OECD Economic Studies No. 32, 2001/I REGULATION, MARKET STRUCTURE AND PERFORMANCE IN TELECOMMUNICATIONS By Olivier Boylaud and Giuseppe Nicoletti TABLE OF CONTENTS Introduction ................................................................................................................................. 100 Regulation and market structure in telecommunications: a cross-country perspective ... 102 Past trends in regulatory reform............................................................................................ 103 Summarising regulatory reform for empirical analysis ....................................................... 111 Evaluating the effects of regulatory reform on performance in telecommunications........ 117 The empirical approach taken here...................................................................................... 119 The performance data ............................................................................................................122 Empirical results...................................................................................................................... 124 Conclusions.................................................................................................................................. 133 Annex. Panel Data Estimation Techniques ......................................................................... 139 Bibliography ................................................................................................................................ 141 The authors wish to thank Dimitri Ypsilanti, Sam Paltridge and Wonki Min for providing comments and data that made this work possible. Comments by Michael P. Feiner, Jørgen Elmeskov, Sally Van Siclen, Deborah Roseveare, Jens Høj and Isabelle Joumard greatly improved the quality of the paper. Martine Levasseur and Mary Thomson provided able statistical assistance. The opinions expressed in the paper are those of the authors and do not engage the OECD or its Member countries. 99 © OECD 2001 INTRODUCTION Over the past two decades, the institutional and regulatory framework of the telecommunications industry has changed radically. In most OECD countries, public telecommunications operators (PTOs) have been fully or partially priva- tised and regulations concerning access to telecommunications markets, provision of services to users and pricing mechanisms have been overhauled. Institutional and regulatory reform was generally spurred by the rapid evolution of both tele- communications technology and the structure of demand for telecommunications services, which has eliminated virtually all natural monopoly conditions, making it possible and efficient for a multiplicity of operators to supply these services to businesses and consumers. In turn, the new market and regulatory environment is having a substantial impact on the structure and organisation of the industry. Technical progress and regulatory changes are generally presumed to have brought about improvements in the amount, the range, the quality and the prices of telecommunications services in the OECD. The size of the communications industry is relatively small, but it has been increasing over the past two decades. In the mid-1980s, the industry represented around 2.5 per cent of GDP, 1.5 per cent of consumer expenditure, between 1.5 and 2.5 per cent of total inputs in industry and services and 3 per cent of goods and services trade in the OECD area. Despite significant reductions in its relative price, in the mid-1990s the share in consumption and trade had remained broadly constant while the share in GDP had risen to around 3 per cent and (partly as a statistical phenomenon due to increasing contracting out by firms) the share in total inputs grew by around 1 percentage point in most OECD countries. Therefore, as a result of changes in technology, industry organisation and the structure and level of prices, the volume of communication services grew rapidly. While there is a broad consensus that regulatory reform in telecommunications is beneficial for businesses and consumers, cross-country empirical evidence is still lacking and a number of policy-relevant issues remain unresolved. A first set of issues concerns the general linkages between ownership, regulation, market struc- ture and performance: is competition conducive to productivity improvements and price reductions in the whole range of telecommunication services? Is it potential competition or actual changes in market structure that bring about the beneficial 100 effects of liberalisation? Does privatisation generally lead to gains in efficiency and © OECD 2001 Regulation, Market Structure and Performance in Telecommunications consumer welfare? A second set of issues (which takes the benefits of competition for granted) concerns regulatory design: what is the regulatory framework which is liable to lead more quickly and more effectively to the development of competi- tion? Is facilities-based competition (in which new entrants are encouraged to build their own infrastructure) superior to service-based competition (coupled with the unbundling of access by third parties to basic network elements and services)? What is the best regulatory framework for interconnection rights and access pricing? How can equal access by consumers to multiple telecommunications operators be ensured? What is the desirable degree of vertical and horizontal integration in the telecommunications industry? This paper deals only with the first set of issues. Its main focus is on the economic effects of changes in regulation that increase the role of market mecha- nisms in the telecommunications industry by eliminating barriers to entry or redefining the role of public enterprises. To this end, the paper empirically investi- gates the linkages between regulatory regimes, market environments and perfor- mance in three services supplied by the telecommunications industry: domestic long distance, international long distance and mobile telecommunications. Based on the comparative experience of a large set of OECD countries over the 1990s, it provides empirical evidence that liberalisation of entry and the development of effective competition in telecommunications services generally lead to higher productivity, lower prices and better quality. To a large extent, the analysis in the paper is of historical interest: its main policy relevance lies in finding (as yet lacking) cross-country empirical support for the entry liberalisation policies that have been adopted by the vast majority of OECD countries during the past two decades. The paper does not address the finer issues related to regulatory design that arise after basic entry liberalisation has been implemented, for which available cross-country information is too recent and sparse to allow in-depth empirical analysis. Country-specific evidence on the economic benefits of market and regulatory changes in the telecommunications industry abounds, but few studies have attempted to look at these effects from a comparative, OECD-wide perspective.1 Focus on single countries was partly related to the lack of internationally compara- ble data on regulatory and market structures. The comparative approach of this paper was made possible by the construction, in the context of OECD-wide work on regulatory reform, of a data set including cross-country benchmark indicators of sectoral regulation, market structure and performance for 23 OECD countries over the 1991-97 period.2 These data were used to investigate the linkages between regulation, market structure and performance by means of cross-country/time- series estimation techniques. The rest of the paper is divided into two parts. The next section describes the evolution of the regulatory and market environment in the telecommunica- tions industry using the data collected and the indicators constructed for the 101 © OECD 2001 OECD Economic Studies No. 32, 2001/I analysis of the effects of regulation and market structure on performance. The final section presents the analytical framework, examines the data used to proxy for the various dimensions of performance (considering also their limita- tions), and discusses the results of the panel estimates for the individual services and overall. Throughout the paper, the description of cross-country pat- terns and trends in the various dimensions of performance is kept to a minimum – extensive discussion of patterns and trends in the telecommunica- tions industry can be found in the OECD Communications Outlook 1999, which is the main source for the performance data. REGULATION AND MARKET STRUCTURE IN TELECOMMUNICATIONS: A CROSS-COUNTRY PERSPECTIVE The telecommunications industry provides many services to businesses and consumers, using a growing variety of technologies and spanning an increasing range of communications media (voice, image, data, etc.). Ideally, the effects of competition on performance ought to be studied at the level of the single markets in which these services are supplied and demanded. However, due to data constraints, a trade-off exists between the chosen level of disaggregation and the possibility to perform cross-country comparisons. Furthermore, some services (such as local fixed voice telephony) are still largely monopolistic in a vast major- ity of countries, while others (such as so-called value added services) have gener- ally been competitive throughout the nineties. Analysis of these services would not yield insights on the relationship between competition and