Is it time to repeal telco regulation?

(A more developed version of this post is available on Emerald publishing’s Info periodical (paywall)).

The telecoms liberalisation process is a true EU success. It has eliminated borders for fixed line telephony, driven rapid roll out of broadband, and the sophisticated incorporation of antitrust concepts is a genuine technocratic triumph (one need only look at the cast-in-law definitions that still haunt the FCC to feel justifiably proud!).  But the only true measure of success is when the rules are no longer needed and can be repealed!

Martin Bangemann – architect of an EU success story

Later this year, a new European Commission President will make digital a top priority.  As this blog argues more generally, their plan must mark a switch from supply side thinking (e.g. broadband deployment) to promoting adoption and use of information technology across the entire private and public sector.  There is no more elegant a way of emphasising the raised ambitions than to start the process of repealing the telecoms rules that are too often currently considered to be the digital policy.

The case is not simply political; the rules have developed two fundamental flaws:

1. the framework promotes horizontal competition within the telecoms sector; yet the impact of vertically related players is now arguably the dominant industry driver; and
2. regulation is becoming ‘capitalised’ into a political economy, distorting incentives and not serving European consumers, notably with respect to spectrum allocation.

1. From horizontal to vertical

The growing importance of vertical relationships can be seen at both the retail and wholesale level.

Retail

Regulators have successfully ensured retail competition and consumer prices have trended steadily downwards.  But it is services like Whatsapp that are truly disrupting the rents on SMS, just as Skype turned international telephony on its head a decade earlier.  And players like Fon have the potential to change the face of mobile data by leveraging the peer economy.

Wholesale

The heart of the regulator’s task was to set prices for electronic communications network providers to buy wholesale capacity from incumbent operators.  That remains a necessity for some challengers (discussed further below), but the defining wholesale relationships now are those of the major ISPs with the largest online content services.  If regulators were once mediating between David and Goliath, the new battle is between giants.

While some of the incumbents have called for regulation of these relationships (a reversal of rhetoric that is worrying in its own right), the fact is that the commercial links do not begin and end with the connecting of networks, as it does between horizontally competing telcos.  There may be marketing, content, advertising, software or other links that are much more significant in practise.

Whatever the breadth of the relationship between a telco and an online player, bargaining power is fundamentally affected by the number of outside options the other party has, and on the telco side of this equation regulation is a major determinant of market structure.

In other words, regulators cannot hope to have a proper overview of these vertical relationships, but their horizontal interventions are distorting the commercial bargaining power of the telcos.

2. Distorted political-economic incentives

Regulators’ decisions have changed the face of the market since 1998, to the benefit of consumers.  But regulation has also – inevitably – embedded itself in all of the stakeholders’ incentives, and that is now a threat to consumers’ long term interests.  The new, pro-regulatory rhetoric of many incumbents is a red flag in its own right, but there are issues for most other stakeholders too.

Challengers

The most effective competition generally came from e.g. cable TV players which needed little from regulated incumbents.  Spectrum is the best way to help establish more competitors not dependent upon ex ante regulation.

Nonetheless, other challengers are clearly dependent on timely regulation, but as the market consolidates, pockets are deeper and ex post scrutiny is more feasible.  More importantly:

• can challengers make the sort of long term investment decisions that policy makers want with an unknown a big as regulation to take into account?
• If the Commission announced the end game for telco regulation, the sector would still have half a decade to prepare, including more cross-border consolidation.

Mobile operators

The defining issue in the mobile market has been roaming, or rather the Single Market.  My contention is that a rush to (roaming) regulation was made too easy by the presence of the 2002 regulatory framework that could be built upon, and the macro policy picture ignored:

• Demand: why did mobile operators never perceive, and respond to, demand for pan-European services?  I suggest the answer lies primarily in e.g. the failure of services sector liberalisation.  With more cross-border business, a market with 3 or more mobile operators almost certainly have met the sort of demand single market entrepreneurs would have reflected.
• Supply: Single Market services needed someone to go first, and the candidate for that was Vodafone. Yet when they acquired Mannesman, the competition authorities bizarrely decided to limit the scope for ‘one Europe’ services.  Even so, the merger precipitated a wave of pan-European industry alliances which might in turn have led to the consolidation now recognised as essential.  And yet, with the industry in positive flux, the publication of socially regressive, price setting, roaming legislation quickly overwhelmed other market dynamics.

Incumbent spectrum holders

Spectrum is the big story for the future of telecoms sector, and the Commission has rightly pushed for more rational management of this truly scarce resource.  Leaving aside whether this should EU or national management, there is still far too little hard inter-departmental (defence, cultural, communications … needs) discussion about spectrum allocation.

Two issues exist:

1. pricing mechanisms are still insufficient for policy makers to compare possible spectrum uses, and to give incentives for incumbent holders (‘hoarders’) to relinquish control.
2. while spectrum is vital for infrastructure competition, the cost of missing competition is masked by the presence of regulation, and reduces the political pressure on hoarders.  In other words, announcing an end to regulation would improve the hand of telecoms policy makers, relative to other parts of government, when making the case for more spectrum!

Regulators

Structural reform applies to government too, as I argued recently.  Regulators could no doubt fine tune the application of today’s rules for decades to come, but the best ones’ have kept their eye on the original goal and have strived to put themselves out of work, knowing that their effectiveness and experience will be snapped up.  The Dutch seem to have gone furthest in providing officials with a clear perspective of life-after-telecoms, and this can be emulated in other countries.

Let’s celebrate success

Commissioners Reding and Kroes both recognised that digital policy needed to be about demand as much, if not more, than supply.  When heads of state met to discuss digital last October, their communique recognised the change in the nature of the debate, even while invited to consider a new set of amendments to the telco rule book.

It is time for the new President to declare telco liberalisation successfully completed, and signal that the ‘Digital Agenda’ is no longer simply a sectoral portfolio, but policy for the college as a whole.

The “Digital President’s” ultimate challenge

All being well, a new Commission President will take office this year, having proclaimed ‘Digital’ to be her/his top priority.  But what should a Digital President do?  Sort out our fragmented telecoms market?  Perhaps.  Foster entrepreneurial start-ups?  Definitely.  But the real challenge is driving technology-based productivity gains in the rest of the economy: manufacturing, services and the public sector.

Competition can do most of the work in the private sector, which is why completing the single market remains so vital.  But the public sector is the largest part of the economy, generally a monopolist provider, and historically a victim of “Baumol’s disease”.  (The American economist, William Baumol, argued in the 1960s that it was impossible to achieve significant productivity gains by the state because it naturally focused on labour intensive services.)

Public spending % of GDP: maroon > 55%, red 50–55%, orange 45–50%, yellow 40–45%, green 35–40%, blue 30–35% “Depense-publique-sur-PIB” by Marc Baronnet – Own work. Licensed under CC BY-SA 3.0 via Wikimedia Commons.

Baumol’s disease has been born out over the last 50 years, but in their recent book entitled The Fourth Revolution, The Global Race to Reinvent the State, John Micklethwait and Adrian Woolridge suggest that the picture could now change.  After charting the history of the western state, the authors argue that it is living up to Plato’s two great concerns: that voters would always favour short-term benefits, and that politicians would pander to this by offering entitlements to paid for by the next (unborn) generation. But they see two contemporary phenomena that will precipitate change.

The first is an emerging Asian model of technocratic government – the book focuses mostly on China, but identifies Singapore as the intellectual origins.  The key features of the model are long term planning and ruthless meritocracy.

Second is technology.  In Education, Moocs create radical new economies of scale for teaching, while giving all students a chance to learn from the best teachers.  The advent of wearable technology places prevention firmly alongside cure in health planning.  Big data helps focus law enforcement towards emerging trouble spots.  Meanwhile, open public data changes the level of accountability of every public service, and private sector developments could reduce demand for some public goods, such as ride-sharing needing less roads.  Ultimately, there is a need to reset our ambitions for the state, and to turn to technology, and the networked society, to find alternative means to the end.

Moreover, the two forces combine.  China has far fewer public sector traditions than the west; has studied the good and the bad of our systems; and can impose best practices quickly.  Given how important the state has been in fostering western economic success, a modern, effective Chinese public sector will become an inescapable global benchmark. The EU neither runs the most costly and labour-intensive parts of the public sector, nor even has competence over them.

The authors are dismissive of the EU, but a Commission that used the relenting economic crisis to drive an EU-wide debate about public sector reform would render a huge service to European citizens.  Fostering the reinvention of the public sector is the real challenge of the ‘Digital President’.

The Single Market for trust

Late in the 20th century the early adopter in me wanted an LCD TV. Prices on the (Belgian) high street were astronomical, but I found an offer 25% (€500!) cheaper on a French website.  Could I trust the seller?  It didn’t take much search effort to discover lots of customers frustrated with late deliveries, but it told me the company existed, and the savings were just too significant to overlook.  My TV arrived just under a month later, and my calculated act of cross-border trust was rewarded.

The Internet is a boon for small businesses because consumers have been willing to trust the online environment.  Where has the trust come from? Not from regulation I would suggest, but a system of organised ‘word of mouth’.

It began with eBay (and no doubt before them).  After each transaction, sellers and buyers ‘rate’ each other, and subsequent transactors were comforted dealing with someone with a large, positive record.

The beauty of the system is that it leverages technology and, thus, ‘scales’.  Moreover, it works cross-border by default – ratings use the universal language of numbers, and machine translation is more than sufficient to give you a flavour of qualitative comments.

The systems’ main shortcoming was gaming (paid-for ratings), not least because most users originally used pseudonyms.  But here social networks are beginning to show their real value. Posting and liking make such networks fun, but they put a premium on real names, and Facebook has quietly emerged as an (the) identity verifier for the web.

Traditional rating systems were good enough for buying goods, but are the 2.0 systems with real names sufficient if you are thinking of opening your home or car to a stranger?  That’s the question posed by the sharing / collaborative / Peer-2-Peer economy.  And it is really a question about regulation itself – put bluntly, do new business models need licenses and inspectors if they can be regulated by ‘data’?  Regulators don’t scale easily, but they won’t need to if I can get trustworthy information from peers about my room for the night, or about the person and car taking me there?

The P2P economy is giving us a new taste of how broadly disruptive the Internet is really going to be, and that inevitably includes to government as well.  My belief is that the adaptation of government service provision to the Internet could prove to be every bit as decisive for competitiveness as measures to improve private sector productivity.