for competition on international routes, as expanded access make the network more valuable for all users.

The truth is that, at the international level, governments have practically lost the power to dictate who can provide services. For example, the development of alternative calling procedures such as call-back and refile have introduced competition even where none would seem to be available, and done so at a pace few would have expected just a few years ago. Rather than engage in a futile attempt to resist such trends toward competition, regulators should embrace and expand them to reach every aspect of the industry.

Perhaps more than any other factor, interconnection is the key to opening a nation's telecommunications markets to new competition. New entrants and new systems must be able to interoperate with existing facilities -- and do so on fair terms and at fair prices -- if they are to have any meaningful opportunity to attract customers currently served by dominant incumbent operators. The alternative -- forcing each new entrant to establish a complete national or regional network -- would severely limit entry and deny the benefits of many innovative services that could be provided by interconnected networks. This lesson is demonstrated by the experience in Chile, where reform efforts took hold only after implementation of a strong interconnection regime, and in India, where difficulties with interconnection threatened to bring liberalization efforts to a halt.

Dominant incumbent carriers should not be expected to make their networks available to competitors at the transparent, nondiscriminatory, cost-based rates necessary to make interconnection succeed. Accordingly, the regulatory regime must take the lead in mandating a framework for interconnection terms and conditions. For example, incumbent operators should be required to provide interconnection equal in type, quality, and price to that which the incumbent provides to its own operating subsidiaries. Interconnection pricing should be cost-based and forward-looking to ensure that new entrants bear only their fair share of operating expenses. The regulator should establish and publish interconnection standards.

Once such a framework is in place, new entrants will be able to negotiate agreements with incumbents. Establishing specific time limits within which to achieve an interconnection agreement or proceed to arbitration will prevent stalling tactics by incumbent operators. All interconnection agreements should be published and their terms and conditions made generally available to other interconnecting operators.

Unlike wires, switches, and cables, radio spectrum is a finite resource. Responsibility for coordinating and overseeing the use of that resource within a given country naturally rests at the national level, since only by mandating nationwide frequency uses can a country ensure the nationwide interoperability of systems and avoid harmful interference from incompatible uses in neighboring regions. Centralizing the spectrum allocation and oversight function not only ensures that a nation's systems can "talk" to each other, but it is an important step toward rationalizing telecommunications policy.

A regulatory system must have clear and fair rules for allocating scarce spectrum resources both among competing uses and among competing providers. Increasingly, auctions and competitive tenders have been deemed an appropriate method for deciding among competing commercial uses. Such a process can assure transparency in decisionmaking, but only if the technical parameters for service in a particular frequency band and the service rules applicable thereto are established beforehand and maintained throughout. The Indian basic telecom tender (although it did not involve spectrum) illustrates the difficulties that can arise when rules are changed in mid-stream to the apparent advantage of some providers over others. In addition, auctions are not appropriate in some contexts. For example, allocations for non-commercial uses such as public safety and essential services should not be subject to auction, nor should services that are inherently multi-national such as those provided by satellite.

Spectrum management functions need not necessarily be consolidated with other regulatory functions, and an argument can be made that political decisions on how best to allocate scarce spectrum resources should be separated from the administrative tasks of assigning licenses or concessions to particular parties and regulating their conduct thereafter. Authority should, however, be centralized to streamline decisionmaking. In the U.S., the FCC manages commercial spectrum while NTIA manages government spectrum, but the government's increased use of commercial systems has introduced unnecessary confusion and jurisdictional squabbles. No matter where this function resides, however, it is imperative that spectrum be managed in a fair and transparent manner.

It has become increasingly evident that the demand for telecommunications services far surpasses the ability of individual governments to pay for the development of a network able to provide such services. Private investment is therefore crucial to the success of any reform. In addition to providing inflows of capital, private investment stimulates development of new technologies, equipment, services, new sources of information, jobs, and managerial skills. Such investment helps speed infrastructure growth and improvements, increases efficiency in the provision of services, and permits responsiveness to customer needs.

At the start of 1997, more than 40 state monopoly carriers had been privatized since British Telecommunications plc. became the first in 1984. These sales raised a combined $160 billion, with foreign investors accounting for approximately one-third. In some countries, such as Chile, this has enabled the repatriation of capital that took flight under prior economic or governmental conditions.

Privatization of telecommunications operating companies may be total or partial, and may or may not involve transfer of control. France, for example, has only partially privatized its dominant carrier, France Telecom. In various circumstances, privatization has been accomplished through a number of different means: single auction, a series of partial sales, and public offerings of shares on trading exchanges, for example. Even partial privatization of state-held operators can enhance their abilities, both financial and managerial, so long as the funds raised are reinvested in the carrier rather than applied toward general obligations of the government. Privatization is not, however, a solution in and of itself; rather, it is one objective along the path to a fully competitive market. But getting the state out of the business of offering telecommunications services helps create a competitive environment.

Accordingly, there must be a transition to privatization in all areas -- local, long distance, and international. During the transition process, the market should be open to new entrants. International investment in both old and new providers should be permitted. Foreign involvement can bring needed capital to expensive infrastructure projects, and can also infuse technical, managerial, and commercial expertise. Given the many opportunities available for capital investment around the world, the only way to attract such investment is to commit to fair, open, and pro-competitive regulatory principles and demonstrate a commitment to follow through on that commitment. Implementing rules that do not discriminate against foreign-manufactured telecommunications equipment will further enhance the market's attractiveness while also lowering costs and providing more opportunities for innovation and modernization.

Some countries, such as Chile and India, have established boards specifically charged with reviewing proposed foreign investments in telecommunications companies and projects. In both countries, these boards are intended to facilitate such investment by consolidating the required approvals in a single body. In the U.S., the FCC determines whether a proposed foreign investment complies with statutory limitations or whether proposed entry by a foreign carrier is in the public interest, allowing the commission to bring its knowledge of the industry to bear in making its decision. The importance of these institutional reviews, however, will markedly decrease as multilateral agreements such as that reached by the WTO erode the remaining limitations on foreign investment and entry.

Metcalfe's Law holds that the value of a network is equivalent to the square of the number of nodes. In other words, as networks grow, the utility of being connected to the network not only grows, but does so exponentially. Accordingly, promoting a telecommunications network that reaches as many citizens as possible serves not only those added to the network but also those already part of it.

The goal of providing all people with greater access to both basic and advanced telecommunications services should be an essential element of any modern telecommunications policy. Widespread access to such services not only affords new economic and social opportunities to previously unserved or underserved areas of the country, but also can unleash gains in productivity and profitability that create a demand for still greater development of the network. In a country with relatively low teledensity, the telecommunications network must first be expanded before the baseline level of service can be raised.

The exact trade-off between investing in access for a dwindling number of unserved areas at the expense of upgrading central services in the economic core of the country is ultimately a political decision. However, even by dedicating only a relatively small amount -- approximately two to five percent of all revenues generated by telecommunications service providers -- would create a pool of funding capable of financing a universal service program commensurate with the size and development of the existing network. For example, in the U.S., the FCC collects just over 2% of telecom revenues to fund a very comprehensive program that includes everything from supports for rural telephone users to subsidies for wiring schools and libraries for Internet service. A more ambitious program may actually prove to be less effective, due to the burden on service providers and the unrealistic demands on existing infrastructure. A number of countries have adopted innovative strategies to harness the power of market forces to further universal service goals, in particular by conducting tenders in which service providers compete for infrastructure projects that carry government subsidies. This mixture of public goals and private enterprise may prove the most efficacious in extending service to all but the most remote or impoverished areas.

The first goal should be to provide basic telephone services throughout the country. Given its sheer size and other geographic challenges, the Russian Republic may be best served by using alternative infrastructure -- i.e., wireless and satellite -- in extending services. Thus, as in the U.S. and Chile, universal service goals should be pursued in a manner that favors neither a particular technology, a particular organizational structure, nor a particular provider (especially an incumbent). And in order to harness competitive forces to reach those otherwise unserved, a fund such as that established in Chile could be established that would identify needed expansions, conduct competitive tenders, and subsidize construction by the bidder that can deliver the infrastructure at the lowest level of subsidy.

* * *

As demonstrated by the WTO Reference Paper and developments in countries around the world, the regulatory reforms outlined above enjoy wide acceptance. This unusual similarity in approach is due to the increasingly widespread understanding that such reforms benefit everyone. Customers get more, better, and more innovative services with lower prices. As the number, availability, and variety of services grows, operators are able to increase their traffic, revenues, and profits even as the number of competitors in the marketplace increases. Investors can achieve competitive returns and enjoy new opportunities both in terms of new service offerings and new markets in which to offer them. Even those working in the telecommunications industry benefit from the greater opportunities in their growing sector of the economy, better salaries, and the potential for an ownership share in their newly-privatized employers. It is true that governments must forego daily control over the operations of service providers in order to achieve these benefits. However, they retain the ability to establish ground rules, set overall policy, and implement regulatory oversight and are more than compensated for the diminution in control through higher tax revenue, reduction of national debt, revenues from privatization, and -- most importantly -- the kind of modernized telecommunications capability that is necessary to sustain growth throughout any national economy.