Case 4: Macedonia Telecommunication

Case 4: Macedonia Telecommunication

Another example of a privatization arrangement that sacrifices state interests for those of politicians because of corruption was the investment in the company Macedonia Telecommunication.

The concluded privatization contract between the government and the investor, Hungarian MATAV (later acquired by Deutche Telecomm), provided the company with a natural monopoly by blocking entry of other telecommunication carriers into the market. For example, if an internet or satellite carrier wants to enter the market, it would have to go through the fixed telecommunication networks owned and controlled by the investor. (See Part III, Section 3.4.1.)

High governmental officials decided to privatize the company quickly without parliamentary debate. Private interests influenced the nature of the contract and its provisions, such as Hungarian investor MATAV, who gained rights to fixed telephony as well as installations, rather than the government retaining these rights on, which would enable new capital to enter the telecommunication market and provide future profits from concessions. The telecom was sold without public participation, violating the required bidding process and with no information about the investor, no expert analysis of the pricing, or cost-benefits, and without time to determine if privatization was necessary for the country much less urgent, as the abbreviated process might suggest [that].

In March 2005, Bosnia’s Supreme Court backed a ruling by the Regional Court of Mostar that established that HT Mostar had a 51% ownership stake in HT Mobile. The stake in Eronet was sold to private companies based in the Croat area of BIH, drawing protests from HT Mostar which claimed that the sale was illegal. HT Mostar alleged that the past management privatized HT Moblie without a tender, share offer, or regulatory approval. In late 2002, the Hercegovian Bank, holder of a disputed 4.48% stake, transferred ownership of its stake to the municipality of Grude in lieu of frozen funds owned by the bank to the municipality. HT Mostar appealed to the Appelate Court in Mostar claiming that it had a first right of refusal when the bank sold its stake. The court ruled in May 2004 that the sale of HT Mobile shares to Alpina Commerc, Hercegovina Osiguranje and the Municipal Council for Grude was legal.¹⁵

The analyses show that corruption affects capital inflows through law and order and undermines the tradition of law and order when judicial decisions and laws are for sale. It leads to the failure of a country’s integrity, resulting in insecurity of property rights, which alienates investors.¹⁷

Corruption negatively effects growth in several ways: It represents an additional cost to the economy, distorts market competition, generates monopoly,¹⁸ eliminates regular and transparent functioning of market mechanisms, leads to poor allocation of resources, and leads to a loss of legitimacy in the state and less FDI appeal.

Corruption lowers productivity in the economy through undermining government stability. As politicians look for corrupt income through illegal payoffs, the allocation of capital goods will not be optimal, because they prefer bigger public projects, which promise large rents and low risks of discovery. Corruption also lowers a state’s bureaucratic quality as public officials get appointed not on the merits of capacity and efficiency but through nepotism and bribes. Weak state institutions, bad economic policy, and an unfavorable market environment promote corruption.

Corruption in privatization of public utility sector leads to increases in supply costs, which in turn results in increased tariffs or other financial loses leading to reduced services. Increased tariffs in the public utility sector hurt low-income households the most, since their budgets are more limited, and they may have to give up essentials, such as education and health care, while middle- and high-income families may just sacrifice luxuries.

For the poor living in rural areas, the higher tariffs and higher connection costs resulting from corrupt management practices create a higher barrier to access to the service than for the high -income. Corruption in the public utility sector leads to reduced budgetary revenues from export. Excess costs of projects and concessions are funded partly through electricity tariffs and foreign borrowing, and the illicit funds flow to the foreign accounts of government officials. The diversion of these funds harm growth and leads to lower employment, reduced resources for social programs and development of rural areas. Well known private investors in the public utility sector would be willing to invest in modernizing the infrastructure in countries only if they can count on fair and stable rules.

Hence, building strong and politically independent institutions—those connected with the markets—will help governments reduce corruption and promote growth.

rights protection and high corruption levels.

Figure 1: My own calculation

See more at: Emi Velkova, Integration of South-East Europe in the EU: Corruption, Foreign Direct Investment and Development, Harvard University Law School, ELRC, Working Papers Forum, April 7, 2006

In Transparency International’s 2005 Index (CPI), all SEE countries, except Slovenia, are ranked as highly corrupt. To put this result in a regional perspective, in the same CPI Slovenia ranked 31st with a score of 6.1, Bulgaria ranked 55 with a score of 4, and Croatia ranked 70 with a score of 3.4.

Corruption is perceived to be worse in Albania (rank 117, score 2.4), Bosnia and Herzegovina (rank 88, score 2.9), Serbia and Montenegro (rank 97, score 2.8). Macedonia (rank 103, score 2.7) is just marginally above the threshold score of 3, below which classifies corruption as rampant.¹⁹ According to Southeast European Legal Development Survey the most corrupted occupations are court officials, police and customs officers, tax officials, municipal officials and doctors. Enforcement agencies are the most corrupt institutions because they have capacity and opportunity for corruption due to their low wages,²⁰ high discretion and no accountability.

Corruption in SEE countries is a consequence of a weak property rights system and weak institutions, the Government, Public Prosecution, Judiciary and Directory of Telecommunication. For instance, the court system in Albania, according to SELDI, and in Bosnia and Herzegovina, according to the Economic Freedom Index, are the most corrupt. Judges in SEE countries are corrupted because they have low wages, high discretion, low accountability, and a willingness to make decisions against the state and implement those decisions. There exists political influence of the executive in the appointment, assignment, remuneration, and removal of magistrates. The corruption of judges through bribes and other favors prevents FDI from promoting growth in the region. Corruption reduces FDI inflows in the public utility sector and attracts lower quality investment. If judges are corrupted, the law cannot serve as an instrument against corruption; investment contracts lack legal protection

Corruption in privatization often leads the state to conclude long term arrangements with clauses that grant investors exclusive rights and other privileges that prevent competition as well as clauses that fix the price for a long time period that negatively affects countries that are politically and economic unstable.

Contracts in the public utility sector have features of relational contracts. Relational contracts are often incomplete characterized by long-tem arrangements, higher uncertainty at the negotiation stage about future consequences of present acts and the investment of the resources unique to the transaction. This implies that parties should accommodate each other’s needs during the time of performance, without any explicit arrangement.

The need for high investments in infrastructure in public utility sector ex. pipelines, cable landing, makes it difficult for the contracting party to exit from the relationship even when things go better for the one party than expected for the other.

In this type of “repeated players” contracts if parties fail to allocate certain risk, parties would still be able to protect themselves (ex. if contract fails to specify price term for some period during the duration of the contract). In the case of breach of contracts in the public utility sector damages are enormous and will rarely be fully compensatory because of the nature of the long term contract, which can lead to high losses to the parties.

Corruption in the public utility contract as a form of non-equal bargaining contracts, puts the state in a very weak and vulnerable position and puts into question the beneficial effect of an investment. Further, the state is obliged to pay damages resulting from such contractual agreements while at the same time those agreements distort market competition by creating monopolies and thus preventing growth.

The telecommunication industry provides services and infrastructure essential to end users and other services essential to a wide range of industries. Therefore, the price of telecommunication services, availability, quality and competition is becoming a key determinant for sustainable growth of the country. In OECD countries, telecommunication contributed about 2.5% in the mid-1980s to roughly 3% in the mid-1990s and lead to an increase share of inputs to industry and services from 2.5% to 3.5% on average while it remained constant at approximately 1.5% and 3% in consumer expenditures and in trade of goods and services.²¹

Many countries privatized their telecommunication operators partially or wholly and started to liberalize the telecom sector unilaterally or based on multinational agreements, such as the WTO Agreement on Basic Telecommunications, leading to greater competition in the telecom sector in the area of networks and services. Competition in network infrastructure allows new entrants to the market to build their own facilities and service, while competition provides opportunity for third parties to access the basic network, which is known as “unbundling.”

Liberalization in telecommunication has a great impact on economic growth. For instance, in Latin American countries free competition lead to growth of the telephone connections twice as fast in Chile (where the government could issue licenses at any time) as in Argentina, Venezuela and Mexico. (In these countries the incumbent enjoyed monopoly privileges for six to ten years.) In Chile, the higher growth was due to more private investments and rural penetration.²²

Consumers benefit from competition in the telecommunication market as the costs become lower. Telecommunication companies can benefit from liberalization of the telecom market if they develop a strong network through alliances or mergers because the value of the product will depend of the supply side or the number of network subscribers.


3.2. Property rights in telecommunication²³

Investors, in signing telecommunication contracts with the state, require certain property rights in order to construct, maintain and operate their networks. How many rights they enjoy will depend on the property law system and land structures in SEE countries.

Investors require the following basic rights with regard to public and private land: The right to install and maintain infrastructure; compulsory purchase powers to obtain the main sites needed for network roll out (e.g., to erect microwave transmission towers or base stations); rights to access and share the bottleneck facilities (generally included in the network regimes).Additional rights such as, cut trees or erect network infrastructure in state-owned land or environmentally sensitive areas and also coordinate the property rights exercised by different utilities.

Mobile operators in general will need fewer rights than the fixed operators

There are several options in regulating telecommunication sector such as: private contract, concession contract, discretionary regulation and variants and hybrids. They all have their advantages and disadvantages.

The main advantage of the private contract is that the rights and duties of the contracting parties are clearly defined and the contract has a greatest scope for competitive market forces to shape services offerings and control costs. However concluding private contract bears potential risks for the parties such as if it does not cover all possible circumstances, if commercial courts are weak, meaning they lack integrity or independence, and the possibility of high costs related to negotiating and enforcing the contract with small customers.

Similar to the private contract the concession contract defines parties rights and obligations. Other positive side is that the competitive market can determine supplier costs. In this type of the contractual agreement the government usually monitors the companies compliance with a concession contract, but the agency can not unilaterally change the awarded contract terms. With this type of contract the parties bear following risks concerning the incompleteness of the contract, lack of integrity of the commercial courts.²⁴ The Government represents consumers meaning that they do not participate so the market forces have a less influence. Often the government specifies the minimum quality of the provided service and the bidder who proposes the lowest tariff gets the concession award. The market conditions influences the contracts through the competitive bidding.²⁵

Discretionary regulation allows flexibility in regulating telecommunication depending on unforeseen circumstances. A regulatory commission or an individual regulator enjoys discretion to set the prices and services standards for the regulated firm.

Usually a Commission of three to seven members decides regulatory issues by majority vote or an independent regulator enjoys the discretion to set the prices and service standards for the regulated firm. In the U.S. appointed Commission sets cost of service regulation while in the U.K. before 1980s the individual regulators had the authority to decide in the original price cap that later in 1998 was replaced with Commission.

Hybrid forms

In practice most often in practice contracts in public utility sector are hybrid of the private contract, concession contract and discretionary regulations.

In some cases concession contracts that are awarded through competitive bidding are subject to more direct market forces than concession contracts awarded without bidding. In some cases the politics influence is almost unlimited such as in Sri Lanka where ministers in the Parliament set tariffs. In other cases the politics has a great influence but it is limited by various statutory and institutional constraints, including U.S. cost-of service and the British price cap approaches. ²⁶ A government awards a concession for the fixed term specifying the prices of different services. The contract interpretation can differ depending on the legal system, for example under the French law the concessionary may need to renegotiate price or service terms during the contract duration. The parties have a right to appeal to specialized administrative courts which have some discretionary power to change the contract and not just to interpret it if parties lack to agree. The legislature might set a minimum rate of return at least as large as interest paid on government debt. For example in 1980s public utility companies were suppose to earn a return at least at 10 percent per year.
To summarize: in choosing a possible solution for regulating telecommunication we have to consider the possible market conditions and transactions costs of long-term contracts. If transactions costs are high the government should intervene more in order for the market to be more efficient. On the other hand in the nearly perfect and efficient legal system, contracts can be enforced without discretionary regulation. Thus hybrid form contracts and discretionary regulation might be the best solutions for transition countries, such as in the SEE states, where market conditions are complex and unstable, thus any incomplete contract would lead to renegotiations and possible disputes. However, because of the pervasive corruption problem in SEE countries, the states should grant discretionary power to commissioners instead of regulators in order to reduce corruption opportunities.
3. 4. Monopoly

The telecommunication industry went through changes from monopoly to competition. Many countries around the world have a dominant or monopolistic operator in the telecommunication sector.

The arguments in favor of a monopolistic telecommunication structure are:

• 
  The establishment of a telecom sector imposes large fixed costs, and under the natural monopoly argument, a single company would provide better services at lower costs than two or more companies.²⁷;
  
• 
  Under the network externalities argument the network increases for each user as the number of network subscribers increase, which results in greater total value compared to unconnected networks.²⁸
  
• 
  The monopoly enables cross-subsidies between different services or users, such as rural telephony or local service with some other activities or users, such as urban telephony or international services.²⁹
  
• 
  The state has a security interest in controlling the telecommunication sector.
  

What will be the scope of government intervention in the case of monopoly in the telecommunication sector? It will depend on the possible transaction costs in particular market conditions. If transaction costs are relatively high there will be a need to establish discretion regulation. Concession contracts are appropriate if transaction costs are moderate while private contracts are appropriate if transaction costs are low.³¹

Until January 1997, the single operating company in Macedonia Postal Telephone and Telegraph Company provided a variety of communication services in the state: telecommunication, postal, banking and others. In January 1997 the company split into two shareholding companies: Macedonian Telecommunication and Macedonian Post.

On January 15, 2000, the Hungarian telecom operator Magyar Telekom, later acquired by Deutsche Telekom, acquired 51% of the capital of Macedonia Telecommunication from the Macedonian Government. Magyar Telekom’s dominant position in shares as well as in the market required new regulations for Macedonian Telecommunication. Therefore, the Ministry of Transportation and Connections (MTC) granted a concession to Macedonian Telecom (MT) for eighteen years (ending December, 31, 2018), providing exclusivity to the end of 2004 and allowing the company to enjoy monopoly rights in the following telecommunication services: fixed line telephony, telegraph, telex, public telephone, rented lines, in addition to building, possessing, renting, restoring and managing the fixed public telecommunication networks.³² The contract’s exclusivity for providing telecommunication services required a well designed system for tariff regulations under which MT would be compensated for its expenses, and thus the concession granter found a price cap appropriate for regulating the tariffs.

The price cap method, or the method of controlled percentage, forbids MT from increasing their prices above the controlled percentage calculated as the difference between the living standard expenses index (Consumer Price Index, or CPI) in a one-year period measured in percentages, increased by 6 percentage points.

CP - The controlled percentage

CPI x - The living expense index in the year x

CPIx-1 - Living expense index in the year x+1

6pp – Six percentage points
The difference between the controlled prices should not exceed the controlled percent set by the formula above. This model of determining prices provides MT with flexibility to increase or decrease the regulated micro prices.

After privatization the new MT management team dealt with existing telecom prices, which did not reflect the actual expenses and were not protecting consumers. For example, the price for local calls had always been significantly lower than for international calls as the state sought to protect the public interest. Prices for international calls, however, had always been very high, with a much higher margin than the standard one to subsidize other services. To solve this problem the MT management team started price approximation through the changes in determining the tariffs from impuls system to tariffing the blocks of 20 to 60 seconds. These measures were taken in accordance with the international standard for the telecommunication liberalization requirement. The tables below show the effective prices per minute in the 25 EU countries.

Country	E-cents, VAT included	EU 25 weighted
Maktel__19.03__35.50'>Maktel__0.571__12.40'>Maktel	0.571	12.40
IS	7.90	12.40
ES	8.90	12.40
CY	9.30	12.40
EE	9.60	12.40
DE	11.70	12.40
LV	11.90	12.40
MT	12.60	12.40
NL	12.90	12.40
UK	13.30	12.40
FR	13.40	12.40
IE	14.80	12.40
SK	17.60	12.40
BE	20.80	12,40

Data source for Macedonia: Macedonia Telecommunication

Country	E-Cents, VAT included	EU 25 Weighted
Maktel	19.03	35.50
CY	21.70	35.50
IT	22.20	35.50
EE	24.80	35.50
MT	25.10	35.50
PL	30.80	35.50
LU	30.90	35.50
DK	36.90	35.50
PT	36,90	35.50
LT	38.80	35.50
HU	46.70	35.50
AT	49.00	35.50
BE	57.20	35.50
SK	58,80	35.50

Data Source for Macedonia: Macedonia Telecommunication

Country	E-cents VAT included	EU 25 weighted
SE	0.58	2.1
CY	0.67	2.1
DK	0.77	2.1
NL	0.85	2.1
EE	0.99	2.1
DE	1.23	2.1
MT	1.59	2.1
CZ	1.80	2.1
HU	2.30	2.1
UK	2.52	2.1
PT	2.81	2.1
Maktel	2.85	2.1
PL	3.83	2.1
LT	4.07	2.1
LV	5.95	2.1

Data source for Macedonia: Macedonian Telecommunication

MT is among the most expensive providers for international calls in Europe. The absence of competition in the telecommunication market provided the company with the opportunity to maintain high rates for international calls and subsidize other services.

Table 4 shows the effect of cross-subsidization, the high share of revenues generated from international calls and other calls in MT (Macedonian Telecommunication).

Table 4

Revenues generated from regulated communication based on destination (in euro)

Time period	Local	National	Fixed to mobile	International	Total
2000	10,750,639	4,753,439	9,685,384	28,524,977	53,714,439
2001	17,090,052	6,024,466	20,550,032	25,579,537	69,244,088
2002	21,069,254	8,788,310	32,477,447	20,601,675	82,936,686
2003	23,837,236	9,669,267	33,525,166	16,789,108	83,820,777
2004	21,756,776	9,484,757	32,294,096	14,985,878	78,521,507
2005	20,606,482	8,485,506	31,454,440	13,211,239	73,757,627

Source: Macedonia Telecommunication

Source: Macedonia Telecommunication

In March 2005 the Macedonian Government enacted The Law for Electronic Telecommunication³³with the purpose to prescribe conditions for communication services, to establish a competitive market for electronic communication, and to combat the abuse of power by operators and communication providers with SMP.³⁴ The law defines an operator with significant market power as one who has the power or capacity by itself or together with other operators to provide services independently from its competitors and subscribers in that market in relation to the prices or the offer.³⁵

The law stipulates that the MT has an obligation to provide interconnection services or access to alternative providers in accordance with the Reference Interconnection Offer (RIO) and Reference Unbundling Offer (RUO). Under RIO, any operator with SMP enables its subscribers access to the services of other operators with whom he has interconnection for public telephone services. Under RUO, the SMP operator rents the local segment of its own electronic telecommunication network to the new operators by granting them access to telephone services. MT is responsible for its obligations to the agency for electronic telecommunication being established in 2005 as an independent regulatory body. The agency has the authority to supervise, monitor the service operators and service providers, stimulate non-discriminatory interconnection offers, initiate interconnection, and determine operators with SMP.³⁶ The agency is also responsible for liberalization as one of the conditions for the country’s EU accession. There are 26 registered and notified providers/operators of public fixed telephone services. In reality, however, the number of operators is significantly lower and is limited only to the international call market.

The first sign of liberalization in fixed telephone services appeared in February 2006 with the network access agreement between MT and ten more providers with lower international call prices then those offered by MT. The telephone companies Ozone and Next Tel are the most competitive providers in the country for international calling. By offering pre-paid cards they were able to gain significant profits.

The process of telecom liberalization started in international calling. Consumers currently make international calls for prices up to 70% lower than those offered by MT, although limited to prepaid cards. At the local and national level, however, monopoly still exists. Besides the RIO offer by MT, the conditions for interconnection are not attractive for alternative providers as MT wholesale prices are at or lower than retail prices and thus enables entrance of different operators at the local and national markets.