PART IV 4. Regulation and liberalization of telecommunication and its impact on growth

Regulation and deregulation means the establishment and reduction of state oversight and of constraints on firms in the telecommunication sector. Liberalization means the opening of the markets to competition.

Telecommunication literally means conveying information from a distance. Countries regulate the telecommunication sector in order to restrict natural monopolies³⁷ and their externalities as networks and spillover effects on public welfare, such as health, information and defense. Empirical studies indicate that public-owned telecommunication companies tend to be less efficient than private ones as markets with open competition perform better than markets with no competition.³⁸

Critics have suggested that efficient incentives may not always be present if the newly privatized firms operate in a monopoly or uncompetitive market. Privatization of assets could decrease efficiency if there is a lack of competition in the market and firms with market power fail to take advantage of least-cost technologies or otherwise engage in inefficient practices (see, for example, Leibenstein, 1966).³⁹ In this case, the costs will not be reduced and the quantity or quality of services might not always be ideal unless they are monitored, which means imposing additional costs that could offset any savings. Thus competition has a great role for successful privatization.⁴⁰ Competition in the telecommunication market passes savings on to consumers and reduces popular suspicion of monopoly abuse. Private telecom companies cannot price significantly above their long-run marginal costs, though they may be able to in the short term if demand temporarily outstrips supply, but only for as long as it takes to build additional capacity.

Some free markets proponents claim that if we deregulate telecommunication Adams Smith’s invisible hand would trigger a consumer-friendly explosion of diverse telecommunication products at efficiently low prices.⁴¹ Others claim that the government need to intervene in order to protect consumers against consolidation and monopoly.⁴² Studies demonstrate that regulating monopolies is less efficient than deregulating them. Regulators often lack the necessary technical skills, and their political considerations tend to distort the regulatory process, and they are more often exposed to capture. Thus fostering competition in the telecommunications industry in SEE countries might yield better outcomes than regulating them. This is also supported by technological evolution. For example, as the price of mobile communications decreases, mobile networks become cheaper to deploy sparsely populated areas
Regulation = Competition = Investment = Penetration
The economic theory of regulation was originally developed by Stigler (1971) based on the optimizing behavior of politicians and interest groups. Regulators would be subsumed under politicians who would maximize votes by pleasing some interest groups and burdening others. Imperfect information is a prerequisite for the success of interest groups and propaganda in convincing citizens to vote in favor of a politician who places a net burden on them.⁴³
The primary drive of investment in telecommunication is the level of expected returns and the risk and uncertainty associated with these returns considering the high investment networks costs. Investment returns and risks are associated with a wide range of secondary factors that can influence them, economy-wide or specific to the telecom market and company.

Economic factors that affect investment are GDP per capita, demographic/geographic characteristics, economic cycles or fluctuations and general regulation (not sector specific). By modeling the supply and demand of the telecommunication industry, Roller and Waverman (2001) found that GDP per capita has a positive and significant effect on the demand for investment. On the other hand, in specific situations an increase in the GDP per capita might be inversely related to investments. Thus the rate of return on investments in emerging markets, such as in SEE countries, should be higher, and investments (per capita) should also be higher. Demography, structure and distribution of human population may also require increases in investment in network infrastructure, while migration to urban areas may reduce the necessity to invest in rural areas, while low population density may require higher investment levels. Economic cycles or fluctuations are linked to increases and decreases in investment in property, plant and equipment. Investment in communication networks peaked in 2000, driven mainly by investment in infrastructure to support 2G mobile telephony, investment by new entrants into the fixed telephony market due to market liberalization that provided local loop unbundling, and investments by both incumbent and entrants in national and international backbone networks as well as the auctions for 3G mobile telephony licenses.

Since 2001 investment in the telecommunication industry in Europe declined as a result of the deflating of the telecom bubble in 2000. Some companies experienced high debt by acquiring new technology (3G licenses, investment of new entrants in backbone networks) and thus accessing capital. In contrast, the investment in the satellite industry followed a different pattern with its peak in 2003 and later decline. In general, liberalization in the European market that started in 1998 required a lot of investment in infrastructure while in subsequent periods the need for such investment diminished.
Access regulation is the most important aspect of regulation in the telecom sector. This regulation relates to infrastructure-based competition and stipulates that the incumbent has an obligation to supply network services (interconnection)⁴⁴ to new entrants and to share with them network elements (e.g unbundled local loops). Access and interconnection between carriers enable users to call anybody and to receive call by anyone. The lack of interconnection is a major barrier in telecommunication competition and can lead to a change of the regulation. (ex. the U.S.).

New investment is highly correlated to how the agency regulates access. An initial low-access price may increase opportunities for later investment if entrants need an early phrase of service based competition before they engage in facility based competition. Limited access conditions deter entry but at the same time encourage entrants to invest in their own network (Cave and Vogelsang, 2003). It is often argued that prices should be set lower in order to counteract the anticompetitive nature of the incumbent and to encourage competitors to invest more in infrastructure. If prices are too low, regulation might lead to inefficiency. If fixed costs are related to the bottleneck, the regulator needs to determine how much the entrants should contribute toward fixed costs of a service they use to supply their customers. Conversely, particularly favorable conditions could erode the value of the first mover advantage (Jorde et al, 2000) and might delay investment by new entrants (Pindyck, 2004). Jorde argues that unbundling the network access works in favor of new entrants and reduces incentives for the incumbent to upgrade the network and deploy new systems. Any investments in new businesses are risky, and in the case of success, rivals will share benefits while in failure the incumbent will bear full costs.

Some countries liberalize all markets immediately. However, developing countries adopt a different approach where incumbents retain a monopoly over so-called basic telecommunication services or international long-distance fixed voice services, and the corresponding network infrastructure. Ghana and Uganda adopted a more radical approach by awarding licenses for a second network operator prior to or at the same time as the sale of a strategic stake in the incumbent operator, leaving the latter with no exclusivity period.

In understanding and justifying government intervention in the telecommunication sector, we should consider the transaction costs imposed on the parties involved in the contract. Different institutional arrangement can affect transaction costs, and some will be more efficient than others. According to Robert Thomas and Douglas North, development of a legal system to enforce contracts was critical to Western economic development because it reduced the costs of commercial transactions essential to a modern specialized economy.⁴⁵ The Government has the power to impose duties on individuals through an effective legal system. It is believed that government intervention is justified if it clarifies ambiguous property rights or somehow reduces transaction costs.⁴⁶

Fully defined property rights would provide less reason for government to intervene in markets in a world with no transaction costs (Coase).⁴⁷ Ambiguous property rights make it easier for one party to harm others without gaining their consent. Cleary and fully defined property rights would protect third parties from not participating in the transaction and make it easier for the parties to get engaged in variety of different voluntary transactions. Transactions in efficient markets are characterized by at least one person better off, no one else worse off, and no single transaction failing this test.

These guidelines justify government intervention as a form of regulation as long as they aim to clarify ambiguous property rights or otherwise reduce transaction costs.

Countries that have fully liberalized telecommunication markets have adopted different combinations of antitrust and sector-specific regulatory instruments.⁴⁸ Studies show that countries that strike the right balance tend to have more competitive telecommunication markets. However, balance in the market for fixed local service matters less if prices are set below costs as they discourage possible competition.
4.2. International regulation of telecommunication
Beside domestic law, international law regulates telecommunication industry because of its transnational nature. For example, as national law regulates rights and obligations of the telecommunication operator to use public and private property, international law regulates rights and obligations of operators that would like to construct wireless (satellite) or wireline (cable) networks across and between sovereign jurisdictions.

Relevant international organizations for regulating telecommunication are: the International Telecommunication Union,(ITU), World Trade Organization (WTO),and the Satellite organizations, INTELSAT, INMARSAT and EUTELSAT.

ITU legal instruments are constitution, convention, administrative regulations that are binding to Member States. In addition, the various ITU bodies adopt not in practice very binding instruments, recommendations, resolutions and decisions The constitution sets forth the fundamental legal principles that govern international telecommunication law (Chapter VI). According to Article 37 and 34, the public has a right to communicate by way of the international service and has a right of privacy. However, member states have a right to exercise reservation of the majority of provisions, such as with respect to termination of telecommunications (Article 34), suspension of service (Article 35) and avoidance of any responsibility for damage and related claims.

The agreement between states over the international accounting rates was one of the most important issues that was agreed at the ITU. The International Accounting Rate comprises a series of related rates, such as a collection charge⁵⁰, accounting rate⁵¹ and settlement rate⁵² that are intended to provide equitable payment to the terminating operator for the termination of the international call and, where relevant, to any transit operators that have handled the call.
The World Trade Organization⁵³ is another organization relevant to the telecommunication industry as it facilitates administration, operation and enforcement of multinational trade agreements. The WTO Agreement on Basic Telecommunication Services (signed 15 February 1997 and came into effect on 5 February 1998)⁵⁴ sets the basic telecommunication sector principles: independent national regulatory authorities, transparent licensing regimes, controls on dominant or major suppliers, a competitively neutral universal service obligation, transparent licensing regimes, and cost-oriented interconnection.

In the absence of direct effect under national or EU law the only possible mechanism for a party that seeks enforcement against another member state to comply with the obligation related to telecommunication sector is through WTO Dispute Settlement Body (A Panel). If the member state fails to enforce the decision issued by the Panel, the complaining party may suspend trade concessions and obligations not only in telecommunication sector but even in other sectors under the same agreement (GATS).

International law regulates satellite markets in a number of treaties and conventions. The international space and marine law provide principles and regulate rights and obligations in launching satellites, liability for the damage caused by satellite or any other space object and property rights to lay submarine cables.

International space law provides principles for satellite launching and operation, especially with respect to liability of damage cause by the satellite or any other object.

The Outer Space Treaty⁵⁵ agreed at the United Nations in 1967 is the primary international law source for telecommunications satellites launching and operation. The Treaty regulates the following: outer space and celestial bodies may not be subject to national appropriation (Article II); states are responsible under international law for their activities in outer space carried by governmental or non-governmental authorities (they require authorization and continues supervision), (Article VI), the international damage liability of the State that launches or procures the launching of the object into outer space (including the moon and other celestial bodies the object and the State from which territory or facility the object has been launched) to another State (Article VII), States in which the object is registered has jurisdiction and control over any object in outer space(Article VIII).

The right to construct wireless (satellite)⁵⁶ cables is governed by international conventions adopted at international satellite organizations such as INTELSAT, INMARSAT and EUTELSAT. Current non-geostationary system that operates in medium earth orbits (MEOs and ICO) and low earth orbits (LEOs) such as Globalstar is a multinational private consortia that operates under private agreement and is subject to national legislation.

The EU telecommunication Satellite Organization (EUTELSAT) currently has 48 members with a purpose to ensure that the satellite companies, now private since 2001, respect the basic principles of pan – European coverage, universal service, non-discrimination and fair competition.

As part of the EU liberalization program, Member States party to any international satellite organization has the obligation to notify the Commission of any measures that could breach European Competition Law.⁵⁷

International law (the UN Convention on the Law of the Sea) and national marine laws both regulate landing rights in respect to laying down submarine cables.⁵⁸ Environmental laws and national and local planning lows regulate the establishment of cable landing stations.

The EU Access and Interconnection Directive does not explicitly state cable landing stations, but implicitly those and other facilities mean access and interconnection and therefore impose obligation SMP operator.

Some EU member states have already adopted national legislations that impose obligation upon incumbent operators to access and interconnect with other operators to its submarine cables.

The international organizations and treaties provide intergovernmental accepted principles, rules and regulation for the telecommunication sector. The international trade agreements regulate market access and competition while the sea and space treaties regulate rights and obligations of operators through their respected governments.

ITU continues to be a very relevant organization for the telecommunication sector especially in ensuring international cooperation. In the near future, the WTO role as the forum for telecommunication law will loose its importance as countries are moving towards telecommunication liberalization, as the EU legislative framework moves towards less detailed competition telecommunication model. WTO, EU and Satellite regulations might loose their significance in the telecommunication sector as most countries start to rely on open competition laws, which means that international law looses its significance in regulating the telecommunication sector. Although this might be true for developed countries it might not be relevant for developing countries such as SEE states as their markets and institutions are underdeveloped and because of the existence of the pervasive corruption problem. For the SEE countries WTO role in settling disputes in telecommunication should remain very significant as their telecommunication markets are still not liberalized and developed. SEE countries lack conditions for enforcing competition law because of judicial corruption, weak property rights protection, lack of judicial knowledge and any case law in the telecommunication sector.

Thus, developing countries such as SEE states should design strict, predictable and enforceable telecommunication regulations in accordance with the EU and WTO requirements and rely on their enforcement institutions, arbitrations or panels in resolving possible telecommunication disputes.

The U.S. is a leading country in the expertise in the competition in telecommunication as they had a long tradition in regulating private telecommunication carriers and because they are pioneers in regulating competition in telecommunication. Other countries adopted their model with many modifications. Specialized regulatory agencies such as Federal Communications Commission (FCC) and general agencies like the state public utility commissions (PUC) and antitrust authorities regulate telecommunication sector. Federal Trade Commission and the Antitrust Division of the Department of Justice (DOJ) are competent in ensuring effective competition. Both DOJs and FCC are responsible for mergers and acquisitions in the telecom sector.

Up to the 1980s the telephone industry in the U.S. was practically a natural monopoly.⁵⁹ The AT&T (Bell) company started as a vertical integrated company that offered network services along with manufacturing equipment.⁶⁰ Because AT&T offered only standardize equipment (Western Electric) to its subscribers and it charged prices above costs for it, and how the pressure from the enterprenuers arose. Competition in long-distance telephony can originally pinpointed to the emergence of the microwave technology that confronted AT&T cross-subsidized price structure. The liberalization of telecommunication initially was invoked by MCIs antitrust suit against AT&T in accordance with violation of Section 2 of the Sherman Act of 1980s under the essential facility doctrine⁶¹ as the later refused to allow MCI to interconnect with AT&Ts local distribution facilities.⁶² The US District Court of Columbia issued a judgment in favor of MCI. According to the courts’ decision the AT&T in1984 was broken into seven regional Bell companies as independent local exchange carriers (Baby Bells) in exchange for being permitted to enter into other business lines (such as data services) and compete with virtually no restrictions in long distance (inter-LATA) services. In addition the court imposed a number of lines of business restrictions in offering local telephone service if they posses a strong market power such as entering into certain lines of business including long distance services, information services and telecommunication equipment manufacturing. In 1989 AT&T was relived from the rate of return regulation and came under flexible price caps.

On 1994, AT&T share of revenues of the long-distance market went down from 90.1 to 55.2 percent ⁶³ and as a result of that in 1995 the FCC reclassified AT&T as a non-dominant carrier for the domestic and international telephone service with the consequence that its long-distance telephone rates stopped being regulated⁶⁴

Rate of return regulation (ROR) the U.S. used many years to regulate telecommunications carriers. This regulation has a positive side as it limits monopoly rents and provides a stable environment to attract investment. The negative side is that it provides limited incentives for firms to cut costs and improve efficiency. As markets become more competitive the incumbent may overprice monopoly services to subsidize competitive services. Firms may use this kind of regulation in order to undermine rivals ability to compete with them. Therefore the US adopted a price cap regulation a formula that sets in advance to determine the price increases for a firm’s services for a period to several years. During this period the firm may benefit of it incremental productivity gains. The price cap formula may cause prices to rise less rapidly during the period, the firms will have an incentives to invest in new services and regulators might order price reduction that reflect productivity gains.
Price caps has an advantage that it reduces firms incentives to cross-subsidize and thus reduces a firm’s profits. The main disadvantages to price caps is that they create incentives for firms to cut on the behalf of the quality of their service; the price levels might be inappropriate over time as a result of unexpected changes in demands or in real costs. Thus the shorter periods plans help to ensure that the rates do not drift too far out of line but they also reduce efficiency incentives as the firms will get an unfavorable adjustment to prices if it improves efficiency. Longer price caps are appropriate for experiences regulators that are able and have knowledge to reduce the uncertainty.
In 1990s FCC started to use price cap regulation for AT&T and it worked well as both AT&T and consumers benefited from this regulation promoted by the increase in the competition. After implementing price cap regulation for AT&T the FCC adopted a hybrid of price cap and ROR regulation for local exchange carriers. This hybrid plan allowed the local exchange carriers to keep all their marginal productivity gains until the rate of return reached a certain level. Above that level the carriers had to share further efficiency gains equally with their customers, which reduce their efficiency incentives by 50 %. At a still higher rate of return the plan reverted to pure cost-plus regulation. Under this hybrid plan many firms increase their efficiency, but the drawback of this approach is that this regulation might be good for some firms while it might cause financial distress to the others. Thus FCC introduced several options: firms could choose a lower price reductions in which case they would have to share its profits with the consumers, or choosing a pure price caps (with no sharing the gains with consumers) but have to agree with higher annual prices reductions.

Telecommunication Act from 1996 originated form the Communication Act from 1934 provides the following legal framework for the U.S. telecommunication regulation:

- The rules applicable for wireless telephony⁶⁶

- A new regime for universal system facilitated by subsidies at state and federal level with an aim to facilitate access to all rural areas at affordable conditions including school libraries and health care institutions. ⁶⁷ and

- Pricing rules applicable to all telecommunication carriers (FCC regulates interstate long –distance telecommunication services and the state utility commissions regulate interstate long distance and local services.

State utility commissions like FCC regulates the prices of interstate long distance and local services and consumer protection. Unlike FCC have cross sector responsibility including energy and transport companies. State commissions also play a role of a mediator and arbitrator when the operators are not able to reach an agreement (the state commission may set the price).

The Department of Justice and its Antitrust Division enforce antitrust law. It ensures that a markets in the nation functions competitively, vigorous, efficient and free of undue restrictions.⁷¹
Federal Courts enforce telecommunication laws and its constitutionality, conflicts of jurisdictions, the regulatory agencies compliance with the Administrative Procedures Act, antitrust cases. Federal regulators and state level regulators are political appointees with regulatory commissioners at a federal level are appointed by the president while at the state level by the governor, legislature or directly by the state voters. Antitrust regulation and competition regulation can complement the regulation if regulation does not address the same question it can be an substitute.
For SEE countries that lack strong sate and regulatory institutions ROR regulation is not appropriate as it is costly and subject of abuse in the absent of judicial precedents. A price caps regulation or a hybrid form is more simple and transparent than ROR regulation and it is more suitable for SEE countries because of the problem of institutional corruption. In addition because SEE regulators are not very experienced, able and have knowledge to reduce the uncertainty, price cap formula should be determined on a shorten periods that would enable regulators to enjoy flexibility in the case of the unforeseen circumstances.

5.2. U.K.
The liberalization of telecom in the U.K started with the Governments Decision to privatize BT, instead of breaking it up virtually along the lines as was the AT&T case in the U.S.

The U.K. telecommunication policy has some specific features compared to other countries in my analyses. Like in the U.S. the specific rules regulated Telecom industry and the licenses of various operators and the regulator has the same enforcement power as the antitrust authorities, meaning that it is empowered to implement general antitrust provisions. A key features of the UK telecom system are the strong emphasis of the facilities based competition and reliance of price caps to regulate retail and wholesale market. The BT was forced to provide equal access to telecom services to competitors and to unbundled its local loop. The UK was the first to experiment auctions with 3gb licenses.

Between 1912 and 1980 the State was the owner of the UK telecom sector in the absence of competition. In the meanwhile the important reform was the transformation of the General Post Office (GPO) from a government department into a public corporation through the1969 Post Office Act.
Liberalization of telecom initially started with the Telecommunication Act from 1981 which granted Government with powers to authorize another competitor to compete with British Telecom (BT) and to supply and maintain terminal equipment. It ended the BT monopoly over terminal equipment. Thus the Mercury Communication Limited got the license to operate the new voice and data system based on digital technology.⁷²

The Act established an independent sector-specific regulatory authority the Office of Telecommunication (OFTEL) and the officer Director General of Telecommunication.

OFTEL regulated the prices through an RPI-X price cap applicable to a weighted basket of services. In 1984 the basket included local and domestic long distance services and covered about half of the BT ‘s total sales. International telephone services, private circuits and apparatus and connection charges were not part of the regulated basket.
The U.K. legal regulation of telecommunication is based on the EU legal framework as a member state. In particular the EC Licensing Directive which defines the set of general conditions that apply to all providers of publicly telephone services (Condition 1-36) such as transparency, objectivity, proportionality and non-discrimination and special conditions which are only triggered only in certain circumstances (Condition 37-64). ⁷³

The Directive also sets the certain procedures for appealing against national regulation authority decisions, such as the national courts can review decisions concerning the grant of refusal of licenses, the inclusion of license decisions and the enforcement and revocation of licenses. The Courts can review the procedural issues of the decision. Besides judicial review the courts apply competition rules as well.

The U.K. also adopted the Equal Access Directive (EC) 98/61. The Articles 81and 82 from the EU Treaty set a basis for a Fair Trading Condition and allows the DGT to take immediate enforcement against anti-competitive agreements

and dominant power abuses.

Across the EU region most states to some extent control ownership in the telecommunication industry being former national monopolies. Since 2005 most governments no longer retained a majority, France sold a stake of France Telecom in mid-2005 to alleviate its own debt burdens, while Iceland in August 2005 instigated the sale of its remaining 60% share. A number of governments retain a golden share in their national incumbents, which allows them to veto decisions that could fundamentally change the structure of the company. This could potentially be used to block hostile takeovers. For example the European Commission (EC) has endeavored to suppress the use of golden shares in an effort to eliminate cross-border barriers to investment, and to boost mergers. EU targets have included Italy’s Telecom Italia, Denmark’s Tele Denmark and the Dutch companies KPN and TPG. In October 2002, the EU acted against Italy and Spain over laws preventing foreign firms from taking over privatized utilities.

- The adoption of the Service Directive⁷⁵ of 1990, which opened the sector to limited competition

- Full liberalization, known as “1998 acquis,” totally eliminated any special or exclusive rights, introduced the authorization regime which permitted the use of individual authorization for public telephony services as well as the establishment of terrestrial or satellite infrastructure and imposed requirements for operators with significant market power (SMP)⁷⁶.

From 1990s to 2005 the EU adopted several Directives aimed to remove the restrictions in the telecom market in the area of services, cable use, mobile network and competition. In 2002 the European Council adopted the New Regulatory Framework (NRF)⁷⁷ and the European leaders agreed on the Europe 2005 Action Plan aimed at fostering the development of the knowledge based economy in Europe from 2003-2006. In 2005 the EC adopted the 2010 European Information Society 2010 initiative to foster growth and jobs in the information society and media industries.

The Directore General of the Competition Commission has a power to intervene against undertakings engaged in anti-competitive practices, and could even require from the Member States to fundamentally alter the terms of entry in a particular market, it is responsible for electronic commercial issues including regulating the provision for “information society services” usually offered by telecommunication service providers and is also responsible for data protection issues

Finally the Court of Justice plays the major role for the telecom market development in the EU states in deciding cases related to telecommunication, in interpretation of the telecommunication measures and questions referred by the national state authority.

In April 2002 the EU adopted a new regulatory framework that entered into force in July 2003. Ministers agreed to five elements for the package: the Access and Interconnection Directive, Authorisation Directive, Universal Service Obligation Directive , Data Protection Directive and Local Loop Unbundling Regulation. The EC has a competence to review the national authority decisions and can veto any national level decision if the EC court finds that it impedes the functioning of the single market or favors a dominant operator (meaning if it has a significant market power).
In 2000, the EU adopted a “ Regulation⁸⁰ on unbundled access to the local loop”⁸¹ provides in details guidance for national regulators on how to give new entrants access to the copper wire “local loop” of the former monopoly service provider. It also sets out the requirement for the publication of the reference offer, which was later replaced by the Access Directive.⁸²

The Competition Directive adopted in September 2002 consolidates previous directive on liberalization. Primarily, the Directive requires the member states to abolish special of exclusive rights relating to electronic communications and networks.

The main purpose of this Access Directive⁸³ was to impose obligations on operators to unbundle their local loops to competing operators on non-discriminatory terms and conditions. The unbundling can be full, meaning the competing operator takes full control over the local loop, or shared, where the incumbent operator hands over the digital traffic over the xDSL channel according to the agreed standard.

The Access Directive requires member states to oblige SMP operators to allow different providers to access their networks. SMP operators are obliged to publish a Reference Interconnection Offer (RIO) which outlines the terms in a transparent manner, including pricing under which interconnection agreement can be concluded.

SMP operators are obliged to respond to the requests for interconnection based on the RIO and must do so in a non-discriminatory manner. The National Regulatory Authority (NRA) for communication in each country can request a SMP operator to revise its RIO, if it determines that RIO does not provide terms that are conductive to competition. According to the Commission local loop unbundling obligation is still not fully enforced by Estonia, Cyprus, Lithuania, Latvia, Malta, Poland, Slovenia and Slovakia while problems with effective interconnection still remain in Estonia, Lithuania, Malta, Poland and Slovakia.⁸⁴

In 2002 EU ministers drafted the Universal Service and User’s rights Directive (USO)⁸⁵ for electronic communication such as telephone, fax, e-mail and the Internet. According to the Directive the countries should provide telecommunication services to all areas of their country, even those areas that are remote and expensive to connect. Member States can choose the method of funding for the service, public (the State) or private (operators) or combination of both. Article 19 of the Universal Service Directive requires carrier selection and pre-selection from all operators of fixed telephony with significant market power.

Carrier selection and pre-selection are the basic mechanisms enabling competition in the liberalized market. It allows a subscriber who is connected to the incumbent operator’s network to select a competitive operator to perform local calls, long distance calls, and international calls by dialing a carrier selection sequence.

In some member states the scope of USO has not yet been fully defined in accordance with the Directive. In Germany, the law did not require that connection to the public telephone network should permit functional Internet access, while in Ireland the NRA and the incumbent argued the definition of “functional Internet access” itself.

The Authorisation Directive⁸⁷ eliminates the use of licenses in the telecommunication networks by introducing operators notifications.

The new updated Data Protection Directive⁸⁸ has application to all communication services and networks with an aim to ensure the confidentiality of communication.⁸⁹It addresses the processing of personal data and the privacy protection in the electronic communication sector.

With the “ 2003 acquis” the E.U. amended the regulation of the telecommunication sector. It introduced extensive use of general authorization where the operator can start telecommunication services without permission from prior regulators. Only activities that require access to limited activities may be subject to individual authorizations. The definition of SMP operator the states should set up fairly narrow after rigorous analyses based on competition law principles.⁹⁰

In 2004 the EC opened the final stage of infringement proceedings against Belgium, Greece and Luxemburg.

To summarize: the European legal framework in the telecommunication sector has an aim to promote competition that would led to more investments within Member States, innovation and increase consumer benefits by lowering prices to the consumers and by ensuring that all citizens can afford the basic communication services at an affordable price. It is designed to ensure cheaper communication services for all by facilitating competition in national liberalized markets. The EU strategy objective is to promoting growth and job opportunities.⁹¹

A key component in facilitating competition is identifying operators that posses Significant Market Power (SMP), generally classified as one that holds a market share of 25% or a more in a communication market. It is obliged to provide new entrants an opportunity to compete with SMP operators by creating a fair playing field. The EU Regulatory framework still needs to be enforced in many countries, for example in Greece. Also not all countries have established regulators or are entirely independent from government influence.
5.4. Australia and New Zealand
Both models are not suitable for SEE countries but it is worth looking at them too.

In Australia generic competition regulator (The Australian Competition and Consumer Commission) and a sector - specific regulator (The Australian Communication Authority) regulate telecommunication industry. The ACC has jurisdiction over interconnection regulation, whereas the ACA has responsibility for licensing, technical regulation, spectrum regulation and consumer protection.⁹²

SEE countries can not imitate both models as they lack a generic competition regulator, and their judicial institutions differ. Further dual regulatory bodies will raise costs as well as it would require implementation of coordination measures.

In conclusion, there is no unique model for regulating the telecommunication sector. The central question and main dilemma in each country is whether to regulate or deregulate the sector and to what extent. In addition the countries should decide whether to delegate the regulation to the particular Agency or leave it as a subject to general competition law, or combine them both. The existing models range from one to another extreme: granting considerable powers to federal regulatory agency the U.S. model and to leaving it solely subject to normal competition law (New Zealand). The E.U., Chile and Australia models are somewhere in the middle.

The adopted EU Legislative Framework for telecommunication regulation is consistent with the EU general competition law. Under the Directives regulators first must conduct market analyses to determine whether the markets are effectively competitive or suffer from Significant Market Power (SMP). Ex ante regulation is warranted only in the latter case if necessary, justified and proportional.

In the U.S. the telecommunication sector is heavily regulated; thus it’s very costly protected by the constitutional provisions, administrative law and extensive case law. In U.K. the Parliament has a power to intervene in the telecommunication sector and change laws, which threatens the stability of any legal arrangement. This system can potentially lead to investors lack of confidence but had not been the case perhaps because in the past the political party system was stable.

In designing telecommunication regulation for the particular country we need to consider that the investors look for credible and stable regulation as they would like to be confident that their investment will not be subject to regulatory opportunism such as through prices changes.
5.5. South-East Europe⁹⁴
5.5.1. Telecommunication privatization
Privatization in SEE countries was initially introduced in 1989 with the Law on Social Capital in the Former Yugoslav Federation. The government and its prime minister, Ante Markovic, introduced the concept of privatization through which internal shares were issued to all employees of socially owned enterprises (SOEs).⁹⁵ In this process the enterprises in SEE states were transformed into joint sock companies or limited liability companies. The real privatization boost came after enactment of the Law on Transformation of Enterprises with Social Capital in 1993. Under this Law, previous privatization through internal shares was generally recognized, but only after an audit of official supervisory institutions, authorized by the law to approve privatization transactions made by the previous law.

The primary motive for privatization of state-owned enterprises in SEE countries including telecommunication has been a widespread belief that the private sector is inherently more efficient than the public sector in that a private contractor is motivated by profit to achieve greater efficiencies and better customer service than a public enterprise. These efficiency gains, if realized, should eventually reduce costs to the taxpayer of supporting the former state-owned enterprises⁹⁶ and improve services.⁹⁷

The Law on Transformation of Enterprises with Social Capital into companies with fully defined ownership rights had a following objective: increasing the efficiency of the economy, attracting foreign capital, developing a capital market and providing new possibilities in servicing the internal and external debt of the country. Unlike other sectors when the Privatization Agencies in SEE countries were in charge of privatization in the case of infrastructure and utilities (ex. Power Utility, Telecommunication) they were under the authority of respective ministries.

Prior to privatization the state owned entity PTT (Post, telegraph and telecommunication) state owned entity provided telecom services and there was no accounting or structural separation between the telecommunication and postal services and military and national security agency often had a significant influence in both.

The company enjoyed monopoly rights over fixed telephony services and telecommunication infrastructure. State owned incumbent enjoyed property rights (such as the use of public property for minimal or a low payment) special radio spectrum rights, special customs duties and tax exemption. The public official’s employment status made the restructuring of the firm very difficult, with too much employees and thus leading to its inefficiency. No independent regulator existed. Prior to privatization the state owned incumbent had no or minimal obligations. poor service quality, long waiting list for telephone lines, inaccurate and late billing an limited range of services. The tariffs were not balanced with high international and long distance tariffs (above costs) and cheap, below cost installation, line rental and local call rates. The lucrative revenue generated form high international and long-distance tariffs the state used to subsidize the below-cost local tariffs, keeping them low for political and social reasons. The PTT company provided sometimes services below costs of free for some government officials or ministries, or waiting for late payments.

5.5.2. Regulation of telecommunication and growth in SEE states

Before 1990s, SEE states regulated the telecommunication industry, which lead to low penetration rates, poor service quality, and financial difficulties of the incumbent operator. After the 1990s, privatization of telecommunication companies by foreign investment began.

The telecommunication sector is a driver for growth in SEE states not only because it is an important service industry but also because it enables infrastructure for an information society. In analyzing the development of the telecommunication sector in SEE states we consider three networks: a public switched telephone network (PSTN), a mobile network, and a broadband network.

In SEE countries, poor economic and unstable political conditions in recent years led to low investment in all telecommunication sectors. Telecommunication infrastructure in a large part of the region was damaged during the conflicts in Bosnia and Kosovo, resulting in a decline of living standards and no growth. For example, Serbia’s per capita GDP fell by 50%–60% during the some periods in 1990s.

The number of subscribers of PSTN and generated revenues in the region are declining. The penetration rate (subscribers per 100 population) has declined from 27.6 to 25.8 due to the availability of alternative communication opportunities—mobile and broadband usage; however, it might also be the result of strong tariff rebalancing without sufficient consumer protection in terms of low usage tariff options forcing low-income users to terminate their subscription as being unaffordable to them.(Appendix, Figure ) All SEE countries, except for Croatia, have low local call tariffs and high international call, tariffs which is considered typical for unbalanced tariffs.⁹⁸


Figure 2 – Positioning of countries according to their residential tariffs for local and international calls measured by partial purchase parity euros relative to EU average tariffs.

The Figure 2, places countries and geographic units based upon their tariffs.

The first cluster has low local tariffs and high international call tariffs that are typical for unbalanced tariffs. The other cluster has tariffs that are moderate above EU average and international call tariffs that are around EU average.

The EU monitoring studies show that SEE countries have inbound tariffs significantly higher than outgoing tariffs, except in Kosovo and Bosnia & Herzegovina. A good example might be the case of Bulgaria and Turkey, where it costs eight times more to call into the country from the U.S. than a call in the other direction. The difference between incoming calls and outgoing calls seems to be a reflection of the old ITU accounting range system, which previously defined tariffs for international calls. This might indicate a lack of sufficient competitive on termination of international calls or of the national termination rates defined by RIOs of the SMP operator that are not yet available for termination of international calls.⁹⁹

The pricing for three minute call for residential users in Bulgaria, Croatia , Romania and Turkey are at a level that is slightly below the European average, Kosovo is more less in the same category (Appendix, Figure 3). On the other hand in Serbia the price for local calls is extremely low about 5% of the European average. A three-minute call costs about 1/15 of the costs in neighboring Croatia. Tariffs for other SEE countries and units are significantly lower than the EU average. (Appendix, Figure 3).
The Table 8 (see below) shows that in almost all countries and geographic units the state retained some ownership with privatization. The only exception is Montenegro, where the privatization process of the incumbent operator was completed in April 2005 by selling the 51.2% share owned by the states to Magyar Telecom. States in Croatia and Macedonia hold minority stakes, while in the other countries and geographic regions the incumbent operator retained majority ownership.



In all countries there is a growth in the use of mobile phone networks. The average penetration rate increased from 49% to 59% in 2005. This growth is a result of more competition, with two or three operators in each market. So far, only Croatia has licensed 3G networks.
Tariffs in mobile networks are considered favorable and well adjusted vis-à-vis the EU tariffs system. The only exception is Albania, where the prices rank among the highest in the EU.

The experience in the EU shows that a good regulatory environment is a good indicator for broadband growth. Member states that had success in adopting regulations in the area of local loop unbundling and bit stream access show higher growth rates than countries with less regulations. Well designed regulation considering the country specific characteristics leads to more competition, which attracts the investment that leads to more penetration. The low use of broadband access,¹⁰⁰ below the EU average is excluding Croatia is the obstacle for countries growth as the national economy can not benefit from participations in EU markets including the gap in the high gap in the living standards in the E.U. and SEE countries.

In 2005, all SEE countries established an independent regulator, the National Regulatory Agency (NRA) in accordance with the EU Framework, but it does not always mean that legislation is sufficient for effective independence. National legal traditions, culture, and path dependence influence the work of the NRA; therefore, SEE countries should focus on establishing independent bodies in practice. SEE countries and geographic units, except for Albania¹⁰¹ and Kosovo, have adopted laws to liberalize all networks and services.

The EU legislative Framework requires that states apply general authorization without the need for prior approval unless it requires the use of limited resources, in which case the fee should no be higher than necessary to cover NRA administrative costs. Only Macedonia adopted a primary law¹⁰² to set up this framework, and the process is still in progress. It requires adoption of secondary legislation to make the legal provisions effective. The other countries require individual licenses. EU legislation sets up conditions for designating SMP operators and their obligation is to publish a reference interconnection offer (RIO)¹⁰³. Only Macedonia is in the process of implementing these legal provisions, which are not attractive because of the high interconnection costs. SEE countries have still not implemented the process of carries and pre-carries selection in accordance with article 19 of the Universal Service Directive.

Carriers and pre-carriers selection are the basic mechanisms for enabling competition. Carrier selection allows a subscriber connected to the incumbent network to select a competing operator to perform local calls, long distance calls, or international calls by dialing a selection sequence. Pre-carrier selection allows a subscriber to make a permanent selection of an alternative operator for all or certain types of calls. Only in Croatia have the first two operators started this pre-selection activity but no carrier selection. SEE countries and geographic units had adopted legal provisions concerning reference unbundling offer (RUO) and local loop unbundling¹⁰⁴ and, but have not yet started their implementation.