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World Bank Discussion Papers

TelecommunicationsSector Reformin Asla

Toward a New Pragmatism

Peter L. SmithGregory Staple

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232 L World Bank Discussion Papers

TelecommunicationsSector Reformin Asia

Toward a New Pragmatism

Peter L. SmithGregory Staple

The World BankWashington, D.C.

Copyright 0 1994The Intemational Bank for Reconsrtructionand Development/THE WORLD BANK1818 H Street, N.W.Washington, D.C. 20433, U.SA

Al rights reservedManufactured in the United States of AmericaFir printingJanuary 1994

Discussion Papers present results of country analysis or research that are circulated to encourage discussionand conmnent within the development conununity. To present these results with the least possible delay, thetypescript of this paper has not been prepared in accordance with the procedures appropriate to formalpnnted texts, and the World Bank accepts no responsibility for errors. Some sources cited in this paper maybe informal documents that are not readily available.

The findings, interpretations, and conctusions expressed in this paper are entirely those of the author(s)and should not be attributed in any manner to the World Bank, to its affiliated organizations, or to membersof its Board of Executive Directors or the countries they represent The World Bank does hot guarantee theaccuracy of the data induded in this publication and accepts no responsibility whatsoever for anyconsequence of their use. Any maps that accompany the text have been prepared solely for the convenienceof readers; the designations and presentation of material in them do not imply the expression of any opinionwhatsoever on the part of the World Bank, its affiliates, or its Board or member countries concerning thelegal status of any country, territory, city, or area or of the authorities thereof or conceming the delimitationof its boundaries or its national affilation.

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ISSN: 0259-21 OX

Petcr L. Smith is senior telecommunications policy specialist in the TeecomMmunications and InformaticsDivision ofthe Wodd Bank's Industry and Energy Department. At the time this paper was written, GregoryStaple was a consultant to the World Bank for this study.

Cataloging-in-Publication Data for this tide is available directly from Iibray of Congress.

CONrE.TS

F o reword .......................... v

Abssra c.......................................... vi

Acknowledgments; ................................... vii

Executive Summary and Condusions ........................ ix

I. In tro d u ction ..................................... 1

EI. Emonomic Issues .................................. 7

A. Economies of Scale and Scope ........................ 8B. Externalities ................................... 14C. Cross-Subsidies ................................. 17

m. Diversfying Supply The Scope for Competition ............. 23

A. Facilities-based Compeition ......................... 25B. Services Compettion .........m .................... 34C. Customer Premises E pent........................ 37

IV. Increasing Private-Sctor n ................... 43

A. Privatzation of the Dominant Carrier ....... .. .......... 45B. "Bottom-Up- Options for Prie Investment ............... 51

V. Improving Public Regultion .......................... 63

A. The Need for Regulation ........................... 63B. Intemational Experience with Regulation ................. 66C. Addressing Regulatory Shortfalls ....................... 71

VI. Implemeg Sector Rdorm .......................... 79

A. Context: Economic and Political Conditions ............... 79B. Sequence: ncrementalism vs. Quantum Leaps .............. 81C. Managing the Process: Leadership and Coordination .......... 85

App=eNc Sdelcted Tdcmnmicaions ndicatnrs .............. 89

Glossary . ......................................... 97

..

Text Boxes

1. Telecommunications Sector Reform in Asia: Some Conclusions .... xviii

2. Telecommunications Sector Reform in Asia: Five Country Profiles.. xx

3. The Telephone "Takeoff' in the United States: The Historical Roleof Independent Telephone Companies ..................... 27

4. Local Service Competition: International Experience .... ....... 28

5. Virtual Telephone (VT) Service: Voice Mail, Pay Phones, and Paging 30

6. "Cream Skimming": The Continuing Debate ................ 31

7. Paging: Stretching the Local Telephone Base ................ 34

8. The Welfare Consequences of Selling Public Enterprises: WorldBank Research ................................... 44

9. Private Ownership and Special Interests ................... 46

10. Restructuring the Telecommunications Sector. The Legislative Elements 50

11. Alternative Approaches to Issuing Tele cations Franchises . . . 53

12. Asian Satellites: New Technologies or New Services? .... ...... 57

13. Special Telecommunications Zones (STZs): A Test-Bed for Reform? 58

14. Regulatory Fundamentals ....................... 65

15. License Elements for Public Telecommn ications Operators .... ... 68

16. Links Between Microeconomic Policy and Public Utility Regulation . . 69

17. The Challenge for New Regulators: Setting Priorities .... ...... 74

18. Craffing a Reform Agenda: Local World Bank Workshops .... ... 86

1. Market Liberalization in Selected Asian Countries .... ......... 24

2. How Long Does it Take to Divest a Stae-Owned TelecommunicationsOperator? ...................................... 48

3. Preparing for Divestiture: Allocating the Work .... .......... 49

4. Organizing the Telecommunications Regulatory Agency: Example A . 82

5. Organizing the Telecommunications Regulatory Agency: Example B . 83

6. The Sequencing of Reforms: International Experience .... ...... 84

iv

FOREWORD

Since the mid-1980s, a growing number of developing-country governments have becomeaware of the need to overhaul the telecommunications sector in order to generate capital forinvestment, improve the performance of the operating enterprises, and respond to rapidly growingbusiness pressures for improved telecommunications services. The movement toward reform isdriven by the same forces at work in developed countries-technology and demand-and isreinforced by the recognition of the sector's importance for productivity, competitiveness, andparticip.tion in the world economy.

In Asia, telecommunications sector reform is already under way. Far-reaching changesin sector structure have been implemented in a few Asian countries and are under activeconsideration in others. Nevertheless, in several dzveloping countries in the region,telecommunications sectors continue to perform substantially and chronically beneath the needs oftheir respective economies, particularly in terms of their inability to meet effective demand forservice. Therefore it is likely that telecomnmunications sector reform will need to be addressed bymany World Bank client countries in Asia.

The design and implemention of programs to optimize sector performance raise manycomplex issues. If the programs are poorly designed or implemented, Wy run a significant riskof failure. Thus, the quality of the World Bank's advice to client countries can be a key factor inthe success of their sector reform programs. In this context, the Bank's Asia Technical Departmentcommissioned this report to improve the ability of the Bank to respond effectively to clients in Asiathat need advice and assistance in designig and implementing telcommunications sector reform.

The work behind this report included the development of short profiles oftelecommunications sector developments in six countries both within and outside Asia: Mexico,New Zealand, Phlppines, Thailand, Singapore, and Sri Lanka More important, the report basbenefitted from the authors' access to a wide range of published and unpublished material ontelecommunications sector developments in every region of the world, interviews with seniordeveloping country officials and review comments from colleagues in the Bank.

The report's purpose is to provide a measure of practical guidance to the World Bank andits clients considering strategies for telcommuications sector development. It examines keyaspects of economic analysis related to policies for the sector and four main elements ofteleommunications sector reform programs: supply diversification, private-sector participation,reguation, and implementation of reforms. The report identifies key issues, synthesizes lessonsof experience, describes best practices, and draws conclusions of particular relevance to developingcountries in Asia.

Daniel RitchieDirector

Asia Technical Department

ABSTRACT

Govermments in Asia are reappraising telecommunications policies in light of changingtechnological and economic conditions, particularly chronic unmet demand for telecommunicationsservices. This report challenges the economic rationales (economies of scale and scope, andexternalities, for example) that have been used to support monopoly provision ofteleomnmunications services, and it reviews four main elements of sector reform: supplydiversification, private-sector participation, regulation, and implementation of reforms. The reportsynthesizes lessons of experience and draws conclusions of special relevance for Asia's developingcountries, and it concludes that current policy initiatives must be broadened and deepened if thenew, pragmatic approach to telecmmunications policy is to succeed in doubling or tripling theregion's telephone base.

vi

ACKNOWLEDGMENITS

The authors wish to ffiank Steven Globernman, Norman Nicholls, David Townsend, andFrancoise Clottes for contributions to this report and to the supplementary document,Telecommunicatons Sector Reform in Asia: Working Papers. They also wish to thank: manycolleagues in developing countries and the Bank for sharing their ideas, suggestions, andexperiences; Ahmed Galal, Pierre Guislain, Alice H111, Roger Noll, Robert Panfil,Peter R. Scherer, Robert R. T -.ylor, and Bjom Wellenius for review comments; John Green foreditorial assistance; and Lori Hylan for additional assistance with editing and charts.

Telecommunicatons Sector Reform in Asia: Working Papers is available from the Industry andEnergy Department, The World Bank, 1818 H Street, NW, Washington, DC 20433 USA.

vi,

EXECUTiVE SU1MARY and CONCLUSIONS

(i) The Asia-Pacific region now has the most dynamic and rapidly growing regional economyin the world. A crucial question is whether the region's telecommunications sectors, apart from thosein the half-dozen wealthiest states, can keep pace with the region's growth and expansion. Their abilityor inability to do so will affect the region's economic prospects, especially those of the low- and middle-income countries (LICs and MICs), well into the next century.'

(ii) There is reason for optimism. It is generally agreed that the limited attention accordedtelecommunications in the past and the prevalence of state-run monopolies has cost Asia's poorercountries dearly, economically and socially. Today more than 2.8 billion persons in Asia's LICs haveaccess to little more than 25 million telephone lines. This has prompted nations as different as China andSri Lanka, and Thailand and Indonesia to make rapid expansion of their telecommnications infrastucturea priority.

(iii) China, for example, has set a target of installing 4-5 million new telephone lines amally to1995, and at least 8 million lines per year thereafter, to more than triple the current base of 17.5 millionlines by 2000. Similarly, ndonesia aims roughly to double its base of telephone lines, to more than 2.5million, by 1995 and add another 5 million lines by 2000. The new investment required for these andother programs in Asian LICs is estimated to exceed $90-120 billion for switching and transmissionfacilities alone.

A New Prag sm

(iv) The economic and political challenge of raising these funds and meeting the underlyingdemand for services has given birdh to a new pragmatism in sector policy. The role of state-ownedmonopolies is receding, and investment by private companies in the telecommications sector isgrowing; the range of telecommunications suppliers also is increasing, especially for wireless services(e.g., cellular radio), and regulation is being refashioned.

(v) The impact of these new policy initiatives, if sustained, may be profound. Asia's LlCs andMlCs are home to almost half the world's population. But the will to adopt and implement a newdirection for telecommunications varies greatly from one country to another. In India, for example,despite the estimated demand for 40-60 million new lines, the debate over how best to increase supplyis unresolved. And in the Philippines, although the telecommunications sector is almost entirely privatelyowned, its performance in meeting demand for service has been disappointing.

(vi) This report concludes that if the new pragmatism on telecommumications policy is to succeedin doubling, or even tripling, the region's teiephone base, current policy initiatives will need to bebroadened and deepened. Recent international experience and sector stdies suggest that the followingpoints are of utmost importance:

1. Based on 1990 per capita GNP, AsiLn counries may be classified as Low-ncome ($610 or kss): BangLadesh. Bhuan,Cambodia, China, Idia, Indonesia, Lao PDR, Mynamarw, epal, Pakistan, Sri Lanka. and Vietnam; Lower middlencome (S611-2.465): Malaysia, Philippines, and Thaiand; Upper midle-income (S2.466-7.619): Republic of Korea. Word DevelopmentReport 1992 (Oxford U. Press, New York, 1992) p. 306.

ix

Telcommnurdcaions Sector Reform in Asia: Toward A New Pragmatism

(1) The cost to national economies of providing only very limited or no telecmmunicationsservice to millions of people will be, in most cses, greater than any loss of econoniesof scale and scope from franchising new service providers.

(2) The very small base of telephones in most LICs (fewer than two lines per hundredpopulation) means that divestiture and privatization of a state-owned operator is, at best,a partial solution to closing the gap between demand and supply. More important thanthis "top-down" approach are likely to be various "bottom-up" approaches, funded by amix of public and private capital, involving new concessions to independent wireline andwireless (cellular radio) telephone companies, build-transfer schemes, joint ventures, andrevenue sharing contrcts for transmission and switching facilities.

(3) A broadly available, mature telephone network is not a prerequisite to liberalizing marketentry. To the contrary, the history of wireline and cellular service teaches that wheretelephone density is low, licensing multiple service providers is probably the best wayto accelerate the investment necessary to create a more broadly based and mature nationalnetwork.

(4) New service suppliers are unlikely to obtain reasonable interconnection terms from theicumbent operator without regulatory aid. Regulation is thus essential to foster the typeof bottom-up investment necessary to close the telecommunications gap in Asia.

Bad

(vii) The reappraisal of telecommnications policy in Asia is part of a wider international process thatbegan in the 1970s. In rich and poor nations alike, governments are trying to adapt their policies to meetthe chaning technological and economic conditions afficting the supply of teleni serviceson the one hand, and to satisfy the rising and more diverse demand for services on the other.Telecommunications now touches most sectors of the economy: fanning and finance, tourism andtextiles, etrhandising and man i. Tus, getting sector policy "right' is of great economicconsequence.

(viii) At the center of the current policy reappraisal are questions of structre: Should more than onetelephone company be permitted? And if so, should the market be divided geographically (by region),functionally (by service), technologically (by transmission method), or otherwise? The answers to thesequestions are still being debated, but the conventional view, which favored one supplier with a legalmonopoly, a pyramid-like network architecture largely dependent on wireline faciities, and a homogenousproduct, is rapidly losing support.

(ix) In the past, a centralized, state-owned monopoly was preferred by most countries because basictelecommunications service was thought to be a natlral monopoly-i.e., economies of scale and scopemade it more efficient for one company to provide service. However, the changing pattern of demandand faling switching and transmission costs appear to have made telecommications a competitiveindustry for the majority of services including, in many cases, basic telephony. The most efficientstucture for the sector thus is one that is plural and competitive, with a mix of service providers, privateand public, using various technologies (wvireless and wireline) and offering heterogeneous services to meetthe different needs of users: in sum, a community of networks.

I

E cwe Summay

providers, private and public, using various technologies (wireless and wireline) and offeringheterogeneous services to meet the different needs of users: in sum, a conmnunity of networks.

(x) The case for a plural industry structure has gained additional support from the belief thatwhere demand for service is not being met and the existing supplier is unresponsive, the economic costto users and the national economy from continuing the status quo is much greater than any loss ofeconomies of scale and scope from franchising new providers.

(xi) Local economic reforms also are spurring a reappraisal of teleconmmunications policy in Asia.Throughout the region, liberalization of trade and foreign investment rules, banking reforms, exportpromotion schemes, and increased reliance on market forces have made access to high-qualityteleconmunicrations services ever more important. Improved telecommunications now is generally seenas a vital component of a multistaged structural adjustment because efficient information flows foster *Sewider introduction of product and service markets. Further, because many of the light manufacturingbusinesses (electronics, muto parts) and labor-intensive products (garments, leather goods, agrcultproduce) which Asia's lUCs export are sensitive to shifts in foreign economic conditions and tastes,reliable telecommunications facilities are often crucial to the very businesses that are at the forefront ofthese reform programs. The pressure on LlCs to address the shortfall of the telecommunications sectorconsequently is often more urgent than in industrialized countries.

(xii) Achieving agreement on the proper response to the telecomnunications crisis in Asia, aselsewhere, has proven to be a contentious and often drawn-out process. International precedents arerarely decisive. Most of Asia's telecommunications policy makers now have some fmiity with sectorreforms in South America (Argenfina, Mexico, Venezuela), various Commonwealt states (the U.K.,Australia, Canada, New Zealand) and Japan. Bur, although these initiatives offer important lessons,programs that seem promising in a country that already has five or ten telephone lines per hundredpersons (let alone 30 or 40) may be wholly inadequate where there are fewer than two telephone linesin service per hundred persons, as is the case in most of Asia.2

(xiii) In such countries, privatzing the state-owned carrier, may have only a small impact on sectorperformance. The base of telephones is simply too small and the demand too great. The overriding issueis, how best to mobilize other sources of capital, especially from the private sector, to meet the demandsof the great majority of people who must now do without any telephone service. In these circumstances,traditional arguments that market liberalization (i.e., competitive service suppliers, independent telephonecompanies) will ilpair the ability of the existing operator to promote nationwide service are notpersuasive: the current service is anything but universal and, in the absence of changed policies, theprospects for achieving significant improvetaent are small. Further, in many Asian UCs, compettiveentry is likely to accelerate network expansion by providing additional channels for investment as wellas by improving technical efficiency through greater use of foreign expertise.

(xiv) Likewise, arguments that multiple service providers are inefficient make little sense in acountry where the telecommnications network covers only a fraction of demand. In India, for example,

2. See the figures in the Appendix for country-by-contzy staistics.

xi

Teleommnunications Sector Reform in Asia: Toward A New Pragnwism

the gap between current supply (approximately seven million lines) and potential demand is so large thatworry about "excess" or duplicative investments is, at besl, a distant concem. Of necessity, therefore,Asia's LICs and MICs will increasingly become a test-bed, technically and institutionally, for buildingout telephone networks in innovative ways.

(xv) This is already happening in several countries. Yet if the new pragmatism is to succeed, itmust be extended along several dimensions. For instance, liberalization has already led some countriesto grant new licenses to provide value-added services (electronic mail, store-and-forward facsimile) ona nationwide basis, but telephone service, which is geographically limited to a snull fraction of thepopulation, is still a countrywide monopoly. In some countries, competing cellular radio licenses havebeen granted in major urban areas, but the new licensees are not authorized to construct microwave radiolinks to provide intercity or regional coverage. Elsewhere, private companies are permitted to install verysmall aperture terminals (VSATs) to ensure reliable satellite-based communications, but they nay notresell the excess capacity to other users. Further, the failure of a monopoly operator to provide servicehas prompted govermnents to launch "crash programs" to construct new exchange facilities with foreignpartners, but once built, all new facilities must be turned over to the existing monopoly operator.

(xvi) Similarly, despite the significant resource constraints the region faces, many countries havecontinued to favor capital-intensive programs for expanding access to telecomnicatiofis services ratherthan employing more decentralized and often less expensive access options that new technologies aremaking available. Household telephone service is favored over public pay telephones, land-lineextensions over wireless systems, cellular radio over tnunked mobile and paging services, new telephoneexchanges over voice mail, and contiguous (predonanldy urban) telephone networks over stand-aloneor independet ones.

(xvii) Against this background, a key question today is, how can Asia's LICs and M[Cs begin tomove their new pragmatism from the periphery to the center of the telecommunications reform agenda?This report makes a numiber of detailed suggestions to promote that shift. It is also designed to providea policy almanac for those countries that are still debating the best way to meet the unsatisfied demandfor telecommunications service; however, detailed country-specific analysis will still be required todetermine which policy options are best suited to national conditions. There is no universally applicabletemplate for sector refonn.

(xviii) The report consists of five main chapters, summarized below, beginning with Chapter U; thefirst chapter contains an introduction. Some of the main conclusions are also in Box 1, and Box 2contains an overview of sector reforms in five Asia-Pacific countries, based on the country profilescompiled in the Working Papers.

Chapter H. Economic Principles

(xix) The traditional argument that the telephone industry is a natural monopoly remainscontroversial. Moreover, the existence of economies of scale and scope, per se, has limited significancefor policies toward entry of new service providers. If entrants do not iimpose congestion costs onincumbents and interconnection is not foreclosed, either by the exercise of market power or by relatively

xii

Exraeuve Summary

high transaction costs, it can be argued that a laissez-faire attitude toward entrants on the part ofgovermneat policy makers is warranted, especially for low-income countries, which tend to suffer chroniccapacity shortages and other inefficiencies on the part of protected incumbent suppliers.

(xx) Arguments that network externalities or other external economies mitigate against the benefitsof competitive entry implicitly assume that interconnection among competing networks is either notpossible or that would-be subscribers discount the possibility of interconnection. If, for one reason oranother, the market cannot efficiently promote interconnection within both the long-distance and localsectors as well as between long-distance and local, there is a case for public policy intervention.Examples of policies to promote competitive entry in the United States include the mandatory unbundlingof basic exchange services and mandatory interconnection.

(xxi) Arguments against allowing competitive entry also tend to minimize the existence of users withdiverse needs and priorities. Heterogeneous demands on the part of telephone users accentae theadvantages of having a number of rival suppliers, since it is unlikely that any single supplier could satisfya broad range of heterogeneous customers. Even in the case of "plain old telephone service" (POTS),the speed with which installations are made and the comnitment to maintaining quality are relevantdimensions of performance. Given the more limited experience of telephone operators in low-incomeconmtries compared to that of operators in high-income countries, there is likely to be greaterheterogeneity among suppliers of POTS in the former countries than in the latter. This strengthensarguments for allowing diversity in the supply of telephone services in low-income countries.

Chapter HI. Divesying Supply

(xxii) Once a government is persuaded that encouraging new service suppliers is more likely to closefte gap between demand and supply than maintaining the status quo, hard choices still must be madeabout where to start and how to proceed. This chapter argues that liberalization should be given a highpriority in the area where the shortfall of supply typically is the greatest: l1cal exchange service.

(xxiii) By and large, governments should adopt a "serve it or lose it" policy to require carriers to meetthe paid demand for new service within a given time or face the prospect of (a) having a competingcompany licensed to provide service or (b) having portions of their service territory refranchised to othercarriers. The hitories of wireline and cellular radio service both suggest that a broadly available, maturetelephone network is not a prerequisite to liberalizng market entry. In fact the opposite is true: licensingmultiple service providers probably is the best way to accelerate the investment necessary to establish amore broadly based and mature national telecommunications network.

(xxiv) Liberalizng market entry does not require a vertical divestiture of the existing carrier, althoughthat may be desirable in some cases to promote equitable interconmection. At root, a serve-it-or-lose-itpolicy should be designed to lift the artificial (legal) barriers to market entry which to date have blockedthe type of "bottom-up" network expansion programs led by independent local telephone companies,municipal enterprises, and public-private joint ventures that successfully developed telephone servicetroughout North America and Finland during the early twentieth century and are playing a major rolein building out China's telephone network today.

xiii

Telwcormwaions Sector Reform in Asia: Toward A New Prgmadsm

(xxv) Any policy to liberalize the provision of local exchange services should be technologicallyneutral; wireless operators (cellular radio) should be permitted to meet the demand for both mobile andfixed service. Further, government policy should be institutionally neutral; private and public enterprises(includin municipalides and cooperatives) should be able to apply for service licenses.

(xxvi) In many cases, the liberalization of locl exchange service might be complemented byintroducing competition for long-distance transmission services, although generally this step is not neededas urgendy. Competitive tranission networks for long-distance telephony have proven viable even inrelatively small countries with approximately I million exchange lines (such as New Zealand), and it islikely that competition would be beneficial in other Asian countries (India, China, and Indonesia, forexample). The growth of domestic satellite carriers might provide a platform for a second long-distancecarrier in some of these countries.

(xxvii) Competition for transmission service (local or long distance) does not mean that a governmentmust abandon subsidies for socially desirable services, where they are necessary. The key is properlyto cost out the desired subsidies and assign the cost equitably among carriers so that they can berecovered through network connection charges or (preferably) general tax revenues.

(xxvii) Even where a country decides to proceed slowly with facilities-based competition for localor long-distance service, resale of the monopoly carer's service offerings should be permitted. At aminimnm, companies must be free to lease dedicated ciruits in bulk and to resell them to provide value-added data processing and information services to business and residential users. Value-added service

proviers should also be pemited to own the necesary switching facilities they need to operate theirbusinesses efficiendy.

(xxix) Serious consideration also should be given to the introduction of basic resale services.Experience suggests that resale leads to price and service competition (custom calling plans, volumediscounts, and itemized billing options, for example) which would otherwise be unavailable. It alsoencourages the underlying carrier to adopt a more cost-based tariff structure, and thus to operate moreefficiently to reduce the margin for resale.

(xxx) Governments should speed up the lDeralization of telecommnications terminal equipment.The benefits of allowing users to buy or lease the equipment of their choice, subject to appropriatemeasures to ensure that technical standards are met, have now been demonsated in numerous countries.Asian LICs are in a position to reap a harvest of benefits from the successful experiences of others.

Chapter IV. Incresin Private Sector Participation

(xxxi) Fostering more private investment in telecommunications is already an important part of mostsector refonm programs in Asia. But the privatization or divestiture of the state-owned carrier is onlyone measure among many and, given the very low telephone penetration in Asia's UCs, may not be themost significant for boosting private investment. Of greater importance may be fostring bottom-upschemes for private-sector entry to the market to promote constuction of new telecommunicationsfacilities by a mix of independent enterprises.

xiv

Executve Sunmuiy

(xxxii) A large body of international experience with the divestiture of state-owned telecommuni-cations operators suggests the importance of several conmon procedural and substantive issues. Theyinclide the need (1) to state clearly the objectives for divestiture at the outset; (2) to allow sufficient timeto prepare a carrier for sale (typically two to three years); and (3) to secure the legal conditions for sale,which usually involve adopting a legislative reform package and organizing a regulator that is independentof the incumbent operator. Experience also suggests that the success of a divestiture will be decisivelyaffected by the economic incentive reflected in the price-control rule and the network performance targets,both quantitative (number and location of access lines to be added) and qualitative (rnmber of pennissiblefaults and response to outages).

(xxxiii) New entry and other 'bottom-up' measures for private-sector development are likely tobecome increasingly important in Asia's LICs, and they may become the prevalent means of closing thegap between demand and supply. They may take several forms: competitive franchises granted toindependent telephone conpanies in designated areas, refranchising of unserved or underserved areas ofthe country, capital provided by municipalities or the private sector through a build-transfer (B-T)scheme, or a joint venture. The service provider may be a stand-alone company or a subcontractor foran existing licensee; the scope of service may be limited to local exchange services or may exend tointerexchange offerings.

(xxxiv) A bottom-up program for promoting more private investment, like a top-down divestiture,will not be effective without matching regulatory and institutional commitments. Among other things,where multiple operators are to be licensed a clear policy decision must be made regarding interconnec-tion and pricing. However, full interconnection wil not always be necessary for all services becmuse,as with electronic mail and database services, some subscnrbers may be satisfied initially with self-contained networks, the growth of which may in fact speed new servce to users.

Chapter V. Reglaon

(xxxv) Regulation has been the weakest part of sector reform in poorer countries, and Asia's LlCsare no exception. If this deficiency is not addressed, ambitious plans for sectoral expansion are likelyto be compromised. Effective regulation, to the extent that it contributes to establishing appropriateincentives, is inportant for attacting substantial amounts of private capital to telecomunuications.

(xxxvi) Regulation must be broadly understood to include a country's political and judicial competenceas well as its commercial customs. Whether or not an effective regulatory regime can be designed fortelecommunications (or any other industry) will depend on how well the new regime fits with existinggovernmental inutions. Regulatory designs cannot easily be transplanted unchanged from one countryto another.

(xxxvii) The increasing scope for competition and private service suppliers in the telecomunicationssector have led some to argue that no special public utility or common carrier rules are needed: thegeneral application of competition laws will be sufficient. Experience in several countries (New Zealand,Mexico, and the U.S.) suggests that the "no regulation" option is illusory. One principal reason is thatnew service suppliers are likely to be stillborn unless they can interconnect their facilities with the

xv

Telecommunicatons Seaor Reform in Aha: Toward A New Pragmatism

incumbent carrier's network on reasonable terms. Without regulatory intervention, interconnection hasproven to be unsatisfactory. Further, absent regulatory oversight, either the dominant carrier or theministry responsible for the carrier become the de facto rule maker for the sector, often to thedisadvantage of would-be competitors and consumers.

(xxxviii) It is desirable that market liberalization be accompanied by the creation of a regulatory bodyat arm's length from the dominant operator. Further, there are advantages to organizing the regulatoras a multimember commission rather than a single director general, in part to spread the workload;continuity can be provided by staggering the terms of a multimember commission. In any event, theregulator should have a clear legislative mandate, secure finding, and a staff of competent professionals.The regulatory process should be accessible to both the regulated providers and to users. Relevantpolicies and rules should be published and adequate scope provided for public participation in theirformulation. A politically strong, professionally competent, and publicly accountable regulatorycommission is most likely to be able to employ a light-handed approach to regulation appropriate to manysitations.

(xxxix) The scarcity of regulatory resources in LICs makes setting priorities especially crucial. Inthis regard, interconnection matters, the price-contro! rule for the dominant supplier, policing transactionswith affiliated companies, frequency management (which directly affects the options for market entry),and data collection deserve to be at the top of the agenda. Further, the time required to address each ofthese matters may be reduced by writing clear price and performance standards into carrier licenses orconcessions; outside contractors can be used to monitor these standards.

(XI) Other regulatory functions such as frequency allocation can also be contracted out and the costrecovered from user fees. The initial licensing decision, however, should be made by the government.

Chapter VW. Implemeg Sector Reform

(xli) The timing and sequencing of reforms is crucial. There is frequently a fairly short periodto launch a reform program, often tied to the calendar of a govermnent's overall economic program aswell as to election cycles. A purely technocratic initiative which does not adequately consider the overallcontext of a reform program and the need to manage a restucturing process over several years (evendivestiture is never a singular event) is likely to fail.

(xlii) Most countries, including those in Asia, have folowed a sequential approach to narketliberalization. Typically, the terminal equipment market is opened to competitive supply; then value-added services, satellite-based and wireless services (mobile radio, paging) are liberalized; finally themarket for basic switched services is opened to competition, starting with interexchange services. Sucha progression may be beneficial where a country has limited experience with managing economicrecu ring and a new regulator must be put in place. However, sequencing may have an unacceptablyhigh cost where tLere are very large unmet demands for service-demands that might be more quicldysatisfied by lifting barriers to market entry at the outset of a sector reform program, not toward the end.Beyond that, incrementalism can dissipate public support for reform. Once expectations have been raised,only a bold initiative, one that makes a real break from the past, is likely to be acceptable.

xvi

Exeutive Summary

(xliii) Notwithstanding the drawbacks to incremental market liberalization, experience suggests thata step-by-step approach to divestiture is essential. Unless divestiture is preceded by a restructuringprocess in which the state-owned carrier is commercialized and the government's regulatoryresponsibilities are separated from its policy-making and operational roles, the sales price of the carriermay be reduced and sector efficiency greatly hurt in the postdivestiture period.

(xliv) International experience has also shown that a successful telecommunications reform programmust have the unflagging commitment of the head of government. A nation's telecommunicationsnetwork, no matter how underdeveloped, is one of its chief national assets, and the complex task ofrestructuring the sector, let alone managing a divestiture with competing economic, social, and nationalsecurity interests involved, cannot be effectively carried out without strong leadership.

(xlv) Such leadership is a necessary-but not a sufficient-condition for change. For that to occur,a cross-goverrnment and cross-private-sector coalition must be built. Again, experience shows thatmomentum for reform comes most often from without (that is, outside the state-owned post, telephone,and telegraph department), and not from within. Reform is most likely to move forward if championedby a broad coalition of users and would-be suppliers. Telecommunications sector reform can also behastened by links to other sector reform programs. Initiatives to restructure the electric power sector,which is often also dominated by a poorly run state monopoly, may be particularly instructive.

xvii

Telecomnwniidons Sector Reform in Asia: Toward A New Pragnotism

Box 1

Telecommunications Sector Reform in Asia: Some Conclusions

Economic Considerations

Technological innovations and the diverse service needs of users have reduced the 'naturalmonopoly" aspects of providing telecommunications. In most UCs, new service suppliers willstimulate the incumbent carrier to be more productive and also reduce the very large economiclosses caused when limited or no service is available to meet the paid demands of users.

In any event, cross-subsidies are an inefficient way to broaden telephone access in most LUCsbecause there is substantial unmet demand foi service by users who are willing and able to payfor it. Socially desirable services (e.g., for the disabled) are best subsidized, where necessary,through general aid programs. Many rural users can afford to pay for telecommunications service,and below-cost tariffs may deter new carriers from meeting this demand where they are legallypermitted to do so.

Diversifying Supply

of Govemments should adopt 'serve it or lose it" policies so that areas which are underserved orunserved can be franchised, on competitive terms, to new carriers.

I/ Competition between wireline and wireless services should be encouraged and multiple cellularradio and paging licenses granted; wireless (e.g., cellular radio) carriers should be permitted toserve fixed locations. Where competition is permitted at the outset, there is strong evidence thatnetwork investment is more rapid than when competition is adopted at a later stage.

Much higher priority should be given to pay phones, paging, and voice mail services to meet thepublic's need for network access.

Competing long-distance transmission services are likely to be viable in many Asian UCs (e.g.,India, China, Indonesia) and might be based on existing satellite or microwave networks.

The provision of value-added telecommunications services, includirig voice mail, shotud be fullycompetitive; it is also desirable to liberalize the resale of basic switched telephony, especiallywhere competing facilities are not peirmitted. Likewise, users should be free to buy telecommuni-cations terminal equipment from the supplier of their choice.

Increasing Private-Sector Participaton

P, The very small base of telephones in most UCs means that divestiture is, at best, a partial solutionto fostering more private investment in the sector. More important than this 'top-down' approachmay be various 'bottom-up" approaches to private sector development.

it 'Bottom-up" approaches to private sector development may involve one or more of the following:new concessions to independent telephone companies; new cellular radio licenses; revenuesharing contracts for new privately built facilities; local-foreign joint ventures; and build-transfer(B-T) schemes for transmission or local exchange facilities.

Other opportunities for private investment may exist for satellite service (especially for systemsusing verysmall aperture terminals (VSATs)l; paging, data networks and high-speed digital overlayfacilies.

xvff

&eauiv Summary

BoxI

Increasing Private Sector Participation (cont.)

it Corporatization and divestiture of the state-owned telecommunications operator, as part of a moregeneral sector reform program, is likely to produce net economic benefits for a country. In tiisregard, the restructuring and privatization of the electric power sector, often dominated by state-owned monopolies, may offer important lessons for the telecomnmunications sector.

Regulation

.f Because regulation involves a country's political and judicial institutions as well as its commercialcustoms, effective regulation will depend on how well the new regime fits with existinggovemmental instrtutions. Regulatory designs thus cannot be easily transported from one countryto another.

of Privatization, as well as a market with multiple suppliers, makes a regulatory body desirable.Experience has shown that new service suppliers will not be able to interconnect with theincumbent operator on reasonable terms without regulatory aid; regulation may thus play anessential role in fostering the 'bottom-up" investment which is crucial to network growth.

For many countries, a multimember commission separate from the dominant operator and witha clear legal mandate, secure funding (from license fees, for example), and professional,competent staff will be the most effective regulator. In some countries, it may be desirable forthe commission to regulate other industries (e.g., power generation) as well as telecommnunica-tions, or to exercise its powers in close consultation with relevant govemment ministries.

if In poor countries, where professional resources are scarce and experience limited, settingregulatory priorities is key. Five matters should be at the top of the agenda: interconnection, theprice-control rule, oversight of affiliated companies, frequency management, and data collection.

P0, The burden on new regulators may be reduced if the government writes price control, intercon-nection, and performance targets into the initial carrier licenses or concessions. Further, oversightof these provisions may be contracted out (e.g., to an international accounting firm); so too mightfrequency management and type approval standards for telecommunications equipment (wherewarranted).

Implementing Sector Reform

I-1 Timing and sequencing of reforms are crucial. Timing is especially important for a majorprivatization initiative, which is likely to be closely tied to economic reform and the election cycle.

of Sequencing also may significantly affect the public benefit of a reform program. Ideally, a state-owned carrier should be placed on a commercial footing before divestiture occurs and the marketis opened to competition. Regulation also should be in place.

If In poor countries with limited telephone penetration, step-by-step liberalization of the market maybe less effective than a more radical open-door policy that offers multiple concessions (or B-Tschemes) to unserved or underserved areas.

Regardless of the program adopted, experience shows that successful telecommunications reformmust be led and supported by the highest level of the govemment. Reform also requires cross-industry coalitions. Further, reforms in one sector (e.g., electric power, transportation, water) canoften provide momentum and example for action in another sector.

xix

Teckommwucions Sector Reform in Asia: Toward A New Pragmatism

Box 2TELECOMMUNICATIONS SECTOR REFORM IN ASIA:

FIVE COUNTRY PROFILES

Now ZealandSince 1987 the telecommunications sector in New Zealand has changed from one of the most highly regulated,state-controlled sectors to one of the least-regulated, with the government holding only a residual financialinterest. The dominant carrier, Telecom New Zealand (TNZ), has been privatized, and competition for bothlong-distance and local exchange service initiated, notwithstanding the relatively small size of the existingnetwork, approximately one million lines. These steps have lead to significant new investment in networkfacilities, marked productivity gains by TNZ, reduced prices (by 1991 business telephone charges had fallenover 30% in real terms, and residential charges fell 15%). and a substantial increase in govemment income.

There is evidence, however, that these benefits are less than what might have been achieved, due to theabsence of a sector-specific regulator. Price control, interconnection, and service discrimination issues havebeen left to the marketplace, with recourse to the courts or New Zealand's Commerce Commission in the eventof anticompetitive conduct. This has led to protracted litigation on TNZ's interconnection terms as well as onthe allocation of cellular radio licenses. On the other hand, the absence of a regulator plainly has given themajor service providers a wider degree of commercial freedom than they might otherwise have had, to thebenefit of TNZ and some users.

SingaporeTelecommunications has been a government monopoly in Singapore since 1953, but with results strikinglydifferent from those achieved by state-owned operators in other countries. From 1977 to 1989, theTelecommunications Authority of Singapore (TAS) tripled the number of main lines Iby 1990 there were 38lines per hundred inhabitants) and Singapore today has one of the world's most modem and efficient networks.

In 1992, new legislation divested the telecommunications and postal services of TAS into separate state-ownedoperating cornpanies, Singapore Telecommunications PTE Ltd. (ST) and Singapore Post PTE Ltd. (SP); a re-chartered TAS assumed the regulatory functions previously exercised by the operator. The legislation directedTAS to grant ST a new services license that included a 1 5-year monopoly for basic voice telephony and a five-year monopoly for cellular radio services. The legislation also provided for eventual public sale of ST shares.

Reform in Singapore is primarily a result of government efforts to leverage the success of TAS rather than toremedy its failures. The corporatization and eventual privatization of ST are intended to give the companyflexibility to reinvest large operating surpluses outside of Singapore. This has already begun to happen,especially in East Asia; ST now has commrunication interests in Sri Lanka, Vietnam, Thailand, and Hong Kong.The impetus for privatization is also political. The govemment is committed to a wider distribution of shareownership and to more directly sharing the financial success of Singapore's statutory boards such as TAS.

While Singapore's successes may not easily be transferable, one important factor is the pervasive 'goodgovemment' ethic and sense of national purpose. This has enabled Singapore to tum interlocking policy-regulatory-operational structures for telecommunications into an economic engine, whereas other countrieshave found the combination of these functions to be a recipe for economic stagnation and corruption.

PliIppinesThe telecommunications sector in the Philippines has almost always been privately owned. Even so, sectorperformance has been suboptimal along several dimensions, suggesting that private (rather than govemment)provision of service is not a guarantor of perfornance.

Symptomatic of the sector's poor performance are long waiting lists for new telephone lines; very limited ruralservice (six to seven lines per hundred people in Manila but telephone penetration is typically 5-10% of thatfigure in the rest of the country); low call completion rates; and limited productivity (approximately three staffper hundred access lines). These conditions reflect chronic underinvestment in the sector, due in part topolitical risks, but due also to sector policies.

xx

readive Summa y

Box 2Country Profiles (continued)

Prime factors have been the near-monopoly of the Philippine Long Distance Telephone Company IPLDT), theconduct of PLDT's controlling shareholders, and the limited political power of the sector regulator. Acumbersome two-step (legislative charter and regulatory franchise) process for authorizing new entrants andPLDT's largely successful efforts to limit interconnection have also helped to maintain the status quo.

Following recent presidential elections, there ara some signs that demands for new service have finally led thegovemment to break PLDT's monopoly by supporting new concessions and mandating reasonableinterconnection terms for competing service suppliers. As in the past, however, current reforms are beingconducted piecemeal, in the absence of an overall legislative reform policy or an augmented regulator.

ThailandThailand, like the Philippines, has not undertaken a comprehensive sector reform. Instead, a series of tentative,but increasingly bold, steps have been taken toward opening telecommunicatons to private investment withinthe existing legal and regulatory framework. This process has accelerated since 1991, and some of the mostambitious measures-large-scale B-T concessions-have just been implemented.

Telecommunication services are provided primarily by two state-owned companies, the TelecommunicationsOrganization of Thailand (TOT) and the Communications Authority of Thailand (CAT). TOT provides domesticservice and connection to neighboring countries; CAT provides all other intemational service. The poorperformance of these companies in the face of an otherwise fast-growing private economy has led thegovernment to grant the private sector a greater role in telecommunications.

Initially, TOT and CAT issued private concessions for value-added services such as paging and datatransmission. Mobile telephone concessions followed, and there are now over 200,000 cellular radiosubscribers, almost 15% of the terrestrial base. The relative success of these early ventures led to larger B-Tconcessions for building out the basic telephone network-over two million new lines in Bangkok and oneminion new lines in the provinces. (In 1990, 70% of total line capacity was in metropolrtan areas with atelephone density of 14 per hundred inhabitants; the density is 2% or less in the provinces.)

The need to build out the basic network more rapidly has led Thailand to consider whether TOT (and CAT)should be privatized and competing carriers licensed, possibly based on the recently granted B-T concessions.A new communications regulatory authority also has been proposed. These developments have highlightedthe urgent need for sectorwide legislation to restate the roles of the principal public and private player.

Sri LankaSince 1985 Sri Lanka has pursued a step-by-step sector retorm program that has been strongly influenced byother Commonwealth countries. The govemment operator, Sri Lanka Telecom (SLT) has been corporatized,the scope for private investment has been broadened, an independent regulator has been chartered, and allthese steps have significantly increased the level and scope of available telecommunications. This is especiallyso for wireless services: there are now two cellular radio operators, and a third nationwide license is expected.At the same time, the government has acknowledged that the shortfall of telephone lines is much greater thanpreviously estimated and that SLT, despite corporatization, may not be able to satisfy the demand.

As in Thailand and the Phllippines, a frank appraisal of the gap between supply and demand has led thegovemment to consider whether the shortfall of main lines should be closed by offering a S-T contract to aforeign company or a concession for a second license, perhaps a joint venture with SLT? Or should thegovemment grant SLT more autonomy by reincorporating SLT and privatizing it or otherwise so that it can buildout the network more rapidly? Resolution of this issue in Sri Lanka is likely to determine the stucture of thesector during the last half of the 1 990s and may well have an impact on the path taken in other countries.

These profiles are based on studies conducted for this report. The sudffes, plus a comparative review of sectorreform in Mexico, are contained in Telecommunications Sector Reform in Asia: Working Papers.

xxi

I. INTRODUCTION

Why should there be a "crisisT in the supply of a commodity-telecommuni-canons-for which there are so many potenial buyers and sellers?

Gabriel Roth'

1.01 By almost any measure, the availability, performance, and choice of telecommunuication servicesin most of Asia's low- and middle-income countries-hIdia, Nepal, Bhutan, Pakistan, Bangladesh, SriLanka, Myanmar, China, Indonesia, Vietnam, Laos, Cambodia, Thailand, and the Philippines- fall farshort of the demand. The deficit is very large, in both absolute and comparative terms, given thedramatic and continuing expansion of the telecommunications sector in neighboring states, such asTaiwan, South Korea, Malaysia, and Japan.

1.02 More than 2.8 billion people in Asia's LICs must make do with little more than 25 milliontelephone lines, an average of less than one line per hundred persons.2 Further, despite a rush of recentnetwork expansion plans, from 1982 to 1991 the average annual growth in the number of telephone linesin Asia's LICs was only 7 percent, and hundreds of thousands were added to paid waiting lists for newservice. Moreover, in almost all the region's LICs, the great majority of installed lines (85-90 percent)are in urban areas, with 15-20 percent of the population, and public telephones are a rarity (e.g., in 1991there were reported to be fewer than 150,000 public call boxes for the 1 billion people in India andIndonesia see Appendix Figure A-5.)

1.03 Beyond that, in most LlCs public networks are badly congested. Call completion rates are low,often less than 40 percent, and dedicated circuits for business users are expensive and hard to come by.Furdter, although new cellular telephone services have been licensed in most Asian LICs and MICs, thefranchises are limited to a few major cities, and capacity tends to be quicldy oversubscnrbed.

1.04 Because telecommumcations and electronic information processing now touch most aspects of theeconomy, the suboptika performance of the telecommunications sector in these LICs has seriouseconomic consequences. Telecommunication is as critical a factor for production as labor, land, orcapital. It is also vital to the very export areas lost LICs are counting upon to boost their economicperformance: agricultural commodities, the textdle industry, product assembly, and tourism.3 In addition,telecommunications provide vital links among manar, wholesalers, and retailers for inventorycontrol, just-in-time delivery, and customized production runs. The sector thus has a major effect on thelocation decisions of foreign enterprises.

1.05 Most governments have recognized the implications of the telecommunications shortfall in Asia'sLICs. For example, the June 1992 Declaration by the members of the Asia-Pacific Telecommunity(APT), including most of Asia's LICs, acknowledged that regional growth had "suffered due to the lowpriority allotted to the telecommunicadons sector and inadequate [past] investment.- The Declarationurged all states to emphasize "the telecommunications sector in their national plans; ... promote policiesthat will facilitate raising funds for the development of telecommumcations; ... seek solutions to networkexpansion, particularly in rural areas, that lead to self-sustainig growth; ... restructure [the sector] tomake it more efficient and responsive to market forces according to local conditions."4

1

Telecommunications Sector Reform in Asia: Toward A New Pragmatism

1.06 In May1993 the APT's recommendations were augmented by the ITU's first TelecommunicationsDevelopment Conference (TDC) for Asia. At the TDC, delegates from 38 countries in the Asia-Pacificregion adopted a resolution containing a set of common policy principles including: having atelecormnunications investment base that is "as wide as possible"; separating regulatory and operatingfunctions for telecormnunications and providing access to all users of "at least basic telecommunicationsservices in a competitive environment."5

1.07 The recommendations of the APT and ITU are being considered across the region and, in somecountries, implementation has been stzrted with the aid of the World Bank.6 Even so, it has taken theAsian region somewhat longer, as compared for instance to Latin America, to come to grips with theneed for telecommunications sector reforms.' Many governments also remain uncertain as to the lessonsof sectoral chanves in other parts of the world, the applicability of these lessons to Asia, and whereforeign experiences are relevant, how they might best be implemented locally. This report is designedto respond to these uncertainties in a practical fashion.

nternational Experience With Sector Reform

1.08 During the last decade, some consensus has emerged among telecommunications policy makersabout the measures that are most likely to improve sector performance. It is widely agreed, for example,that increasing the proportion of gross domestic product (GDP) invested in the telecommunications sector(whether from public or private sources) is necessary but not sufficient to ensure lasting improvementsin the quantity, quality and range of a nation's telecommunications services. Of crucial importance aresuch factors as sector organization and regulation; whether the dominant carrier is subject to commercialdiscipline; the opportunities for new suppliers to enter the market; and regulatory safeguards to deter thedommnant carrier from using its market power to operate in ways that do not serve the public interest.

1.09 Most recent telecommunications sector reform programs thus have taken a comprehensiveapproach. There have been three parts: (1) to commercialize the operations of the national telephoneentity through managerial reforms, corporatization, and/or privatization; (2) to liberalize the supply ofservces by increasing competition and encouraging pnvate companies to invest in telecormunicationsbusinesses; and (3) to separate the government's policy and regulatory responsibilities from the telephoneoperator.

What Approach For Asia?

1.10 A primary question facing Asia's LICs is whether the next round of telecommunications reformsin their region can or should strike a different balance. That is, can the telmmications issues facedby Asia's poorest and most populous countries be addressed effectively by tailoring the dominant reformparadigm that emerged in the 1980s to local conditions, or will alternative approaches be required? Howmuch does it matter, for instance, that by 1990, the national carrier in most Asian LICs had achieved atelephone penetration rate only 5-10 percent of that in Poland or in Mexico (before divestiture!); that theaverage GDP per capita in the region's LICs was less than $500 (1991) compared to $2,500 or more inLatin America and Eastern Europe; that much of the population and a sizable amount of these nations'private capital is in small towns and villages, and not in one or two cities?

2

1. Introduction

1.11 Similarly, how important is it that technological innovation and diverse user needs have made theeconomies of scale and scope for telecommunications services less and less determinative of marketstructure since the 1970s, when the current wave of telecommunications reform began; that the physicaloptions available for building out networks today-cellular radio systems, fiber-optic cables, 'smart"switches, international satellite systems-are markedly different from those available only a decade ago?And of what relevance is it that a telecommunications reform program in the mid-1990s may attract theinterest of a dozen or more foreign telecommunications operators and investment groups, few of whichhad any experience with or interest in overseas operations in the mid-1980s?

1.12 Even an equivocal answer to these questions will seem wrong for some countries in a region aslarge and diverse as Asia, with both city-states and continent-sized nations, centrally planned economiesand market-driven ones. The working hypothesis of this report is that the answers to these questions areboth "yes" and "no." Yes, the size of the problem confronting telecommunications reformers in AsianLICs is of a different order of magnitude than those facing reformers in most other regions. Indeed, insome respects, the very limited telephone access achieved in most LICs is analogous to that of manymiddle- and upper-income countries in the late nineteenth or early twentieth centuries, when a variety ofindependent telephone companies sprang up to meet popular demand, and monopolies had yet to beformed. But no, the programmatic options for Asia are not altogether different from those in LadnAmerica and Eastern Europe. Here, as in those regions, the overriding need is for monopolists toincrease commercial efficiency; to foster new entry where existing suppliers cannot or will not meetdemand; and to put in place the necessary legal and regulatory arrangements to ensure that the improvedperformance will be sustainable.

1.13 Nevertheless, it is likely that the massive quantttve task at hand will require a qualitaive shiftin the approach to sectoral reform throughout the region. Meeting the demand for service in Asia's UCsfor the remainder of this decade, even at current income levels, would probably mean adding at least 75-100 million new main telephone lines at a capital cost of at least $90-120 billion.8 Therefore Asia's LICswill need to be a large-scale testbed for various new institutional and technical approaches to building outnetworks. In most countries, holding to the present course simply will not close the telecommunicationsgap; a new pragmatism is required.

1.14 This report and the bulk of the analysis which follows are designed to assist the Bank and itsciients in meeting this imperative. By examining more closely the three main strands of the reformprograms outlined above-liberalization, corporatization and/or privatization, and regulation-in selectedcountries, the report seeks to identify key issues, synthesize the lessons of experience, descrbe bestpractices, and draw conclusions of particular relevance to Asia. The aim is to provide a degree ofpractical guidance beyond that available in more general Bank reports on sectoral reform.'

1.15 Although the report is primarily concerned with the telecommunications sector, it has somerelevance to issues facing the electric power sector and other public utilities in Asian UCs. The converseis also true. The Bank recently completed a two-year review of its role in the electric power sector inLICs which, as with telecommunications, typically consists of a single national entity operating as amonopoly. The Bank found that the declining performance of the power sector in many LICs (e.g., thefalling real value of tariffs, reduced investment, and rising customer delinquencies) was due to thesector's fundamental structural problems. Unless commercial prnciples were introduced to the sector"with enterprises distanced from excessive government day-to-day management" and new entrantsencouraged to invest in the sector, the Bank concluded that "the required power sector investment [couldnot] be mobilized in the 1990s."IO

3

Telecommunications Secior Reform in Asia: Toward A New Pragmaism

1.16 It was therefore recommended that in conjunction with other economy-wide initiatives, the Bankshould support setting up transparent regulatory processes that are clearly independent of power suppliersand aggressively pursue the commercialization of and private sector participation in developing countrypower sectors." This report endorses the thust of those recommendations for the telecommunicationssector.

Organiztion of the Report

1.17 This report is divided into five parts. Chapter n provides a summary of the basic microeconomicissues underlying policy debates on teleconmnunications sector reform. Chapter m considers options fordiversifying supply and increasing competition. Chapter IV looks at the various means for increasingprivate-sector participation in telecomunnications and associated investment and financial vehicles.Chapter V examines sector regulation, and Chapter VI discusses the management of sector reform-howthe process fits into the larger economic and pclitical context and the sequencing of specific proposals(privatization, new franchises, regulation). The appendix provides background statistical information.Outlines of the reform experiences of selected countries and additional consideration of economic issuesin sector reform are available in a supplement to this report, Telecommwndcations Sector Refiorm in Asia:Working Papers.

4

L. Introdxcfion

NOTES

1. Roth, G. Transidon, Newsltter of the World Bank Socialist Economies Group, July-August 1991.

2. For comparative indicators, see the tables in Appendix A. See also Asia Pac.fic Tekcomwrdcaion Indkators (ITU,Gaeeva, 1993).

3. Many of the economic benefds of telecommunications are realized principally through improving the efficiency withwhich markets operate. Poorer countries, therefore, arguably have a keener interest than richer ones in improvedteleconmnunications facilides. Exports of products that are both labor-intensive and sensitive to changing consumerfashions (such as garments, shoes, and fumiture) are especially reliant upon good telecommunications facilities. Inaddition, the export of intermediate products (such as automobile parts) requires close contact with customers who arecarefully nonitoring their inventory levels. In addition, because multinational companies are managed on an integratedbasis, they may be reluctant to establish new facilities where basic operational and fnancial information cannot beobtained or effectively transmitted. See, for example. H. Lantzke, A. Mody. and R. Bruce, "TelecommunicationsReform In India: An Iternational Perspective.' Informal Discussion Paper, World Bank, January 27, 1992, pp. 3-4.See also *lssues In Telecommunications Development Policy Responses and Sector Strategy for Sub-Sahran Africa,"Division Note No. 6, Industry and Energy Division, Africa Technical Department, The World Bank, Washington,D.C., April 1991, pp. 4-5.

4. "Asia-Pacific Declaration On Strategies For Accelerting The Growth Of Telecommunications.' Meeting of the Asia-Pacific Telecomunuity, Singapore, June 1992.

5. "Development partners agree on telecommunication development plan for Asia and the Pacific." Press Release.rTIU/93-7, 17 May 1993, p. 3.

6. The Bank has made project loans or provided technical assistance to the telecommuniatons sectors in Bangldesh.India, Indonesia, Laos, Nepal, Pakistan, the Philippines, Sri Lanka, and Thailand. For a general overview of theBank's role in the telecommunications sector, see B. Wdkenius et al., 'Telecomunikations: World Bank Experienceand Strategy." DiscussionPaper No. 192, (Washington, D.C. 1993) at Annex 1. The Asian DevelopmentBank (ADB)has also provided 20 loans and 15 technical assistance grans totaling approiately $825 milLion totelecommunications sectors in the Asia-Pacific region. For deails, see S. Silvie Catlo; r. *Regulatory Problems ofAccelerating Availability of Basic Services.' ITU Asia Telecom '93, Regulatory Symposium, Supplement, Singapore.17-23 May 1993.

7. Since the lte 1980s. the pace of sectoral reform has accelerated in the region with dhe corporatization and partiaprivatization (1989) of Syaikat Telekom Malaysia, and the planned privatizaons (n 1993) of the Singapore andPakist tclephone companies. Value-added serrvices have been lberalized in Indonesia and other countries; oDmpeingcellular telephone licenses have been awarded in India, Pakistan, and Sri Lanka; China has begun to decentralize theresponsibility for telecommunication services to provincial and local bodies that may later be corporatized; Tbailandhas commied itself to two large build-transfer (B-i) schemes to expand its basic network in conjunction wih theprivate sector; telephone operations run by government departments have been transferred to state enterprises in SriLanka (1991) and Fiji (1990) and are subject to new regulatory oversighL

See, respectively, Working Papers B, C, D. and F for a more extensive review of sector reforms in New Zealand,the Philippines, Thailand, and Sri Lanka.

8. See Asia Pacific Tekcommwuication Indicators, op. cit., p. xxi. Assming an average investment cost of $1,500 perline, almost $400 billion would be required for Asia's LUCs to reach a telephone densiLy of 10 lines per 100inhkhitants.

The latent demand for telephone service in LICs is difficult to gauge and may be greatly understated by officialstatistics. A lower bound is provided by the pool of people who have already put down a deposit for new service.However, the size of the pool (often numbering in the hundreds of thousands) and the lengdh of the waiting period(often several years) may discourage many people fron even getting in line.

5

Telecommwunicafions Sector Reform in Asia: Toward A New Pragwlism

In many LICs, a more readistic measure of demand may be derived from the level of GNP per capita. Cross-countryempirical analysis has shown a fairly strong correlation between GNP per capita (wealth) and access lines in service(teledensiiy). See, for example, Asia Pacfc Telecommuntcadons Indicators, op. cit., pp. ix-x for a detailed reviewof the correlation between wealth and teledensity in Asia. See also 1991 International Telecom Sattsdcs (Siemoens.Munich, 1991) pp. 20-21; R. J. Saunders, J. J. Warford, B. Wellenius. Teccomnwucations and EconomicDevelopment [2d Edition forthcoming] (Johns Hopkins University Press, Baltimore) Chapter 4.

Using GNP per capita also enables one to take into account future economic and population growth in projectingtelephone demand. For example, in Bangladesh in 1990 there were approximately 200,000 access lines in service fora population of approximately I 15 million, and the paid waiting list was approximately 98,000. However, based onthe country's GNP per capita, the latent denund for service was estimated to be almost 300,000 lines.

It is arguable that this estimate is also too low because it is projected from telephone penetration data from othercountries, which also suffer from the same supply constraints as Bangladesh. To avoid this bias, one might estimatedemand based on the number of households with sufficient income to pay for phone service (at current prices) if itwere available. Applying this methodology in Bangladesh suggested that the level of unmetdemand was approximatelyI million lines. See Coopers & Lybrnd, "The World Bank, The People's Republic of Bangladesh:Tclecommunications Sector Reform Study Phase I Report," Novenber 1992, Section 3.2.2.

9. See, for example, Bjorn Wellenius et al., 'Telecommunications: World Bank Experience And Strategy,' op. cit.;*Issues in Telecommunications Development Policy Responses and Sector Strategy For Sub-Saharan Africa." WorldBank, op. cit., note 3.

10. "The Bank's Role in the Electric Power Sector: Policies For Effective Institutional, Regulatry, and FinancalReform." (World Bank Policy Paper, The World Bank. Washington, D.C.) January 1993. p. 3.

11. Ibid. pp. 4 and 5.

6

H. ECONOMIC ISSUES

Telecommunicadons operators that have a monopoly may act as barriers rather thanconduitsbetween customersand telecomnwunications techologiesand networks. Further,in many low-income countries, the incumbent monopolistis chronically underfinanced andinefficient, The resultant unsatisfactory performance is much more likely to besustainable in the absence of competition or potential competidon.

Informal World Bank Departmental Paper'

2.01 Perhaps the most fuindamental question a country must answer in reforming itstelecommunications sector is, how much should market forces be relied upon to direct economic activityin the sector relative to government intervention of various sorts including regulation? Reliance on themarket as a "governance structure' is broadly defended on the grounds that private-sector resource-allocation decisions will generally promote both allocative and technical efficiency. Allocative efficiencyimplies that real output cannot be increased by shifting resources from one activity to another. Technicalefficiency assumes that, in all activities being undertaken, the value of output is being maximized for anygiven expenditure on inputs.

2.02 Telecommunications is partally an input to other economic activities (e.g., business use of datanetworks) and partly a direct consumption good (e.g., households calling friends on the public switchednetwork). Both sets of users want the "right" telecommunications services provided at the lowest possiblecost. Promotir.g allocative and technical efficiency contnbutes to the achievement of these objectives.It also ensu is that the telecommunications sector will make an optimum contribution to the economicwelfare of the general economy.

2.03 At a conceptual level, it is relatively easy to segment "market governance" and "public-sectorgovernance. " Market governance encompasses the allocation of resources by private investors, ormanagers acting for them, subject to legislation and jurisprudence protecting private property rights andconditioned by comnpetition from other privately owned organizations. Public-sector governanceencompasses the allocation of resources in response to govermment fiat, either direct or indirect. Fo-example, if a ministry manages the resource allocation process, (e.g., for a state-ownedtelecommunications company) public-sector governance is essentially direct. On the other hand,govermnent activity might take the form of regulation, in which case it is largely indirect.

2.04 At a practical level, it is quite difficult to characteize the mix of market governance and public-sector governance in any 'real-world" telecommunications industry. Both are present to a greater orlesser degree, and there is no obvious way to quantify their relative importance. For example, is itnecessarily appropriate to characterize a regime of open entry competition with mandatory interconnectionas involving less public-sector governance than a regime of rate-based, rate-of-return monopoly withclosed entry? As another examp,e, how would one characterize a telecommunications regime where therewas a monopoly, government-owned carrier not subject to any regulation and charged with maximiprofits for the benefit of the public treasury?

2.05 The foregoing questions are not rhetorical, as one can certainy essay answers. Rather, they aremeant to underscore the complex nature of real-world policy enviromnents when set against the simpledichotomy of market goverance versus public-sector govemance. In this context, it should be noted that

7

Telecomwnications Sector Reform in sia: Toward A New Pragmatism

the distinction between market and public-sector governance is invoked in this chapter as a conceptualdevice. In particular, it is useful for classifying changes in policy regimes at the margin. For example,a decision to privatize a government-owned telephone carrier can be usefully seen as a po!icy designedto invoke more 'market direction' and less 'political direction" of the resource allocation process. Adecision to privatize the carrier and (at the same time) impose a comprehensive rate-base, rate-of-returnregulatory srstem might be seen as a substitution of one form of public sector governance for another.

2.06 There is no implication in counterposing market govemance and public-sector governance thatone will necessarily encourage greater efficiency than the other under all circurstannes. Under specificcircumances, substitution of market governance for public-sector govemance, on the margin, willplausibly lead to improved efficiency in a host of telecommunications activities. This is especially likelyto be true when regulatory barriers to competition are eliminated in markets that can sustain active inter-firm rivalry. Under other circumstances, improved efficiency is less plausible or, alternatively, may berealized only if new forms of public-sector governance are introduced alongside new applications ofmarket governnce.

2.07 The purpose of this chapter is to identify and briefly assess the major economic issues that figureprominently in policy debates about whether there are unique features of telecommunications servceprovision which make an increased emphasis on market governance either irrelevant or inappropriate, orwhich otherwise suggest continued or new important elements of government intervention. Detailedconsideration of these issues is provided in W'orking Paper G.

2.08 One ubiquitous fication to an increased emphasis on market governance intelecommunications is the presumed existence of natual monopoly conditions in one or more segmentsof the industry, in particular local distribution. A second broad qualification derives from the intsicnature of telecommunications systems as networks, i.e., collections of interdependentusers. Two specificfeatures of telecommunications networks have been identified as relevant to the restructuring debate. Oneis the potential for significant externalities to characterize the network. A second and related feature isthe difficulty in coordinating the realization of "critical mass" when growing the network. Yet anotherbroad qualification to increased reliance upon market forces is a view that basic telephone service is a"necesity" and that reliance upon the market would cause significant financial hardship to specificsubscriber groups. Indeed, whole groups of subscrbers might be deprived of telephone service. Thisconsideration is often tied into arguments for maintainin pricing cross-subsidies.

2.09 In the following sections we consider each of these qualifications. Section A addresses therelevance of economies of scale and scope to telecommunications restructring. Section B considers thenature and significance of externalities and related economic features of telecommunications networks.Section C disacsses pricing crossubsidies as a policy issue in telecommunications.2

A. Economies of Scale and Scope

2.10 A taditional question that has been addressed in public utility economics is whether an industyis a "natural monopoly," meaning that only one firm can produce output while operating at miimefficient size. The recognition that firms typically produce multiple products adds complexity to thedefinition of natural monopoly, since the scope of production, as well as the rate of output for any oneproduction process, may influence optimal firm size.3

8

ii. Economic Issus

Defining the Concepts

2.11 Economies of scale exist when a production function exhibits increasing retums to scale. Asingle-product firm that enjoys economies of scale over any range of output will have decreasing averagecosts over the output range.4 Economies of scale arise primarily from the indivisibility of factor inputs.Indivisibility simply means that the potential services supplied by different factor inputs are not"exhausted" in proportion to the use of those services. For example, capital equipment is usually"lumpy." That is, it cannot be installed in infinitely divisible units. As a result, installed equipment canbe used more intensively as output increases until the equipment is being used to capacity. This moreintensive use of equipment will be associated with declining average costs.

2.12 In the case of a multiproduct firm, one can continue to talk about economies of scale at theindividual product level. In this case, one is talking about increasing production of a single productholding production of all other products constant. Alternatively, one can consider the impact of an equi-proportional expansion of all outputs on average costs. In this case, economies of scale are representedby the more general concept of decreasing ray average cost.5 A firm enjoying decreasing ray averagecosts can expand all outputs in proportion with a less-than-proportional increase in its total costs. Theunderlying rationale for decreasing ray average costs is the same as that underlying decreasing averagecosts for a single-product firm, namely, the existence of indivisible inputs that are used in the productionof all outputs.

2.13 Finally, there are economies of scope. The latter exist when combining the production of twoor more products in a single firm leads to lower costs than when the same volumes of the variousproducts are pmduced in separate firms.' Economies of scope are potentially created by the existenceof inputs that are indivisible and can be used to produce two or more products in a complementaryfashion. For example, fiber-optic cable can be used to carry both telecommunications and broadcastsipas.

2.14 A cost function exhbits the property of natural monopoly when it is subadditive. Subadditivitymeans that a single firm can produce any level of output more efficiently than two or more smallerfiS. 7 Subadditivity of the firm's cost function is a necessary and sufficient condition for naturalmonopoly only when aUl firms have access to the same technology, where technology is defined broadlyto encompass managerial expertise, administrative systems and so forth, and when market coordination,e.g., interconnection, between separate firms is unable to achieve the same economies (say, bynetworking or pooling arrangements) as internal coordination within a single firm.

Evaluating The Evidence

2.15 Available studies of production conditions in teiecommunications services tend to take two forms:(i) econometric estimation of production and cost functions; and (ii) engineering studies of the relationshipbetween cost and output. Both types of studies have been subject to a range of criticisms including thedifficulties both have in separating the impact of scale from the impact of technological change. Inparticular, if improved efficiency of a large firm is associated with technological change that can beadopted by smaller finns as well, evidence showing that firms gain efficiency as they grow larger ispotentially spurious.8

9

Telecomnications Sector Reform in Asia: Toward A New Pragmatism

2.16 As noted above, indivisible capital equipment is traditionally seen as underlying economics ofscale in teleconmunications. In particular, investments in terrestrial transmission capacity, including thelocal loop, are suggested to contribute to decreasing average costs of toll and, especially, local survicesince this capacity cannot be continuously "scaled down" to serve smaller and smaller markets.Economies of scale at the multiproduct level have been associated with overhead functions such asnetwork planning and development which, it is suggested, involve inputs such as skilled systems designersand engineers, whose work efforts will not increase in proportion to the size of the overall system theydesign.

2.17 One can find empirical studies supporting various conclusions on the magnitude of scale andscope economies in telecommunications.9 The most judicious interpretation of the available evidenceappears to be that it does not provide reliable support for the thesis that the overall supply ofteleconmmunications services is a natural monopoly, at least in North America where most of the relevantresearch has been focused. Specifically, economies of scale and scope are insufficient to cause unit coststo decline continuously as existing volumes of local and long-distance traffic are concentrated in a singlecarrier. Nor is there persuasive evidence that unit costs decrease continuously with increased output ineither the local or long-istance segments of the network over the ranges of output experienced. Thislatter conclusion is probably most disputed when applied to the local segment where the "sunk" costs ofwired access remain high; however, wireless technologies arguably have lower sunk costs or(equivalently) smaller required indivisible capital investments. The available evidence and expert opinionare more unified in concluding that long-distance telecommunications do not exhibit decreasing averagecosts over large ranges of output.

2.18 One might argue that empirical studies would be more persuasive of the existence of naturalmonopoly in low-income countries where output levels of different telecommunications services arerelatively low. That is, economies of scale and scope are less likely to have been exhausted at the lowerlevels of output produced in low-income countries. On the other hand, several important qualificationsto the practical relevance of conventional cost function studies may be particularly significant in thedeveloping-ountry context. In particular, it is unlikely that all firms will operate with the sametechnology. Indeed, it is likely that some firms will be more technically efficient than others. Put morepointedly, small firms may have lower costs than large firms even in the presence of subadditive costconditions if the latter are substantially less efficient in a technical sense than the former.

2.19 An acknowledgment that product offerings are differentiated also requires the analyst to focus notjust on the relationship between costs and firm size but also on the linkage between firm size and otherperformance attributes such as innovativeness, quality of product offerings and responsiveness toconsumers. In this regard, a larger number of smaller firms may constitute the "optimal" marketstructure, even in the presence of economies of scale and/or scope. One must therefore come to gripswith how performance along a number of dimensions is related to firm size and scope, as well as therelative weight consumers place on different aspects of performance.'0

Relevance of the Evidence

2.20 One might argue that if there are uncertainties about the nature and extent of economies of scaleand scope, a policy of open entry should be implemented, thereby allowing market processes to revealoptimal firm size. Indeed, one might further argue that even if econometric or other evidence werepersuasive about the existence of a natural monopoly, it would be a mistake to prevent entry on the basis

10

nI. Economic Issues

of this evidence since ongoing technological change could reduce the minimum size at which firms canefficiently compete in different segments of the industry. In this regard, it has been suggested that therapid diffusion of digital technology in telecommunications is reducing the magnitude of the indivisibleinvestments new suppliers must make to compete with either established toll- or local-service providers.A related notion is that entrants might actually introduce superior techniques and products. Perhaps ofgreater relevance, the threat of entry itself may be an important discipline on the efficiency of incumbentmonopolists, although if the monopoly is regulated, the efficiency of the incumbent producer will reflectthe nature and comprehensiveness of regulation as well."

2.21 Are there any grounds for imposing a de jure monopoly when there is evidence of naturalmonopoly? One relatively complex justification rests upon a demonstration that given relatively largeeconomies of scale and relatively weak economies of scope, there may be no set of prices the incumbentmonopolist can set which will be "sustainable against competitive entry.'2 The implication is that openentry might actually lead to the emergence of an inefficient market structure. In fact, the practicalrelevance of this caveat is highly questionable. A more relevant concern is that the regulator or otherpublic agency may mandate the incumbent to charge prices which are unsustainable in that they do notreflect relative costs of different services. This will be true if there are cross-subsidies in the pricingstructure.

2.22 Another potential qualification to allowing open entry tests of natural monopoly is if there areexternalities associated with entry. For example, completely unrestricted access to spectrum, rights ofway for cable and so forth would arguably lead to congestion and disruptions of service on existingsystems. Inefficient entry might occur because entering firms ignore the congestion costs they imposeupon other would-be suppliers. A related argument is that the need to interconnect different networksmay itself give rise to social costs such as monitoring compatibility and policing, tandards. Withoutdenying the relevance of some of these qualifications, virtually no economist advocating open-entry testsof market structure has also advocated the abandonment of managing the use of spectrum and other so-called common-property resources."3

2.23 One other qualification to the open-entry position might be noted. Specifically, if somesignificant proportion of costs associated with entering the telecommunications industry is "sunk," in thatit cannot be recovered if production ceases, there may be a concern on the part of any would-be entrantthat consumers will act in an opportunistic way after it makes the required sunk-cost investments. Forexample, imagine that a firm invests in local-loop facilities expecting to charge prices sufficient to recoverall costs plus a normal rate of return. Once the investment is made, subscribers know that service willcontinue to be provided as long as the supplier can recover variable costs. They can threaten theincumbent with buying service from a new carrier unless the incumbent lowers price to variable cost.Knowing that this type of behavior is a possibility, would-be suppliers may refrain from entering theindustry at all unless they are given an "exclusive franchise" for some period of time.'4

2.24 This latter argument might be thought to be especially relevant in low-income countries wheremajor new sunk-cost investments must be made; however, the rapid growth of networks in these countries(with demand growth usually outstripping supply growth) serves as some guarantee against opportunisticbehavior on the part of consumers. Also much of the equipment going into the network is fungible, e.g.,radio-based equipment, wnich can be sold for reuse elsewhere. Finally, entrants can mitigate theaforementioned risks of opportunism by "preselling" capacity. That is, entrants might sell some amountof capacity through a longer-term contract prior to sinking arge costs.'5 Similarly, some form of "up-front" cammitment by the supplier may be required to provide consumers with confidence that supply

11

Telcommunications Sector Reform in Asia: Toward A New Pragnmaism

will be forthcoming; however, when the entrant is a relatively large, multinational company, thereputation of the company may itself be the requisite 'bond" offered by the would-be supplier."

2.25 Removing legal barriers to entry does not necessarily ensure that competitive suppliers will entera market. In particular, incumbent firms may use their ownership of so-called bottleneck facilities orother "first-mover" advantages to slow the rate of entry and growth of rivals. Over time, alternativesto existing bottleneck facilities may well emerge; however, one must still consider whether there is a needfor pro-active policies to hasten actual and potential entry (and not simply "allow" entry) to the extentthat actual and potential entry improves the performance of industries.1'

2.26 In the U.S., two policies might be highlighted as examples of entry-promotion policies: (i) themandatory unbundling of basic exchange services, e.g., separating the sale of different elements oftransmission and switching components of the network, and (ii) mandatory interconnection." To theextent that competition is possible in different "basic" network services such as local switching,unbundling enables consumers to buy those specific services from a number of suppliers, and this, inturn, shrinks the portion of the network providing a bottleneck to competition. Mandatoryinterconnection to botdeneck facilities, either through direct provision of service or colocation of physicalfacilities, mitigates the risk that incumbents will foreclose entry into broad sectors of the industry bydenying economic access to specific individual sectors."9

2.27 Not all economists agree that preventing foreclosure of access to bottleneck facilities is a relevantfocus for public policy in telecommunications. A contrary position has been put forth along the followinglines:

(i) Intercormection makes networks into complements rather than substitutes. In doing so,it suppresses competition. Moreover, it can lead to standardization of networks aroundthe lowest common denominator, thereby denying subscribers the benefits of productdifferentiation.

(ii) Mandatory interconnection can actually make it more difficult for new toll carriers toenter the market, since they could not form exclusive alliances with local exchangecamers.

(iii) Competition among long-distance suppliers for local exchange franchises leads to fastergrowth of access capacity.20

The argument appeals to early U.S. experience for supporting evidence. Independent telephonecompanies arguably flourished during the period that the Bell Conmpany had restrictive interconnectionpolicies. When Bell changed its policies to encourage interconnection with independents, the latter wereunavailable as local outlets for rival networks, and conmpetition was suppressed.2'

2.28 The early U.S. experience with competition is discussed at greater length in Chapter mI. At thispoint, two observations are offered about the case against mandatory interconnection. First, it is unclearwhy adoptng standards to ensure compatibility at network "connection points' obviates the potential forcompetition through product differentiation. A variety of attributes would seemingly remain viabledimensions for competition including new pricing packages, trsmission speeds, reliability and so forth.Second, competition should not necessarily be equated to numbers of competitors. If regulation or relatedpolicies can promote the availability of local-access facilities at competitive prices, the supply of servicesinterconnected with local facilities can be workably competitive even with a single, integrated local

12

IH. Ec Isues

exchange carrier. Presumably, once adequate altematives to the incumbent local exchange carrier exist,mandatory interconnection will no longer be relevant.

2.29 A more indirect argument against mandatory interconnection might be made, particularly in thecontext of LICs. This argument builds on the notion that investors in telephone networks in thesecountries have limited access to foreign capital markets. As such, the main source of financing fornetwork development and expansion are the operating earnings generated by selling telephone servicesat prices that exceed their associated costs.' In this context, a regulated monopoly protected fromcompetitive encroachment and promised a "fair" rate of return on invested capital might be the mostfavorable environment for encouraging long-term investment in network development and expansion.

2.30 The foregoing argument embodies the critical notion that investors in the telephone networks oflow-income countries cannot effectively gain access to international capital markets. While it is likelythat, for various reasons, most investments in poorer countries will have higher costs-of-capital thancomparable investments in wealthier countries, it is arguably overstating the case to suggest that investorsin LICs are precluded from raising money internationally. Moreover, given the numerous "high-priority"infrastructure investments that are required in developing countries, it is not obvious that the implicit costof internally generated funds from a national telecomunnications supplier would be lower than the explicitcost of fuids raised in international capital markets.

2.31 The availability of international fmancing for teleommunications networks in LICs would seemto be eihanced by the proliferation of strategic alliances in the telecommunications industry. Substntialinvestments by large North American and European telephone companies in telephone systems ofdeveloping countries suggest the availability of forign funding for network expansion and monin those countries.

2.32 Putting aside the argument that intenally generated funds must be created by establishing aregulated (or unregulated) monopoly, it might also be suggested that the availability of internallygenerated profits does not necessarily translate into capital investment. In particular, while a firmshielded from market competition may have access to financial capital, it may be slow to deploy thiscapital in new investments in the networl. Indeed, management may choose to dissipate profits in theform of generous payments to other factors of production, including themselves. Perhaps a more relevantconcern is that a protected supplier will be less efficient in deploying its capital than a supplier in acompetitive environment.

2.33 Another point is that, in the long run, new investment opportunities in an industry are createdprimarily by innovation in the form of new goods and services. The latter stimublates demand growthwhich, in tmn, stimlates investment. An environment characteized by competitive entry is more likelyto encourage innovation than an environment where entry is restricted and supply is effectively cartelized.

2.34 Other theoretical arguments bearing upon the linkage between entry conditions and investmentare related to the presumed existence of network extemalities. These arguments, as well as relatedevidence, are discussed in Section B.

13

Telcomnunicaoions Sector Reform in Asia: Toward A New Pragmarism

Policy Implications

2.35 Evaluation of the relevant issues suggests that economies of scale and scope per se have limitedsignificance for policies toward entry. If entrants do not impose congestion costs on incmbents andinterconnection is not foreclosed, either by the exercise of market power or by relatively high transactioncosts, a "laissez-faire" attitude toward entrants on the part of government policy makers seems generallywarranted. Although theoretical arguments have been made that this recommendation must be qualifiedby a country's stage of development, they are not persuasive. Indeed, given chronic capacity shortagesin low-income countries along with associated risks that protected incumbent suppliers will exhibit chronicinefficiencies of one sort or another, potential entry into both long-distance and local-service segmentsis arguably a very important instrument for improving performance in these sectors in developingcountries.13

B. Externalities

2.36 The existence of externalities is a ubiquitous rationalization for government intervention intomarket governance. There are several potential externalities associated with the operation oftelecommunications networks.

Nature of Potential Ex lities and Empirical Evidence

2.37 One externality derives from the possibility that a new subscriber joining a network will confera benefit on existing subscnrbers because one more telephone can be reached by the latter. A largenetwork, accordingly, should be more valuable to belong to than a small one, all other things constant.

2.38 In fact, economists have identified two subcategories of this extenality. One is associated withan increase in the penetration ratio with no expansion in the population (Type I extemality). A secondis associated with an increase in the number of telephones with no change in the penetration rate CypeII externality).34 As a practical matter, in developed countries such as Canada and the United States,which have very high penetration rates, any empircally relevant exemality will be of the Type U1 variety;however, in low-income countries, both types of externalities may be empirically relevant. Indeed, giventhe relatively low subscriber penetration rates, Type I externalities may be more important than the TypeHI variety.

2.39 Although evidence has been found to support the existence of network externalities in high-incomecountries, the empirical effect is small and frail statistically.25 Indeed, stronger support can be foundfor the existence of a so-called calling externality. That is, calling per telephone inceases with marketsize holding constant the nber of telephones that can be reached. The notion underlying a callingexemality is that a call from A to B can stimulate a call in the reverse direction; however, it is extemelydifficult to estimate the magnitude of calling externalities with any reliability. Moreover, some unknownproportion of these calling externalities can presumably be internalized by private parties. For example,a call from party A to party B can elicit a commitment for a return call from B to A.

14

11. Economic Issa

impications of Extemalities

2.40 One potential implication of the presence of significant externalities is that competitivelydetermined prices may be too high and therefore may not lead to efficient-sized networks or to thesocially "optimal" volume of calling. This is because competitively determined prices will not reflectexternalities associated with access and (primarily) local calling. As noted above, both access and callingin low-income countries will be at a much-reduced level compared to developed countries. All otherthings constant, this suggests that externalities may be greater in low-income country networks.

2.41 A second and related implication is that fr tion of nonintercomected long-distance andlocal networks associated with ownership and operation by multiple suppliers may inhibit demand andslow the overall growth of the industry. This seemingly follows from the inference that hithertounconnected subscribers are more likely to join a large network than a small network. Indeed, unlessthere is a reasonable prospect of the network reaching a 'critical size," many would-be subscribers maynot join at all. Critical size is less likely to be reached if networks are highly fragmented.2'

2.42 In fact, in both developed and low-income countries, the practical relevance of these implicationsis likely to be quite limited. For example, in the latter, there is usually excess demand for access.Moreover, among those with the ability to pay, demand for access and for calling tends to be relativelyprice inelastic. Hence, if supply is available, network growth and usage will be largely conditioned byincome levels rather than by prices.

2.43 The critical size argument implicitly assumes that irterconnection among competing networks iseither not possible or that would-be subscribr discount the possibility of intercoimeton. As notedearlier, if, for one reason or another, the market cannot efficiently promote interconnection both witinthe toll and local sectors as well as between toll and local, there is a case for public policy intervention.In act, given fairly homogeneous technical standards in the industry, physical problems withinterconnection tend to be minimal. Also, numbers of interconnectors are likely to be sufficiently smallunder most circumstances so that large number bargaining problems are unlikely to prevail.=

2.44 The critical mass argument also tends to minimize the existence of users with diverse needs andpnorities. Heterogeneous demands on the part of telephone users accentuate the advantges of havinga number of rival suppliers, since it is unlikely that any single supplier could satisfy a broad range ofheterogeneous customers. To be sure, the demand for "plain old telephone service" (POTS) is liklwy tobe relatively more important in developing countries; however, the speed with which installations aremade, the commitment to maintaining quality and so forth are also relevant dimensions of networkperformance for POTS. Given the more limited historical experience of telephone operators indeveloping countries, there is lilcdy to be greater hetrogeneity among suppliers of POTS in low-incomecountries than in developed countries. This strengthens arguments for allowing diversity in the supplyof telephone service including POTS.

Empirical Evidence

2.45 As noted earlier, the linkage between industial structure and investment in thetelecommunications industry cannot be definitively identified on theoretical grounds. Hence, empiricalevidence on the linkage is useful. Of primary interest here is the relationship between structure andinvestment in low-income countries. One apprnach to developing relevant evidence would be to examine

15

Telecomnunicaxions Sector Refonn in Asia: Toward A New Pragmatism

the experience of telephone systems in their early stages of growth in now-developed countries. Sincemany conditions affecting the industry, technology in particular, have changed substantially over the past75 years, one mst be cautious in extrapolating historical experience to present circumstances.

2.46 Notwithstanding these caveats, the early U.S. experience is instructive. One view holds thatprivate capital was attracted by the telephone industry's regulated monopoly status. An alternative viewis that independent competition stimulated growth of the network, the extension of service to unservedor underserved areas, and the development and application of telephone technology?' While it isimpossible to assess the debate definitely in this chapter, the latter position is generally supported byseveral historical accounts of the early Bell System experience. See Chapter III, Box 3.

2.47 To be sure, there was a major expansion of the Bell System after 1913 when an agreementbetween Bell and the independents led to a regulated monopoly environment. However, it has beenargued that special discount rates for night-time calling, classification of messages between person-to-person and station-to-station calls, intensive national advertising and subscriber education and the generalacceptance of long-distance calls as a part of doing business were the major stimulants.? That is, it canbe argued that the expansion was stimulated by technological changes and changes in network use patternsrather than by the regulated monopoly environment.

2.48 Historians also have addressed the availability of financial capital in its examination of the earlyU.S. experience.' One study concluded that the founders of Bell were unable to excite the interestsof large investors in the commercial prospects of telephony. They therefore enlisted local agents acrossthe country to lease the company's equipment to acumes in return for an annual commission. Thestrategy of leasing and the prices charged were designed to firish the company with a steady flow ofincome. The leasing arrangemeats also shifted onto the shoulders of the local agents the costs ofpromotion in the field, including all expenditures associated with the marketing, construction andoperations of telephone plants.3" This suggests that the Bell System relied on the finacing capabilitiesof independent telephone industry entrepreneurs much as would have been true if multiple networksuppliers had been responsible for building out the capacity of the network instead of the Bell System.

2.49 It should also be noted that early telephone connections in the U.S. were all point-to-point. Therewas no switched network. Exchange technology created a new and far larger market for telephoneistumnts aIa services, a market whose exploding demand the Bell interests found difficult to satisfy.Again, the growth of the Bell System was clearly abetted by technological change. Indeed, it can beargued that the Bell System failed fully to capitalize on changing technology.

2.50 One early competitor was Westem Union. It can be argued that its entry stimulated a fasterexpansion of capacity than would otherwise have taken place in that it accelerated the estblishment ofcetral exchanges. This underscores the caveat that even if monopoly status provides access to lower-costcapital, the incentive to invest will be stronger when competition is present.

2.51 The early competition between Bell and Western Union also highlights potential problemsascated with interconnection. Specifically, the competition between Bell and Western Union wasapparently an obstacle to the development of interconnected city lines. However, interconnection wasalso a problem even within the Bell System, as Bell apparently experienced difficulties getting its ownlicnsees interested in interconnecting with the long-distance network it was trying to develop.

16

11 Economic issues

2.52 In summary, reviews of early U.S. experience with telephony tends to support the posidon thatcompetition stimulated the growth of the network, especially in rural areas. They also identify theconstraints imposed by interconnection problems on network growth.

C. Cross-Subsidies

2.53 One broad reservation about relying extensively upon market governance is that products will besupplied only to those with the ability to pay for them. Moreover, producers must expect to recover allcosts, explicit and implicit, if they are to supply output in a competitive market. The imnplication is thatspecific groups in society may be denied what is considered a "necessary" service unless marketimperatives are "overruled" by public policy initiatives.

2.54 Traditionally, telecommunications regulators have embedded cross-subsidies in the pricingstructure. One conventional definition identifies the presence of cross-subsidies by the failure of pricesto cover "stand-alone' costs. That is, prices will be above stand-alone costs for some services (orsubscribers) and below stand-alone costs for other services or subscribers.

2.55 As noted above, such cross-subsidies are unsustainable in an unregulated environment.32 Evenin a regulated environment, the regulator must ensure that competitive entry is not motivated by a desireto arbitrage away differences between prices and costs, where such differences reflect public policypriorities. This will be a difficult task in the best of circumstances, imposing risks that, on the one hand,inefficient entrants will successfully enter the industry and, on the other, that more efficient suppliers willbe denied entry by the regulator.

2.56 Given the relatively large nunmbers of low-income households in low-income countries, cross-subsidization through the telephone pricing structure is an unlikely way to alter fumdamentally thedistribution of income. Nevertheless, the extension of telephone service to specific geographic regionsor specific groups of subscribers might be seen as an important public policy objective for reasons of'nation-building," broadly defined.? The question then arises, how best to achieve the desired extensionof service?

2.57 In this regard, economists offer several prescriptions that are (arguably) relevant for low-incomecountries as well as developed countries. One is that income transfers should be effected directly throughtax-transfer policies rather than by constraining producers to charge artificially high prices to someconsumers and artificially low prices to others. A second is that the transfers should affect behavior atthe margin. Put simply, income transfers are ineffective if they do not change behavior significantly inthe desired direction.

2.58 To be sure, a policy prescription advocating the implementation of tax-transfer schemes carrieswith it the challenge of demonstradng that feasible schemes can be implemented to effect the desiredtransfers with lower dead-weight costs than would be imposed by a regulated pricing strucure. A varietyof targeted income-transfer schemes that have been put in place, particularly in U.S. states, under thebroad heading of telephone lifeline plans are suggestive in this regard;' however, the relevance of suchapproaches may be limited in low-income countries where the majority of the population exists atrelatively and absolutely low incomes.

17

Telecommunications Sector Reform in Asia: Toward A New Pragmatism

2.59 Nevertheless, broad-scale direct transfers might be quite feasible in low-income countries toachieve certain minimal network expansion targets. For example, public telephone offices might be setup in rural areas to provide service with payment for the service funded by international aid programsor subsidies from general tax revenue, including taxes on profitable telecommunications services. Thegoals of regional network expansion might well be met in this way without introducing large and probablydurable distortions in the telephone pricing system.

2.60 One final point should be underscored regarding cross-subsidies. Extending telephone serviceto poor subscribers is best promoted in the long run by encouraging an environment in which suppliersare driven to provide desired levels of service at the lowest possible cost. Restricting entry and othermanifestations of competition in order to preserve cross-subsidies in the pricing structure are likely to bean extremely perverse policy. Indeed, it may result in depriving the great majority of the poor and ruralpopulations from any telephone service at all, even if many can afford it, since protected incumbentsuppliers may fail to provide adequate and timely supply.

18

11. &onomic Issues

NOTES

1. P. Smith, "Myths, Conventional Wisdoms, Straw Men And Hypotheses: For Discussion," Discussion Paper. AsiaDivision, Industry and Energy Department. World Bank, Washington, D.C., August 28, 1992.

2. Much of the discussion in this chapter parallels economic theory developed in 'Brazil Reforming TheTelecommunications Sector: Policy Issues and Options For The 1990s," Report No. 10213-BR. World Bank, LatinAmerica and the Caribbean Regional Office, February 24, 1992.

3. The seminal article identifying natural monopoly cost conditions in a multiproduct setting is William Baumol,'Cost-Based Tests of a Natural Monopoly." The American Economic Revkw. 1982.

4. More formally, at any output level q, C(rq)lrq > C(q)/q for all 0 < r < 1, where C(q) represents the costfunction.

S. The concept of decreasing ray average cost is formally defined as: C(rq) > rC(q) for all 0 < r < 1.

6. For output leves Ql and Q2, economies of scope can be said to exist if C(Q1,O) + C(0,Q2) > C(QI,Q2).

7. For a full exposition of the concept of subaddidvity, see D. Evans and J. Heckman, 'Multiproduct Cost FunctionEstimates and Natural Monopoly Tests for the Bell System' in D. Evans, ed., Breaking Up Betl. Amsterdam:North Holland, 1983.

8. This point is discussed in detail in H. Lantzke, A. Mody, and R. Bruce, 'Telecommunications Reform in India:An International Perspective." op. ciL, Chapter I. note 3.

9. Working Paper 2 contains reviews of a number of leading studies.

10. .or example, if consumers place relatively litde value on pmduct differenliation and buy on the basis of price,minimum efficient scale and scope will be primarily dictated by cost-output relationshiDs.

11. There are numerous discussions in the economics literature of the influence of potential entry on the behavior ofincumbent firms. For an overview and references, see Dennis W. Charliton and Jeffrey M. Perloff, AModernIudustrial Organkation, Harper Collins Publishers. 1990.

12. For a discussion, see J. Panzar and R. Willig, "Free Entry and the Sustainability of Naural Monopoly". BeUJournal of Economics, 1977.

13. To be sure, there are disagreements about how to manage spectrum use.

14. This argument is elaborated upon in V. Goldberg, " Regulation and Administered Contracts", The Bell Journal ofEconomics, 1976.

15. An example of this involves charging a relatively high installation fee.

16. Competition taking the form of "bonded" preselling of output is sinilar to compedtive bidding for franchises tosupply. Vigorous pre-entry competition could well provide consumers with the benefits of competition even if onlyone or a few suppliers ultimately wind up serving the markeL

17. There is substanial evidence in he litrature that both actual and potential enty encourage increased efficiency onthe part of incumbent firms. This view is an increasingly prominent basis for telecommunications policy in theUnited States. See J. B. Meisel, 'ONA. Unbundling and Competition in lnterstate Access Markets".Telecommunicatons Policy, April 1992.

19

Telecommunications Sector Reform :n Asia: Toward A New Pragmatism

18. Ibid.

19. If all sectors of the industry were perfectly contestable, mandatory interconnection would be irrelevant sincecompetitive sources of interconnection would arise if existing owners of access facilities tried to impose monopolyprices or other anticompettivc terms of exchange. In the more realistic case, wherc competitive sources ofinterconnection between networks of subscribers take time to develop, particularly at the local level, mandatoryinterconnection can help speed the entry of rival network suppliers. See also the discussion in Chapter V. SectionC, Addressing Regulatory Shortfalls.

20. See M. Mueller, 'Interconnection Policy and Network Economics," Paper presented at the 16th AnnualTelecommunications Policy Research Conference. Airlie, Virginia, October 31, 1988.

21. Ibid.

22. An argument along these lines can be found in L. L. Selwyn, *Telecommunications Regulation and InfrastructureDevelopment: Alternative Models for the Public/Private Partnership," paper presented at InternationalTelecommunications Union, Europa Telecom 92 Forum, Budapest, October 15, 1992.

23. Allowing free entry does not necessarily imply that there should be forbearance from all forms of price and servicequality regulation. If a sector is not workably competitive and shows limited promise of becoming so within theforeseeable future, continued regulation of some form may be appropriate. On the other hand, the closer the sectorCoMes to being workably competitive, the more likely it is that regulaion wIll mitigate the efficiency benefitsoffered by competidon. There is no single definition of workable competition. The relevant notion underlying anydefinition is that no 'real-world' industry could meet the stringent definition of a purely competitive industry.Hence, workable compedtion represents an industrial structure that approximates the behavior and performance ofa purely compedtive industry while not necessarily satisfying all of the textbook attributes, such as homogeneousproduct offerings. As a practical matter, an industry will likely be workably competitive if there are multiplesuppliers and/or if entry and exit are reatively easy.

24. For a discussion of this distinction, see L. D. Taylor, "Network Externality and the Demand For ResidentialLong-Distance Telephone Services: A Comment," Mimeo, March 1987.

25. Ibid.

26. This argument is elaborated in D. Allen, "New Telecommunications Services: Network Extemalities and CriticalMass." Telecommunicadons Poli&y, September 1988.

27. To be sure, problems of interconnecdion can and do exist ii 'real world" telecommunications systems. Forexample. problems seem acute in Russia; however, the prim v cause in this case seems to be the fragmentedpolitical jurisdiction within Russia rather than the number of i -ri"v. See 'Why Ivan Can't Place a Call,"Busrness Week, December 14, 1992.

28. See, for example, ri. Mueller, "Telecommunications Development Models and Telephone History: A Response ToThe World Bank," ICTM Newsletter; (Omaha, NB) Vol. 2. No. 2 December 1991.

29. See H. Coon, American Tel & Tel. Tze Story oja Great Moaopo*, Freeport. New York: Books For LibrariesPress, 1971.

30. See R. W. Garnet, The Telephone Enterprise, Baltimore: The Johns Hopkins Press, 1985.

31. Id., p.15.

32. It might be argued that pricing cross-subsidies are also unsustainable in the long run under a regime of regulatedcompetition; however, this chapter will not elaborate upon this assertion.

20

II. Economic Issuas

33. Viewed in this context, die rationale for subsidy is really an externalides argument writ large; e.g., it can beargued that greater polidcal cohesion, reductions in regional tensions, and so forth contribute to a better quality oflife for most eesidenIs of a country, and not just those groups getdng telephone service.

34. For a discussion of some of these plans, see U.S. Federal-State Joint Board, Monitoring Report, CC Docket No.87-339, mimeo, Septeirber 1987.

21

m. DIVERSIFYING SUPPLY: THE SCOPE FOR COMPETMIION

So far as telecommnication is concerned, the situadon in developing countres probablyis more like dha of OECD countries 75 years ago than that in advanced countries today.The core problems involved in getting from one percent penetration to ten or twenty ornore are quite different from those of an extensively developed network.... [ rosssubsidies and network integration are probably far less important than encouragingnetwork expnsion. by whatever means are avaiable.

Roger Noll, Stanford University'

3.01 Chapter H has outlined why, in most circumstances, removing barriers to market entry is morelikely to improve sector performance than to damage it. But just which facilities and services should beopened to competition? And how should this be done?

3.02 Each country ultimately must answer these questions for itself, and changing technologies andmarket conditions mean that the answers must be revisited regularly. It may be useful, therefore, to viewcompetion for telecommunications services and equipment along the following continuum, from wherethe market is essentially closed to where it is fully open.2

a. Relatively closed (e.g., Vietnam, Palistan, Singapore)

* Monopoly of network facilities* Competition for customer premises equipment (CPE) and some services (e.g., data

networks over leased lines or corporate, privately owned networks are permitted)

b. Pardally open (e.g., Germany, France, Thailand, India, Malaysia, Sri Lanka, Mexico)

* Monopoly of network facilities* Competition for CPE and some telecommunications services (e.g., mobile, value added,

satellite) except basic switched telephony

c. Relatively open (e.g., Canada, Australia)

* Competitive networks permitted for mobile and long-distance telephony, but not for localloops

* All services are competitive and resale is permitted (except possibly for internationalservices)

d. Wide Open (e.g., U.K., New Zealand)

* Competing local and long-distance networks permited (subject to some licensing hurdlesand foreign ownership restrictions)

* All services competitive (writh some exceptions for iternational senrices)3

3.03 This continuum provides a reference for the more detailed review of competition below. (Seealso Figure 1 for a country-by-country comparison of market liberalization in Asia.) Our analysis of

23

TecwmmWarcafions Seaor Reform in Asia: Toward A New Pragmatism

Figure 1

Market Uberalization In Selected Asian Countries1992

Value Cellular Long LocalTerminal Added Radio/Paging Distance Exchange

Country Equipment Services Services Services Service

Bangladesh _ _ (3 0 0 0China O 0India O O _ *

Japan 0 0 O 0Indonesia QMalaysia 0 0 _ *

Pakistan O O 0 0Philippines O ( __O__

Singapore 0 0 |______ *

Sn Lanka 0 0 O *Thailand O O _ * -Vietnam O O * 0Key: Relatively Closed

Q Partially Open(3 Relatively Open0 Wide Open

24

*nl. Diversifying Supply: The Scope for Comperition

competition policy starts with local exchange service, of which the absence in many LICs is often feltkeenly.

A. Facilities-based Competition4

Local Networks

3.04 For many years, the conventional view has held that economies of scale make multiple localexchange carriers viable only in exceptional circumstances. As discussed in Chapter II, this is now opento serious question.5

3.05 The advent of wireless technologies (cellular radio, tmnked mobile) and the falling cost andenhanced software capabilities of local switching facilities has made it possible and, in most cases,desirable to permit multiple local exchange carriers-whether public or privately owned, and whetherwireline or wireless-to build out the teleconmnunications network.6 Indeed, without fostering this kindof pluralism or "community of networks"-as China, among others, has found-a rapid expansion oftelecommunications access in Asian LlCs during the next decade is unlikely.

3.06 Whether economics or law (an exclusive franchise) keeps the provision of local exchange servicea monopoly is of much more than academic interest in almost every Asian LIC. Given the paucity oftelephone lines in these countries, the cost of deciding the competition issue by legislative fiat (that is,barring new entry across the board) is likely to be very much higher than allowing the market to decide.In the latter case, the risk of market failure may be placed largely upon new, privately financedcompanies rather than the existing public network and ratepayers. Consumers might also be hurt by acarrier's failure, but many users might prefer to accept this risk when the altemative is to make do withvery poor service or none at all.

3.07 One of the obstacles facing potential new entrants for the provision of local exchange service isthe reluctance of the dominant operator to provide interconnection. However, the incentive of thedominant operator to refuse or limit such interconnection can be changed if it is required to divest itslocal business from its long-distance business. In this case, it is likely that the long-distance operator willhave an economic incentive to interconnect with every local carrier in order to maximize its traffic,revenues, and profits.

3.08 The case bor "letting a thousand telephone companies bloom," particularly in underserved areas,is by no means agreed. But the historical, technical and practical arguments-especially the impressiverecord of China's Township and Village Enterprises (TVEs) in the 1980s-are beginning to tip thebalance.

History

3.09 As noted in Chapter II, one of the most important historical precedents is that of the United Statesfrom approximately 1895 to 1920 after Alexander Graham Bell's patents had expired and before theAT&T consolidation. While the evidence is not undisputed, Milton Mueller, a leading authority on thehistory of U.S. network development, states that "[v]irtually every scholar who has written [about thisperiodi has concluded that independent competition stimulated growth, extended service to unserved

25

Telecommunications Sector Reform in Asia: Toward A New Pragmatism

area[s] and created pressures which improved both the development and the application of telephonetechnology."7 See also Box 3.

3.10 It is unilikely, as Mueller acknowledges, that the U.S. experience could be reproduced in mostLUCs simply by per mitting open entry; some ground rules must be established to prevent a dominantcarrier from using physical rights of way, scarce frequencies or refusal to interconnect to frustrate entryby new terrestrial or radio-based carriers. But the U.S. experience provides an important caution forcountries that seek to prejudge the viability of independent telephone companies, even where they operateon a stand-alone basis.'

3.11 FurLher, Mueller contends that what was most impressive about the U.S. experience withcompetition was the dramatic expansion of service in rural areas. Prior to competition, in the early 1890sthe U.S. telephone penetration rate was 0.4 percent overall, with virtually no service to rural areas, whichthen accounted for over 60 percent of the population. Yet by 1920, one third of farm families in Americahad a telephone, and the penetration was highest where independent telephone companies were thestrongest.9 After open entry was closed off in the 1920s, rural telephony in the U.S. was boosted bysubsidized loans from the new Rural Electrification Administration (REA). But, notes Mueller, it islikely that the REA would have been relatively ineffectual if the open entry policies at the beginning efthe century had not permitted the independent telephone companies to establish themselves.

3.12 The U.S. history also argues for a broader view of the dimensions of telecommunicationsdemand. In the early twentieth century, many U.S. planners saw the telephone primarily as an urban andbusiness technology, and accordingly they invested heavily in long-distance facilities between major cities.However, the U.S. independents found that much of the demand for telephony was for local and regionalcommunications. And much of that demand originated in rural areas and small towns; the rightframework was simply required to give it expression.

3.13 About one hundred years later the same appears to be true in much of Asia. The desire fortelephony in rural areas is strong and there is considerable evidence that the money is there to pay forit.'0 What most Asian LICs lack are the right policy vehicles to allow this demand to be translated intofacilities and services.

Technology

3.14 The technical case for a more flexible entry policy is twofold. Both alternative local distributionfacilities and local exchange switches have become cost effective at a smaller and smaller scale. Further,the software-based capabilities of "smart' digital switches have made it possible to "reinvent" thearchitecture of the local network and accommodate multiple service providers (see Box 4).

3.15 Since the 1980s, new radio technologies (trunked mobile radio, cellular telephony), have becomea viable alternative to wireline networks, especially for business users and where rapid construction (orextension) of a network is desired." This is being recognized in rich and poor countries alike.

3.16 In the U.S., for example, the number of cellular radio customers has passed 10 million (7 percentof the wireline base) and since 1991 more wireless than terrestrial customers have been added annually(over 2.5 million vs. approximately 2.0 million).'2 The success of cellular telephony has also prompted

26

*11. Diversifying Supply: The Scope for Competition

Box 3

The Telphone 'Takeoff In the United State:The Historical Role of Independent Telephone Companies

Several histories of the U.S. telephone network have underscored the vital role of independenttelephone companies during the early 20th century in bringing telephone service to rural areas. Sosuccessful were the independents-i.e., companies not part of the Bell Telephone System -that from1908 to 1923 a higher percentage of farm families had telephone service in the U.S. than nonfarmfamilies.

Operating companies were formed in the U.S. shortly after the telephone's invention in the 1 870s.One of the first was the Bell Telephone Company of Massachusetts, the precursor to the AmericanTelephone and Telegraph Compeny (AT&T). But the near monopoly over local service enjoyed by Bellof Massachusetts and its sister companies did not always exist. From 1877 to 1894, the Bellcompanies had a strong patent position based on Alexander Graham Bell's inventions. But when thepatents expired in 1894 almost 20 years of fierce rivalry ensued between the Bell companies andsmaller independent companies.

The independents focused on serving rural areas and smaller communities. AT&T devoted most ofits resources to serving large cities and providing long-distance connections.

Horace Coon, Robert Gamet, Milton Mueller and other historians of the U.S. telephone system haveconcluded that the competition for territory and customers between AT&T and the independents fromapproximately 1894 to 1912 greatly accelerated the expansion of U.S. service. Independentsdemonstrated to the Bell interests the capacity of the public to take, use and pay for more telephones.In many places they compelled Bell companies to reduce their rates and give better service. As aresult, U.S. telephone penetration grew from less than 1 % in 1890 to over 18% by 1 910; in Europe,where there was no competition, the penetration rate stayed at 1 % to 2% until the 1 920s.

The difficulties that independents faced in expanding and developing their networks were, accordingto Coon, largely the result of anticompettive behavior directly or indirectly attributable to Bellcompanies. One action was the refusal of the Bell System to connect with independent systems. Asecond was the refusal to sell telephone equipment to non-Bell compafies. A third was the influenceexerted by Bell System bankers, including the J.P. Morgan group, to prevent the financing of large,independent units.

Under its chairman, Theodore Vail, AT&T steadily absorbed most of its competitors, taking advantageof its ability to refuse interconnection. But, in 1912, the independents filed a legal complaint allegingthat AT&T's practices violated the antitrust laws. After the U.S. Department of Justice intervened,a compromise was reached under which AT&T refrained from making further acquisitions and allowedinterconnection of its facilities. The compromise effectively ceded a portion of U.S. local exchangeservice (approximately 15%) to non-Bell companies but preserved AT&T's long-distance monopoly.This compromise held for approximately 70 years, until AT&T divested its local exchange operationsin 1984.

Source: H. Coon, American Tel & Tel: The Story of a Great Monopoly (Books For Libraries Press,Freeport, N.Y. 1971); C.S. Fischer, American Calling A Social Histry of The Telephone to1940 (U. of Califomia Press, Beckley, 1992); R.W. Garnet, The Telephone Enterprise (JohnsHopkins University Press, Baltimore, 1985). M. M jeller, "The Telephone War*nterconnxction Competition and Monopoly in the Making of Universal Telephone Service1894-1920." PhD Dissertation, U. of Pennsylvania, 1989.

27

Telecommuncations Secaor Reform in Asia: Toward A Nev Pragmarism

Box 4

Local Service Competiton:Intenadonal Experence

As yet, only a small number of countries have authorized two or more companies to provide localexchange service using wireline facilities in the same area. But the number is growing.

The main examples are:

1. The United States, in the late 19th and early 20th centuries, and in the 1980s and1 990s, the authorization of competing metropolitan area networks (MANs).

2. The U.K. permits cable TV companies and, since 1991, independent telephonecompanies to compete for local service with BT and Mercury; in addition, the U.K. hasbegun to license radio-based local transmission services.

3. In Finland, effective January 1, 1994, duopolistic competition in the provision of bothlocal and long-distance services will begin.

4. In New Zealand, statutory barriers to entry into telecommunications network marketswere removed in 1987.

5. In France, the govemment is reported to have approved a plan for the Paris-based utilityCompagnie Gendrale des Eaux to offer a fixed residential local telephone servicecombining its cable TV network and DECT technology.

Beyond that, more than 20 countries have now licensed cellular radio companies to provide servicein competition with the dominant local wireline carrier. The list includes several LICs in Asia, such asIndia, Pakistan, Sri Lanka and Thailand.

the U.S. regulator, the Federal Communications Commission (FCC), to move forward with licensing asecond generation of wireless service (dubbed PCS, personal communications service) on the 2.2 GHzband. Other countries are doing the same. As the Economist recently noted, "A high-capacity digitalwireless network covering the whole of Britain could cost under $2 billion to build, several times lessthan a wire-based network-and would not require streets to be dug up or ugly overhead cables to beinstalled."13

3.17 The advantages of cellular networks-in terms of cost and timing-have not been lost on middle-and low-income countries. To date, however, the licenses granted for most developing-country cellularradio systems, including those in Asia today, have been restricted to urban areas. Radio technologieshave particular appeal in many developing-country cities because of the structural difficulty of installingcopper wire (or fiber-optic cables) where utility rights-of-way (underground ducting, main sewerage) arelimited, the population density is high, and there are numerous construction projects.

3.18 Yet cellular radio is also appealing in rural as well as urban areas because, in comparison towireline facilities, the cost of adding new subscnbers is distance-insensitive. The cost is similar whetherthe new subscriber is 1 kilometer or 10 kilometers from a base site, and an operator can increase itscustomer base at a relatively low per-subscnrber cost.

28

l l. Diversifying Supply: 7he Scopefor Competition

3.19 For this reason, it is misleading to view cellular radio as a wholly "mobile" service, andespecially so in the countless "green paddy" sites throughout Asia, i.e., the numerous small and medium-sized conmmunities with little or no telephone service. Provided sufficient frequencies are made availablein such areas, cellular technology may be equally capable of providing a "fixed" service for residentialand business premises. Moreover, given the modest infrastructure requirements for cellular service andthe falling cost of equipment,'' the longer-term potential for cellular systems to provide "wireless tailsW"in Asia may well exceed the opportunities for "mobile" service.'5

3.20 More scope for independent local exchange companies also is being hastened by advances insignaling and switching technologies (i.e., the "intelligent network"). Modem digital switches may becost-effective at a fairly low level (a few hundred lines). They also have a greater capacity to interworkwith other network facilities because stored program control switches often make it possible toreconfigure a network hierarchy and the routing of traffic without rewiring the network; the changes canbe made at the software level, not in the hardware."6

3.21 As such, intelligent-network technologies make it easier for national network planners tocontemplate separating the ownership and operation of various network elements in ways not heretoforepossible. The telecommunications infrastructure may thus be built in modular or "tinker-toy" fashion,with facilities being built jointly by a mix of national and local companies, with differng ownership.'In addition, even very basic intelligent-network technologies may make it possible to offer a range ofvirtual telephone services that were not practical before (see Box 5).

Counyry Experience

3.22 The case for encouraging independent local telephone companies does not tum on technologyalone or the early years of telephony in the United States. A strong case for a franchising policy thatrequires carriers to serve all of their assigned territory or to relinquish an exclusive concession to othercarriers (a "serve it or loose it" policy) is supported by the modern Chinese experience.

3.23 Since the 1980s, China's local exchange capacity has been built up simultaneously by provincialtelegraph and telephone companies (P&Ts) and township and village enterprises (TVEs). Currently, over200 TVEs and more than 2,000 mining towns, oil fields and industi areas without P&T service havebeen allowed to develop and operate their own networks. Capital is typically provided by users, the localmunicipality and the P&T. In some provinces, TVEs now account for 30-40 percent of the new linesinstalled, and the growth rate of TVE-built facilities is often as fast as that of the P&T."

3.24 By contrast, where national telephone companies have an across-the-board national monopolywithout any enforceable geographical performance targets, the distribution of telephone service is likelyto be skewed heavily to a handful of cities. Such is the case in many LICs. Some of these countries arenow trying to remedy the shortfall by the use of B-T schemes or otherwise. However, the roo; of theproblem-the across-theboard monopoly of the national operator-has yet to be seriously reconsidered."

3.25 To sum up, the technical, historical and country studies surveyed above strongly suggest that theconventional wisdom is wrong. A broadly available, mature telephone network should not be considereda prerequisite for network competition; in fact, exactly the opposite may be the case. That is, in many

29

Teecommwuications Sector Reform in Asia: Toward A New Pragmatism

Box 5

Virtual Telephone (VT) Service:Voice Mail, Pay Phones and Paging

At $1,500 or more per line, the cost of new telephone exchanges and the 'local loop" connecting thesubscriber has priced telephone service out of the reach of many in LICs. And even where peoplehave the money, it may take several years for the telephone company to complete a new installation.

Could virtual telephone service (VT) provide an answer? Some developing-country telephonecompanies believe it can. Recently, three local subsidiaries of TeleBras, the Brazilian phone company.signed a contract with a U.S. manufacturer of voice mail systems to install VT equipment capable ofserving up to 60,000 customers. The voice mail equipment bought by Brazil will give every customera unique telephone number that corresponds to a voice mail box connected to a local telephoneexchange. The equipment can be integrated with digital or analog systems. A VT subscriber will thusbe able to receive a detailed message in his or her voice mail box, and it can be retrieved from anytouch-tone telephone.

VT subscribers will also have the option of carrying a radio pager (often known as a "beeper') so thatwhen a voice message has been put in the mailbox, the pager will alert the subscriber with a signal.The message can then be retrieved and new messages sent from the nearest available phone.

At a capital cost of $50 per subscriber, VT service is cheap by comparison to the cost of adding anew dedicated lire. VT mailboxes are expected to rent for $3-5 per month (plus a usage charge); thepaging option may cost an additional $10.

Telephone companies in Mexico, the Philippines and Thailand have also begun to explore the potentialof VT service. However, to use the systems effectively, a country must also make a new commitmentto expanding the availability of pay phones and paging systems. These 'light-service' options havebeen often overlooked by many UCs (see Box 2 above) that have given priority to adding fixedexchange rines.

cases licensing multiple service providers is an approach that accelerates the network investment necessaryto create a widely based and mature telecommunicatons network.21

Domestic Long-Distance Networks3.26 Since the 1980s, competitive transmission networks for public long-distance switched telephoneservices have proven to be viable even in relatively small countries with approximately I millionexchange lines. Competitive networks have been licensed in the U.S. (1970s), the U.K. (1984), Japan(1985), New Zealand (1988), Sweden (1990) and Australia (1991). It seems likely, therefore, that at leastthose Asian countries with a relatively large number of exchange lines, such as Mndia, China, Indonesiaand Malaysia, also could support at least two long-distance carriers.

3.27 However, with limited exceptions (e.g., possibly Malaysia, in 1994), sector reform in Asia's LICsand MICs has not been accompanied by the authorization of a second or third long-distance carrier.3Although the reasons vary from country to country, there is a conunon fear that network competition willjeopardize the revenue base of the exnistng carrier and lead to a reduction in long-distance service profits

30

1L. Diversifying Supply: The Scope for Comperition

that would otherwise be used to expand local exchange networks (Box 6) and price increases for localservice. Governments have also argued that absent an exclusive franchise, the increased risk willdiscourage the investment required to optimize the size of the main network.

Box 6'Cram Simmning:

The Continuing Debat

One of the arguments frequently raised by opponents of competition for telecommunication servicesis that new entrants are likely to serve only the most profitable customers - that is, to "skim thecream' that is essential to subsidize network expansion. And it is said that the richest 'cream" is tobe had by serving large business customers and long-distance users rather than residential customers,where the revenue per line is more limited.

An economic case can be made for and against 'cream skimming." While it is true that new entrantslikely will seek out the most profitable market segments first, these segments may be profitable largelybecause tariffs for business and long-distance services are set markedly above cost. Thus, whetheror not the resulting profit is used by the dominant carrier to subsidize other services or simply paidover to shareholders or the government, sector investment is distorted. In these circumstances,"cream skimming" by a new entrant may spur the existing operator to adopt more efficient pricing andinvestment practices, to the long-term benefit of all ratepayers.

A further argument in favor of 'cream skimming" is that it signals that customers are willing and ableto pay for a service the incumbent operator is not providing, even at a relatively high price.Accordingly, where there is significant unmet demand, the public interest may be best served bymeeting the paid demand. Last, by focusing on the most profitable market segments, such as long-distance or international service, a new entrant may create a positive effect on service at the local-exchange level. Especially in UCs where the number of local access lines is limited andinterconnection to long-distance and intemational gateway facilities is uneven, new competitors mayhave a strong interest in seeing the base of local access lines grow to increase their own share of long-distance traffic. In this way, competition for the "cream" may lead to more 'mgk' for everyone.

On the other hand, it can be argued that "cream skimming" has significant economic costs where itleads to duplication of expensive facilities that have demonstrated economies of scale. Further, wherecompeting long-distance carriers are not required to make an equal contribution to the cost of havingaccess to local-exchange facilities, they may be unfairly subsidized by the dominant carrier'sratepayers. But the solution here (as discussed eLsewherel is to establish properly the cost of localaccess and ensure that it is shared by competing carriers in rough proportion to the costs they impose.

Second, the lost "subsidies" that may result from "cream skimming" can be mitigated, if desired, bywriting in qualitative and quantitative service requirements to the licenses for competing carriers. (Forexample, new-long distance carriers might be required to roll-out service across a country accordingto an agreed schedule.) In many UCs, however, across-the-board subsidies for local exchange serviceare questionable because the network is limited. The subsidies primarily benefit middle- and upper-income residential uers.

31

Telecommunications Sector Reform in Asia: Toward A New Pragmatism

Cross-Subsidies and Network Development

3.28 International experience suggests that these concerns have been overstated and can be satisfactorilyresolved, even in a relatively poor country.7 First (as noted earlier), where telephone penetration islimited, the licensing of competing long-distance carriers can act as a spur rather than a brake on thedevelopment of the local network because the larger the number of lines that can feed traffic to long-distance operators, the greater the potential for profit.

3.29 A country that desires to use long-distance competition to stimulate the growth of the localnetwork must therefore balance the public interest in nondiscriminatory access to long-distance carrierswith the need to compensate carriers for improving the performance of existing local exchange facilitiesor stimulating service to new areas. This is commonly done by phasing in "equal access" requirements-i.e., the ability of a subscriber to route a long-distance call over a comnpeting carrier with equalconvenience. Competing long-distance carriers may also be granted some leeway in setting the terms forinterconnection arrangements with local exchange providers, although the regulator (or the courts) mustultimately have the power to mandate interconnection in order to promote competition.

3.30 Second, any proposal for network competition must be linked to a plan for addressing the likelyimpact on local exchange tariffs, the local network "deficit" and govermnent revenues. The politicaldifficulties of forging an agreement on such a plan should not be underestimated. The plan mustgenerally win the support of the key groups affected by the reform effort-the employees of the dominantcarrier, management, customers, and government ministries. However, from the technical standpoint,other countries have shown that the accounting, pricing and institutional adjustments are manageable.

3.31 The approach taken in Canada and Australia, each of which has authorized new facilities-basedlong-distance carriers since 1991, may be most helpful. Both countries are large and, for the most part,thinly populated, with numerous far-flung rural commwuities. Each country thus took some care toensure thnat approval of a second (or third) long-distance carrier would not jeopardize long-standinggovernment commitments to nationwide affordable telephone service.

3.32 Thus, prior to initiating competition, regulators in both Canada and Australia took steps toquantify (a) the actual cost of providing local exchange access in different parts of the country, and (b)the revenue contribution which long-distance services were making to these costs. This information wasused to devise a series of connection or access charges so that the deficit incurred in high-cost local areaswould be shared between the existing carrier and the new competitor. In Canada, for example, this ledto contribution charges for carriers based upon the number of trunk lines used by a long-distance carrierto gain access to local exchange facilities in a given area and the local revenue short fall for that area?Other methods of "taxing" competing carriers for local access are also possible and may, in fact, be moredesirable to the extent that they are less sensitive to a subscriber's choice of service or carrier.

3.33 Any interconnection plans and the cost-accounting studies upon which it is based will be complex.But the principles underlying such plans are reasonably straightforward and of broad application. Thus,competition does not mean that a government must abandon subsidies for basic service. (As notedelsewhere, rural telecommunication is profitable in many areas and hence will require no subsidy.2')The key is to cost out the proposed subsidies and then, through connection charges or otherwise, dividethe cost equitably among competitors.

32

MII. Divwrsifying Supply: The Scope for Competition

Competition vs. Privaization

3.34 Another imporLant reason why some countries have deferred network competition is the desireof governments to maximize the sales price for a newly privatized carrier (e.g., as in Argentina andMexico). Nevertheless, the experience of several Asia-Pacific countries-most notably Australia, Korea,New Zealand and Japan-suggests that a successful reform package can include both privatization andnetwork competition. But it is important that all the elements of the package be known in advance, eventhough they may be implemented stepwise (i.e., competition is phased in). For a further discussion ofthis issue, see Chapter VI on the sequencing of sector reform.

3.35 Where long-distance network competition is not an element of the initial reform program, thereare still several steps that might ensure that the monopoly carrier is subject to a credible threat of futurecompetition. One approach, as was taken in Mexico, is to place a fixed time limit (e.g., seven years)on the carrier's network monopoly and, in the interim, to require the carrier to draw up plans forproviding equal access to competing carriers. In addition, as was also the case in Mexico, a countrymight choose to adopt a liberal approach to the construction of long-distance microwave radio or fiber-optic networks by alternative carriers (e.g., a trunk network that links regional cellular radio operators;a railroad carrier's national network). These networks may also provide a competitive stimulus to thedominant carrier insofar as they may put in place the future backbone of a second or third public network(see Working Paper A).

Laternational Networks

3.36 In certain respects, the economic case for competing international service providers arguably isstronger than that for network competition domestically.3 The margin on international calls in mostLICs typically is well above that for domestic interexchange service, and the surplus earned onintemational traffic is often the carrier's principal source of foreign exchange.2 If equitableinterconnection arrangements are put in place, the new facilities needed by a second (or third)international carrier may be limited largely to a gateway exchange, one or more international earthstations and the acquisition of an initial block of circuits on relevant transoceanic cables. The cost ofthese facilities is relatively small (by comparison to the cost of building a competing domestic network)and is declining.'

3.37 The two major hurdles faced by a new international carrier are (a) building a sufficient volumeof outbound traffic to cover its initial facilities and staff costs, and (b) getting foreign interconnectionagreements so that it need not rely upon carriers from other countries to "land' its foreign traffic and canobtain a fair share of inbound traffic. Regulators in Japan, New Zealand and Korea have demonstratedthat these hurdles can be fairly easily surmounted if users are permitted access to the international carrierof their choice call by call (e.g., by dialing 001 for the old carrier and 002 for the new one). This "equalaccess" approach (in contrast to the presubscription required in the U.K. and the U.S.) has ensured veryrapid growth of the new carriers in these markets. In turn, this has allowed the carriers quickly to reachthe traffic benchmarks (typically 3 percent or 5 percent of the outbound stream) set by foreign carriersfor a direct interconnection.'

3.38 Competition need not be introduced by licensing a new stand-alone international carrier. It canbe done by enlarging the franchise of a domestic carrier or value-added service provider or satellite

33

Telwcommnucafions Sector Reform in Asia: roward A New Pragmauism

company, as with DACOM in Korea (which was fornerly owned by the dominant carrier and offeredonly enhanced services), OPTUS in Australia (based upon a privatized AUSSAT) and Eastern Telecomin the Philippines (which was first an international telex carrier). A limited degree of internationalcompetition might also be initiated by divesting an existing international monopoly among a number ofdomestic regional carriers.29

B. Services Competition

3.39 Much service competition is possible without licensing new physical distribution networks.30First (as discussed earlier), a single national transmission network can provide a platform for competitiveswitching facilities offering value added services. Second, a network monopoly for conventional wirelinetelephony does not preclude transmission facilities for alternative networks such as cellular radio, paging,and satellite-based services (Box 7). Third, where facilities-based competition is not favored, servicecompetition may be provided if third parties can freely lease and resell the capacity of the monopolycarrier. However, this option may be limited in many LICs where there is typically a shortage of leasedlines.

Box 7

Paging: Stretching The Local Telephone Base

Radio pagers or "beepers" are often hard to find in poor countries, although they may offer aninexpensive means of keeping people in touch where the wireline telephone network is limited.

Pagers are small, hand-held receivers that provide one-way message or data delivery by radio.Dedicated frequencies for paging are not essential: pages may be broadcast over a subcarrier for atelevision or FM radio frequency carried via a terrestrial or satellite transmitter. The paging receiverprocesses and then displays the radio signal on a small liquid nrystal screen. The most popular modelsusually display only 20-30 characters at a time, although some pagers can store several thousandcharacters.

There is ample evidence that, even whdrm telephone service is quitc limited, the market can supportmultiple paging operators. Entry costs for new service providers are low, and there are numerousmanufacturers of transmitters and paging receivers. And the market for pagers, which may now costless than $100, is highly competitive since most developed countries have completely deregulatedtheir sale.

In liberalized markets, paging penetration, even in middle-income countries, is 2-3%; in Hong Kong itis over 10%; and in Singapore 14%1 By comparison, in most Asian LiCs paging service is still almostnonexistent, although China, India and Indonesia have recently taken steps to authorize additionalnetworks. This suggests that paging should be given a much higher priority by LICs and could in factprovide a test-bed for more liberal competition policies for other services.

3.39 Service resale is commonly divided into two categories: (1) value-added resale and (2) basic orsimple resale. The definition of these terms varies but, by and large, value-added resale involves thepurchase and sale of transmission capacity (leased lines) to provide customers with a different service ora service that reflects the addition of new value to the original telecommunications service. In the case

34

11. Diversifing Supply: The Scop for Competition

of basic resale, the dominant facilities-based carriers are required to make transmission capacity availablein bulk (e.g., at wholesale rates) and permit third parties (resellers) to retail the capacity to individualusers in smaller increments.

3.40 Liberalizing the market for value-added resale has become a priority for sector reform indeveloped and developing countries alike because telecommunications-based transactions are now criticalto most service and manufacturing industries. The data processing and information exchange requiredfor banking, transportation, import-export, warehousing, accounting, and engineering, among otherbusinesses, are all now dependent on the telecom network in one degree or another. Thus, a country thatfails to allow such businesses to lease the dedicated circuits they require runs the risk of allowing thenational telephone carrier to become the de facto gatekeeper of these sectors of its economy as well asthe telecommunications sector.

Implementing Value-Added Resale

3.41 How should valuc-added resle be implemented? The first step is definition: Precisely whichservices should be opened to competition or reserved as a monopoly? The answer is invariablyproblematic and will remain so if only because digital networks may be technically unable to distinguishbetween a basic bit stream (voice telephony) and a value-added bit stream (data traffic).3" The additionof value to a telephone service also involves a subjective judgment.

3.42 As noted earlier, these problems have led some countries to avoid basing entry policies n thedefinition of value-added services and instead to favor a policy that distinguishes between facilities-basedcompanies (Type I) and nonfacilities-based (Type II). This approach may look appealing, but if an open-entry policy is adopted for Type II carriers, the service limits for them must still be decided. A policymust also be adopted on the types of equipment a Type It carrier may own without being disqualified.Thus, so long as a country wishes to protect voice telephony from competition, the definitional approachand the Type I/Type II carrier approach both require hard choices.

3.43 In practice, regardless of the regulatory regime chosen, countries have tended to be results-oriented, and there is surprising similarity between the liberalization permitted under each of the twoapproaches described above. For example, following the Computer 11 proceeding of the U.S. FederalCommunications Commission (FCC) in 1980, many countries (Hong Kong, Sri Lanka, the Philippines)have chosen to define value-added service as one which employs computer processing to act on theformat, content, code or protocol of the subscriber's information; provides the subscriber additional,different or restrucured information; or involves subscriber interaction with stored information.3Under this approach, packet switched data transmission, data processing and data-base informationservices, electronic mail (E-mail), voice mail and storeand-forward facsimile services are considered tobe value-added services. These services are roughly the same as the services that generally may beoffered by Type II carriers in such countries as Japan and Korea.

3.44 The foregoing does not mean that the way in which value-added resale is implemented is whollyunimportant. There may be commercialy important differences between a North American approach,under which value-added providers are entirely deregulated; a U.K. approach, which requires providersto meet the terms of a Class License (no application is required); and a Japanese approach (also adoptedin Korea and Hong Kong), which requires value-added companies to be individually registered. In

35

Telecommunications Sector Reform in Asia: Toward A New Pragmatism

addition, some countries (as reflected in the European Community Services Directive) still have network-by-network licensing requirements to protect the market position of public data networks. Whereregulatory resources are limited, the simplicity of the North American approach-which is essentially self-policing-has much to recommend it.

Implementing Basic Resale

3.45 The benefits of basic resale frequently have been foregone in the process of sectoral reform. InMexico, for example, to protect the company's market value the government chose not to requireTELMEX to resell basic services for seven years following privatization. Likewise, both the U.K. andJapan initially chose to introduce facilities-based competition without permitting basic resale.

3.46 Yet basic resale may provide important benefits, especially where facilities-based competition isnot penritted. Experience in Canada (and the U.S.) suggests that resale leads to price and servicecompetition (e.g., custom calling plans, volume discounts, itemized billing options) which wouldotherwise be unavailable. Resale also tends to stimulate demand and to prompt the carrier whose servicesare being resold to adopt a more cost-based tariff structure, and thus to operate more efficiently to reducethe margins for resale.

3.47 Some observers are skeptical about the practicality of basic resale in low-income countries. Insuch countries, the network generally is underdeveloped and poorly dimensioned, and leased capacity istherefore scarce; call completion rates are low, particularly for long-distance services; and often noarrangements exist for oilling calls originated by alternative carriers. Such circumstances may indeedmake resale difficult. But that does not mean it should be prohibited across the board. Poor servicequality and network congestion might well encourage an innovative resale carrier to engineer the privateswitching facilities and leased lines needed to route traffic around congested facilities, to the benefit ofpublic network users as well as the reseller's customers.

3.48 There is precedent for handling both the technical and the financial issues associated withtheimplementation of such a resale policy. Notably, the North American market now supports hundredsof resale carriers, some with switches and some without. Where resale has not been tried before, it maybe appropriate to establish a joint (carrier-reseller) committee chaired by the govermnent to work out thetechnical details.

3.49 The profit from simple resale is often the greatest on long-distance routes where retail tariffs havebeen set significantly above cost to subsidize the cost of local and rural service. Because resale customersbypass these charges, a government also may wish to impose a separate "social contribution charge" onthe resale carrier proportional to the subsidy th: network has lost. In Canada (as noted earlier), this isdone by levying a contribution charge on the number of lines the reseller uses to connect its switch tothe public network; charges might also be levied based on a reseller's gross revenues or market share.Again, the approach taken will depend on local conditions.

36

/l1. Diversifying Supply: The Scope for Competition

C. Customer Prenises Equipment

3.50 The benefits of allowing users to buy or lease teleconmnunication terminal equipment from othersuppliers as well as the national telephone company have been widely demonstrated. Ending the exclusiverights of the dominant carrier to supply customer premises equipment (CPE) in fact is often one of theearly steps a country takes toward liberalizing the market for equipment and services. That is the case,for example, in Sri Lanka, Pakistan, and Singapore.

3.51 The transition to a competitive market for CPE typically involves several steps. First, to ensurethat the CPE market is truly competitive, the monopoly carrier must unbundle or separately charge forthe CPE it provides. To accomplish this under a rate-of-return regime, the CPE must be properly 'waluedand then subtracted from the value of the ratebase used to detennine the carrier's revenue requirements.A compensating tariff adjustrnent is then required (This may have to be done in stages if CPE rentalsaccount for a significant share of company revenues.) In addition, competitive safeguards should beadopted (e.g., requiring separate accounts or even a separate subsidiary) so that, following liberalization,the telephone company cannot use the profits from its monopoly services to subsidize its CPE business.

3.52 Second, a competitive CPE market raises the question of how best to ensure that equipment thatis not acquired from the telephone company may be connected with the public network and interoperatewidt other CPE. A minimum "no harm to the network" standard may be desirable to ensure thatequipment stanidards are not used in an anticompetitive fashion by incumbent operators and suppliers.In any ev ent, any standards must be transparent for users and suppliers, and the approval process shouldbe even-handedly administered. The equipment approval or certification body thus should be separatefrom the established carrier.33

3.53 There are two separate tasks to be performed: (1) determining which standards CPE must meetto be connected to the network-traditionally a regulatory role; and (2) verifying that a given piece ofequipment complies with the standard-is typically an engineering task. Both might be contracted outto a foreign regulatory or standards body. Alternatively, a country could choose simply to permit thesale of any CPE that meets the type approval standard in a specified list of countries. The approach takenwill depend upon the technical characteristics of a country's network and the resources available.'

3.54 Finally, the transition will require the govermnent to adopt and administer rules that define thescope of CPE that may be competitively provided. This definition may require modification as newcategories of equipment become available and as the extent of competition changes. For example, shouldCPE include telex equipment? How should wiring on the customner's premises be treated? What aboutswitches used by value-added service providers? Countries may differ on their answers to thesequestions, but as a national network becomes less homogeneous and more like a "community ofnetworks," as is now the case in most industrialized countries, a flexible approach to CPE is likely to bemost desirable.

37

Telecommunications Sector Reform in Asia: Toward A New Pragmatim

NOTES

Letter from R. Noll, Professor of Public Policy. Stanford University to P. Smith, World Bank. October 29, 1992.

2. Liberalization is not necessarily a linear process in which a country proceeds from one end of this continuum to dieother. Some countries may choose to leap-frog one stage (see, for example, the discussion of New Zealand inAppendix B.2): others may selectively open markets for radio-based and data services while maintaining strictmonopolies over wireline services (e.g., Indonesia, Thailand).

3. See generally H. Inen, 'Models of Service Competition," World Bank Seminar on Strategic Options ForDevelopment of Telecommunications Sector In Developing Countries, Jakarta, 11-12 December, 1991.

4. Some countries (e.g.. Japan. Korea, Canada) denote facilities-based carriers as Type I companies and non-facilitiesbased carriers as Type II companies. The latter class of carriers compete by leasing transmission facilities from TypeI carriers. The distinction is not always clear cut, however. Often Type [I carriers own their own swikches while TypeI carriers may own transmission facilities and switches.

Because the economies of scale for switching facilities have tended to decline over time relative to local transmissionfacilities, it is more economic for various entrepreneurs to interconnect their own switches with the public network.Thus, where non-facilities based competition is permitted, the Type nl carrier comnmonly leases transmission facilitiesfrom a network operator but adds value (by reformatting a message or adding new information) and links customersto the public network via its own switch.

The integration of switching and information (value added) fimctions may also occur in the public network. Modemsoftware controlled switches and common-channel signaling systems (e.g., Signaling System 7, SS7) provide manyopportunities for the dominant carrier to provide both switching and databasc services. Effective service competitionmay thus depend upon allowing private and public switching facilities that are optimized for different services;permtng inkpendent service providers to lease the necessry tansmission capacity to allow ese separate switchingsystems to interwork; and putting in place sufficient competitive safeguards to prevent the donunant carrier from usingit transmission monopoly unfairly to favor its own value added or information services busness. See, e.g.,K. H. Neumann, "Models of Service Competition in Telecommunications." in B. Weilenius et al., eds., Restuclurgand Managing the Telecommwucations Sector (he World Bank. Washington, D.C.. 1989) pp. 19-27.

5. See also B. Carsberg, "Approaches to Regulation-Reflections On The U.K. Experinc," ITU Asia Telecom '93,Regulatory Symposium, Supplement, Sinppore, 17-23 May 1993, 'After beginning, cautiously, with one competitorto British Telecom in basic network operation, a policy review concluded in 1991 that there should be no fixed lImiton the number of competitors in basic telecomnunications....Extensive financial modelling, carried out at Oftel,indicated that, in many situations, the financial penalty from duplication of resources in a competitive market wasrelatively small. This was among the important reasons that led us to conclude that no fixed limit generally wasneeded on the number of competitors." pp. 3-4.

6. There are three main technological options for introducing competition for local services: (1) build a parallel cablenetwork using newer technology (fiber optical cable; broadband cable television links); (2) build a network using analternative technology (celluar radio, satellite mobile); (3) provide access over the existing local loop to muliplecarriers by using 'smart" software-controlled switches or new rmultiplexing techniques (for 'data over voice"). Thelast two options are likely to be most attacive in LlCs.

7. M. Mueller, "Telecommunications Development Models And Telephone History: A Response To The World Bank.'ICTM Newsletter, (Omaha, NB) Vol. 2. No. 2, Decenber 1991, p. B.

8. Mueller contends that network expansion in the U.S. was actually spurred by the lack of interconnection between localtelcos prior to AT&T's consolidation of the network. One reason is that the absence of iterconnection enhanced thevalue of a network by stimulating new subscribers who could not necessarily expect that they would gain access tothe independene's exisn customem via a copetng company.

38

111. Diversifying Supply: The Scope for Conyeition

See also E.B. Parker and H.E. Hudson, Electronic Byways State Policies for Rural Development ThroughTelecommunications (Westview Press, Boulder, CO. 1992) which updates the argument for telephone companycompetition in rural aras of the United States. The authors recommend, among other things, that U.S. stateregulatory commissions should encouragecompedtion for servicesto all locationswhere local telephone carrierscharge.extraordinary installatdon fees' and "solicit competitive bids for telephone service to locadons outside telephonefranchise boundaries." Id. at 204-206. *From die perspectiveof the carrier that previously had an exclusive franchisefor unserved territory, such a competidve policy could be described as a 'serve-it-or-lose-it' policy. The proposedcompelitive policy-essentially, a 'sunsetting' of exclusive territorial rights is unserved areas-is a necessary first stepfor introducing service to many locations." Id. at p. 206.

9. M. Mueller, op. cit., note 6. p. 8. See also M. Mueller "The Telephone War: Interconnection, Compedtion andMonopoly in the Making of Universal Telephone Service, 1894-1920." PhD Dissertation, U. of Pennsylvania. 1989.See, e.g., C. S. Fischer, America Catling A Social History of the Telephone to 1940 (U. of California Press, Berkeley.1992) p. 3.

10. For example, a recent World Bank discussion paper on India found, "many rural consumers can pay relatively largesums for telecommunications connections, and the need for subsidizing them is not likely warranted. The Governmentpolicy of dispersing industry has had the effect of relocating substantial industrial firns in rural areas, and connecdonsrather than subsidies are what they require. Many such firms are willing to finance communicadon networks eitherby themselves or through cooperative ventures. A regulatory framework that prevents such investmene is the principlebarrier to the growth of such communicadons networks." H. Lantzke, A. Mody, R. Bruce, "TelecommunicationsReform in India: An Intemational Perspective," Informal Discussion Paper, January 27, 1992, p. 30. See also A.Dymond and B. Mrazek, "Making Rural Telecommunications Profitable-Balancing Financial And EconomicObjectives," Intelecom Research & Consultancy Ltd., Vancouver, B.C. (1993) summarizng field experience and casestudies regarding rural telecommunications investment in Pakistan, with additional information on Botswana, Bolivia,Zimbabwe and Mozambique.

I1. Mobile telephony traditionally has used a small group of dedicated frequencies, with limited channel capacity.However, by dividing service areas into discrete radio "cells" and installing transmission and switching equipmentwhich reuses a frequency as a user travels from cell-to-cell, cellul2r- telephony may increase the capacity of a givenfrequency block more than tenfold.

Cellular telephone systems must be interconnected with the public switched telephone network to provide universalconnectivity-otherwisecalls may only be made to cellularsubscribers. Provided interconnectionexists. the economiesof scale for a cellular system are modest. It is therfore possible for a country to subdivide its terriory into severalfianchise areas (by region or by city) and to license two (or more) competing networks in each franchise area. Inmany countries, one license has been granted to the existing wireline carrier and the other to an independentcompany.

12. See "Long Distance Phone Companies Gird For Wireless War." Wa Steet JournAl August S, 1992. In 1992 theU.S. also inaugurated what is reportedly the first 'wireless" city. On December 2. Quitaque, Texas, a ruralcommunity northeast of Lubbock with approximnately 500 residents, began using a customized digital cellular radionetwork bui; by lnter-Digital Communications Corporation. Quitaque's 300-plus tdephone subscribers are first linked(by wire, to a local cluster box, handling 24 lines. Next to each cluster box is a pole-mounted antenna which sendsand receives radio signals (at 454 MHz). via a substadon, to a remote switching station. The switching station alsoserves as the link between a Quitaque subscriber and the U.S. public switched telephone network. The Inter-DigitalSystem can serve subscribers within a 40 mile radius of Quitaque merely by adding new cluster boxes. "WirelessCity," Discover, May 1993, p. 21.

13. "The turning of telecoms." The Economist, November 14, 1992, p. 16. It bears noting, however, that existinganalogue cellular systems have significant capacity limitations, given the limited spectrun allocated to them.

14. In 1990, one leading operator estimated the infrastrucure co"ts for an analogue celhluar system in an urban area at$1,200 per subscriber and ceDular phones at about $900 per unit. By 1995, digital cellular systems are expected tocost about $600 per subscriber and subscriber units $500 or less. See R. Maule, "Ile Role of Radio Bypass of

39

Telecommuicationrs Sector Reform in Asia: Toward A New Pragmatism

Landline In Develop:ng Countries." Pacific Telecommunication Council 13th Annual Conference, Honolulu, January13-16. 1991, Proceedings, pp. 169-171.

15. In 1991 the base of mobile phones as a percentage of main lines in Thailand (14%) and the Philippines (5%) wasalready greater than the percentage in more industrialized countries such as Australia, Japan and Korea. And, atcurrent rates of growth, technology and spectrum permitting, the ITU estimates that mobile phones are likely tooutnumber fixed link telephones by 1997 in Thailand and 1995 in the Philippines. For comparative statistics on mobileservice in Asia-Pacific countries, see Appendix A. Tabic A.2. See also Asia-Pacific Teleconmmwicadons Indicators.,(ITU, Geneva 1993) Figure H and Table 20.

16. Increasingly, the strategic core of the network is not located in hardware (trunk transmission facilities, local exchanges)but in the software (service control points) necessary to manage, control and communicate with the various componentsof the network. See, e.g., R. Bruce and L. Kneifel, "Regulating The Environment For The Developmnent Of FutureLocal Network Architectures: Key Elements Of A National Infrastructure Policy In The United States." InternationalInstitute of Conmunications Telecommunications Forum, Washington, D.C., 25-26 January 1993.

17. The provisi on of local telephone service by two or more companies in the samne area is often thought to be fraught withproblems. In fact, however, such competition has been introduced relatively smoothly, even where the competingcrriers both use many of the same wireline facilities. (Competition between cellular radio carriers in the same areais now the rule in numerous countries including tie United States, the U.K., Japan, Australia, Gennany. Pakistan,and Sri lAnka.)

Local exchange service consists of three main types of faciities: local loops between subscriberpremises and the localexchange, local exchange switches and trunks between local exchanges. A competitive carrier typically chooses onlyto constructnew local swichesand some interexchangetrunks. In businessareas. however.a local carrier may chooseto build its own local area network to connect its principal customers to its own switches. Similarly, where acompetitor is also wiring a neighborhood for other services (cable TV) it may run drop wires to each house.

From an cnginecring standpoint, xperince in the U.K. and the U.S. has shown that this kind of local competitionis feasble if there is adequate regulatory oversighL In particular, competitors generaly must be provided adequateaccess to common rights of way and the opportunities to "co-locate" their own switches with those of the domiantoperao.

Local competition may also force regulators to more carefidly define the boundaries of local franchise areas. Forexample, in the United States. AT&rs divestiture of the local BeD Operating Companies (BOCs) required thegovernment to draw the boumdaries for more than 400 local access and transport areas (LATAs) that define thetrritory within which the BOCs may provide service. Imer-LATA service is defined as long distance service fromwhich the BOCs are barred. These boundary line issues may be avoided, of course, if competing carriers can providelcal and long distance service.

18. See also 'People's Republic of China Telecomnmunication Sector Study: Survey, Assessment and StrategyRecommendation.' Report No. 9413-CHA, World Bank, Washington, D.C. February 14, 1992, pp. 29-34. As of198R, TVEs accounted for approximately 29% of the installed capacity of lines in rural areas of China. China'swillingness to encourage TVE's to establish their own telecom facilities and thus to compete for development capitalseems to be reflected in other enterprise reforms. For background on China's reforms, see P. Harold. WChina'sReform Experience to Date," Discussion Paper No. 180, World Bank. Washington, D.C. 1992.

19. Independent regional and local fianchises have been a fixture of the Funish and U.S. telecommunications industry forover 100 years. Since 1992, the U.K. has also followed suit. Among richer countries, the U.K. and the U.S. alsohave taken the lead in encouraging local exchange competition among wireline carriers; several otber counries havebegun to foster international competition between cellular radio and fixed telephony.

20. This conclusion apparendy also is true for wireless services: There is a close relationship between market structureand market growth for mobile communications. The evidence from the Asia-Pacific region appears to indicate thatcounlies which have adopted competition from the sta;t of the service (e.g.. Thailand, Hong Kong) have ared better

40

I1I. Diversifying Supply: The Scopefor Competition

than those which adopted competition at a later stage of market development (e.g., New Zealand, Australia). Thereare, however, some exceptons to this: Singapore, ror instance, has achieved a rmladvely high level of penetrationunder monopoly conditions." Asia-Pacific Telcommwuncations Indicators Op. cit., D. xix.

21. In February 1993 the Malaysian Minister of Energy, Telecommunication, and Posts announced that the governmentwould license a second f&cililies-based telecommunications carrier to compete with Telekom Malaysia. Forbackground, see S. Mohammed. 'Regulatory Round Up: Asia-Regulation and Telecommunication Investment-Malaysian Experience.' ITU Telecom '93, Regulatory Symposium. 7-23 May 1993, Singapore.

22. A more detailed rebuttal of the arguments against network competition in LICs is presented in T.H. Chowdary,"Telecommunications restucturing in developing countries." Telecommunications Policy Sept./Oct. 1992, pp. 591-602.

23. See Competition in die Provision of Public Long Distance Voice Tekphone Services and Related Resak and SharingIssues, CRTC Telecom Decision 92-12, June 12, 1992.

24. See, e.g., the references at note 8 above.

25. On the other hand, in many LICs low call completion rates for international services are primarily due to poorlydesigned or congested domestic switching and transmission facilities rather than underprovisioned internationalcapacity. In such cases, adding a second or third international carrier may not improve service unless conmetingcarriers also can address domestic bottlenecks (e.g.. by building an interconnecting urban overlay network, as is thecase with some new joint ventures in Russia).

26. Most Third-World countries have substantially more incoming than outgoing international traffic (Appendix A,Figure 4). This leads to a net revenue surplus (i.e., the local company is paid mnore for completing calls at home thanit must pay out to foreign comnpanies for completing calls overseas). This surplus, ofte paid in U.S. dollars. iscurrendy one of the principle profit centers for telecom operators in LCs, frequently accounting for 30% or more oftotal revenues.

Thesevaluable foreign exchangeearnings are generally used to meetthe telecom operator'sannual expenses; a portionis also handed over to the government. This may be costing devcloping countries dearly. The reason is that the netearnings from international telecom traffic might generate three or four times the level of foreign exchange for telecomdevelopment if they were properly leveraged in connection with a bank loan.

For example, assume that a state-owned operator in Country A wishes to borrow $300 million for a major networkexpansion project. Assume also tat a multilateral organization, such as the World Bank, agrees to support the projectand providc 30% of the finance with 50% to be syndicated by commercial banks and 20% (or $60 million) to be putup by ihe borrower as an 'equity' stake. How will Country A find the money? One option might be to pledge aportion of the operator's international settlement revenues. Thus, a $20 million settlement stream might be enoughto secure a $60 million equity stake in a fmancing worth up to $300 million.

As yet, this financing approach has not been fully tested. It has been proposed in Guatemala. And, in Mexico, arelated fiancing scheme has been used by TELMEX, the Mexican phone company, to presell over $600 million inlong-distance revenues to raise much-needed foreign exchange. The potential for leveraging a poor or middle-incomecountry's international revenue stream may even be greater.

27. See generally G. Staple. "hernadonal Telecommunications Ls Shifting Paradigm: How Will It Affect Your Business? 'Pacific Telecommunications Council 15th Annual Conference, Honolulu, January 17-20, 1993, Proceedings. Vol. H.pp. 591-592.

28. For a comparative review of the market shares and traffic base of international carriers in Asia and other regions, seeG. Staple. ed., TeleGeography 1992 (International Institute of Communications, London, 1992). p. 71.

41

Telecommunications Sector Reforn in Asia: Toward A New Pragmatism

29. A regional divestiture of long distance companies need not lead to competition for international service. A case in pointis Argentina where the international carrier, Telintar, is owned jointly by the two privatized companies created in 1990from the former government carrier.

30. Service competition is not a substitute for facilities-based competition. One reason is that even if resale is unrestricted,subscribers' welfare will be affected by the existing supplier's choice of network technology and its geographicaldistribution. Facilities competition tends to optimize the timely configuration of the network and hence networkservices. Thus, both facilities and services competition are desirable, especially in LICs where capacity shortages andunderinvestment in the network mav deter effective resale competition.

31. Beyond that, "smart terminals may permit companies to convert a basic traffic stream to an enhanced (value add4d)one by adding a store and forward feature. Likewise, modern digital switches and network software may enable thenetwork of a monopoly carrier to be "virtally" partitioned so as to accommodate competitors which might otherwisebe required to construct their own facilities.

32. This definition is codified at Section 64.702 of the U.S. Federal Communications Commission rules. 47 CFR § 64.702(1992).

33. Even so, lengthy testing and high 'type-approval' fees may well be used to discourage competitive suppliers. Theseand other concerns led New Zealand not to adopt any standards approval process when the telecommunicationsterminal market was opened to competiton.

34. Because basic teleconmnunication technologies, unlike agricultural techniques, for example, can be readiy implementedin quite different geographical areas, LUCs are probably best off adopting international or regional equipment standards.Insisting on a separate set of national standards is only likely to increase the cost of domestic equipment and limit thechoice available to users with nimited offsetting benefits. For these and other reasons, the Asia-Pacific TeleCommunity(APT) has recommended that countries in the region seek to pool their resources to promote carrier standards. Theadoption of regional (or global) standards may also deter dominant suppliers in the market (e.g., an existing foreign-owned switch rnanufacturer) from using proprietary standards to block new entrants as the market expands.

42

IV. INCREASING PRIVATE-SECTOR PARTICIPATION

Privatization is a complement to, and not a replacementfor, the other aspects of privatesector] development... .In many instancesprivatizaton wil be less important to the growthof the private sector than the emergence of new private business. Measures to supportfree entry by private operators wil also be crucial....

Privatization: The Lessons of Expericnce1

4.01 Increasing the private sector's role in providing telecommunications services is already aprominent element of many telecommunications sector reform programs in Asia. Often privateinvestment is sought because the resources necessary to meet telecommunications performance targets farexceed available government funds. This is especially true in some of the most populous countries(Indonesia and Thailand) where unmet demand for telecommunications is very large and growing.

4.02 It is also widely believed that a privately owned telecommunications operator will be moreefficient than a government carrier and will attract greater investment (Box 8). But this is not always thecase: the discussion in the Working Papers of the telecommunications sector in the Philippines details theunsatisfactory performance of its mainly privately owned sector; see also Box 9 on special interests).

4.03 Divestiture is only one of several options for increasing private-sector investment intelecomnunications. In this report, the terms divestite and privatization refer to measures resultingin the transfer from the public to the private sector of ownership over facilities or services.2 Increasedprivate provision of telecommunications services may be achieved in other ways, such as licensing newcarriers for underserved areas or for alternative networks (e.g., digital overlay facilities, teleports, cellularradio). Build-transfer (B-T) schemes may also offer substantial scope for private investment with orwithout divestiture.3

4.04 There are other avenues short of divestiture for reducing the govermnent's role intelecommunications. For example, a state-owned carrier may hire private-sector contractors forconstruction, maintenance, transportation, routine engineering, and billing services. Private expertise maybe brought in by using equipment suppliers to provide training and technical assistance; by employing'shadow managers" from foreign telecommunications companies; and by granting management contractsto outside companies for specific lines of business.4

4.05 Increasing private-sector participation is better seen as a process than an event. It includes arange of options and reflects a new public philosophy: the state's overriding obligation is to assure thatthe public receives the services it requires rather than to provide those services itself.'

4.06 The remainder of this chapter has two parts, the first dealing with "top-down" privatization ordivestitre, and the second with alternative means of increasing private investment, typically involvingthe granting of new licenses. The report characterizes these approaches as "bottom-up" measures becausethey usually involve private capital in building new telecommunications facilities from scratch, eventhough the facilities put in place may serve the same function as those of the incumbent ("top") carrier.Asia's poorer countries will need to be familiar with both approaches. Divestiture alone is unlikely toremedy the telecommunications gap-the existing base of telephone lines is simply too small.'

43

Tdecommuncaicons Sector Reform in Asia: Toward A New Pragmatism

Box 8The Welfare Consequences of Selling Public Enterprises:

World Bank Research

Much of the divestiture debate has been intu- 4. Finally, divestiture often led to diversificationitive, theoretical, even ideological. Privatization's of output into activities where there wereeffect on welfare has not been rigorously ana- economies of scope.lyzed. New World Bank research' on the welfateconsequences of privatization of 12 firms in Chi- Who Were Winners and Losers?le, Malaysia, Mexico, and U.K. providessystematic and quantifiable evidence of the 1. Foreigners vs. Nedonals: Where foreignerseffects of privatization on efficiency of the enter- were involved, they did well for themselves,prise, on subsequent investment, and on but they also contributed to national welfare.consumer welfare. The cases cover telecom- Only in one telecommunications case did theymunication 13 firms), airlines (4 firms), electricity do so well that domrestic actors were worse(2 firms), a lottery company, a port, and a trans- off.port company. The methodologV captures theimpact of divestiture on all important economic 2. Consumers vs. Buyers: Consumers of tele.actors (government, consumers, buyers, communications services in the U.K. and Chileworkers, and competitors), and addresses the benefitted substantially from divestiture. In allcounterfactual question: what would have but three of the remaining cases, consumershappened in the absence of divestiture? were either left unaffected-thanks to

cornpetition-or were only modestly worseWhat Are the Mdin Findings? Off.

In 11 of the 12 cases analyzed, divestiture 3. Government vs. Buyers: Buyers, includingimproved world (national plus intemational) wel- many small shareholders in the U.K. andfare; the exception was one of the airlines. It pension funds in Chile, came out ahead inalso improved domestic welfare in 10 cases; the every case except one. Govemments lost inadditional exception was one telecommuni- four cases, but only by small amounts.cations transaction. The welfare gains weresubstantial. In more than half the cases, the 4. Workers: Contrary to conventional wisdom,perpetual annual benefits to society in relation to in no cese in the sample did divestiture makepredivestiture annual sales average 10 percent. workers as a whole worse off, even taking

into account all layoffs or forced retirements.Fron Where Did the Changes Come? In three cases, workers made substantihl

gains (the U.K.'s National Freight, Mexico's1. The mostsignificant change brought about by TELMEX and Chile's electricity distribution,

divestiture was a dramatc increase in invest- ENERSIS).ment. A striking example is Chile, where alocal telecommunications company doubled 5. Competicrs: Given the prevalence of nearits capacity in the 5 years after divestiture. monopolies in the sample, divestiture had no

significant effect on competitors. The two2. Seven of the 12 firms improved productivity exceptions were in Chile and Malaysia. In the

through better labor-management relations former, expansion of the divested CTC, theand performance-based compensation. local carrier, benefitted ENTEL, the long-dis-

tance carrier. But in Malaysia, the divested3. Output prices did not change in half the lottery company (Sports Toto) gained at the

cases, and where prices did change they expense of its competitors by acquiring aoverwhelmingly enhaned welfare by moving greater market share.toward levels that more closely reflect scarci-ty values.

A. Galal et al., "Welfare Consequences of Selling Public Enterprises-Case Studies From Chile,Malaysia, Mexico and the U.K." 4 Vols., The World Bank, Washington, D.C. 1992.

Source: Adapted from Priwvatzabn: The Lessons of Exrpexince. Country Economics Department, The WorldBank, Washington, D.C., April 1992.

44

IV. Increasing Private-Sector Participation

A. Privatization of the Dominant Carrier

Setting Objectives

4.07 There are several possible-and often conflicting-objectives for transferring ownership of a state-owned telecommunications carrier to private hands. Deciding which objectives should take precedenceis essential to a successful divestiture.

4.08 A prime goal of divestiture is to improve the efficiency of a poorly run business by injecting newcapital and management. With rare exception (Working Paper E on Singapore), state-owned telephoneoperators in Asia have been marked by poor service, low call-completion rates, underutilized switchingcapacity, a large backlog of applications for new lines, an inefficient and/or corrupt staff, inadequateinvestment funds, and a pricing structure that is distorted by political considerations to favor certain usergroups, equipment manufacturers, or regions. Private ownership is no guarantee, of course, that suchproblems will be entirely eliminated (Box 9). But divestiture is an important means of creating a moreefficient telecommunications operator over the longer run.

4.09 Divestiture may also be motivated by fiscal reasons: to help solve a budgetary shortfall or toreduce public-sector debt and future borrowing. Further, privatizing the government carrier may be seenas a vehicle for building up the local stock market and for sharing the state's wealth ("popularcapitalism"), and hence as a first step to privatizing other state-owned enterprises.

4.10 These objectives often work against one another. A government which primarily wishes tomaximize the sale price for a carrier may have less interest in the control of service prices followingdivestiture. Similarly, a country's national and telecommunications sector development goals may conflictin some respects with the interests of any particular player in the game- the operator, potentialcompetitors, potential buyers, investment bankers seeking to sell the state's assets, consultants seekingadvisory business, and equipment suppliers.

4.11 Furthermore, the govermnent itself has conflicting interests. For instance, the interest of thefinance ministry in maximizing revenue from a telephone company sale (which requires maximizing thetelephone company's monopoly power) may conflict with the national interest in reducing costs andincreasing choice for customers, because achieving those goals requires some degree of competition. Forthese and other reasons, it is crucially important that a country set its divestiture priorities at the outset.7

4.12 The first questions to be answered are, how does divestiture fit into the government's goals forthe telecommunications sector, and how do those goals relate to the government's overall economic,social, and political programs? The answers to these questions should set the parameters for anydivestiture program because divestiture is not an end in itself. The international evidence suggests thatdivestiture alone is unlikely to maximize gains in econormic efficiency if it is not accompanied by marketliberalization. It is competition and the regulatory institutions, broadly defined, and not ownership alonethat is often of decisive importances (Chapter VI).

4.13 Second, a government must weigh the concerns of the different players involved in the divestitureprocess and set clear policy guidelines. This may be difficult, but there is no short-cut. Unless thegovernment has a clear strategy before it start the divestiture process, it can easily lose control. Duringthe divestiture process a government may need to modify its position. That should be done, so long asthe overriding goals for the sector can be preserved.

45

Teecommunications Sector Refonn in Asia: Toward A New Pragmatism

Box 9

Private Ownership and Special Interests

Whenever poll icians rather than markets control economic access-from import lcenses to planningpermission for buildings, to the award of govemment contracts-there you will find the specilinterests, fryingtogercontrolof thisnonmarketpower. - Rupert Pennant-Rea, Editor, TheEconomist*

State-owned telecommunications operators in developing countries are frequently alleged to sufferfrom corrupt procurement and service practices. But profiteering by vested interests (i.e., cronies ofthe government or the dominant shareholders) through schemes for contract rebates or 'fraudulent'dealing with affiliated companies have also been reported by several private telephone companies inSouth America as well as in Asia.

The potential for achieving monopoly profits, coupled with close government control in most countries,makes telecommunications a natural target for cronyism. There are several tactics that the well-connected may pursue.

First, where new franchises are to be granted or carriers to be divested, special interests may seekto broker the drrangement through a domestic affiliate or a joint venture. Second, govemment croniesmay seek to obtain side commitments regarding procurement by the privatized company or to secureoptions on real property which the company will need following divestiture. Third, special interestsmay seek to co-opt the privatization process by ensuring that they have a veto over key personnel.

The poor performance of a major privately owned operator in the Philippines, in terms of meetingdemand for services, seems to be due in part to the conduct of special interests. For example, thereis evidence that one of the recent controlling interests in the operator was able, through varioustransactions, effectively to transfer very significant revenues from the operator to other accountsbenefittng those interests. This could be done by (a) obtaining commissions on equipment procuredby nonlinked companies; (b) acquiring land, supplies, or services from companies linked to theoperator's controlling interest or senior management; or (c) negotiating favorable interconnection andrevenue settlement arrangements with other carriers in which the major operator's controlling interestalso has an interest.

The effect of such practices is to provide a very high premium to the controlling interest in a privatelyowned company to maintain control. Thus, even though an expansion of service may otherwise beprofitable, new investment might not be undertaken because it would require diluting the equity stakeof the controlling group. As a result, where "cronyism' is rampant, a privately owned monopoly mayinvest less than one would expect of a profit maximizing company.

Any privatization program that does not take account of the potential for profiteering by specialinterests may not deliver the economic benefits its supporters have promised.

* 'An Editor's Farewell," The Economist, March 27, 1993, p. 18.

Managing the Divesfitre

4.14 Once the objectives for divesfiture have been set, a more detailed plan must be drawn up. Again,there is no 'best practice" on what to include. Divestiture may involve the sale, total or partial, of thestate's ownership in the dominant telecommunications operator through a series of public share offerings(U.K., Japan, Malaysia).9 Alternatively, a strategic stake in the operator may be sold by competitivetender to a prequalified group of bidders (as in Mexico, New Zealand, and Australia), following wbichthe bidder or the govermment may sell additional shares in the company.

46

IV. Increasing Privaxc-Saor Panidpaion

4.15 There is now a large body of international experience available to any country contemplating theseoptions.'" See also the discussion of divestiture in the appendixes regarding Mexico, New Zealand,Singapore, and Sri Lanka. It is beyond the scope of the report to review these experiences in depth, butprocedural and substantive matters have arisen which require some discussion.

Procedural Matters

4.16 First, there is considerable agreemnent that once the government has set its objectives fordivestiture and agreed on a program, clear lines of authority nust be established for implementing it.Further, the process should be as transparent as possible so that all the main actors know who isresponsible for maning the key decisions and the provisional time line for doing so.

4.17 One investment banker involved in several privatizations put it this way:

An evenhanded, orderly process is absolutely essential to gain the confidence of potentialinvestors. Particularly in the telecom field, oppeators will be hesitant to pay top dollaror devote their scarce human resources to a country where they cannot have confidencein the practicality of the business system. They will reason that if the government doesnot manage a sale well, then it is unlikely to provide a healthy regulatory enviromnentover the medium or long term."

4.18 Second, sufficient time must be provided to prepare the carrier for sale. This process will usuallyrequire at least one to two years, and often longer (see Figure 2). The presale process is likely to be ateam effort. It will have technical, managerial, accounting, fmancial, legal, and employment components,and it may also involve an interim period of restructuring or corporatization. See Figure 3 for some ofthe key tasks likely to be involved.

4.19 Third, the government must secure the legal conditions for the sale. This generally involvesadoption of a legislative reform package. A crucial part of this package is the creation of a regulatoryagency independent of the incumbent operator to oversee the sale after divestiture (see Chapter V). Thescope of the necessary legislation will vary from country to country, but a firm legal basis is aprerequisite for an effective share sale.'2 See Box 10 for an outline of a sector reform bill; see also Box15 in Chapter V for model licensing provisions.

Substantive Matters

4.20 There are three core issues any country must address in implementing a divestiture:

a. The permissible pricing stucture after divestiture for various services, including local, long-distance, and value-added services, and the mechanisms for authorizing dhanges therein;

47

Telecomnunicadions Sector RJonrm in Asia: Toward A New Pragmaism

Figure 2

How Long Does It Take to Divest aState-Owned Telecommunications Operator?

Argentina DD-P1 ~~p22 1p2

Mexico DD - -p29 p2

Japan C p1 2 op

Malaysia DD-C pi

PaWistan C DD PI (est)

New Zealand DD Ci p2 est)

Singapore DD CPl (est.)

I I I I I1985 86 87 88 89 90 91 92 93 94 95

Key: DD - government decision to divestC - corporatizationp1 - privatization (first share sale)p2 - privatization (further share sale or reofferng by initial buyers)

48

Preparlng For Divestiture:Allocating The Work

INT'L INT'L iNT'L BUS/ INT'LLOCAL MINISTRY AUDIT LOCAL LAW TECH. CON- INVESTMENT

ACTIVITY CONSULTANTCY OF P&T CARRIER FIRM LAW FIRM FIRM SULTING FiRM BANKING FIRM

Physical Plant Assessment P L

Receivables Assessment P L

Supplier Payables Assessment P L P

Independent review of latest auditors report _ __P L p =

Changing legal status of carrier/staff L L P P P P P

Separatlon of regulatory functions L L P P P

Determination of shares to be offered L = r

Valuation of carrier p p L P

Descriptive material on carrier P L P

Preparation of Invitation to Bid ___ L

Information briefing for potential bidders P P - L

Evaluation of bids, selection L P _ = P

Negotiation with selected bidders L P P p

Selection ot winner(s) L p P p

Drafting negotiation of license (concession) L P P P P p

Negotiation/finalizatlon of documents L P =__ _ __

L: Lead Organization P: Participating Organization

Source: Adapted from Booz, Allen & Hamilton 1992

3C

col

Tdecommucations Sector Reform in Asia: Toward A New Pragmwism

Box 10Restructuring The Telecommunications Sector:

The Legislative Elements

Legislation ordinarily is a prerequisite for transferring the telecommunications operations of a ministryto a corporation, whether privately owned or not. The new law usually authorizes the transfer of theassets of the state-owned operator to a designated corporation, creates a regulatory body to overseethe new corporation, fixes the basic competition rules for the telecommunications sector, and statesthe powers and responsibilities ot the regulator vis-a-vis the ministry, other govemment bodies, andthe judiciary.

The extent of the operator's franchise and its obligations (e.g., regarding service and pricing) aretypically spelled out in the license or concession {Box 15) or the company's articles of incorporation,rather than in the basic law. Administrative rules adopted by the new regulator may also be important.

The following outline describes, in abbreviated form, the content of selected telecommunicationsprivatization laws:*

"National Telecommunications Act of 19--"

Article 1 - Purposes of ActArticle 2 - Definitions (e.g., telecommunications, public networks, private networks)Article 3 - Creation of independent regulatory commissionArticle 4 - Powers & duties of commission (re licensing, tariff review, equipment

approval, frequency management, right to gather information)Article 5 - Appointment of commissioners, management and staff compensationArticle 6 - Funding of commission (e.g., by license fees)Article 7 - All telecommunications services to be licensed; Types of licenses;

exemptionsArticle B - Application for licenses; processing; public notice and commentArtide 9 - Ucense terms and conditionsArticle 10 - Modification of licenses; assignment; suspension; revocation and renewalArticle 11 - Transfer of rights and liabilities of government operator to new company;

share issuesArticle 12 - License to be granted new company; price controlArticle 13 - Transfer of employees to new company; condition of service; pensionsArticle 14 - Right of licensees to use public way-leaves; access to private propertyArticle 15 - International agreements; non-discrimination; overriding national secUrity

interestsArticle 16 - Enforcement of act; violations; criminal and civil penaltiesArticle 17 - Jurisdiction of courtsArticle 18 - Repeals and amendments of existing laws; other transitional provisions

Ths outlhe draws on the Telecommunications Authority of Singapore Act 1992Z the Sri Lanka Tlecommunicatons Act of1991. the Telecermmunicatkons Bill 1992 (Australial, and the draft Telecommunications BMl 1992 for Pakistan prepared byLatham & Watkins, Washington, D.C. Singapore, Sri Lanka. Australia, and Pakistan a* have a common law tradition; thelgislaftve ealments of a sector restructuring program may differ sonewhat in civ; lw countries.

50

IV. Increasing Pivate-Sector Paridp ation

b. Quantitative performance requirements after divestiture, which are particularly applicablewhere telephone penetration is very limited; and

c. Qualitative performance requirements, which are often crucial to winning consumer supportand ensuring adequate investment in maintenance and new technology.

4.21 These three factors-price regulation, network expansion targets, and quality of service goals-allinteract, often unpredictably. For example, too stringent quality goals (e.g., call completion rates) maycompromise network expansion targets because, other things being equal, the larger the network, themore it may cost per linf. to maintain a given service quality. Likewise, although a cost-based tariffpolicy is generally an important reform objective, the revenue consequences must be taken into account.And, of course, the pricing regime which is effective after divestiture will have a decisive effect on thesale p.ice of the carrier and the qualitative and quantitative commitments any bidder will be likely toaccept.'3

4.22 In most cases, striking the proper balance between tariff structure, quantity, and quality provisionsneed not undermine any of the govermnent's n,ain objectives in the divestiture process. On the contray,it is only by going through this process that the government is likely to develop an equitable and efficientframework for divestiture that will improve telecommunications service while enhancing the success ofthe share sale. Finally, regardless of the issue, flexibility is essential. Divestiture is inevitably a complexprocess, and openmindedness is an important asset. Overspecific legislation and unrealistic promises-toemployees or customers-are likely only to impair the overall result or lead to disappointments.'4

B. "Bottom-Up" Options for Private Investment

4.23 Because most low- and middle-income countries in Asia have less than two lines per hundredpeople, divestiture of the stae-owned carrier will, at most, only partially solve the shortfall of supply.The demand is simply too great and the current base of telephone lines too small.

4.24 New entry and other "bottom-up" measures for private-sector participation are likely to becomeincreasingly important in Asia's LICs, and they may become the prevalent means of closing the gapbetween demand and supply. They may take several forms: competitive franchises granted to independenttelephone companies in designated areas; refrancising of unserved or underserved areas of the country;capital provided by public companies (including nunicipalities) or the private sector through a build-transfer (B-T) scheme, or a joint venture. The service provider may be a stand-alone company or asubcontractor for an existing licensee; the scope of service may be limited to local exchange services ormay extend to interexchange offerings.

4.25 The form and geographical coverage "bottom-up" schemes take will necessarily vary from countryto country. In some countries, an expanded role for private networks-now serving railroad, power, orport authorities-may be the center of the policy."5 In other states, the precedents for the "bottom-up"or modular approaches to solving the supply-side problem are just beginning to emerge. At root,however, the new interest in modular expansion of the network reflects the view that where the demandfor basic telephone service is not being met and the existing supplier is unresponsive, the economic costto users and the national economy from continuing the status quo is much greater than any loss ofeconomies of scale and scope from franchising new service providers.

51

Telecomunmications Sector Reform In Asia: Toward A New Pragmatism

4.26 "Bottom-up" private development, like divestiture, will not be effective, however, if it is notsupported by appropriate regulatory and institutional commitments. Among other things, where multipleoperators are to be licensed in a country, a clear policy decision must be made at the outset regardinginterconnection terms and pricing. Similarly, there must be a means of resolving interconnection disputesbetween operators, although in practice full interconnection will not always be necessary. Some usersmay be satisfied with self-contained networks similar to those that link branches of a private business,but the goverment (or the courts) must be willing to address matters of interconnection where the needarises.

Local and Regional Franchises

4.27 Several Asian countries have begun to explore the scope for local and regional telephoneconpanies, although as yet with limited private-sector involvement. The largest program, both in itsgeographic reach and the number of customers served, is in China. Since the 1980s, China's localexchange capacity has been built up simultaneously by posts and telecommunications administrations andtownship and village enterprises (TVEs). While provincial P&Ts are entitled to install facilitiesthroughout a province, in smaller communities where waiting lists are long and service is limited, theMinistry of Posts and Telecomnunications (MPT) has permitted TVEs to install their own local exchangefacilities and interconnect them on standard terms with the public switched telephone network (PSTN).In some provinces, the TVEs now account for 3040 percent of the total number of exchange lines, andthis base is growing as fast as that of the provincial telephone company. Box 11 provides a discussionof alternative approaches to issuing telemunications franchises.

4.28 A form of local franchising also exists in the Philippines. There are currently about 900,000telephone lines in the PhFilippines, of which 85 percent are installed in Metro Manila. Since 1989,however, the Municipal Telephone Act has given qualified private operators the option to provide publiccalling offices (PCOs) in over half of the 1,050 communities lacking service. Thus far, the government-owned Municipal Telephone Project Office (MTPO) is responsible for serving the remainingmunicipalities. In 1992, a joint private sector-govermnent commission recommended that the scope ofPCO services be expanded and that financial incentives be provided to operators; the commission alsorecommended that the government impose fines on long-distance companies which deliberately delay orrefuse interconnection."6

4.29 India also has experimented with local fanchises. Since 1986, telephone service in two of India'slargest cities, New Delhi and Bombay, has been provided by a state-owned company, NMaaharTelephone Nigam Ltd. (MTNL). MTNL has autonomy in the day-to-day operation of telephone service,but must clear investment decisions with the Indian Department of Telecommunications (DOT). Arevenue-sharing systemi between MTNL and DOT is negotiated annually. In December 1991, the IndianMinistry of Communications found that MTNL had significantly improved billing service and more thandombled call completion rates from 1986 to 1990. MTNL's success has prompted the governmeut toconsider granting independent telephone franchises to other cities and regions in which private (domesticand foreign) companies could invest.'7

4.30 India's DOT has also granted competing cellular radio licenses by metropolitan areas. InNovember 1992, licenses were awarded, following a competitive tender, to several private companies forservice in Bombay, New Delhi, and Calcutta. Each of the joint ventures that won the license had foreipginvestors.19

52

IV. IncreJing Privte-Sector PFcr1pation

Box 11Altemrati Approaches to lssuing TelecommunicatIons Franchise

Frnchise. Franchises or ilcences for the provislon of public telecommunications services, whatherconventional local or long-distance, or cellular telephone service, can be issued In different ways,principally by (i) direct assignment, (ii) lottery, or (iii) competitive bidding. In each case, thegovernment should establish the relevant ground rules for service provision and screen applicants withrespect to various technical, economic and financial criteria. Given the impact that well-qualified andwell-financed operators can have on the overall performance of the teolecommunications sector, as wellas the very high value that these franchises may have, the selection process is important.

Direct Assignment. Direct assignment of franchisee is a common approach. However, from a publicpolicy point of view it has the clear disadvantage of not providing for the systematic review ofsitemative applicants and proposals. As a result, key opportunities for optimizing sector performanceor franchise revenues to the government msy be missed. In the worst cases, one may see exclusivefranchises assigned to firms that are substantially unable to provide anything close to an adequatelevel of service. A related concern is that the direct assignment of public telecommunicationsfranchises is likely to go to the politically well-connected and may provide the basis for allegations ofcorruption that can undermine the legitmacy of the franchises. The associated risk, as poticalfortunes change, of a franchise's being revoked may discourage th huge long-term investntsneeded in the telecommunications sectors of most low- and middle-income countris in Asia.

Lottery. The best known use of a lottery appmach was for the allocation of radio frequencies for theprovision of ceilular telephone service in the United States in the 1 980s. In that case, in each cellularfranchise area in the country, one ricence was issued to a local wireline carrier, and a second wasissued by lottery. The approach recognized that the regulator would not be able to make a meaningfuldistinction, based on merit, between marny applicants. On the other hand, many licenses were in factissued to companies that had neither the intention nor the capability to provide service, and werequickly sold. As a result, the scarcity value of the licenses went to the lottery winners.

Compeve Bid. The award of a franchise on the basis of cornpetitive bidding with respect to well-defined criteria will be the best approach in most circumstances. The selection criteria must ultimatelydepend on govemment objectives. Nevertheless, many economists favor franchise fee bidding byprequalified applicants. This approach involves the most transparent process and thereby giveslegitimacy to the franchise award. It will also tend to select the applicant that can create the mostvalue in providing the franchised service. Furthermore, since this approach involves paying thegovernment for the franchise, it not only may result in very substantial payments to the govemment,but also creates a strong incentive for the franchisor to invest quickly to provide service. Thisapproach was used, for example, in Greece in 1992 for the award of two GSM ceflular franchises for$164 million each. A poor relation of this kind of well-structured competitive bid is one where theselection criteria are not well defined. This "beauty contest' approach is typically applied in a waythat involves multiple unweighted evaluation criteria, with the result that the selection cannot becompleted in a transparent way. Like "Direct Assignment," it allows bureaucrats and ministers to pickwinners, a task they are unlikely to be good at. This approach favors companies and individuals thatare effective in influencing governments rather than those that are good at providing service.

Critics of the franchise fee bidding process have argued that it increases the cost of service. On theother hand, in the absence of these fees, the same or similar costs may well be incurred through thepurchase of licences from private arbitrageurs, or the cost savings may instead accrue to thefranchisee as excess profits. Furthermore, to the extent that expected bid prices are considered toohigh, goverrnents can consider issuing more licences to reduce the scarcity value of each franchise,thereby increasing competition in the provision of franchised services.

53

Telecommunications Sector Refonn in Asia: Toward A New Pragmatism

4.31 Although cellular radio is now viewed primarily as a "mobile" service, the cost of radio-basedtelephony is becoming increasingly competitive with land-line service. As mentioned in Chapter MII, theinvestment cost per subscriber (approximately $1,500 including the terminal) is now comparable to thatfor local exchange service, and the more limited economies of scale make multiple franchises moreattractive. As such, regulation permitting, in the mid-1990s India and certain southeast Asian countriescould become proving grounds for some of the first large-scale residential wireless telephone systems inthe world."9

4.32 Finally, it bears emphasis that a "bottom-up' privatization involving local or regional franchisesmay be financed in a variety of ways. In addition to the joint ventures and build-transfer schemesdiscussed below, a form of lease-back financing could be provided by third parties, thereby furtherincreasing the availability and scope for private investment. For example, where prospective operatorslack the capital to secure the necessary local exchange or transmission facilities, a financing companymight be encouraged to construct the necessary facilities and lease them to the service operator with thelease payments tied to the operator's local revenues.20

Build-Transfer S-T) Schemes

Definition

4.33 Build-transfer schemes vary greatly. They are usually specified as build-operate-transfer, inwhich the investors or B-T company maintain ownership of the project assets for a period of years, oras build-transfer-operate, in which ownership of project assets is transferred to a public administrationor sate-owned company immediately upon conmissioning, with the B-T company remaining in place tooperate and manage the new facilties for a period of years. In these schemes, the flow of revenues tothe B-T company (e.g., an agreed share of operating revenues generated by the project) is broadlycomparable to lease payments.

4.34 However, depending on the legal "fine print," the difference between a build-operate-transferscheme and a build-transfer-operate scheme may not be substantive. For example, if a B-T contract statesthat the investors' assets are transferred to the ownership of a government agency, but that the investorcomnpany is to be the sole beneficiary of and to retain control of the assets, the practical significance ofownership is severely diluted and the distinction between the two is blurred.

Characteristics

4.35 A B-T scheme in the telecommunications sector is likely to involve a contract with a state-ownedmonopolist. Although there are now only a limited number of telecommunications B-T schemes, theyalways specify, or imply, a de facto delegation of the incumbent monopolist's franchise to the newinvestors. This element of B-T schemes is a potential source of significant structural complicationsbecause, while the state-owned monopoly may view the B-T scheme as a business deal, it is creating acontractual commitment to a market structure, possibly without the provision of adequate policy analysisby the government.

4.36 Furthermore, as noted above, depending on the specification of a B-T contract, the investors maynot have the physical assets as collateral. The absence of coUateral may not have great practical

54

IV. Increasing Private-Sector Parddpation

significance (because much of the investment in cable networks, once made, is sunk), but it may increasethe perception of risk and thereby increase the cost of capital for the project. The real collateral forinvestors is the contract with the state-owned enterprise, which provides for the B-T company to receivea stream of payments, typically a share of project-related revenues.

Exmples

4.37 Examples of telecommunications B-T schemes can be found in Thailand and donesia. InThailand, two large schemes are at different stages. The first, an arrangement between the Teleph,neOrganization of Thailand (TOT), the dominant state-owned domestic telephone operator, and a Thaicompany, Telecom Asia (formerly CP Telecom), is for the provision of an additional two million linesin the Bangkok metropolitan area. Telecom Asia has signed a contract with the U.S. telephone companyNYNEX to help construct the new facilities. This very large scheme, which involves most new networkinvestment in Bangkok for several years, could lead to de facto privatization of TOT. Arrangements fora second large project to provide an additional one million telephone lines in provincial areas are alsoprogressing between TOT and a consortium, Thai Telephone & Telecommunications (see WorkingPaper D).

4.38 In Indonesia, B-T schemes in the telecommunications sector are known as revenue-sharingarrangements (RSAs). RSAs have been contracted between PT Telkom, the government-owned domestictelecommunications operator, and different investor groups for the provision of both local networks andcellular systems. The implementation of these local network schemes has not been completed. Theschemes are often broken into contract packages of 20,000 (or more) lines, with contracts so far for over500,000 lines.

Advantages

4.39 Where the state-owned monopolist cannot meet demands, and where privatization is believed notto be an easy or acceptable option, B-T schemes offer the potential of accelerated network expansion byan infusion of new capital and improved private-sector operating pr%Ltices. Thus a B-T scheme is apotential solution that avoids possibly difficult or unfeasible proposals to privatize the state-ownedenterprise, and the related requirement to introduce and pass new legislation. For the state-ownedenterprise, the B-T is a form of off-balance-sheet financing that may avoid govermnent controls on moreconventional methods of raising capital such as issuing bonds. For investors, the schemes offer apotential to invest in a sector where there is strong growth in demand, little or limited govermnentsupervision of the delegated nonopoly franchise, and the possibility of reducing costs compared to thoseof the state-owned operator.

Disadvantages

4.40 There are two levels of difficulties associated with B-T schemes for local telecommunicationsnetworks. First, substantial private investment and control in the sector is most likely to optinize sectorperformznce if it is introduced as part of a package of reforms that include competition and regulation.If a B-T scheme is implemented because the government cannot or will not implement a comnprehensivepackage of reforms, it may delegate monopoly power to the private sector without adequate provision for

55

Telecommwdnicaons Sector Reform in Asia: Toward A New Pragmatism

interconnection, regulation, or competition. In that case, any B-T scheme will likely be a second- orthird-best solution, with possibly serious long-term implications for the sector structure.

4.41 A second level of difficulty with telecommunications B-T schemes is the potential complexityassociated with coordinating the B-T operator's distribution networks with those of the state-ownedincumbent. Issues involving interconnection, sharing of ducts, maintenance procedures, and trade-offsbetween maintenance and new investment all must be resolved. These factors tend to increase risks forinvestors, make management coordination harder, and raise the questions for investors as to whether theywill have adequate control over the facilities they have invested in to achieve appropriate levels ofproductivity.

4.42 For these reasons, B-T schemes may be more suitable for separate facilities such as powergeneration plants, satellites, or submarine cables, or in local telecommunications networks, for modularnetwork extensions (e.g., for new industrial estates). Finally, partly because of the unconventional orunique aspects of B-T schemes, most projects appear to have been negotiated rather than bid underverifiable criteria. This makes it difficult to determine if the best proposals have been adopted or the besttenrs obtained for subscribers.

Other Facilites

4.43 "Bottom-up" privatization programs need not be limited to local exchange or cellular radiofacilities. Experience shows that private capital may be attracted to a large number of additional projectsranging from new paging franchises to private satellite earth stations, digital overlay networks, andinternational teleports (see Box 12).21 One or more such projects, often with foreign participation, arealready under way in most of Asia's LICs. The challenge will be to broaden these initiatives.

4.44 For example, Vietnam's communications system, operated by the govermnent's DirectorateGeneral of Posts and Telecommunications (DGPT), has been upgraded by two successive businesscooperation contracts (BCCs) with the Overseas Telecommunications Corporation International (OTCI)of Australia, now known as Telestra. The initial BCC provided for the addition of new earth-stationfacilities and gateway switches to upgrade DGPT's international network, financed by sharing inwardinternational settlement revenues. The follow-on contract involved the insallation of domestic facilitiesincluding trunk exchanges in Hanoi and Ho Chi Mih City. The OTCI earth stations increasedinternational phone traffic from Vietnam to 14 million minutes in 1991, a 1,700 percent increase from1987, and provided significant profits for DGPT and OTCI.2

4.45 Similarly, in Sri Lanka service liberalization has led private investors, in partnership withSingapore Telecom, to establish a rapidly growing public switched data service. This new network,licensed as Lanka Communication Services, now provides Sri Lanka's principle international data linkfor the business community and has played a crucial role in stimulating the export-led expansion of thecountry's garment industry.

4.46 Investment in private satellite business networks, using VSATs, provides yet another example of'bottom-up" privatizations. Since the late 1980s, a number of Asian countries, including Thailand,Indonesia, China, and the Philippines, have liberailized the provision of private satellite networks to allowcompanies to provide point-to-point service to their own facilities and to sublease capacity to third parties.These dedicated networks offer an alternative to existng microwave networks which often do not have

56

IV. Incrwasing Private-Setor Partidpation

the geographic scope necessary to serve dispersed maufacturing and processing facilities. In Thailand,two major VSAT networks have been licensed, one to Samart Company and one to Compunet; thesecomnpanies currently have over 500 VSATs in service, and the business has grown rapidly.24

4.47 In sum, as stated earlier, private development of the telecommunications sector is a broad process.It ranges from 'top-down" divestitures to contracting-out services and a wide variety of "bottom-up'measures including regional franchising, B-T scht -mes, and the licensing of new services. The payofffrom attracting more private investment already has been dernonstrated throughout the region. TMechallenge will be to expand the pace of future projects accordingly (Box 13).

Box 12

Asian Satellites: New Technologies or New Services?

Geostationary satellites have been used to relay transcontinental telephone traffic since the late1960s. In the last decade, several Asian countries-India, China, Indonesia, Japan, and HongKong-have launched their own satellites for domestic and interregional services. Thailand andMalaysia also are planning satellite systems.

Commercial and technical considerations will probably discourage most Asian countries fromauthorizing more than one national satellite system, at least in the near term. But that should notdeter a country from using its satellite system to promote intermodal satellite-terrestrial competitionfor transmission services. If one transmission 'monopoly' is a problem then two (arguably) offer asolution.

Several countries recently have begun to address this challenge. Because satellite service becameavailable after public telephony was well established, the domestic satellite (domsat) operator isusually organized separately from the telecom operator. (In China, for example, there is the ChinaSatellite Telecommunications Broadcasting Corporation; in India, there is INSAT.) Historically thesedomsats have acted as carriers' carriers. They do not provide service directly to end users eventhough some may have the financial and technical skills to do so.

But several Asian countries have begun to rethink the role of their national domsats. Part of theimpetus for a more liberal policy has come from the development of new point-to-multipoint satelliteservices using relatively inexpensive very small aperture terminals (VSATs). Networks of VSATs arenow used by private businesses to suppiy intracorporate communications in lieu of terrestrial leasedlines, and there is strong evidence that such services can be provided competitively, as is now thecase in many countries, including Argentina, France, Thailand, Australia, and Venezuela.

Further interest in widening the role for domsats has come from proposals from Motorola and othercompanies to build low-Earth-orbit satellite (LEOS) systems for mobile telephony worldwide. Whileit is unlikely that any LEOS network will be operational before the mid-1 990s, the plans of thesecompanies have begun to focus the needs of existing domsats on their future markets as well as thestrong interest of private investors in satellite communications. Australia's success in privatizing itsdomsat system, known as AUSSAT, and licensing the new company to provide competitivetelecommunication services to the country is also attracting attention.

57

Telecommuncations Sector Reform in Asia: Toward A New Pragmatism

Box 13

Special Telecommunications Zones (STZs):A Test-Bed for Reform?

Since the 1 990s, most Asian countries have sought to stimulate exports, attract foreign investment,and boost local manufacturing by creating special geographical zones, often adjacent to a major port.They may be known as export processing zones (EPZs), free trade zones (FTZs), or special economiczones (SEZsl. Companies doing business in these areas typically can avoid customs duties and receivesignificant tax and investment concessions. Some of these initiatives have had remarkable success,as perhaps evidenced most visibly by the SEZs in China.

Could special telecommunications zones (STZs)-where telecommunications entry barriers are largelyremoved and nonstandard tariffs apply-be equally effective in attracting new private capital to thetelecommunications sector and enhancing the attraction of existing free-trade zones? Many think thatthey could, and that STZs might also provide a new test-bed for "bottom-up" privatization and sectorreform, just as the SEZs have done in China.

A special telecommunications zone might be thought of as a teleport-a special local distributionnetwork with its own microwave or satellite links to the existing national network-with "light-handed" regulation. Within the STZ, entry conditions would be liberalized, and special service andtariff conditions would apply.

In 1992, a task force of the Pacific Economic Cooperation Council (PECC) conducted detailed studiesof the potential for new teleports in low-income countries, with a focus on the Bantam IslandDevelopment Project in Indonesia and the Eastem Seaboard Development Project in Thailand. BantamIsland lies in Indonesia's Riau province 20 km south of Singapore, and is fast becoming a new centerfor light manufacturing and services in the region. PT INDOSAT is currently constructing a thirdintemational gateway on Bantam with local exchange facilities provided by PT TELKOM. Thailand'seastem seaboard is also the center of new commercial activity which is being spurred, in part, by theaggressive provision of new telecommunications facilities.

Although both the Indonesian and Thai teleports are being built by existing state-owned enterprises,PECC suggests that the teleport model might be equally developed by private-sector companies.Further, because foreign companies locating in new teleports are likely to have access to competingservices from foreign carriers, (e.g., private lines, virtual private networks), special regulatory or tariffconcessions may be required to keep the local carrier competitive.

The STZ concept has also won support elsewhere. The Dominican Republic has set up a combinationdata- and export-processing zone in Isidro. Several state governments in the United States are alsoexploring the potential for STZs. One of the best-known advocates is the Chairman of the IllinoisCommerce Commission, who recently proposed that the entire Chicago Loop area (downtownl becomea telecommunications free trade zone (TFTZ). Wfitin the TFTZ, any company meeting minimumqualifications would be permitted to offer both local exchange and value-added services. The pricesand terms of these services would be left to the market rather than the regulator.

Source: Triple-T Port (Teleport) for Developing Economies,' Second Phase Report Triple-T TaskForce, The Japan National Committee For Pacific Economic Cooperation, July 1992; TradeZones: "Crafting a model for local exchange competition," Terrance L Bamish, Craig M.Klawson, and Calvin S. Monson, Illinois Commerce Commission, January 1992.

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IV. Increasing rivate-Sector Partciptuion

NOTES

1. Privatzation: The Lessons of Experience, Country Economics Department, The World Bank, April 1992, p. iii.

2. This definition follows the one in Privatization: 7he Lessons of Experience, op. cit., note 1. See also P. Guislain,Divestiture of State Enterprises An Overview of she Legal Framework, World Bank Technical Paper No. 186 (TheWorld Bank, Washington, D.C. 1992) p. 1.

3. For a more comprehensive list of options for private-sector investment, see W. W. Ambrose, P. R. Hennemeyer andJ. P. Chapon, Privatizing Telecommunications Systems Business Opportunities in Developing Countries, IFC DiscussionPaper No. 10 (International Finance Corporation, Washington, D.C., 1990).

4. The scope for management reform (i.e., excluding divestiture) to improvc the efficiency of state-ownedtelecommunication enterprises is beyond the scope of this report. For some suggestions on this matter, see lssuesin Telecommunications Development." Division Note No. 6, Industry and Energy Division, Africa TechnicalDepartnent. op. cit., Chapter 1, note 3.

5. In Singapore, for example, although the 1992 reform law reserved the right for die Telecommunications Authority ofSingpore (TAS) to provide teleconmnunication service, the TAS was expected to delegate this responsibility by licenseto Singapore Telecom and other carriers. See generally T. Gaebler and D. Osborne, Reinventng Government, HowThe Entrepreneurial Spirit Is Transforming the Public Sector (Addison-Wesley. N.Y., 1992).

6. For many Asian LlCs, including several of the most populous ones, the preconditions for privatization (as conparedto liberalization) probably do not yet exist, and in other countries privatization mnay be politically difficult or impossiblein the short term.

7. The priorities which are set for a divestiure have significant implications for the way the divestiture is implementodand for the predivestiture reforms. If sector efficiency is the paramount goal, then more attention may be given topredivestiture reform (e.g., corporatizing the carrier and comnmercializing its activities; liberalizing market entry soas to reduce the reach of the carrier's monopoly powar; setting up an effective regulator). Likewise, if wider shareownership is a prime goal of divestiture, a public flotation may be the right technique, but may not result in revenuemaximization or technology transfers. For a furtier discussion of the need to assess competing objectives at the outsetof divestiture, see P. Guislain, 'Divestiture of State Enterprises.' op. CiL, pp. 3-8.

8. See e.g., the discussion in W. H. Melody. "Telecommunications Reform: Which Sectors To Privatize?Telecommunications Journal. Vol. 59 (1992), pp. 297-300 and B. Levy and P. T. Spiller *Regulation, Institutionsand Commitment in Telecommunications: A Comparative Analysis of Five Country Studies.' Annual BankConference on Development Economics, Washington. D.C., May 3-4, 1993.

9. A PTT need not, of corse, be privatized as is. A separate sale of long distance and/or the sateUite communicationsbusiness may deserve serious consideration; especiaUly if competition for long distance services is desired post-divestiture. Absent such a vertical restructuring of the company prior to divestiture, experience in the U.S., NewZealand and the U.K. suggest that significant regulatory resources may be required to ensure nondiscriminatory localaccess for a competing interexchange carrier. See also the discussion in Chapter VI on the sequencing of reforms.

10. For an overview, see Privaization: The Lessons of Experience, Country Economics Department, The World Bank,Washington. D.C., April 1992. and Techni;us of Privatization of Stue-Owned Enterprises Vol. L Metods andImplementation; Vol. H. Sekcted Country Case Studies; Vol. m. Inventory of Country Experience and ReferencwManuals, Technical Papers 88, 89, and 90, (The World Bank, Washington. D.C.. 1988).

For a detailed review of telecommunication privatizations, see S. Oxman and L. Grafstein, "Privatization: A Strategicand Fmancial Perspective.' ITU Telecom '92 Regulatory Symposium. Geneva. October 11, 1992; 'WelfareConsequences of Selling Public Enterprises-Case Studies from Chile, Malaysia. Mexico and the U.K.-four volumes,Country Economic Departnent, The World Bank, Washington, D.C., June 1992; Y. Takann. "Nippon Telegraph andTelephone Privatization Study: Experience of Japan and Lessons For Developing Countries.' Discussion Paper No.

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Telecommunications Sector Reform in Asia: Toward A New Pragmatism

179 (The World Bank, Washington D.C. 1992); L. M. Gonzales Lanuza, "The Argentine telephone privatization"Tekcommunications Policy, Vol. 16, No. 9, December 1992, pp. 759-763.

II. S. Oxman and L. Grafstein, 'Privatization: A Strategic and Financial Perceptive." op. cit.

12. "There is, however. no universal recipe as to which divestiture provisions should be left to the discretion of the partiesinvolved, and which ones should be included in: (i) the divestiture law; (ii) implementing decrees or regulations; (iii)decisions of the authorized official (e.g., minister of finance, chairman of the privatization agency): or (iv) generalguidelines. This will in part be a function of the country's legal and political system and traditions (and of itsconstitution in particular), and in pan be the result of political forces, such as the desire of members of the legislatureto keep close tabs on the privatization process. Issues determining this decision include the government's orlegislator's preference for flexibility vs. standardization, centralization vs. decentralizadon, and accountability vs.control." P. Guislain op. cit.. p. 43.

13. It is significant, however, that Mexican privatization was considered to be successful by the government even thoughthe buyer was subject to fairly demanding performance targets, e.g., 12% annual line growth; specific ruralcommitments, and quality of service targets such as < 5% line failures and 90% access to operator assistance within10 seconds. See also Working Paper A.

14. The Puerto Rican Telephone Authority Act of April 10, 1990, is a good illustration of an over-specified privatizationlaw. It contained highly restrictive provisions including (i) minimum net proceeds to be generated by the sale (i.e..$2 billion), afker deduction of the operator's debt and expenses related to the sale; (ii) a freeze on basic voice tariffsfor a three-year period; (iii) a ban on employee dismissals as a direct result of the sale; and (iv) as a prerequisite ofthe consummation of the sale, a requirement that the legislature approve laws creating a Permanent Fund for theDevelopment of Education, a Permanent Infiustructure Fund, and a Puerto Rico Telecommunications RegulatoryCommission. These conditions, and in particular the minimum sale price, precluded the successful conclusion ofnegotiations with interested bidders. As the governnent had no flexibility to acconunodate bidders' concerns, it hadto withdraw the company from the market. Subsequendy, in February 1992, the government sold the Puerto Ricolong-distance business to TeleFonica of Spain. See P. Guislain, op. cit., p. 44, n. 169.

15. Several observers have argued that because private networks in many LlCs are more developed than the publicnetwork, the private networks should be permitted to expand their role in meeting the public's need fortelecommunications service (e.g., by leasing or reselling excess capacity to the public network, or by providingcompetitive intercity links). See "Issues in Telecommunications Development," Division Note 6, note 3 abeve- H.Lantzke, A. Mody and R Bruce, "Telecommunications Reform in India: An International Perspective,' op. it.Chapter 1, note 3. See also M. E. Beesley and B. Laidlaw. lhe Fume of Teecomnunkadons An Assessment of theRole of Competiton in U.K. Policy (Istitute of Economic Affairs, London, 1989) pp. 46-52; 74-75.

16. See L. A. Borjal-Dala Pena, 'Rural Telecom in the Philippines" Transnational Data and Communications Report,November-December 1992, pp. 27-29. See also Working Paper C.

17. Regional franchises were also awarded in Bangladesh to promote service in over 400 rural subdisuics (thana).Although three licenses were originally issued (in 1988 and 1989), only one licensee, BRTA, an indigenous companywith a license to import and assemble Mitel switches, is still active. (The other two licensees, which had foreigninvestors, ceased operations when a new goverment withdrew from the original franchising agreement.) At December1992 BRTA continued to serve the five dwanas where it had installed exchanges (it had originally agreed to supplyservioe to over 200 thanas by the end of five years). The current government has stated itE comnmitment to the regionalfranchising concepL

18. In February, 1993, however, India's High Court set aside the DOT's selection of cellular licensees because thedepartment had acted in an "arbitrary, irrelevant and even whimsical' manner in rejecting two foreign bidders. Thebidding process is likely to be reopened. See 'India High Court Labels DOT Cellular Ruling 'Whimsical'.' GlobalTelecom Report, May 17, 193, p. 11.

60

IV. Incraasing Private-Sector Part cipation

19. The Tatarstan region of the Russian Republic is also likcly to provide an important test bed for wireless telephonesystems. In August 1992, Hughes NeLwork Systems announced that it had reached agreement with local Tatarsanofficials to build a cellular radio system for the region to provide interexchange calls via a system of mobile satelites.The cost per subscnber for the system is estimated ai $600- 1.000. excluding the terminal. See the Wall Street Journal,August 21. 1992, p. A. 1.

20. For further discussion of asset-based financing, see R. R. Bruce, J. P. Connard and L. Kneifel. Attructing CapitalFor Telecommunications Infrastructure Development: A Bottom Up Approach' World Bank Georgetown Symposium,April. 1991; see also 'Brzil - Reforming the Telecommunications Sector: Policy Issues and Options for t?e 1990s,"Report No. 10213-BR, Infrastructure Operations Division, Latin America and the Caribbean Regional Office (TheWorld Bank, Washington, D.C.). Although govermmentguarantees for asset-based financing schemes may make themmore attractive to the private sector, they do have drawbacks. One is that it may reduce the incentivc to manage newinvestmnent efficiently; another is that a government guaranlee, to the extent it must be reflected in the government'sbudget, may substitute for state investment in the sector, thus reducing the net 'new" money actually invested throughthe private lease-back arrangement.

Lease-back financing and government purchase agrecments or guarantees havc won growing acceptance in thc electricpower industry, where private financing of new generating capacity is increasingly common. For example, a two-hundred-megawatt gas-turbine power plant was commissioned in the spring of 1990 near Manila. The $41 millionproject was built with limited recourse finance by a private company. Hopewell Energy (Philippines) Corporadon,under a build, own, operate, and transfer arrangement. Hopewell received a 12-year contract to supply power to thestate-owned National Power Corporation NPC). Success of this project has :ncouraged Hopewell and NPC tonegotiate a similar power project on a larger scale to provide 700 megawatts of coal-fired generating capacity at a costof $850 million, with commissioning expected in 1995. The World Bank Gmup participated in the Hopewell projectthrougb the International Finance Corporation and is currently exploring similar projects with a number of othersoutheast Asian countries. See 'The Bank's Role in the Electric Power Sector Policies for Effective Institutional,Regulatory and Fimancial Reform." IEN Department. September 15, 1992 (The World Bank, Washington, D.C.).

21. For a review of such privatization opportunities in developing countries as of 1990, see W. W. Ambrose.P. R. Hennemeyerandl. P. Chapon, 'Privatizing TelecommunicationsSystems Business Opportuniies In DevelopingCountries," op. ciL

22. See M. Hiebert, "Party Lines." Far Eastern Eccnonuc Review, 13 February 1992, pp. 40-41; M. Toey, "VietnamAtracting Foreign Interest," Communcations Week Inlernatiosol 2 March 1992. pp. 55-56.

23. See Working Paper E.

24. See Working Paper D.

61

V. IMPROVING PUBLIC REGULATION

T7he single most troubling issue in recent reforms is slow progress in developingregulatory capabilities... .Builing up regulatory institutions where none exist, in countrieswith little or no regulatory tradition in any sector, is proving to be an arduous and longtask. "

Telecommunications: World Bank Experience and Strategy'

A. The Need for Regulton

5.01 In most countries, telecommunications and regulation go hand in hand. A principal reason is that,given elements of natural (or legal) monopoly, a dominant telecommnications provider has an incentiveto raise prices, restrict output, refuse interconnection, and discriminate among different regions andclasses of users.2 Regulation may be explicit, where telecommunications service is largely offered bya private company, or implicit, where the government or a state corporation is the dominant provider.Thus, any sector reform program that seeks to give the dominant carrier more autonomy (e.g., bycorporatization or privatization) or to open the sector to new suppliers, requires that attention be paid toregulation.3

5.02 But is regulation-narrowly defined as control over the entry, output, and pricing of cormmoncarriers-still necessary? As discussed in Chapters II and m, technological innovations have .educedmany of the barriers to the provision of telecommunications services. Monopolies are increasinglycontestable. The architecture of the local network is being reinvented: multiple wireless and wirelinecarriers are becoming the order of the day as the single, centalized, hierarchial network of the past isovertaken by a community of networks. At a time when the age of the network monopoly is passing andgovemmental resources are scarce, is a special regulatory regime for telecommunications really required?

5.03 For several reasons, the answer is still yes. Most important, experience has shown that becauseiterconnection to the incumbent carrier's network usually is crucial to the success of a new carrier,absent regulatory intervention in this area, competitive service providers are likely find their enterprisesstillborn.4 The "no-regulation" option may impose significant costs that include underinvestment intelecolmmunications (i.e., limited new entry), potential losses of scale economies if competitors are unableto interconnect new facilites, reduced output of an unregulated monopolist, and losses of technicalefficiencv ("X-efficiency") because there is no stinmlus for the dominant provider.5

5.04 Beyond that, close examination of the "no regu!ation" option shows that even where generalcompetition policy (antitrust) rules provide a check on the conduct of the telecommunications operators,someone must still deternine whether these operators are acting in the public interest. The question iswhether this is beaer done by judges (often with no functional understanding of telecommunications), orministry officials, as compared to a special regulatory tnbunal. Further, where regulation is left to themarketlace, experience also demonstrates that the dominant operator-not the market-becomes the defacto regulator of the terms and conditions on which competitive service is supplied.'

5.05 There is no international template for regulating a telecommnications sector in transition froma monopoly to a competitive structure. Asian countries have responded to this challenge in very differentways. And there are important differences even among the countries that have chosen analogovs

63

Telecommnwications Reform in Asia: Toward A New Pragnmtism

structural reformns, such as corporatizing the government telecomununications operator or liberalizing data-and private-network services.

5.06 At one end of the spectrum is New Zealand, which in 1987 adopted legislation to open mosttelecommunications services to competition without creating a sector-specific regulator. Price control,interconnection, and service discrimination issues were left primarily to the marketplace, the courts, andthe residual power of the government's "golden share" in the newly privatized telephone company. SeeWorking Paper B for further details.

5.07 At the other end of the spectrum are countries such as China and Vietnam, where the Ministryof Posts and Telecommunications, the dominant telecommunications operator, still acts as the regulatorand policy maker. Between these two poles there is a middle ground that is not easily categorized.Several countries-Sri Lanka, Singapore, Australia, and the Philippines-have set up regulators,ostensibly at arms length from the ministry, to oversee corporatized or privately owned nationaltelecommunications companies. But the autonomy, goals, and effectiveness of these regulators varyconsiderably (see Working Papers A, B, D, and E). Likewise, there are other countries-most notably,Japan and Korea-that have privatized or corporatized their national carriers and licensed strong netwo; rcompetitors but maintain a ministry-based form of regulation (gyousei shido, administrative guidance).7

5.08 There is a third group of countries, now including India, Pakistan, Blangladesh, and Thailand, thathave not formally separated regulation from the operator of the state-owned carrier or telecommunicationsdepartment but are considering this option in the future. Countries in this last group, as well as the UCsthat have already launched new regulatory organizations, are all grappling with a common set of problemssurrounding market liberalization. This is new ground on which the old ideologies offer few answers andthe key resources-well-trained professionals, reliable information, and political will-are usually in evenshorter supply than the telecommunications services that must be regulated.

5.09 Despite the similar technological and economic issues facing the sector across Asia's LICs,because regulation must take account of various political, legal, and commercial factors, regulatoryinstitutions are inevitably country-specific. Indeed, a comparative analysis of the performance ofprivately owned telecommunications companies shows that underlying institutional factors-especially thedegree to which the executive or judicial branch is able to constrain arbitrary administrative behavior(e.g., breach of contract, political favoritism) is of crucial importance in determining the extent to whicha regulator can improve the sector's economic efficiency.'

5.10 Asia's LICs are also aware that the institutional challenge of regulation has both macro and microdimensions; therefore there are country-specific legislative and constitutional issues as well as questionsof technical economic policy and administrative law. Decisions must be made about the regulator's stantsand charter, and its relationship to other policy makers. Should the regulator be one person (a directorgeneral) or a multimember commission? Should the reguL1tor have responsibility for telecommunicationsalone or for other public services-electricity, wate;, and broadcasting-as well? How should theregulator(s) be appointed, and for what term? Should the regulator be answerable to the minister ofcomnmnications, to another ministry (e.g., finance or industry), or to no ministry at all?

5.11 Further, should the regulator's budget be funded out of general revenues or out of license fees?Should the staff be governed by civil-service provisions or private-sector rules? What provision shouldbe made for public participation in regulatory decisions, and what options, if any, should there be forappeals? Should the courts have a role? The minister of communications? The full cabinet? And what

64

V. ImproWng Public Reguuion

Box 14

Regulatory Fundamentals

The fundamental purpose of telecommunications sector regulation Is to optimize sector performanceIn terms of objectives set by the govemment. These may Involve trade-offs between, for example,maximizing output for the sector and the distribution of that output.

Two important economic characteristics of the sector are:

* its capital-intensiveness. Furthermore. once an investment is made, the facilies andequipment cannot easily be put to other uses. This makes investments risk-sensitiveto the extent that they are recovered from revenues over a short period.

* Its significant barriers to entry. One of the most important barriers is the terms forinterconnection with the dominant operator.

Bearing in mind these characteristics, regulation should seek to optimize sector performance by:

1. Creating an environment that is conducive to long term investment, and

2. Enforcing effective measures to moderate or prevent the abuse of monopoly power.

In addition, it is important for agencies to adopt regulatory processes and requirements that are notunduly burdensome and are consistent with efficient carrier operations.

Wth respect to item 1 above, investors need to know that, if the government changes, theirinvestment will not be confiscated without due process or compensation, nor otherwise devalued byunreasonable rules on pricing or the management of their business.

With respect to item 2 above, regulators need to be effective in enforcing measures ti at discouragethe dominant telecommunication operator from (1) restricting output; (2) discriminating unreasonablyin the service provided to different customers; and (3) exploiting its market power contrary to thepublic interest.

In this regard, the credibility and stability of the legal environment may be of overarching importance.A country that lacks the institutional endowment-in terms of legislatures, courts and socialcustoms-to enforce laws and to put in place a system that can restrain arbitrary public or privateaction may be hard pressed to establish a workable regulatory system for the telecommunicationssector.

relationshp should the teleconmmications regulator have to govermnent authorities resonsible forcompetition or trade policy?

5.12 None of these questions is easily answered. However, over the last decade, a growing numberof countries have grappled with these issues, some successfully and others much less so.9 Iheirexperiences offer lessons for countries that are just begnning to rethink their approach to regulation.

65

Telcommwdcajion Reform in Asia: Toward A New Pragmodsm

D. Internional Experiene with Reguation

International Best Practice

Insdtutional Authority

5.13 Despite the institutional problems posed in countries where state power is centralized, there aregood reasons to have a national telecommunications regulatory body with a clear legal mandate,substantial political autonomy, and a core group of competent professionals. In fact, many observersbelieve this to be essential to cope with the large and complex issues raised by privatization and/orliberalization. To be effective, the government's regulatory capability must be well led and strong,technically capable, and politically credible. This appears to be true for industrialized and middle-incomecountries alike. Such an agency can boost investor confidence and thereby promote investment. As onepolicy expert put it, "The successful countries have created agencies that have a professional, politicallyindependent staff paid adequate salaries, given adequate training, and held to the highest standards of civilservice integrity and efficiency."I These staff members are competent in policy analysis, finance,accounting, public-utility economics, law, and engineering.

5.14 The creation of a strong regulatory agency does not mean it must be a teleconmunications-specific regulator. Some of the most effective regulators (e.g., the public utility commissions in thestaes of the United States) typically have responsibility for other industries (power generation,transportation). Cross-industry regulation is also the rule for competition authorities (e.g., the U.S.Federal Trade Commission, the New Zeaand Commerce Commission). And cross-industry regulatorshave been proposed even where industry-specific regulation is already the norm.I'

5.15 A recent World Bank-supported consultancy report which looked at telecommunications regulationin a cross-section of countries (Korea, Malaysia, Indonesia, the U.K., the U.S., and Australia) reacheda similar conclusion.'2 The report found that a regulator's success depended upon its having a definedlegal mandate separate from the ministry having policy responsibility for the sector, and with a formalmechaism for stakeholders (competitors, users, regional interests) to make their views known. Further,the regulator should carry out its duties without day-to-day interference from either the government orthe dominant operator.

5.16 Finally, with respect to administration, the report found that regulatory success was closelycorrelated with the regulator's ability to pay and attract well-qualified staff on terms competitive with theprivate sector. Of equal importance was the regulator's access to a sufficient, stable, and nonbudgetarysource of finance such as license fees.

Transparency

5.17 The ability of regulation to serve the public interest also hinges upon the way the regulator makesdecisions (i.e., the regulatory process) and the scope of the decisions subject to this process. No degreeof instutional competence will legitimate an unpopular decision made behind closed doors, withoutpublic input, and which is not published. Likewise, the regulatory agenda must be manageable;regulators generally should not be asked to step in where ministers fear to tread in maldng basic decisionsabout industry structure, competition, and service goals.

66

V. Improving Public Regulation

5.18 The regulatory process should be impartial and transparent, and users, carriers, and otherinterested parties must be able to participate. Public hearings need not be required-a public notice orconsultative document generally will be sufficient, although where complex pricing or interconnectionissues are involved, a quasi-adjudicatory process may be desirable. It is equally important to publish theregulator's decision to minimize arbitary or capricious action and so that the regulator-as well as theregulated-may be held legally and politically accountable. In some cases, depending upon nationalconditions, the regulator's decision might also provide a basis for judicial review.

5.19 A fair and transparent regulatory process is desirable not only because it is likely to enhance theregulator's autonomy and effectiveness, but also because it makes good business sense. Where the rulesof the game are unknown or uncertain, new investment will be detrred. Telecommunications is acapital-intensive business with relatively long lead times required for installing new facilities andrecovering their costs. Hence, unless new market entrants are assured that they will be treated fairly visa vis other providers and that there are transparent, established procedures, investors will be reluctantto invest in the market."3

License Terns

5.20 The scope of decisions which a regulatory agency faces-and hence the potential risks offailure-also may be redc Led if a govemment properly fixes its policy choices in connection with aprivatization or liberalization program. The licensing process provides a good example (Box 15).

5.21 There are now two competing licensing models: (1) the Anglo-American approach, under whichgeneral authorizations or franchises are granted subject to an overriding set of regulations which arechanged to meet new circumstances; and (2) the Latin or civil-law approach under which a carrier isganted a franchise for a fixed period with detailed quantitative and qualitative requirements that are tobe naintained, but not fundamentally altered, by the regulator. The first approach often leads to moreactive regulatory involvement; the second approach, although easier to administer, may, due to technicalinnovations (e.g., the digitization of a facsimile or audio service) leave the regulator with an outmodedinstrument to enforce the govermnent's policy choices. Nevertheless, where regulatory resources arelimited, a modified civil law approach may be most desirable.

Pricing

5.22 The type of pricing rles applied to telecommnications operators also significantly affects theregulatory process (Box 16). Again, there are two main choices: a rate-base approach, or price caps.The rate-base approach allows the operator a maximum allowable return on a specified base of capitalinvested to provide service (i.e., the rate base). This approach has been most common in North America,where telecommuication services have been furnished privately since the nineeenth century.

5.23 Despite the success of the rate-base approach in capitalizing the telecommunications sector, it islabor-intensive for the regulator, which must routinely scrutinize the dominant carrier's accsonts todetermine the allowable rate base and, once it has been fixed, anmnuy monitor carrier eamnings to ensuecompliance. Even then, the cost-plus nature of rate-base regulation provides little incentive forproductivity improvements. The shortcomings of rate-base regulation have increased support for theprice-cap approach."

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Teleowmmunications Reform in Asia: Toward A New Prgmatism

Box 15

License Elements for Public Telecommunications Operators

Once the business of a state-owned operator is transferred to a separate corporation, whether privatelyowned or not, it is desirable to formalize the terms on which telecommunic.tions services must be provided.A license or concession agreement may provide an offective way to reduce the scope for day-to-day politicalInterforence; it also can resolve some of the thorniest togulatory Issues in advance.

The license granted to the ex-govemment opreator and the basic telecommunications reform law are thustwo of the most crucial documents to be drafted in the corporatization process. Ucense terms vary greatlyfrom country to country, but there are common elements I that generally include:

* A definition of the licensed network and the dividing line between the (public) network, other(private) networks and terminal equipment.

* The services covered by the license (e.g., local exchange, trunk, international, cellular radio, paging,satellite, private circuits).

* Quanitative and qualitative performance targets (e.g., geographic coverage, access lines and ratioof public call boxes per capita, fault levels and repair times).

* A requirement to publish tariffs for all services and an obligation to serve customers without unduepreference or discrimination.

* Social obligations (e.g., free calls to emergency numbers, access to directory services, service todisabled and hearing impaired).

* Prohibition of anticompetitive practices (linked sales; undue cross-subsidies, preferences, ordiscrimination; closed tenders).

a Obigation to connect 'type approved' terminal equipment on a nondiscriminatory basis; rules onsupply of licensee's own equipment.

- Obligation to connect with other networks on reasonable terms; provision for access charges tocompensate licensee for network conveyance and welfare obligations.

* Price control rule (e.g., "price cap') and definition of service baskets to which it applies.

* Code of good practice for doing business with supplers and customers, including confidentialityrules.

* Billing, metering, and record-keeping requirements.

* Prohibition on dealing solely with one foreign carrier in a market where multiple suppliers have beenlicensed to provide international services.

* Numbering arrangements for terrestrial and wireless services and modifications to same.

* Rights of access to public lands and corresponding obligations to provide access to company polesand rights of way.

* -.....Payment of license fee or assessment (e.g., on capital budget or gross turnover).

* Obligation to furnish information sufficient for regulator to perform duties.

* Accounting rules and audit provisions.

* Conditions for revocation, modification, end assignment of Gicen5e; foreign ownership limitations.

* Rules on treatment of complaints, remedies for service interruptions, liability of licensee.

* This lit drws on ite license of British TeecommwjcasFons IB as amended in Soptwnber 1991, the 1990conesion gned Tehaonas de Meico 17ELUE)V. and he license grmned Sr Lanka Teleom (SLTJ inAugust 1991.

68

V. ln1proung Public Regulation

Box 16

Unks Between Microeconomic Policy andPublic Utility Regulation

In North America, companies offering local telephone service traditionally have been defined as "publicutilities," a category including local electricity, natural gas, and water companies. The public utilityregulators overseeing thdse industries usually are guided by legislation and rules which, to animportant degree, reflect the application of microeconomic analysis and policy (e.g., regarding thepower of monopolies to restrict output, discriminate among customers and dictate prices). Theseconcepts, however, are often couched in a somewhat specialized regulatory vocabulary. They includethe following:

The public convenience and necessity. The standard which an applicant for a newservice license must satisfy. The implication of this standard is that even wherethere is a presumption of only one or a small number of operators (e.g., airlines onparticular routes), new entry is justified when the incumbent is not meeting allreasonable, paid demand. Under a "public convenience and necessity" standard, anoperator should be able to maintain an exclusive franchise only where it is meetingall reasonable, paid demand for service.

Unjust discrnination and undue preferences. Rules barring carriers from engagingin 'unjust discrimination and undue preference' are designed to prevent monopoliesfrom taking advantage of their monopoly positions and dealing differently withdifferent customers or groups of customers in ways that are unfair.

Fair and reasonabe rates. In the absence of competitive markets, public utilityregulators adopt price control rules. A 'fair and reasonable rate" standard isdesigned to ensure that the operator obtains a reasonable return on its investmentbut without exploiting its monopoly position in the market. Although regulatorsdiffer about when a rate is 'fair and reasonable", there is general agreement that thestandard is met if a carrier's rates cover the costs of its regulated services over themedium to long term. Further, a rate for a new service may also be consideredreasonable if it covers incremental costs associated therewith and does not imposeany additional costs on existing services.

Interconnection, upon request. Because telecommunications networks exhibit scaleeconomies in some cases, the technical efficiency ot the network may be frustratedif carriers serving adjacent (or even overlapping) territory can refuse interconnection.Further, where competing carriers are licensed, the public may benefit by havingnondiscriminatory access to the networks of all carriers. The mandatoryinterconnection requirements found in most North American public utility laws reflectthese principles.

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Telvommmunicadons Reform in Asia: Toward A New Pragmadsm

5.24 One of the main attractions of price caps is that they provide a significant degree of automaticityto price adjustments. In addition, in theory regulators need not police carrier costs to keep ratesreasonable. Rather, rates are fixed directly by setting a "cap" on the carrier's prices for a given period.The cap is typically tied to the consumer price index (CPI) minus an "x" factor where x is an estimateof the carrier's expected annual productivity gain in comparison to the economy as a whole.

5.25 Price caps tend to reduce both the workload and political burdens on regulators. Agrecement ona price cap-which services should be in the service "basket," whether there should be different caps fordifferent baskets, how large the x factor should be, and how frequently the cap should be reviewed-isusually difficult to achieve. But once details of the cap are resolved, the issue of tariffs has effectivelybeen taken out of the political arena, at least until the cap is revised (e.g., in three to five years). Thisis likely to make the role of the regulator easier and also to create a measure of regulatory certainty notfound under the rate base approach.'5

Current Practice in LICs

5.26 How well 1, ; 'eveloping countries done in taking the foregoing lessons to heart in implementingsector reforms? A preliinnary review of experience in Latin America and Asia suggests that, for variousreasons, the regulatory response to privatization and liberalization has fallen fiLr short of what is needed,even by local standards. Whereas some LICs have carried out satisfactory privatizations in little over oneyear, there is not one with a well-functioning regulatory system. Moreover, the initial operation of someof the largest privatized companies is taking place with little or no competition and in a regulatoryvacuum where decisions on licensing, pricing, accounting standards, and performance monitoring are notproperly discharged.

5.27 The regulatory shortfall in most LICs typically includes six areas:

(a) Autonomy. The regulator is within a ministry or, if separate, lacks a firn legal mandateor the necessary political independence, due to inadequate enabling legislation or decree,the power of special interests, staff limitations, or uncertain funding.

(b) Mission. Lack of a mission statement may be symptomatic of the regulator's dependenceon other political authorities. Yet without an agreed set of goals about what is to bedone, it is unrealistic to expect regulators to fnd the right tools to carry out their job,especially where regulation (as defined in para. 5.02) is new.

(c) Stafig. The regulator's staff lack the essential technical qualifications and trining(e.g., in accounting, financial modeling, law, engineering) to perform crucial tasks, andbudgetary or civil-service rules prevent timely recruitment of qualified personnel toremedy the situation.

(d) Price Control and Accouing Rkles. Inadequate attentionhas been given to developingeffective price control rules and to adopting accounting rules sufficient for the regulatorto determine the dominant carrier's rate base or the cost of providing service, and toquantify the extent of cross-subsidies.

70

V. Improving Public Regulaion

(e) Interconnecdon Rules. Low priority has been given to connection rules and properlycosting out the contribution to local exchange services to be made by carriers providingcompeting local services, such as cellular telephony.

(f) Oversight of Corporate Transactions. Poor monitoring of transactions between carriersand affiliated companies can lead to inadequate regulatory responses to inflatedprocurement, intracorporate transfer prices, or overstated rate bases."6

5.28 The last three regulatory deficits are often a reflection of the first three. For example, settingthe terms for network interconnection and agreeing upon an efficient price-control rule are challengingand time-consuming activities even for an experienced and higlly qualified regulatory staff. Por aninexperienced, poorly trained, and over-worked staff operating in a political environment where arbitraryadministrative action or inactivity often is rewarded, they may be next to impossible.

5.29 Moreover, to carry out these tasks properly, the regulator must have access to detailed accountingand financial information on the economy, the dominant carrier and prospective competitors. Yet, inmost UCs, such information is sketchy, rarely disaggregated to a sufficient degree, of uneven quality,and frequently outdated. The cooperation of the telephone operator may also be limited, at best. Hence,until this information deficit is addressed-and in a comprehensive, consistent, and sustained way-it nbe unrealistic to expect a significant improvement in the performance of the regulator."'

C. Addreing Reguatory Shortfalls

5.30 The solution to the regulatory failings in most LICs is liely to occm along two axes-one largelypolitical or institutional and the other primarily technical. The first will involve a re-examination of theinstitutional variables-e.g., the regulator's legal authority, mission, and enforcement power relative tothe ministry, the legislature, and the courts."' A second set of reforms should focus on securing theregulator's competence: leadership, staffing, and financing.

5.31 The solutions discussed here must be read against the definition of regulation advanced earlierat para. 5.02. Its focus is the relatively narrow subject of common carrier entry, output, and pricecontrol, a fairly specialized matter which does not preclude, and indeed may require, complementarypolicy guidance from a ministry or government department. But the separate importance of the regulatoryrole descnbed here should not be underestimated by any country seeking to promote the growth of itstelecommunication sector.

5.32 A regulator which is politically strong and professionally competent need not necessarily rule witha heavy hand. On the contrary, a light-handed regulatory regime-as in Singapore and Australia, forexample-has been made possible in many ways because the regulator's role is generally accepted by allparties and the objectives of the regulatory regime are clear. Provided these building blocks areestablished, preferably through legislation (See Chapter IV, Box 10), the regulator may well be able toride with a light rein which, competition permitting, is desirable.

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Telecommauications Reform in Asia: Toward A New Pragmatism

Authority and Mission

5.33 As noted earlier, the weight of the evidence suggests that a strong regulator must have a firmlegislative and constitutional base. The regulator also must have clear authority and be at arm's lengthfrom the ministry." It should also have adequate, consistent funding such as that derived from licensefees or an assessment on carriers' revenue rather than from general appropriations. The best way toachieve this is to make the legal and financial status of the regulator a central part of anytelecommunications sector reform legislation. This solution will not be right for all countries, but evenwhere ministry-based regulation has been the rule (as in Singapore), the challenges of liberalization anddivestiture have led countries to re-evaluate their existing approach.

5.34 But how should the regulator be organized-as a directorate general or a commission? And ifa commission, should it be modeled after AUSTEL (Australia), the American FCC, or a United Statesstate public utility board with jurisdiction over several industries?

5.35 Again, most countries seem to prefer a commission as opposed to an office headed by a singledirector general, with the scope of the commission's audtority determined by national conditions. Thetechnical workload and political burden are simply too great to be shouldered effectively by a singleperson. Further, a multimember commanission with staggered terms can give the regulatory environmentstability and predictability when governments change. A multimember commission also may be harderfor special interests to capture' or corrupt. In Sri Lanka, although the 1991 reform bill created aregulator headed by a single director general, legislation has been proposed to convert the office to a five-member board (Working Paper E). Multimember telecomnunications regulatory comumssions are alsothe rule in other Asia-Pacific countries (e.g., Singapore. the Philippines, Australia).

5.36 Constituting the regulator as a commission rather than a director general need not increase itssize. Indeed, the experience of the state regulatory commissions in the United States, which commonlyhave jurisdiction over electricity, gas, and telecommunications utilities, is probably more relevant to LICsthan the FCC (only 20 percent of FCC staff deal with telecommunications common-carrier issues). Areview of these organizations suggests that a professional staff of 40-50 may be sufficient, provided theyhave the right mix of skills.' At least the following regulatory functions must be properly staffed:carrier accounts and financial oversight, tariff and rate review, technical standards and enforcement,economic issues and information management, and administrative and legal support. Two possibleorganizational charts for a telecommnications regulatory commission are shown in Figures 4 and 5.

Setting Priorities

5.37 Telecommunications regulation is a complex and demanding task even where competition alreadyexists and resources are plentiful. Building regulatory competence from scratch in a poor country wherethe monopoly position of the government-owned carrier is well entrenched can be daunting. Not onlymust the new regulator, possibly only one person, cope with the mundane but essential tasks of securingadequate office space, recruiting a staff, and acquiring supplies, but in the first few months the regulatormay also need to address a host of critical issues-from licensing to pricing, interconnection, andcompetition policy-that may determine the success or failure of the regulatory function for years tocome.

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V. Improving Public Regultion

5.38 Many things will be required at once, and the meager data available often come from themonopoly carrier. It is thus essential for the regulator to set priorities to reduce the informadon gap andto build an independent constituency for regulation among prospective service providers, users, and thegeneral public. Some recommendations on the matters that should be at the top of the regulatoryagenda-interconnection, the price control rule, and frequency management-are shown in Box 17.

Implementing Priorities

5.39 This report has stressed that effective regulation need not require a large organization. The keyrequirement is to get the legislative authority, organization structure, core staffing, and prioritiesestablished correctly at the outset. With the essential elements in place, the regulatory tasks are likelyto be manageable, and the agency may also have some latitude in deciding whether a given task is bestdone by its own staff or an outside contractor.

5.40 The resource constraints in LICs-experienced professionals will almost always be in shortsupply, given civil-service salary levels-should make the use of contractors attractive in several areas.For example, if the legislature or the government has written a specific price-control rule andperformance targets for the dorninant carrier, then it should be possible for the regulator to use anaccounting firm or consultancy to monitor compliance. Further, the carrier might be required to pay thecost of preparing periodic compliance reports as part of its license fee. Such a plan would significandyreduce the staff time required for basic economic and accounting tasks.

5.41 Independent contractors and testing laboratories, including the testing organizations set up byforeign regulators, might also be used to handle equipment certification and standards. Likewise, thecomplex and highly specialized tasks associated with radio spectrum management might be contracted out;the cost could be recovered from licensees and companies seeldng to use radio frequencies for new

22services.

5.42 Finally, the regulator could be given the option of delegating the quasi-judicial dispute-resolutionfimctions (e.g., regarding interconnection and tariff complaints) to arbitrators or fact-finding panels.Private arbitration, paid for in part by the parties, might also be explored. These kinds of alternativemeans of dispute resolution need not reduce the regulator's authority so long as a right of appeal ispreserved. Taken together, the foregoing measures can substantially reduce the day-to-day burdens onthe regulator so that the most critical tasks can be accorded the attention they deserve.

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Telecomnunicaions Reform in Asia: Toward A New Pragmatism

Box 17The Chalnge Fo New RegulaWr:

Settig Proris

In low- and middle-income countries where regulatory resources are scarce and experience limited,setting priorities is essential. Four issues deserve to be at the top of the regulatory agenda:

1. InterconnectionAll too often, the terms and conditions on which other networks can be connected to and exchangetraffic with the dominant carrier are put off until new licenses are awarded. This is a mistake becauseit may frustrate the expansion of new service for years, as in the U.S. and New Zealand. By focusingon the interconnection issue at the outset before major new carriers are licensed, as was the case inAustralia, for example, the regulator is not only likely to lay a firm groundwork for future competitionbut also to force the dominant carrier to develop and disclose crucial financial information which willbe useful for other regulatory tasks.

Setting interconnection terms at the outset is also crucial fer diversifying the supply oftelecommunications services because it provides would-be entrants with basic cost data le.g., howmuch it will cost per minute of traffic on a given route) as well as revenue information Ihow much theywill be paid in retum). The interconnection issue also raises the question of access charges: Is thedominant carrier providing service below cost in some areas of the country (villages), and if so, howmuch of this social burden should be recouped from other carriers which connect their facilities to thedominant provider in the form cf access charges?

2. The Price Control RuldIt is probably desirable to wrhia the initial price control rule into the license or concession for thedominant carrier. The regulator's main responsibility would then be to monitor the rule, which mightbe contracted out (e.g., to an accounting firm), rather than to create it. The rule could involve the useof a 'price cap" approach that ties the dominant carrier's prices for a given basket of services tochanges in the general price level minus an 'xw factor (e.g., 5%) reflecting the carrier's expectedproductivity gains as compared to the rest of the economy. Altematively, the regulator might use a'benchmark" approach under which the carrier's prices and service quality standards aie set (and lateradjusted) by comparison to the performance of a broadly comparable group of carriers in othercountries. In either case, the resources used for price regulation would be minimized.

3. Frequency ManagementMany LiCs have a very incomplete picture of how the radio spectrum is being used. Record keepingis typically inadequate and some of the most powerful private and government organizations (e.g., themilitary) may have squatted on spectrum that is nominally allocated for other services. Technologyhas made the opportuniy cost of such an ad hoc approach to spectrum management increasinglyhigh. In the 1 990s, wireless services (cellular radio, telepoint, paging, satellite mobile) will play alarger and larger role in meeting every country's telecommunications needs. But without an accurateinventory of the available spectrum and an adoption of a workable spectrum management plan theopportunity for a full range of wireless services may be lost or compromised. All this requires moneyand a skilled staff. But, as with monitoring a price control rule, outside contractors are available. Itmay also be possible to require companies most likely to bid for the spectrum to do most of theengineering homework themselves.

4. Public ParticipationPoor information is often at the root of regulatory failure. The regulator lacks the information it needsfrom those it regulates; the public lacks the information it needs about the regulator to judge itsperformance. Part of this information gap might be closed if the regulator were to encourage morepublic participation in the regulatory process. Public notice and comment procedures can be routinelyused where crucial decisions are involved. Further, regulators can make full use of their power toobtain economic and accounting information from carriers and, subject to commercial privilege, placethis information in the public record for comment. The use of open meetings, as mandated by the"Sunshine Laws' in the United States, also foster greater public participation. So too can theappointment of consumer advisory groups.

74

V. Improvng Public Regltkion

NOTES

1. *Telecommunications: World Bank Experience and Strategy," Discussion Paper No. 192, (The World Bank,Washington, D.C. 1993) p. 10.

2. The need for regulation thus exists in any sector of the economy where a supplier has monopoly characteristics. Thefailure to make regulation an important plank of sector reform accordingly has also p1agucd refonn efforts in otherareas. Sec, e.g., "Thc World Bank's Role in the Electric Power Sector" op. cit., Chapter 1, note B.

3. A useful overview of the impact of structural reform on regulation is provided in The 0anging TelecommunicationEnvironment, Report of the Advisory Group on Telecommunications Policy (ITU, Geneva, 1989).

4. While some economists assert that the absence of interconnection may sdmulate the growth of competitive localexchange service (see paragraphs 2.26-2.27). the lack of equitable interconnection terms is an almost universalcomplaint of new market entrants. See, e.g., the discussion in Clear Compuntcation Ltd. v. Tekeom Corporadon ofNew Zealknd Ltd et at, Judgment of the Court, December 22, 1992. Afker a three year proceeding, the High Courtof New Zealand ruled that since the outset of competition in 1989, Telecom had abused its dominant position, inviolation of Section 36 of the Commerce Act, in refiusing to pay its chief competitor, Clear Communication, forterminating calls on Clear's network. Further, the court ruled that Telecom had also acted illegally in demanding moremoney for interconnecting Clear's facilities than economics would justify. thus illegally deterring Clear from engagingin competitive conduct in the national telecommunication market. Further, Telecom refused to alow Clear tointerconnect its facilities as a regular private company, thereby preventing Clear from offering competitive service tothe New Zealand governmenL

A comnprehensive review of interconnection arrangemnents in six countries (the U.S., Japan, Australia, the U.K.,France, and Germany) concluded: 'In all countries...interconnection is a matter of involvement for regulatoryauthorities. [Where the regulatory] rules call for the parties concerned [first] to negotiate interconnection agreements... ihe real possibility of coflusive behavior between the incumbent and the interconnecting carriers ... cannot beexcluded. [W"hen there is a true competitive relationship between the parties to an interconnection arrangement, the[parties] as a rule are not able to arrive by thernselves at a satsfactory agreement so that regulatory intervention isrequired." W. Neu and IC H. Neumann, *Interconnection Agreements in Telecommunications.. WIK Diskussion-beitrag No. 106, (Bad Honnef, Germany) April 1993, pp. 86-87. Regulatory intervention was also critical to obtainingfair interconnection fur Mexico's new cellular radio operations (Working Paper A).

See also B. Carsberg. 'Approaches to Regulation: Reflection On the USC. Experience,- op. ciL, Chapter I, n. 10.'As I look back, I see that some things could have been done better. The initial regulatory fammework established bythe Government, did not define the nature or the extent of help that might be given to new entrants ... Consequently,the subject of the arrangements for interonnection between the networks of different operators was consistently subjectto heated dispute. More importandy, the uncertainty impaired the planning of both the original monopolist and thenew entrants. I would certainly recommend that countries which were to establish competition in the future shouldmake this part of the process more definite." pp. 4-5.

5. The potential welfare losses in LlCs from the no-regulation option (e.g., imperfectly compedtive markets and theeconomic cost of "monopoly-induced sloth and rent-seeking') are estimated in L. Jones, "Appropriate RegulatoryTechnology: The Interplay of Economic and Institutional Conditions." Annual Bank Conference on DevelopmentEconomics, The World Bank, Washington, D.C., May 3-4. 1993.

6. In New Zealand, for example, there is no sector regulator. Competition (antitrust) laws have provided the mainconstraint on the privatized operator's activity. However, the country's competition authority, the New ZealandCommerce Commission, recently found that the "pacure...is not of an idustry subject to 'light handed' regulation.In relation to many important segments...Telewm [Telcorn New Zealand, the dominat provider] is the de factoregulator....Telecom rnakes the rules and otder players in the industry, by and large, play by them.' S.M. Lojkiw.'The New Zealand Experience.' TelCommuncations Polkc, Vol. 16, No. 9, at p. 776.

75

Telecommunications Reform in Asia: Toward A New Pragmatism

7. The ministerial model does not separate the government's policy and regulatory functions. Hence, even afkerprivatization or the entry of new carriers, informal mechanisms for accommodating the interests of various public andprivate stakebolders remain the order of the day. Although some observers have commented favombly on thisapproach, (e.g., as to the absence of litipgion) it is clear that the newly "autonomous" telecom operating companieshave paid a significant price for this system (as have many users) and might favor a more explicit North Americanapproach to reguladon. See, e.g.. Y. Takano 'Nippon Telegraph and Telephone Privatizadon Study, The Experienceof Japan and Lessons For Developing Countries, World Bank Discussion Paper, No. 179,* op. cit.

There are oder reasons why a substantially autonomous regulator may be preferble to a Ministry approach. Aregulator is more likely to be viewed as impartial and in practice be less subject to the political give and take whichis customary in a Ministry. lmpartiality also contnbutes to regulatory consistency which reduces risks for investors.Additionally, telecom regulation works best where there is also transparency-thedecision-making process is open andthe results public. (See eg, "The World Bank's Role in the electric Power Sector, op cit.) But Ministries customarilyact behind closed doors and upon confidential advice; they are also adept at putting off hard decisions, whereasregulators have an obligation to respond to petitions, complaints or applications in a timely fashion.

8. See, e.g. B. Levy and P. T. Spiller, ' Regulation, Institutions and Commitment in Telecommmunicadons: AComparative Analysis of Five Country Studies," op. cit., Chapter 4, note 8.

9. For a comprehensive review of the way in which several industrialized and middle-income countries (Canada, France,Germany, Spain, the U.S., Mexico, New Zealand, Japan) have addressed these institutional and organizational issues,see M. Tyler, S. Bednarczyk, "Options for Regulatory Processes and Procedures in Telecommunications," a briefingreport for the ITU Regulatory Colloquium No. 1: The Changing Role of Government In An Era Of Deregulation.February 17-19, 1993. Geneva, Switzerland.

10. N. P. Miller, 'Regulation: Recorcvling Policy Objectives" World Bank Seminar on Implementing Reform In theTelecommunications Sector, Washington, D.C.. April, 1991, pp. 7-S.

I1. In the UK., for example, the alleged unaccoutability of the various "independent" reguiatory agencies (Oftel fortelecommunications: OFGAS for gas distribution; OFFER for electric power generation; OFWAT for drinking water)has prompted calls for reform including the combinadon of some regulatory offices. a new legislative chaner forregulators and a new Office of Regulation which, among othem things, might ensure the consistency of price controlrules from one industry sector to another. See D. Helm, 'Rewrite The Rules For Regulation," Fuiwacial Tuere, April7. 1993, p. 15 and H. Dixon, "Result Against the Regulators." Financial rhnes. May 28, 1993. p. 14. See also C.D.Foster. Privaizion, Pubic Ownership and e Reguaion ofNaturalMonopoly (Blackwell. London. 1992); M. Tyler.et al. "Teleconmnunications Policy and Regulation." Chapter 3, op. cit., note 7.

12. Booz Alen & Hamilton, "Strengthening the Teleconmunications Regulatory and Analytical Capabilities of theDirectorate General of Posts and Telecommunication (DGPT), Govenmuent of Idonesia Ministry of Tourism, Postsand Telecommunications," March, 1992, Vol 3.

13. Thus, as observers have argued, regulatory success can largely be measured in terms of how ef*ictive governmentsare at constraining arbitrary adminictrative action. See. eg., B. Levy and P. T. Spiller. " Regulation, Instittions andCormitment in Telecormnunications: A Comparative Analysis of Five Country Studies," op. ci

14. See. e.g.. L Johnson, 'Price Caps in Telecommunications Regulatory Refor.m" The RAND Corporation, SanaMonica. CA, 1989: M. E. Beesley and S. C. Litlechild, 'The Regulation of Privatized Monopo'ies in the UnitedKingdom,' RAND Journal of Economics, Vol 20, No. 3, Autumn, 1939.

15. For a useful discussion of the comparative merits of rate base vs. price-caps approaches, see "Statenent - The Contolof British Teecoms Prices." Director Genral of Telecomnunications, Oftel, London, 7 July, 198S. For a U.S. view,see Policy and Rules Concernig Rates for Domnnt Carirs Notce of Proposed Rtdemaking. 2 FCC Rcd 5208(1987) and L Selwyn and S. Lundquist, 'Adopting Telecom Regulation to Industry Change: Promoting DevelopmentWithout Comprornising Ratepayer Protection.' EEE C ions Magazine (Janry, 1989).

16. See, eg., the discussion of the Philippines, Working Paper C.

76

V. Imprvving PubUc Repwaion

17. Quesdons about network economics, scale economies, aveae and incrmental costs, demand elsticities, cro-subsidies, productivity impwvents, procureme, and he level of retahod earninp simply cn not be ansredwithout accuate data from the reevant carries. 'k is therefore apparent,' concludes one leading group oftlecomnunications economists, 'that the greatest enmhasb in the area of regulaky sector reform should be ondeveoping the basic tools and information sources necessay to begin considering altrtive development policies.Ideay [such] progams should precede any large scale privatizaion effort, so that the coopeation of the government-controlkd PmT can be assured, before the lure of market forces inevitably begins to conflict with public regulationof the tdecommunications utility.' 'The Vital Role of Regulation In Telecommunicaiom Sector Reformw, Trendsin Communkcados PoUiy (Economics and Technology, Inc., DBoson) Vol. 16, No. 8, August 1991, p. 7.

18. Other government agencics that usually play a role in telecommunications regulation include the entity responsble formanaging the radio spectrum. the trade and industry ministry, the ministry of fnanc (or the treasury), and the defenseministry. As noted earlier, competition or antitrust aL horities may also play a role.

19. For an extended discussion of the pmctical advantages nd disadvantages organizing regulators separate from theminsby responsible for telecmunications, see M. Tyler and S. Bednaryk, 'Teecommunications Policy andRegulation." Chapter 3. op. cit., note 9.

20. See Rulawf Cr Gmcatinr: The Orlanizadonl Perspective, a report to the Secreria de Comnwukadnes yTranspores Sabsecreariade Conmamm aewnersy Desarretlo Techlogico, Economics and Technology. Inc., Boston,MA. Febrny 1991; T. E. Nulty and E. Schneidewind, "Regaory Policy For Telecommunications,' in B. Weleiuset al. (eds.). Rescwitig and MAanging kc Tekecomw ionir SecRor (World Dank, Washingto, D.C. 1989), pp.28-39.

21. The growing commercial vahe of the radio spectrum as prompted several countries to reconsiderdtieir current reginmfor specnn managemenL See. e.g.. Radio C ica SpecrManagementRefoprm, Departentof Tnsportand ic , Canberra, Astlia, Setmber 1992. Further, because the number of radio licenses soughtby tlecom service providers has risen sharply in recent years, failure to accord priory to an effective spectrummanagesnent policy can lead to large reveue losses for the government. For example, in Argentina, once theComision Nacional de Tekeomunicaciones (CNT) adopted an eflective plan for monitoring use of the radio spectum,spectrum fe increased damatcally. From 1990 to 1991, CNT reportedly colected the equialent of only $2 millionin fees; following enofrcementof its new policy, in 1992 fee revenue increased to more hn $10 milion. See A. Hiland M. A. Abdala. 'Regulation. stitutions and Commiunent Privazaton and Regulation in the ArgentineTeleco_mmications Sector.' World B oInfbrnal Discussion Paper, Draft, Policy Research Departme April 8,1993. p. 28.

77

VI. IMPLEMENNG SECTOR REFORM

Define your objectives clearly and move towards them an quantum leaps. Otherwise theinterest groups will have dme to mobilize and drag you down... .t is uncertiy, notspeed, that endangers the success of strsctural reform progrwnmes.

Roger Douglas, former Minister of Finance, New Zealand'

6.01 Prior chapters of this report have concentrated on the 'why" and the "what" of sector reform-onthe rationale for diversifying supply and greater private-sector investment, on the most promising optionsfor pursuing these goals, and on the improvements in the quantity, quality, and range of nationaltelecommunications services which might be expected upon implementation. This section of the reportfocuses on the "when" and the "how' of sector reform.

6.02 The timing and sequencing of reforms generally is crucial to a successful outcome. There isfrequently a fairly short period within which to launch a reform program, often tied to the calendar ofa government's overall economic program as well as to election cycles. Recent experience has alsounderscored the importance of the sector's financial health2 and the ability of current and prospectivestakeholders (employees, residential customers, outside investors, business users) to ate change.A purely technocratic initiative that does not adequately consider (a) the overall context of a reformprogram, (b) tbe importance of pacing or sequencing change, and (c) the need to manage a restucturingprocess over several years (even divesdture is never a "one-shot" event) is likely to fail.

A. Context: Economic and Pitdcal Conditions

6.03 Since the mid- 1980s, there has been a marked shift in the role most Asian goverments wish thestate to play in economic development. Market-oriented reform programs, which favor private ratherthan public capital, have become the order of the day across many sectors, including ports, shipping,hotels, refining, power generation, airlines, and postal services, where govermnent ownershiptraditionally was common. Industrial policy and protectionism have not always been abandoned, but incountry after country economic measures to liberalize trade, promote competition, deregulate financialand capital markets, reduce restrictions on foreign investments, and restructure pub'ic enterprises havebecome prevalent.3

6.04 These economic reform programs have put the perfbrmance of national telecomnmnicationssectors under increased scrutiny because of the crucial role te cations now play in trade,investment, and manufacturig. The commitment to establish an efficient and well-functiomngtelecommunications system and the timetable for doing so have often become a litus test of thegovernment's overall commitment to economic reform.4 Beyond that, as the private sector assumes agreater role in the economy, a new coalition of influential telecommunications users (e.g., manufacturers,import-export businesses, bankers) may be formed with an independent interest in improving thetelecommunications sector's performance.

6.05 Such user groups and their political allies (e.g., finance and economic ministries) may be crucialin launching a reform process and keeping it on course. At the outset, however, the political power oftelecommunications users is likely to be diffse and quite limited compared to that of the dominant carrierand its employees, who are usually unionized. Indeed, given that the PTT is typically one of the largest

79

Teleconimuucaions Secor Reform. Toward A New Pragmaasm

employers in the country and that its employees enjoy a privileged position (in terms of status or pensionrights), it generally will not be possible to restructure (let alone privatize) the dominanttelecommunications service provider unless employment issues are adequately addressed. The experiencesof Mexico and Sri Lanka, among others, are instructive in this regard (Working Papers A and E).

6.06 The politics of sector reform also make it imperative that the needs of users, residential as wellas business, be considered. Because the tariff regimes of most PT&Ts are only loosely linked to costs,with local service often provided below cost, a program which leads the dominant carrier to rebalanceits rates may provoke a polidcal "backlash" unless it is properly justified.5 Again, as with employmentmatters, such issues are best dealt with at the outset of the reform process so that the interested partiesare aware of what the tade-offs are and why the government believes they are worthwhile.

6.07 There is evidence that consumers are willing to accept even quite substantial rises in telephonerates if they are convinced that the funds will be used to provide better service or to extend service tonew areas. Rate rebalancing also is more likely to be acceptable if it is phased in and capped at anagreed level, subject to changes in the general price level. Such measures provide a level of certaintyfor consumers and ensure that they will not be required to bear an unfair or disproportionate burdenbecause of restruchtring.

6.08 For example, in Singapore, prior to passage of a reform bill designed to provide a frameworkfor privatizing Singapore Telecom, the government board responsible for the company directed it torebalance its local triffs. Time charges were introduced for local service, but the flat annual charge forbeing connected to the network was reduced. Singapore Telecommucations was able to increase itsrevenue from business subscrbers without adversely affecting residential users (Working Paper D).

6.09 Similarly, in Mexico the rebalancing of tariffs and adoption of a price-cap rate structue preparedthe way for the 1991 privatztion of TELMEX. The initial price cap was tied to the annual changes inthe CPI. Moreover, the govemment satisfied the concerns of residential users by writing into theTELMEX concession fairly rigorous quantitative and qualitative performance targets, with strict penaltiesfor nonperformance (including the possible loss of monopoly rights; see Worlkng Paper A).

6.10 The economic and political factors noted above are haldly the only ones to be weighed inpreparmg and implemnng an effective sector reform program, especially one aimed at attracting privatecapital from outside the country. Depending upon local conditions, other factors may include (a) recentgrowth in GDP per capita, (b) the degree of currcy convertibility and historic inflation rates, (c) theforeign investment regime, (d) the size of the local capital market, (e) the ectent of import restrictions,and (f) the magnitude of other (competing) privatzation programs, both domestic and international.

6.11 Additional political factors to be taken into account include (a) the stability of the current regime(e.g., the risk of renationalization or repudiation of reform legislation), (b) the existence of a functioninglegal system (e.g., the confidence which domestic and foreign interests have that a commercial disputemay be impartially resolved in a timely way so that, for example, the benefits of a private franchise arenot nullified through unreasonable ex post facto price controls), (c) the extent of basic conmmnicationsfreedoms, and (d) the role of the legislature.

80

WI. Implemencng Sector Reform

B. Sequene entalism Versus Quantm Leaps

6.12 As described at the outset of Chapter m, most countries, including those in Asia, have followedan incremental approach to reform, especially to market hlberalization. Typically, the market for terminalequipment is opened to competitive supply; then value-dded services, satellite-based and wireless services(mobile radio, paging) are also liberalized; and only then may the market for basic switched services beopened to new service providers. This approach has benefits as well as costs.

6.13 Incrementalism may be beneficial when a country has limited experience with managing economicrestructuring, or when there are significant political constraints.! It may also be useful where regulatoryarangements for the sector must be established de novo. However, incremenfalism may have anunacceptably high cost where there are very large unmet demands and a massive infrsucture programultimately will be needed to close the gap. Further, depending upon local conditions, incrementali maydissipate public support for reform which, once expectations have been raised, may perhaps be satisfiedonly by a bold initiative capable of demonstrating a clean break from the past. See, for example, theexperience of New Zealand (Worldng Paper B).

6.14 Whereas an incremental reform program may or may not work best in opening the market to newsuppliers, international experience suggests that a step-by-step approach is almost essential wheredivestiure is involved. Ideally, divestiture should be preceded by (a) a restructuring process in whichthe state-owned carrier is com ialized, and (b) separation of the goverment's regulatoryresponsibilities from its policy-making and operational roles and placement in a separate organization(Chapter V). Further, it is important to get the sector structure 'right' before divestiture. Investrs needto know the competitive structure for the market at the outset. Major stakeholders in a newly priva izedoperator may oppose the licensing of other carriers or a regional divestiure (along the lines of the AT&Tconsent decree) urless these policies were published prior to privatization.

6.15 Further, divestitue experience in a large number of countries has highlighted the importance ofaddressing labor and trade union concerns in advance. Failure to do so may well delay or even deraila divestiture program because civil servants and managers working for the state-owned operator (andthose at similar enterprises) are likely to use their influence to block any divestre program that doesnot make adequate allowance for their interests.

6.16 The advantages of restrucatring and commercializing the stat-owned operator prior toprivatizaon are at least twofold.7 First, a successful resructuing program will enhance the operator'sperformance and will help to increase the sales value at the time of privatization.' Indeed,postprivatizationrestructuring may lead to a situation where all the economic benefits of the restucturingopportunity are realized by the new owners while much could have been captured by the governmet(i.e., the seller). Second, a successfil restucturing program can enhance management and laborproductivity and morale, build confidence in the privatization process and reduce likely objections ofemployees.

6.17 In Asia, Malaysia and Singapore followed effective divestiture processes: restructuring of thedominant carrier and the creation of a regulatory authority preceded the divestiture (Figure 6).9 In thesecases, conmmcialization of the main carrier received priority equal to that of privatization. And inMalaysia, Telekom Malaysia was priv-azed as part of a multisector reform program, as was the case withthe privatization of TELMEX. Depending on the ci tances in a particular country, more rapidreform may be justified (Working Paper A).

81

Telecomnitwuoions Sccor Refonm Toward A New Pragmatism

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82

VI. Implmendng Sector Reform

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83

Tdecommucations Sector Refonrm Towad A New Pragmatism

Figure 6

The Sequencing of Reforms: International ExperiencePossible Routes to a Liberalized Market

Country Sequence

MexicoMalaysiaSingapore

Argentina

Japan

U.K.

New ZealandGermany

5 = Restructuring

Ed = Privatization

_Competiton

84

W. Inmlpmenting Sector Refonn

C. banaging the Process: Leadership and Coordination

6.18 In contrast, the divestiture of NTI in Japan was carried out prior to adequate restructuring or thecreation of an independent regulator. Competition has suffered, as have company stockholders. In 1992,the market value of NTT's shares fell 70 percent from their historic high value, due in part to thegovernment's refusal to require appropriate access charges for competitors to use NTT's network, theabsence of tariff rebalancing, and the postprivatizaton announcement of a possible proposal for a regionaldivestiture of the company.

6.19 International experience has usually shown that a successful telecommunications reform programnmst have the unflagging commitment of the president or prime minister. A country'stelecommunications infrastucure, no matter how underdeveloped, is one of its ciief national assets, andthe complex task of restructuning the sector, let alone managing a divestiture with the competingeconomic, social, and national security interests involved, cannot be effectively done without strongleadership at the top.

6.20 Such leadership is a necessary, but not sufficient, condition for change. For that to occur, across-government and cross-private-sector coalition must be built (see Box 18).10 Again, experienceshows that momentum for reform comes most often from without (e.g., outside the PIT and the ministrythat has oversight), not within. It is critically impor, therefore, that ministries of finance, budget,and industry be committed to a reform program. Likewise, a reform program is most likely to moveforward if it is championed by a broad coalition of users and would-be suppliers. The support of thetelecommunications operator itself, however necessary, may do as much to compromise the reformprocess as to propel it.

6.21 Leadership at the top and a reform coalition requires coordination. This may be prvided by anad-hoc, high-level committee, an interministry task force supported by worldng groups and advisorycommittees, or some other structure. But regardless of the means used to steer the process, publicparticipation-particularly by user groups-will keep the process moving.

6.22 There will also be a need to coordinate the tele ications sector reform process withreforms in other sectors. In this regard, the World Bank or other multilaterl lending agency mightaugment the telecommunications component of more broadly tared public enterprise reform orstructural adjustinent loans. A reform program in one sector-telecomnmications-may have importantimplications for the reform of other sectors, for example, electric power, transport, and water. Suchlinkages, and the synergy possible from joint reform initiatives across various economic sectors, are asyet quite limited in most UICs. But as market-oriented reforms gather momentum in key Asian nations,more and more cross-industry alliances are &ely to be formed, if only because the primary constituencyfor reform-business users of public utility services and would-be competitors-often overlap.

85

Telecoundcaions Sector Reform Toward A New Pragmatism

Box 18

Crafting A Reform Agenda:Local World Bank Workshops

Local workshops jointly sponsored by the World Bank, leading user groups, and the host govemmentcan catalyze the process of sector reform.

At the outset of the reform process, there are typically several competing proposals for action beforethe government, some of which are championed by the 17TT, some by finance and economic minis-tries, and some by user groups. Outside consultants and independent commissions of inquiry may alsohave addressed the issue. A carefully structured two- or three-day workshop open to a broad cross-section of govemment and private interests, including major telecommunications users, can providean invaluable forum to air competing perspectives on reforms; to outline the Bank's own experiencein other countries; to introduce the views of outside experts on sector restructuring; and thereby tobuild both the momentum and the constituency for action.

A December 1991 telecommunications reformn seminar in Jakarta is one case in point. The semninarwas jointly sponsored by the World Bank, the Indonesia Ministry of Tourism Posts &Telecommunications, and the state-owned telephone company, PT Telekomunikasi Indonesia. It wasattended by private business interests, consumer representatives, telecommunications consultants.government officials, and Bank staff. The extensive preparations necessary for the seminar and theintensive exchange of views during the two-day meeting led the government to focus its energies onthe telecommunications reform issue in a new way. The seminar also provided a unique opportunityfor major telecommunications users-which previously had no formal means of expressing their viewsto the government-to underscore their concems. The government also had to respond.

Similarly, a two-day World Bank workshop on sector reform took place in New Delhi in November1992, co-sponsored by the Industrial Credit and Investment Corporation of India Ltd. (ICIC). Theworkshop brought officials from the Department of Telecommunications (DOT) together with civilservants from other ministries, users, and various international experts. Among other things, the NewDelhi workshop highrlghted the importance which nontelecommunications officials have played inadvancing the reform agenda. (In Mexico, for example, responsibility for the TELMEX privatizationwas placed in the Ministry of Finance, not the Ministry of Communications; in Malaysia a special civilservice unit was created to drive the reform process.)

The New Delhi workshop also highlighted the parallels between reforming the electric power sectorof a country and reforming its telecommunications sector. It was noted, for instance, that India'sstat-owned power generating business had already been divested to state electricity boards, with theMinistry of Power retaining the policy-making function and the Central Eectricity Authority acting asthe independent regulator.

The parallels between the electric power and telecommunications sector also suggest the possibilityof joint World Bank workshops to bring together offcials frorn each sector. It is significant that theWorld Bank'i Industry and Energy Division has held several workshops on sector reform. Theseworkshops have stressed the importance of divestiture as well as "bottom-up" privatizations involvingthe construction of private generating capacity and long-term power purchase contracts, tools thatalso apply to 'bottom-up' privatizations in the telecommunications sector.

86

VW. mplemennt g Sector Reorm

NOTES

1. Douglas, Roger. Urflnishd Business. New Zamland: Random House, 1993.

2. Most observers believe dhat the establishment ofa sound (iLe.. profitable) telecommunications business is a prerquiiteto privaion. Hence, tdeecommuncaus opeatlors considerin this course geneally have tried to put dteir ownbouse in order first (e.g., as in Mexico or New Zealand). However. in exceptional cicumstnces and at some riskto the sales price and the result it may be possible to pridtize an operator whose financial rcord is relaivelyuncerti (as in Argentina).

3. In East Asia. econom reform has generally been spunred initially by land reforms that sharply raise mcomes in thecountryside foMowed by (i a tansfer of profits and labor fom farming tO industry, (n) high savings rates whichfinance indotial investments, (ii) low taxes, (iv) vigorous domestic competition; and (v) an opemess to foreigninfluence via foreign prices, goods, invesment, technology or a combmnao of all four. See 'A Survey of China'The Economist, November 18, 1992. p. S.

4. For example. where a goverment seeks to atact capil for a general program of privatization, a sucesfid sale ofshares in the national tdecommuniatins company may bave a large impact on the terms of tbe sale of other statecompanies.

S. Notably, tdis factor has limited stucrl reform of NTT in Japan where NTT reported a $4.4 biDlion deficit for localservce in FY 1990. See Y. Takano. Nppon Telegraph and Telephone P diatitio Study." op. ciL

6. Chinas apprch to reform of the tel - sector has been marked by gdualism, d liand adaputio. 'Its large size and provincial strucure foster sh experimns and make such an

appach nappropiat, if not inevitable. P. HaroK 'Cbinas Reform Experice to Dame,' Discussion Paper No.180. The World Bank, Washingon, D.C. 1992. p. 4.

7. For furtier discussion, see Tecommcations Sector Isues and opms. European Bak for Reonstumc andDevelopmnt London. March 1992. See also "Recommendations for the Privatzation of the Offce NadonaLe DesTelacommdmicarions Republigue De Cdte D 7voi,' Booz, Alen & Hamilton, Inc., January. 1991.

8. In order tu detrmine the price they are willing to pay, ivestrs need to know the regulatory regime applicable to thecompany post-privatution. Uncerinty with regard to the applicable regime resuls in lower investor interest andsales price. Regulatory staliy, backed by a credible undertag by the government not to modify it, or at least notto the detriment of the company. may be essaent to auract buyers. See P. Guislin 'Divestiture of Stat Enterprises.'op. cia, pp. vu-ux.

9. This order may not be 'ideal,' of course, in Asian LICs such as India or Bangladesh, where restuctrig woudd lielydelay tbe licensg of much-needed ncw opeators.

10. k is significant that both the _n and railways p antio in Japan were strted by the PrvionalComission on Admnsative Reform. a consutivebody to the prioe minister. Mostof the comnssiosmemberswee selcted from the private sector and included representatives of prate companies and labor unions. professorsat private uiversities. and representatives of nonpfit organations. The commissnwas chaired by a praFt-secwrexecutive widely known for his personal itgrity. and thus exhibited the objectivity necessary to engender publicsuporL As a condition for assuming a charmship of the commission, ths executive secured assuance from theprime misr in public that the conmission's recommendations would be implenented Consequently, decisin onprvation could be caried out drectly beten the prime miniser and the commission without direct supervisionby a specific minitry, such as the Ministry of Post & Telcommuniations. which was initially not supportive of thepriatizaton. See Y. Takano. "ppon Telepbone & Telgraph Pdvation Study,' op. cit., pp. S. 9. and 122.

87

APPENDIX: SELECTED TELECONMMUCATIONS INDICATORS

Figure A-1: Waiting Time for Telephone Lines ....................... 91

Figure A-2: Teledensity and Wealth in Low-Teledensity Countries (fewer than1 main line per 100 inhabitants). 92

Figure A-3: Teledensity and Wealth in Medium-Teledensity Counties(1-10 main lines per 100 inhabitants) .92

Figure A-4: Teledensity and Wealth in High-Teledensity Countries(more than 20 main lines per 100 inhabiants .93

Figure A-5: Pay Phones, 1991 (selected countries) .93

Figure A-6: Cellular Radio Subscnbers, 1991 (selected countries) .94

Figure A-7: Pagers, 1991 (selected countries) .94

Figure A-8: Interational Telephone Circuit Traffic for Selected Asian Countries, 1991 95

89

Appendix: Selected Telecommunicatons Indicators

igupe A-1: Waiting Time for Telephone Lines

Micronesia '10Nepal >10

Lao P.D.R. >10Westem Samoa >10

Philippines >10

Vietnam . 10Myanar10Mongolia ,10

Cambodia >10

Sri Lanka 9.9Thauland .&6

Bangladesh 8.4

Pakistan 6Fiji 52

India 4.9Brunei Darussalam 3.7

Indonesia 2.6Kirbat t 1.3

Maldives 1.1Malaysia 0.9

China 0.8New Caledonia 0.8

Papus New Guinea 0.5Macau 02

Singapore 0

0 1 2 3 4 5 6 7 8 9 10

Number of years from 1991 to eliminate waiting list based onrecent growth rate in main lines

Source: ITU, Asia-Pacific Telecommuniations ind!cators% 1993.

91

Telecommunications Sector Reform in Asia: Toward a New Pragmatism

Fiure A-2: Teledensity and Wealth in Low-Teledensity Countries (fewer than 1 main ln per 100inhabitants)

T.hdus ini Linpssi 100 Iulml1.40~~~~~~~~~~~~~~~~~~~~~~

1.20

1.00

0.80

0.60

0.40 o

0.20 GOto

0.00 DCurh0 100 200 300 400 500 600 700 800

MDPPeiCqi CS

Sac ITU, A*Pawlk TeenWfniaus bn, 193

F re A-3: Teledeniy ad Wealth in Medim-Teledensity Countries (1-10 main linw per 100

Tchh Ml liiupw 1X0 hibilst

12

6 rip

4 b

awdows=1 u p

50s 1,000 I 50 2,000 2.500GOPu(Pei tm (SI

Sourm: ffU. Amad keIA sh hudbs 1993

92

APPenfdt: Selectd Tedelecm ufdcadiw Indkaon

ylpe A- Tdemdty ad Weat in HgbhTeledeuht Coustre (X11e t_n 3 m11d NM Pr13o IhbIotants)

TeboMftUfspe10hdaMf55

50

45 0

40

35

30

25

2010 5,000 10,000 15,000 20,000 25,000 30.000

Sour ffU, AW&fPc Tecmnmkohar In*l 1993

igue A-S: pay Phones, 1991 (selected counries)

4 1Repubis of Korea

India

InKdonesia

Thaltand

Phippines

Pakistan

0 10w 200 300 400 500 600 7 60 90

Thousandslnds 1969

Source: MIT. Sbme. Py.mmid Research and AT&T

93

Telecommunicadons Sector Reform in Asia: Toward a New Prgmatsm

fgu A.6: Celulr Radio Subsciibers, 191 (selected co tries)

Japan , -, \s i . .,., 11.1jaw

Malaysia I 3.9

Repubic of Korea .3.8

Thailan; 3.7

Philippines 0.5

Sri Lanka 0.1

Indonesia 0.1

Paidstan 0.1

China 0

0 2 4 6 8 10 12

Celludar moble telephone subscbers per 1000 inhabimints

Souce: ITU. Asia-Pacifc rebcmmurkajorks dto, Ig93.

Ftu A-7: Pagers, 11 (selected countries)

Thalland,.

Mwaysla .

Indonesla .. :

Paidan

Sri Lanka E, ,..

0 20 40 60 80 100 120 140 160 180 200

Thousands

Source: ITU, Siemens. Pyrmid Research and AT&T

94

Appeadbx. SLccred Tekeommwicoiion Indicators

Figue A-8: Int1n.ooml Tdepone Circuit Traffic for Selected Asian Countries, 1991

mons low0

f un00|* Ouong

* 800 |SW Incoming

700

600

500

400

300

200

100

BUQigIdSuI Indomnm Japa MalaysI. Pakistn Phtilppbies Republicof VietnamKorea

Source: TeIe-Gsography (1992), Washington, D.C.

95

GLOSSARY

This glossary is not meant to be a definitve lexicon, but rather an aid to the reader in understanding theterms found in this volume.

Aces charge Fee imposed by local exchange carriers (LECs) on interexchange carriers and on endusers to defray that portion of the costs of the LEC's facilities that are associated with or otherwiseassigned to the provision of interexchange services.

APT Asia-Pacific Telecommunity.

AT&T American Telephone & Telegraph Company, the largest U.S. provider of domestic and intema-tional long-distance conications services.

AUSTEL The Aualian Telecommunications Authority.

BCC Business cooperation contracts.

BOC Bell operating company, a local exchange carrier in the United States that was part of the Bellsystem before the breakup of AT&T. There are seven regional Bell operating companies (RBOCs),each of which has one or more BOC subsidiaries.

BRTA Bangladesh Rural Teleconmunications Authority.

B-T Build-tansfer (scheme), generic term for both Build-Opeate-Tnsfer and Build-Transfer-Operatesequence.

Carrier Any individual, partnership, association, joint stock company, trust, corporation, or governmentagency that provides telecommunications facilities or services for hire.

Cellular radio telephone service A telephone service provided by low-power radio transmitters arrangedin a honeycomb pattern to permit reuse of a frequency many times in a given area, mainly for mobileuse but also in fixed applications.

Central office A teecmunications exchange or switching facility.

CNT Comision Nacional de Telecomunicaciones.

Common carrier A carrier that provides teleconication services to the public at large and isgenerally subject to nondiscrimination requiremeuts.

Cream skimmin A situation in which market suppliers can selective choose to serve only the morepmfitable areas (i.e., the "cream' of the market), for example, high-volume, lower-cost routes, whileignoring areas which are less profitable.

Cros-subsidization The practice of using surplus revenues generated from one product or service tosupport another.

97

Telecommcations Sector Reform in Asia: Toward A New Pragmatism

CPE Customer premises equipment. This includes telephone handsets, key telephone systems, privatebranch exchanges, and other termial equipment necesary for the transmission and reception oftelommunications, located at customers' premises.

CPI Consumer price index.

DACOM Data Communications Corporation (Korea).

DECT Digital European Cordless Telephone.

Debt financing The long-term borrowing of money by a business, usually in exchange for debt securitiesor a note, to obtain working capital or other funds necessary for investment or operations or to retireother indebtedness.

Deregulation Removal of a regulation or regulations governing a telecommunications service or pro-vider. The deregulated service or provider is principally subject to the dictates of the marketplace.

Developed countries Refers to the industialized nations, particularly all members of the Organizationfor Economic Cooperation and Development (OECD).

Deveoping countries A broad range of countries that generally lack a high degree of industializafion,infrstrucur, and other capita invesent or advanced ling stndards among their populations asa whole.

DGPT Departm General of Posts and Telecommumcations (Vietnam).

Digital exnge (digitl switch) An electronic switching system using logic circuits that handle digitalsignals without converting them into analog form.

Digia transmission system A transmission system in which information is ransmited in a series ofpulses and in which the signals can be regenerated.

D _minant carrier A regulatory classification for the tele nications provider that has the largestmarket share or is otherwise able to exercise market power.

Damsat Domestic satellite (usually domestic satellite operator).

DOT Department of Telecommunications (India).

Doopoly The market situation in which there are only two sellers of a particular good or service.

Economies of scple exist when a production function exhibits increasing returns to scale.

Ecanmies of scope exist when the production of two or more products in a single firm leads to lowercost than when the same volumes of the same products are produced in separate firms.

98

GiOs

Electronic messaging The creation, transfer, storage, and retrieval of text, graphics, images, voice, ormessages of any nature entirely by electronic means. Messaging implies retrieval at the recipient'sdiscretion. Facilities are generally provided for filing, redirecting, and replying to messages received.

ENERSIS Chile's electric power distributor.

EPZ Export processing zone.

Facimile service The commuimications process in which graphics or text documents are scanned,transnitted (typically via dJ-up lephone line) and reproduced on paper by a receiver.

FCC Federal Communications Commission, the U.S. telecommunications regulator at the federal(national) level.

Fibe-optic cable A communication cable containing one or more low-loss, highly transparent silica,glass, or plastic fibers used to transmit information in the form of light (i.e., signals in the visible ornearly visible region of the frquency spectu).

Franchise Authorization given to a company by a govenent to provide a public stility service. Itusually specifies the geographic area of service and other obligations and privileges.

VIZ Free trade zone.

ICIC Industrial Credit and Investment Corporation (India) Ltd.

INSAT India's satellite communications operator.

ISDN Integrated services digital network, an all-digital network handling a multiplicity of services withstandard interfaces for user access.

fTU Intemational Telemmucation Union, the speciaized agency of the United Nations responsiblefor international telecommication matters.

Leased line A communications facility that is provided to the customer for a flat monthly charge.

LEOS Low earth orbit satellite.

UC Low-mcome country.

Long-diance service A telecommunications uransmission service, particularly telephone service, thatconnects locations which cannot be reached with a local telephone call, that is, which lie outside ofeach other's local exchange area.

Long-distane network Network imvolved in transporting information from one geographic location toanother. Often called the toll network in North America and the tunk network in Great Britain.

Loop See 'Subscriber loop."

99

Telecommunications Sector Reform in Asia: Towd A New Pragmairsm

Ma_ahagar Npigm (MNlTL) India's state-owned telephone company for provision of services in theBombay and Delhi areas.

MIC Middle-income country.

Microwave radio link A radio transmission system using frequencies above 1 gigahertz (GHz), capableof carrying large numbers of telecommunication circuits using beams relayed by means of highlydirective antennas.

Mobile services Radiocommunication services between ships, aircraft, road vehicles, or other stationsfor use while in motion or between such stations and fixed points on land.

Monopoly A market structure with only one firm selling a given good or service and no other firmsselling closely related goods or services.

MPIT Ministry of Posts and Telecommunications in various countries, e.g., China.

MT7PO Municipal Telephone Project Office (Philippines).

Network facilies All equipment, sites, lines, circuits, and software that are used to provide telecom-munications services.

NPC National Power Corporation (Philippines).

NYNEX Regional Bell holding company operating in the northeastern United States.

OECD Organzation for Economic Co-Operation and Development, an intergovernmental organizationhat is a forun for the industrial countries.

OFTEL Office of Telecomunications, the regulatory body set up to supervise the implementation oftelecommunications policies, competition, and licenses in the United Kingdom.

OPTUS Australia's second teleconmiunications operator.

Packet switchig A data communications service in which a data stream is divided into units called'packets' (typically composed of approxiately 200 characters) that are separately routed to adestination where the original message is reconstituted.

PMX Private branch exchange.

PCO Public call office, a telephone station available for the use of the public, generally on payment ofa fee to an attendant or a coin box.

PCS Pesonal communcations services.

PECC Pacific Economic Cooperation Council.

PIT Philipines Long Distance Telephone Company.

100

Glossary

Price cap regulation A method of regulating prices whereby a 'cap" is placed on the prices of a basketof services, with annual increases tied to an inflation factor.

Private network A teleconmmnications network that is separate from the public switched telephonenetwork, based on a configuration of leased or owned facilities.

Privauzation Transfer of a utility organization (such as a telecommunications operator) from govemmentownership to private ownership.

Provincial P&T Provincial Post and Telecommunications Administration (China).

PSIN Public switched telephone network, a country's public telephone system, including land lines,exchanges, trunks, central offices, switching centers, and, in some countries, the telephones.

FrO Public telecomnications operator, usually a company or entity offering a publictelecommunications service.

PIT Post, Telegraph, and Telephone, usually the name given to the government department ̂ r stateentity that provides postal and tele unications services.

Public udlity co ission An agency charged with regulating teecommunications or other public utilityservices, usually within a state of the United States. Sometimes called a public service commission or,more generally, a regulatory agency.

Raio paging A service that provides selective calling from any telephone through a base station to oneor a predetermined group of radio receivers, which emit an audible, visual, or tactile alert andsomeimes then record a numeric, alphaic, or even a short verbal message.

Radio spectrum The portion of the electromagnetic spectrum within wich frequeces can be generatedand detected by electronic means.

Rate base regulation Regulation of prices that common carriers charge, based on fixing a rate of returnon the carrier's investment or rate base.

Rate-of-retun regulation A synonym of Rate base regulation.

Regulation The process ensuring that public utilities such as common carriers operate in accordance withlegal rules. These rules may govern the offering of service by a carrier and include practices,classifications, and definitions.

Regulatory agency An agency empowered to control and monitor the commercial activities of radio andtelevision broadcasters, cable system operators, telecommunications carriers, or any other public utilityin the public interest.

Resale The sale or lease on a commercial basis, with or without adding value, of telecommnationsservices leased from a telecomnmnications carrier.

RSA Revenue sharing arrangements, a form of build-transfer scheme (Indonesia).

101

Telckowuications Sector Reform in Asia: Toward A New Pragmadsm

SEZ Special economic zone.

SLT Sri LaIka T o ncations Company.

SP Singapore Post PTE Ltd.

SS7 Signalling System 7.

ST Singapore Teleco ications PrE Ltd.

STZ Special telecommunications zone.

Subscriber loop A link, usually a pair of wires, between a customer's station and dte switching centerfrom which the station is served. Same as "Local loop."

TAS Telecommunications Authority of Singapore.

TDC Telecommunity Development Conference (Asi).

T'elbnking A service which allows clients to carry out bankig transactions firom dheir home orbusiness over a communication network, such as videotex.

TelecomAsia A build-ansfer telecommncations operator in Thaiand (fimerly CP Telecom).

Td_eenty Number of access lines relative to population.

TeleFonica Long-distance telephone carrier (Spain).

Teleport A facility ging access to a satelite network or other long-haul tlecommunons network.Though usually comected to a building or real estate complex offering shared tenant services (suchas a free enterprise zone or industrial park) a teleport sometimes also strvces the greater regionacommunity beyond the tenans of the individual development.

TELMEX Me.-ico's main telecomnications pator.

TFFZ Teleconmmmications fiee trade zone.

TOT Telephone Oganization of Thailand.

TVE Township and village enterprise (China).

Type I Class of Japanese telecommunications operators and service providers that own their facilities.

Type I Class of Japanese teleommunicatons operators and service providers that lease facilites fromType I carriers to provide service to the public.

UnIera seice The concept tbat every individual withi a country should have basic telephone seimceavailable at an affordable price. The concept varies among countries.

102

Glossary

Vdaueadded (enhanced services In general, services that add value to a basic transmission service ormodify subscrber-supplied messages. There is, however, no simple definition of what is a value-addedor an enhanced service. The FCC advanced the following definiion of an enhanced service in itsComputer H decision: "The offering of computer processing applications (in conjunction with, or asan enhancement to, information transmission capacity) which act on the format, content, code,protocol, or similar aspects of the subscriber's information, or which permit storage and retrieval ofinformation by subscribers. "

VAN Value-added network(s), communications networks or systems which are enhanced or have valueadded through data processing such as protocol and code conversion, storage, and forwarding.

Voice mail Message and storage service; the telephone equivalent of electronic mail.

VSAT Very small aperture satellite terminal.

103

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NL. 2112 Atakicrq Ale$uood . Anmie Tinker and Maijnrie A. Koliulnuky

No. 2113 PIoertn Rrdrnuior ime l-ai t : 3a;7e .Srlenr Revolntoen. FridaJtilianwoi

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No. 214 F'roti ,llnfacrocovnif Corrticreion to PublitcSector Re$nn: 77ce Critiial Role ofEliruarinO. Eduard io WVe%ner 1).

No. 21 ( China: Rerforve aned Ievs'lopmenteerin I 1992-93. lPeter Hrrold .cnd Kajir Lail

No. 211. 7iue Reforcee APblic Bsu tI>fhlie Yires jot .'hyiitiUltue inIi vain Mlarconm. Odiii Knudwum. and Johnl Nash

No. 217 Mat.ltlanaic! Fisherr Reusorero: Pcrt'ed-circp o!f a S%ympmnpoaen C('-Sponwsoredl Icy the Wi'orld laceL' .i,k d Pt'nvvee'uave lieeirrry o/

li:shiers held en nimae Perre.June 1992. Eduardo A. LoayZa

NIo. 2 1 8 (;oh'eprrariu. atnt rire leakutp 1lAtaer Alechlaniazed lFanpu: 7laorc'g-al Pevryeurir and Enmpirrcal lividernr. Klaus W.1)einingcr

No. 21 I)9 eeloptnenr of RutRral Finaciail Mtarker.u in Suib-Salearate Africa. Sabapatcy Thillairajah

No. 2201 77te .Laretione Tranesrpt CfliS. HanmJ. I'ctcrs

No. 221 Polity-lA-r.ed IFinrnvc: 77te L-tptrice cu of lJo!,r Japan. ThecJapaiicsc DiXvclpneuit IBnk anid Thc Japan lEcornoincKcscareih instituitc

No. 222 Alacroeu-otoeni,A .Iavc.Creccrz uve (J/Civna. I'ioer'edinp !C f at Cocrrrenrie iu l)aha,ce.Junt' 199.. ditted b Il Peter larroild. E.C. Hnwa. and Lou Jmt'eI

No. 223 7lie l)11ridolocerer oft /tier Pri'uri Secror iet a Smae,lI lioveonvy in 7arasigion: ITue (a.e °! lMongolia. Hyoclceo I lani1

No. 224 Ti'eurdtl lviron, et'ral Stratt:yfiy.r hia. (cartcr lrTIndei and itaic%hl Kaim inkutty

No. 225 "F'ormrt' lIeu re Xaigel Otlrer rlIydhc aboct: 7radte: P'lrece, r:outard. .Ice11enhandei Inupe'rt. etv ritre kG Cavti )golher .llajorlcirdceraal Eono- 1n11Ce (anil 1i iLar 7hury Alaie for D)ez'elopcianc (Coaierrie3). JC.In Ilanelit

No . 226 .Alocuzolia: FIIrl aeiqVe lidietgatii' fidricp! hcononeuil Tvraacc.iriov. KeN liillg W\l

No. 227 { i:is ereioteo l,and Aljrkeu: lxj'oeoe ogrlcr I:ailrd .Soi.lit Lxpi'tii'zei. AIaIII lierteaId anid 11ertrnd ItCnIAud

No. 22Y IorrJohi Icieu'ecncencct icr !)eive'Io;iui (Kounurio.ec Editcd by Stijii Ciaeswei and Sudrsibian (A;i0ptU

No. 22') A.I.oVolia: .4Ar ofFul I;lnrrnbler Grcp i .1 Tranesiteo 6.12cItcnvny. Caroline iarper

No. 2301 Raisinethc Plodriuriv ity ofi iine' Itanners ic .Seub-SaIhcravc a.rean ta. Katniuc Saite

No. 231 Agcridtkreal iixgecrsion ice AfJia.f Aruna Baglhec

The World Bank

Headquarters European Office Tokyo Office181 11 Strect. N.W 6t .avrenuc d'kna Kokuumi Iluulding A r4 2

W.'lumgton. 1) C. 21'433. U.S.A. 751 th I 'ai. lrmncc 1-1 Marnaoucht 3-.honmcCluvuda-ku. [Iokvo I llI.Japin

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