Study report on Telecommunications: Regulatory Concerns

Description
Early telecommunication technologies included visual signals, such as beacons, smoke signals, semaphore telegraphs, signal flags, and optical heliographs.

Study report on Telecommunications: Regulatory Concerns Contents
Overview 1. Regulation of NGN: Structural Separation, Access Regulation, or No Regulation at All?
Fabian Kirsch and Christian von Hirschhausen

I 1

2. Why Stovepipe Regulation No Longer Works: An Essay on the Need for a New Market-Oriented Communications Policy
Randolph J. May

22

3. The Relationship between Regulation and Competition Policy for Network Industries
David Newbery

35

4. Infrastructure-Based Versus Service-Based Competition in Telecommunications
Jörg Kittl, Martin Lundborg and Ernst-Olav Ruhle

73

5. Market Openness and Trade Liberalisation in Brazil: Financial and Telecommunications Services Sector and Intellectual Property Rights Deliverables
Umberto Celli

97

6. China's Present Regulatory Approach in the Broadband Access Sector - Its Generation and Its Effects on Competition
Zhong Liu

114

7. Microsoft and Trinko: A Tale of Two Courts
Spencer Weber Waller

139

8. Competition Policy and Market Regulation M1069 WORLDCOM/MCI
Apostolov Mico

163

• •

List of Cases Index

179 180

Overview
The prime objective of Antitrust law is to restrict unfair business practices. It promotes competition in the markets. The additional objective of the antitrust law is to protect the interest of consumers and ensure equal opportunities to all competing entrepreneurs in the global market. The rapid growth of telecommunications sector and the related new business strategies for attracting the customers have led to the enactment of Antitrust Laws to regulate the telecommunications market.Two fundamental grounds of competition law governing telecommunications are the market definition and dominance. Market definition defines a relevant market of a firm that has a dominant position in the market. Since the market evolves continually there is a risk of obsolescence. The technology neutral market definition of the new European Union telecommunications regulatory framework seems to be more flexible in addressing this issue on compared to the definitions adapted by US laws.

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Technological innovations in the Telecommunications sector and liberalization policies across the globe have the competition among the telecommunications service providers. Antitrust policy is generally based on the view that competition is desirable among service providers and telecommunications regulations in this regard had a limited application name of promoting universal service. In the USA, however, telecommunications policy makers have embraced competition law with the Telecommunications Act of 1996 to address new challenges that emerged with rapid growth of telecommunications industry. The telecommunications providers pressurized various state governments to revise the current policies and regulations of telecommunications sector and deregulate the market mechanism to encourage competition. Monopolization and vulnerability issues have become important following the Supreme Court decision in the Verizon communication Inc., v. Law offices of Curtis V. Trinko, 540 US 398,124S. Ct. 872 (2004). In the above context Doctrine of Essential Facilities has been developed by multilateral agencies to ensure basic facilities. Essential Facilities means public telecommunications and transport network facilities. The common examples of essential facilities are local exchange switching and network access lines. It becomes a matter of public interest to ensure these essential facilities to the competitors in the market. There are many barriers created by dominant players in the telecommunications market; which include government restrictions like monopoly franchises, restriction on licenses and foreign investments economics of scale - huge capital - spectrum scarcity IPR protection and entry barriers. In India the telecommunications sector till recently relied on sector specific policies. Some of these sector specific policies and regulations created problems for the development of competitive markets in the telecommunications sector. Initially The New Telecom Policy 1994 focused on maximization of

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government revenue through the public auction of regional licenses for basic and mobile telecommunications to the private companies. Subsequently the New Telecom Policy 99 focused on competition and spectrum fee being converted into the model of revenue sharing. From 2001 the private players were allowed to provide long distance services. In the subsequent year international long distance markets were also liberalized. Now on par with other developed countries India has a competition policy for telecommunications sector. India changed the Monopolies Restrictive Trade Practices Act, 1969 into a new competition law known as Competition Act, 2002. Competition law for India was activated by Articles 38 and 39 of the Indian Constitution. Articles 38 and 39 are part of Directive Principles of State Policy. Articles 38 and 39 "mandate, inter alia, that the state shall strive to promote the welfare of the people by securing and protecting as effectively, as it may, a social order in which justice social, economic and political shall inform all the institutions of the national life, and the State shall, in particular, direct its policy towards securing That the ownership and control of material resources of the community are so distributed as best to sub serve the common good; and That the operation of the economic system does not result in the concentration of wealth and means of production to the common detriment Act to provide, keeping in view of the economic development of the country". The Act also envisages the establishment of a Commission to prevent practices having adverse effect on competition and to promote and sustain competition in markets, to protect the interests of consumers and to ensure freedom of trade carried on by other participants in markets. This book contains articles that provide comprehensive view of the antitrust law and principles relating to communication industries. The first article "Regulation of NGN: Structural Separation, Access Regulation, or No Regulation at All?" By Fabian Kirsch and Christian von Hirschhausen highlights the moves taken by the telecommunication

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sector towards Next Generation Networks (NGN). The concept of NGN originated from the world of network operators. It integrates classical telecommunications network and the internet. Most of the OECD countries have declared their plan for the migration to NGNs. The effects of regulations come in the way of three trajectories such as unregulated competition, access regulation and structural regulations. The regulators take different postures on promoting the existing access network investments and protecting competition.

Randolph J. May in his article "Why Stovepipe Regulation No Longer Works: An Essay on the Need for a New Market-Oriented Communications Policy" focuses on how the telecommunications industry has undergone technological and marketplace changes since the enactment of the Telecommunications Act of 1996. In the light of the changes that took place in technology and marketplace a broad consensus is that the existing stovepipe regulatory framework is outdated and has given way for the development of sound communication policy. Author opines that Stovepipe model of regulations are to be confined to the dustbin of the history of communication policy and in its place the congress should adopt a new Digital Age Communication Act. New market oriented regime that employs the antitrust principles, of marketplace and increase in the welfare of the consumer are also discussed. David Newbery in his article "The Relationship between Regulation and Competition Policy for Network Industries" discusses whether regulatory and competition authorities should delegate the regulation of the potentially competitive elements of the utility to specialized regulatory agencies, or are solely responsible for normal competition laws. The specialized agencies are appropriate for telecom and electricity sector in the US by giving references of Australia, England and EU. The author further explains how telecommunications was privatized in the UK, and was liberalized in the

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USA. The author suggests that the energy regulatory authority should take on the task of market surveillance which should be adequately empowered to monitor the relevant markets and make changes. "Infrastructure-Based Versus Service-Based Competition in Telecommunications" by Jörg Kittl, Martin Lundborg and Ernst-Olav Ruhle analyze the market conditions and types of markets, infrastructure or service based competition that gives more favorable results for telecommunications services. Different types of business models were opened for a debate on what kind of competition is sustainable in the context of European frame work. Today's regulatory framework offers several ways of fostering competition and regulators employing different strategies in the past that are opened to the telecommunications market. The study shows that infrastructure based competition has a positive effect on innovation and is more important for business customers than residential customers. It also emphasizes that service based competition appears to be more important for residential markets than business customers.

Umberto Celli in his article "Market Openness and Trade Liberalisation in Brazil: Financial and Telecommunications Services Sector and Intellectual Property Rights Deliverables" tries to assess the internal and external constraints in the telecommunications, banking and insurance services, with respect to enforcement obligations under the country's intellectual property rights law. The exclusion of limitations in telecommunications sector, banking sector and insurance services widens the territory of Brazil in the global economy. The article highlights the conflict of interests that emerged between telecommunications service providers and regulates competition between cable TV operators without classifying the operators in a segmented manner. It also highlights that a balanced and updated regulatory framework would allow the antitrust

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authorities to better oversee the market by restraining anticompetitive practices and protecting users. "China's Present Regulatory Approach in the Broadband Access Sector - Its Generation and Its Effects on Competition" by Zhong Liu examines the evolution of China's present regulatory approach in the broadband access sector and also analyses its effects on competition in the market. Before the generation of China's present regulatory approach and the regulatory delay in broadband enclosement, the policy makers asserted a need to reform and restructure the China's telecommunications industry. One of the objectives of the China's telecommunications industry reforms is the breaking of monopoly and introducing competition in the telecommunications services. Author opines that the China's present approach on competition is not good and there is a need explore another policy. "Microsoft and Trinko: A Tale of Two Courts" by Spencer Weber Waller examines the opinion of the DC circuit in Microsoft and Supreme Court opinion on Trinko and compares these two opinions to define the law of monopolization. Evaluation of the Microsoft and Trinko opinions are the core questions of Section 2 of Sherman Act 1890, which deals with the monopoly power and exclusionary conduct. Congress desired to authorize and promote competition in the local telephone market in the Telecommunication Act of 1996. The net result in Trinko is a form of immunity for incumbent local telecommunications operators. This is inconsistent with the statutory which is set forth by congress. Author concludes that the Microsoft opinion should stand the test of time as a rigorous and well reasoned law of monopolization. In contrast the Trinko suffers from serious errors of law and antitrust policy. Apostolov Mico in his article "Competition Policy and Market Regulation (M1069 WORLDCOM/MCI)" highlights the decisions given by the FCC and US Department of Justice in the two

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telecommunication corporations- World Com and MCI merger case. It is one of the important cases which determines the future development of the telecommunication and internet industry and also analyses competitive effects from the mergers and solutions in the case of anticompetitive outcomes. The impact of the merger on the competition in the internet domain is seen as anticompetitive in the case of WorldCom/MCI, the FCC determining the market power. The author opines that, both FCC and US Dept of Justice did justify and the mergers came up with the same conclusion about anticompetitive effects of the mergers.

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Regulation of NGN: Structural Separation, Access Regulation, or No Regulation at All?
Fabian Kirsch* and Christian von Hirschhausen**
Since the introduction of Next Generation Networks (NGNs) by telecommunication network operators, national regulators have begun to adapt their access regulation regimes to the new technological conditions. The regulatory reactions gravitate towards three distinct regulatory trajectories: unregulated competition, access regulation, and structural separation. We first analyze the extent of market power in access Networks in NGNs from a technological perspective. Second, we use case studies to identify patterns between technological and market conditions and regulators' reactions in selected countries. We find that market power in the access network is likely to prevail. Regulatory reactions differ with the extent of infrastructure competition and the regulators position in the trade-off between promoting investment and protecting competition.

* **

Research Associate, Workgroup for Infrastructure Policy (WIP) Straße des 17, Juni 135 Berlin, 10623 Germany. E-mail: [email protected] German Institute for Economic Research (DIW Berlin), Department of International Economics Mohrenstraße 58 10117 Berlin, Germany. E-mail: [email protected]

© 2008 Fabian Kirsch and Christian Von Hirschhausen. This article was originally published in Communications and Strategies, No 69. Reprinted with permission. Source: ideas.repec.org

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T

he move towards Next Generation Networks (NGNs) has begun to transform

the telecommunication sector from vertically distinct, single-service markets into horizontal, converging multi-service markets. The core of an NGN is a software platform (the IP Multimedia Subsystem) that uses the standardized Internet Protocol (IP) to enable the provision of any service, e.g., data, voice, or video, via any physical network infrastructure, e.g., wireline (copper or fiber) or wireless facilities. The platform thus uncouples the classic relationship between infrastructure and services and facilitates technological convergence. From a techno-economical point of view (1) convergence increases the substitutability of network infrastructures, and (2) the disintegration and IP-based horizontal layering of the network reduces economies of scope between infrastructure and service provisioning. Both effects support infrastructure competition in the access networks. Furthermore, (3) since NGNs provide customers access to a wider range of services over their selected access network, the bandwidth demand increases to levels equal to or greater than the demand in the specific legacy networks. Thus, many operators upgrade their access networks1 when introducing NGNs. National regulators face the question of how to adapt their current access regulation regimes to this changing competitive and dynamic environment in which many incumbents have announced or begun the migration to NGN as well as the rollout of optical high-speed access networks. We observe three emerging regulatory trajectories: (1) unregulated competition, (2) access regulation of integrated companies, and (3) structural separation. As these trajectories span a wide range of regulatory options, we first ask whether market power justifying regulation persists in NGNs. Second, we search for patterns in the technological, market, and institutional conditions affecting the path choice of national regulators. Pending infrastructure investments in many countries have brought issues of regulation and investment to center stage in the literature on access network regulation. DE BIJL & PEITZ (2007) provide a variance analysis of regulatory regimes in the light of investment incentives. They argue in favor of light-handed regulation and note that wholesale access regulation may no longer be appropriate. TARDIFF (2007) assesses the impact of convergence on retail prices in the US broadband sector and argues that the intramodal competition renders retail price regulation unnecessary. BAAKE et. al., (2007) provide an extensive

Regulation of NGN: Structural Separation, Access Regulation, or No Regulation at All? analysis of regulation in dynamic markets, and reason that deregulation is only feasible if convergence leads to a high substitutability of networks. They further argue in favor of regulatory holidays for new networks to protect investment. Furthermore, GUTHRIE (2006) provides a literature review on regulation and investment. The academic literature is supplemented by regulatory inquiries on the national level, e.g., Ofcom (2007) and OPTA (2006c) and supranational level, e.g., ERG (2007a) that provide insight into the market analysis process and regulatory decision-making.

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In this article, we first provide a technology-centered analysis of the impacts of NGNs on market definition and on market power in access networks. We argue that despite convergence, high-speed network operators may, under certain conditions, retain market power, although less power than legacy networks. Second, we use country case studies exemplifying the three aforementioned regulatory trajectories to identify patterns in technological, market, and institutional conditions that can help explain national regulators' choices. We find two regulatory patterns: one that focuses on promoting specific investments, e.g., in the Republic of Korea and the USA, and one that focuses on protecting competition, e.g., in the Netherlands and the UK.

Market Power in Access Networks in NGNs
In the past, residential wireline telephony access networks were a textbook example of monopolistic bottlenecks. With the advent of NGNs, economists began to challenge this view, as convergence sparked the hope for infrastructure competition in the local loop (WEY et. al., 2006). However, this issue has been debated intensely in the context of fiber network rollouts, e.g., in Germany and the Netherlands (WAR, 2005; OPTA, 2006a). We analyze the extent of market power in access networks in NGNs from a technical perspective. We examine the impact of convergence on the market definition of infrastructure services and discuss the potential for infrastructure competition. We assert that infrastructure services are changing from integrated services such as telephony to "unbundled" transport services that complement applications such as voice, TV, or Internet. Based on this definition, we propose two market scenarios for these infrastructure services, the first with a single, vertically differentiated market comprising all access technologies, and the

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second with two markets for "normal-speed" and "high-speed" networks. We argue that multiple networks of the same type remain largely inefficient, except where existing infrastructure can be upgraded. This renders multiple high-speed optical networks unlikely. However, infrastructure competition among normalspeed networks seems possible and may also limit the market power of highspeed networks.

Technological Background of NGNs
The NGN concept stems from the world of network operators. NGNs integrate classical telecommunication networks and the Internet, which has become a communication service platform competing head-to-head with long-established communication networks. One ingredient in the Internet's success is its flexibility, which comes from the separation of transport and service. This separation enables network convergence, i.e., the integration of networks, sub-networks, devices, and services into a "network of networks" using a common set of rules and a single language - the Internet Protocol (IP). In contrast to the Internet, classic communication networks are tightly controlled by network operators, vertically integrated, and designed for specific applications such as telephony. The NGN, as defined in ITU-T (2007), is an abstract concept for networks that incorporate the Internet's horizontal layering principles and technologies with the centralized control of conventional telecommunication networks and are provided as software by the IP Multimedia Subsystem (IMS). A detailed technological discussion is presented by ELIXMANN & SCHIMMEL (2003) and POIKSELKA et. al., (2005). The horizontal structure makes services agnostic to the access network technology, while the Service Delivery and Platform Control (SDPC), i.e., the IMS, integrates the different access and backbone infrastructures as shown in Figure 1. Therefore, any IP service that is made available on an NGN service platform, e.g., IPTV, VoIP, e-mail, WWW, etc., can be delivered over any IP-enabled access network, e.g., DSL, cable TV, WLAN, UMTS, etc., that is connected to the NGN. The basic idea shown in Figure 1 also holds for the more likely case that multiple NGNs will emerge. However, as NGNs build on the simple and standardized IP, any service can be provided effortlessly on any competing NGN.

Regulation of NGN: Structural Separation, Access Regulation, or No Regulation at All? Figure 1 - Architectural Change through the Migration to NGN

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Thus, the effects of the migration to NGNs are twofold. First, the demand-side and supply-side substitutability of different access infrastructures increases through convergence. Second, the standardized IP introduces a predetermined breaking point between infrastructure services and application services that greatly reduces economies of scope compared to the integrated and partly proprietary legacy networks. Third, a customer needs only a single converged access network to access any service. If a customer meets his demand on a single network, e.g., with a triple-play product, the bandwidth demand for that network will increase. As the access network marks the bandwidth bottleneck, the migration to NGN may require infrastructure upgrades to provide sufficient service quality. This is one reason for the large infrastructure investments in fiber networks that accompany the introduction of NGNs.

Effects of NGNs on Market Definition
Access networks in NGN no longer provide integrated transmission and service but unbundled physical transmission capacity and management for packet-based transmission: thus, IP connectivity serves as a complement for IP services. Service bundles such as triple-play - i.e., IP connectivity, telephony, and television increase value for the customer, but on the supply side, the individual services can be unbundled or offered by third parties since the standardized IP reduces economies of scope between services and infrastructure. However, the access technologies differ in their capability to provide high-quality IP connectivity, i.e., bandwidth. Optical fiber networks currently provide the highest bandwidth, followed by cable TV, DSL, and wireless networks.

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The market for IP connectivity can be delimited by the three dimensions; demand substitution, supply substitution, and potential competition (BAKER, 2007). From the demand perspective, IP connectivity presents an upstream product that enables the consumption of downstream application services. These downstream services can be divided by bandwidth requirements into normalspeed services including web browsing, e-mail, music downloads, etc. (up to about 3 to 5 MBit/s) and high-speed services including IPTV, video conferencing, etc. (over 10 MBit/s). While most network operators provide services that are sufficient for normal-speed transmission (high speed services are accessible with a delay or reduction in quality), so far, only optical and hybrid network operators provide suitable offers for both, normal and high-speed services. Thus, demand substitutability of access technologies is expected to be high for users of normalspeed services and low for users of high-speed services. From the supply perspective, the substitutability is de facto limited by the capabilities of the network technologies. Currently, only optical and hybrid networks have the capabilities to provide sufficient bandwidth for high-speed services, while all networks are suitable for normal-speed services. Thus, supply substitutability is low for the high-speed segment, because normal-speed network operators have difficulties upgrading their current networks to provide higher speeds. However, technological advances can be observed in a number of networks that may enhance bandwidth and thus increase supply-side substitutability, while advances in data encoding, for example, reduce the bandwidth demand of some applications and increase demand-side substitutability. We will consider both the single-market and the two-market scenario in the following discussion.

Market Failure in Access Networks in NGNs
In the classic communication networks, the indivisibility of access networks results in deviation from the competitive model, and thus, in market failure. In NGNs, infrastructure-based entry into the local loop can occur in two ways: by constructing new networks or upgrading existing networks. NGNs do not affect the deployment cost of new wireline infrastructures. First, these infrastructures remain subject to significant economies of scale as their deployment requires large, sunk investments e.g., for equipment and civil engineering. For an exemplary cost model of the German fiber to the cabinet (VDSL) network, see

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ILLIC & KULENKAMPFF (2007). Second, property-owners will likely not allow operators to duplicate the last network section on the premise / indoors (ARCEP, 2006). The plans by three French operators to rollout parallel fiber infrastructures to the homes is an example for this issue (ERG, 2007b). Therefore, the construction of parallel infrastructures that are similar in costs and capabilities remains unlikely in NGNs, with the exception of low-cost wireless networks. One may even go as far as to say that infrastructure competition between DSL and cable TV is a historic coincidence. However, providers can enter the market successfully by deploying a superior network with lower costs and/or higher quality alongside an existing infrastructure. Furthermore, existing networks from other domains, such as cable TV or powerline infrastructures, can be upgraded to provide bidirectional IP transmission. With the infrastructure already in place, these upgrades affect only management hardware such as routers and therefore cost less than creating new infrastructure. A third possible exception are preinstalled fiber networks in large apartment complexes, e.g., in the Republic of Korea (REYNOLDS et. al., 2005). We argued that constructing new parallel infrastructures is unlikely. Except in regions under development, one or more access technologies are usually already available, e.g., DSL, cable TV, or mobile networks. In the following, we discuss the development of market power in multiple static networks for the two aforementioned market scenarios. In a single market, potential infrastructure competition exists where multiple networks are available at the same location. Depending on the available transmission capacities, consumers can identify quality differences between infrastructures such as time needed to load websites or download movies. Thus, besides the price differences, the infrastructures are vertically differentiated by bandwidth, i.e., quality. However, under this vertical product differentiation, customers will tend towards higher-quality products when the price difference between high-quality and low-quality products is sufficiently low (SHAKED & SUTTON, 1982). This enables the operator of the highest-quality network to strategically use aggressive or even predatory pricing to gain a dominant market position. Low marginal costs allow the necessary pricing flexibility. The operator remains in this quasi-monopoly position until a competitor can deploy a superior network technology, which remains very difficult. However, as long as

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competitive infrastructures stay in the market, vertical product differentiation limits the ability of the quasi-monopolist to capture monopoly rents, depending on the quality gap between the infrastructures. In the two-market scenario, existing infrastructures compete only in their respective quality domain. The normal-speed market can be served by most access technologies including wireless infrastructures. An increase in bandwidth does not add value for these services, e.g., audio streaming or text-only website accessibility. Therefore, infrastructure competition between a limited number of networks may be sustainable in this market depending on the population density. If multiple infrastructures, e.g., cable TV, operate in the high-speed market, the vertical product differentiation argumentation from the first case applies. An example of this two-market reasoning can be found in the Netherlands, where the regulator distinguishes between unregulated low-quality wholesale bitstream access and regulated highspeed bitstream access (OPTA, 2006c). Thus we conclude that high-speed access network providers are likely retain market power, however limited by convergence. At the current state of technology, it appears that only the normal-speed market allows sustainable infrastructure competition, while a single or high-speed market leaves high-quality network operators some leeway to act strategically and acquire a dominant market position through aggressive pricing or similar strategies. In this technical discussion, we have considered the factor of population density only implicitly and assumed it to be ideal, i.e., high. Decreasing population density, which would be considered in a geographic market analysis, amplifies the results of our arguments.

Regulatory Options for Access Networks in NGN
The sector-specific policy options to address market power in access networks apply to other network industries as well: access and price (de)regulation and structural measures such as different degrees of operational separation (CAVE, 2006). These options affect downstream competition but also the level of innovation or investment in the regulated market. Regulation aims to increase allocative market efficiency and addresses the distribution of rents, while structural measures target the problem of price and non-price discrimination between an integrated monopolist and its competitors. However, strict regulation (or fierce competition) but also a permanent monopoly, reduce investment

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incentives. Along with the introduction of NGNs, operators plan or undertake large asset-specific investments in high-speed infrastructure, which we argued to exhibit market power. Thus, regulatory policy has to balance static efficiency on the basis of existing competition and overall industry investment as new networks are built in the transition phase to full NGNs. Theoretical discussion of this relationship is provided by GURTHRIE (2006) and BAAKE et. al., (2007). In the following, we discuss the impacts of access (de)regulation and structural measures on access networks in NGNs. The two main options for access regulation are either (1) temporary or permanent deregulation, i.e., the removal of sector-specific rules and regulations, or (2) mandated access, i.e., the obligation to grant access to bottleneck facilities at regulated price and quality. Deregulation increases investment incentives as it overcomes the "truncating problem" and allows above-normal profits (CANS &KING, 2003). However, under limited competition or threat of entry into the upstream market - that is, in the absence of alternative infrastructures or in areas of low population density - an integrated incumbent may leverage its market power to competitive downstream segments. We conclude that deregulation in NGNs may be applicable in competitive normal-speed markets. On high-speed markets, deregulation spurs investment but operators' market power is likely to increase market concentration in the long run. Access holidays could address this issue. However, deviations from the optimal length will negatively impact either investment incentives or competition. Mandated access to the bitstream or the unbundled line reduces uncertainty and protects competition in the downstream market while the effects on investment depend on the allowed margin. Furthermore, regulated access to cable ducts can help competitors to deploy, restructure, or upgrade their access infrastructure. In NGNs, physical unbundling becomes increasingly difficult with the rollout of Fiber-to-the-Home (FTTH) deployments as current points of interconnection such as the Main Distribution Frames (MDF) or the street cabinets become obsolete and are phased out. In the case of FTTH, investments by competitors to interconnect physical access points in the local loop could ultimately be stranded. However, independent of the regulatory option chosen, access regulation should be applied symmetrically to all access networks in the market in order to to create a level playing field (CRANDALL et. al., 2002).

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Structural separation, i.e., the virtual or physical division of monopolistic and competitive segments of a vertically integrated monopolist, reduces incentives for price and non-price discrimination and eases regulatory control. Thus, separation supplements access regulation though the disintegration of the monopolist and the introduction of a "bright line of equivalence" that ensures equal treatment of access seekers. CAVE (2006) defines six degrees of separation, from accounting to legal separation. We argued that NGNs technologically reduce economies of scope between infrastructure and services. Thus, structural separation becomes less costly as technical synergy losses from the separation of access networks are mitigated. We conclude from this brief analysis that the two "extreme" options, deregulation and separation, bear a high risk and have a limited scope of application: the former is particularly suited to cases of competition between multiple, equally capable networks, and the latter to cases of low infrastructure competition and a high risk of non-price discrimination. Access regulation is a flexible instrument that can be attuned to a wide range of cases as it protects downstream competition but also includes mechanisms to facilitate investment.

Case Studies on the Regulation of Access Networks in NGN
Incumbents in most OECD countries have announced plans for the migration to NGNs, and pioneering incumbent network operators have begun to move their networks towards NGNs. First regulatory reactions provide early evidence of access network regulation regimes in NGNs. Table 1 - Summary of Case Studies Technological Development UK Migration of Core Network to NGN (21 CN) until 2011 Market Structure BT is dominant firm in broadband market Medium infrastructure competition (cable provider, virgin media reaches 45% of the households) Regulatory Reaction Functional separation of access networks and some backhaul networks from BT (openreach) Threat of ownership unbundling Evaluation Strong regulation to protect service competitors against discriminatory behavior Little investment in optical infrastructures Contd?

Regulation of NGN: Structural Separation, Access Regulation, or No Regulation at All? Contd? NL Migration of the complete network to All-IP and countrywide deployment of fiber until 2010 KPN is dominant telephony provider Strong infrastructure competition between KPN and the cable providers, which reach 94% of households) KT is dominant broadband provider (52%) High infrastructure competition through DSL and cable networks Three integrated telephony providers with geographically separated access networks High infrastructure competition through cable Access regulation demanding a "fully fledged alternative" to the current LLU

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Access regulation despite strong infrastructure competition protects service competitors Subloop unbundling will phase out with FTTH deployment Regulator selects and promotes technologies (picking winners) High broadband penetration rate and advanced networks Regulatory focus on promotion of investment Regulation lacks a transparent framework

Kr Migration to broadband converged network and rollout of 50lOOMbps access networks nationwide US Advanced state of migration to ALL-IP networks and deployment of FTTx

Proactive state intervention drives sector development Symmetric access regulation

Information services (including broadband) are deregulated

Many national regulators are at an early stage of the regulatory process but a survey on a number of OECD countries shows that the regulatory discussion centers on three regulatory models for high-speed networks: (1) access holidays or deregulation, e.g., in the USA and Germany, (2) access regulation, e.g., in the Netherlands, the Republic of Korea, Japan, and Belgium, and (3) structural separation, e.g., in the UK, Australia, and possibly Italy (European Commission, 2007; ERG, 2007b; OECD, 2005). The DSL networks in all these countries except the USA, are subject to access regulation. We chose four case studies that exemplify the different regulatory regimes, i.e., UK for structural separation, the Netherlands and the Republic of Korea for access regulation, and the USA for deregulation. For these countries, we analyze the structure of access network regulation and the technological and competitive arguments for this system.

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Finally, we evaluate the regulatory reactions against our theoretical considerations. The results, summarized in Table 1, show that regulators in the UK and the Netherlands take a sceptical view of competitive development under NGNs, in contrast to the USA, where the FCC has granted access holidays for FTTH deployment. The Republic of Korea also promotes investment through state funding in a regulated environment. However, our analysis only provides early evidence since experience with the respective regimes is still limited.

Structural Separation - The Case of the UK
British Telecom (BT) is one of the European pioneers of the Next Generation Network area. With the migration of its network to NGN (21 Century Network), BT expects savings in operating expenses of £1bn (about 1.5bn €) starting 2008/09. The expected investment amounts to £ 10bn (about 15bn €). BT focuses on the migration of its core network without the deployment of FTTx (NERA, 2007). The core network migration affects only the interconnection points at the edge of the access network as the network hierarchy becomes flatter (Ofcom, 2004, p. 88). Since the geographic structure of BT's network remains unchanged, the overall effects on competitors' networks are limited. The UK telecommunication market is characterized by strong service competition but limited infrastructure competition in the wholesale broadband market. DSL is the dominant access technology with a share of 70% while cable TV has a market share of 30%, and the cable network operator Virgin Media reaches about 45% of British households (Ofcom, 2006).

Regulation of BT's 21st Century Network
Ofcom bases its regulation on principles aimed at providing clarity and transparency for the future regulatory regime (Ofcom, 2005b). These principles include promoting competition at the deepest level of infrastructure that is both economically feasible and sustainable, delivering equality of access beyond this level, and facilitating market entry to remove bottlenecks. Regulation is to be withdrawn where the competitive conditions allow (Ofcom, 2005a, p. 18). In the absence of strong infrastructure competition, Ofcom discussed the options of continuing access regulation or taking structural measures to secure a level playing field through equal access (Ofcom, 2005a, p. 29).

Regulation of NGN: Structural Separation, Access Regulation, or No Regulation at All?

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Besides information asymmetries hampering regulatory price control, Ofcom cites non-price discrimination, i.e., the provision of lower - quality inputs to BT's competitors on the retail market, as a major problem (Ofcom, 2005c, Annex F, p. 70). Ofcom concludes that even with regulatory safeguards in place, access regulation has not succeeded in solving the problems of bottlenecks and discriminatory behavior over the last 20 years. CAVE et. al., (2006) support this view as they find factors increasing the incentives to discriminate in the case of BT's fixed telephone services. These factors are tight upstream regulation of the access network, imperfect competition on the downstream retail market, high substitutability on the downstream market, and downstream economies of scale. Ofcom decided to introduce a "bright line" along which the equivalence of input can be controlled. In June 2005, BT proposed an alternative approach to the Enterprise Act 2002 in which the company agreed on an organizational separation between its upstream non-access division including retail, wholesale, and global services, and its downstream access network and backhaul division. The separation of the access network division is institutionalized by a physical separation of resources, e.g., separate company premises, separate management, a brand name ("openreach"), and a "Code of Practice" that regulates the interaction between BT and openreach employees (Ofcom, 2005a, p. 90). An "Equality of Access Board" (EAB) was established to monitor compliance with these nondiscrimination regulations, as openreach remains part of the BT Group. In the case of BT's failure to comply with the non-discrimination regulations, Ofcom can request market investigation by the Competition Commission under Section 131 of the Act (Ofcom, 2005c, p. 3).

Evaluation
CAVE (2006) notes that structural measures are a viable regulatory solution when the costs of discrimination exceed the costs of implementing these measures, especially in markets with low infrastructure competition. The functional separation of BT's access division "openreach" creates transparency and decreases openreach's incentives to discriminate against competitors on the downstream retail market. BT's compliance with non-discrimination rules is enforced by the threat of ownership unbundling by the Competition Commission under the Enterprise Act 2002. Recent market analyses show that the number of

14

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unbundled local loops has increased since 2005, supported by reduced access prices. Critics argue that BT is implementing these measures too slowly and that the numerous exemptions granted by Ofcom are diminishing the potential positive effects. Furthermore, Ofcom sees the need to promote investments in high-speed access networks and has launched consultations to clarify the necessary regulatory environment (Ofcom, 2007).

Access Regulation - The Case of the Netherlands
In 2005, the Dutch incumbent Koniklijke PTT Nederland (KPN) announced the migration of its network to an All-IP network and a countrywide deployment of geographically optimized FTTx access networks and phase-out of MDF and PSTN/ISDN services until 2010. KPN expects a reduction in operating costs of €850 million up to 2009 while the total capital expenses for the migration are estimated to be €0.9 billion. The extension of fiber to the street cabinets renders the MDFs obsolete. About 200 of the 1,391 MDF locations will remain in operation as interconnection points to the backbone (HENDRIKS, 2007, OPTA, 2006b). KPN expects an additional revenue of €1 billion from sales of the MDF real estate. The Dutch broadband market is characterized by two full-scale network platforms, DSL and cable TV, which each reach over 94% of Dutch households and split the market (60% DSL and 39% cable broadband connections). KPN is dominant in the DSL retail market with a share of 80%, while the remaining 20% are provided by the largest alternative operators BBned, Tele2/Versatel and Orange/Wandoo.

Regulation of KPN's All-IP Network
Despite the high level of infrastructure competition between DSL and cable TV, the Dutch national regulatory authority for telecom and postal services (OPTA) reasons that even in the absence of tactial collusion, two infrastructure platforms form an oligopoly that is likely to lead to cournot prices (OPTA, 2006a). However, structural separation of the access network following the British example is less promising because of the high level of infrastructure competition between DSL and cable, and because OPTA as well as the Dutch competition commission lack the legal power to threaten ownership unbundling in the case of discriminatory behavior (NERA, 2007).

Regulation of NGN: Structural Separation, Access Regulation, or No Regulation at All?

15

Consequently, OPTA decided to maintain access regulation. However, the extension of fiber to the street cabinets renders the current interconnection points obsolete. Therefore, OPTA demanded that KPN provide a fully-fledged alternative to the unbundled access at the MDF. KPN proposed Sub-Loop Unbundling (SLU), i.e., access at the street cabinet, and Wholesale Broadband Access (WBA), i.e., virtual bitstream access, as options to connect to the new access network. These options were regarded as imperfect substitutes for MDF access. SLU requires competitors to expand their network to the street cabinets, which is only feasible in densely populated areas. Further, such investments bear the risk of being stranded if KPN extends the optical network to the homes, entailing the phase-out of street cabinets. In the case of WBA, interconnection usually takes place at a core network switch. Thus, WBA is a step downward on the ladder of investment as it increases competitors' dependency on KPN's infrastructure, e.g., backhaul to the point of interconnection is part of the offer. KPN entered negotiations with its MDF customers and reached an agreement on conditions for MDF phase-out, whereas KPN will phase out only those MDFs by 2009 for which there is no competitive access seeker. Further, KPN continues to offer access to the approximately 180 MDF locations used as metro nodes based on a reference offer, and lines that interconnect at locations to be dismantled are being migrated to either SLU or WBA (KPN, 2007).

Evaluation
In the Dutch case, the speed of the incumbent's network migration is particularly striking. KPN plans to migrate its entire network to ALL-IP and deploy fiber in its access network in only four years, primarily financed through real estate sales of MDF locations. Despite the competition between two infrastructures, OPTA sees a need for access regulation to KPNs network. The definition of an access regulation regime ensures competitive access to KPN's bottleneck facilities at regulated rates. However, the long-term option of SLU is not convincing, as street cabinets are likely to be phased out with the introduction of fiber to the FTTH networks.

Access Regulation and a Proactive Public Policy - The Case of the Republic of Korea
In 2004, the Korean government launched "IT839", the nation's third consecutive national information infrastructure program with the goal of developing a "ubiquitous" network society. One cornerstone of the US $ 70 billion IT839

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project is the development of a fully converged NGN, the so-called "Broadband Converged Network" (BcN) (REYNOLDS et. al., 2005; LEE et. al., 2007). The incumbent KT plans - in line with IT839 - to connect 20 million subscribers to 50100Mbps broadband over a seamlessly integrated wireless (WLAN, Wireless Broadband) and fixed-line FTTH services by 2010. Korea was the world's leading country in broadband development up to 2005, and still enjoys the fourth highest broadband penetration rate within the OECD (OECD, 2007). Its telecommunication sector is characterized by strong infrastructure competition in the wireline as well as the advanced wireless sector. KT is the leading broadband provider with a market share of 52%, followed by Hanaro Telecom, which operates both a DSL and a cable TV network, with 30% (NCA, 2006).

Broadband Converged Network Regulation and Government Support
The Korean telecommunications sector is administered by the Ministry of Information and Communication (MIC). The telecommunications policy is based on government-sector development programs intended to promote Korea's economic growth as well as symmetrical access regulation. The political strategy behind the development programs relies on "picking" winners by financially supporting specific infrastructures but also creating additional demand for these infrastructures (REYNOLDS et. al., 2005). Korea has a history of four consecutive national information infrastructure projects, the National Basic Information System (1987-1991), the Korean Information Infrastructure (1993-2000), IT839 (2004-2006), and U-IT839 (starting 2006). All these projects were carried out in close partnership between the public and the private sector including the incumbent as well as competitors. The Korean Information InfrastructureGovernment project (KII-G) is an example of the government's course of action. The initial funding of US $ 1 billion was provided by the government who also became the main tenant on the network to create additional demand. Furthermore, about 10 million Koreans were trained in the use of IT. Thus, the government acted as a major driver for the development of the country's communication network on both the supply and the demand side. Besides the national development projects, the regulation of access networks facilitates competition on the service market. The Telecommunications Business Act distinguishes among facility-based, specific, and value-added telecommunications providers, whereas the former group is comprised of any network (DSL, cable TV, etc.)

Regulation of NGN: Structural Separation, Access Regulation, or No Regulation at All?

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that offers telecommunication services. These facility-based network operators are subject to symmetric open access requirements for bottleneck facilities. Furthermore, wireline infrastructure competition is supported by the communication infrastructure of large apartment complexes, which enable operators to connect at central main distribution frames. Hanaro Telecom, for example, has succeeded in building a parallel fiber network that connects apartment blocks with more than 200 potential customers (REYNOLDS et. al., 2005).

Evaluation
The Korean government has adopted a very pro-active approach to IT-policy and regulation that one could almost characterize as "strategic planning." The government selects suitable technologies and shapes the institutions and markets to promote their development. In contrast to the Netherlands, the Korean state is the main driver of NGN deployment. Today, Korea has one of the world's most technologically advanced networks, a very high level of broadband penetration, and infrastructure competition in many access markets. However, the interventionist approach is sometimes criticized because the government generally lacks sufficient information and incentives to decide on suitable technologies.

Deregulation - The Case of the USA
In the USA, the migration to IP networks is considered a continuous network evolution rather than a radical innovation (as with NGNs in Europe), and began well ahead of European migration; in fact, the USA leapfrogged the ISDN network evolution altogether. Although the new US networks comprise NGN components such as the IP Multimedia Subsystem (IMS) as a service delivery platform, the term Next Generation Network is not used in the USA. AT & T and Verizon have largely switched their networks to All-IP and have begun to roll out fiber access networks, whereas AT & T deploys fiber-to-the-curb or premise (currently reaching about 5.5 million homes) while Verizon deploys fiber-to-thehome (currently reaching about 6.5 million homes).ln the US broadband market, cable TV was the forerunner and dominant infrastructure while DSL followed. Cable TV network operators have a footprint of over 80% of the US households and a share of 44% in the broadband market (FCC, 2007). The telephony access market is shared by three large companies, AT & T, Verizon, and Qwest, whereas

18

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competitive local exchange carriers provide about 17% of access networks. As the telephony companies traditionally operate in geographically distinct markets, most areas are governed by access network duopolies.

Regulation of "Information Services"
The US employs a vertical regulatory model that classifies infrastructure along the classical "stove-pipes". This categorization by media types leads to the dichotomie between telecommunication services, i.e., common carrier services, and information services, i.e., provision and management of information via telecommunications. While the former are subject to regulation, the latter, which include broadband access, are substantially unregulated (FRIEDEN, 2003). However, this vertical regulatory model becomes increasingly difficult to uphold in converging networks, as e.g., DSL integrates telecommunications and information services. Based on this argument, DSL was declared an information service in 2005 and set on equal footage with cable TV and promotes technology neutral regulation (FCC, 2005). A main argument for this ruling, as well as for the granting of regulatory holidays for fiber to the home and to the premise was the FCCs goal to promote infrastructure investment (FCC, 2003, 2004).

Evaluation
The results of this approach are mixed. Companies such as AT & T and Verizon have begun to deploy fiber to the local loop, either to the curb or to the home. The broadband availability and penetration is high, compared to the G7 states and the entry price level for DSL is low. However, fiber investment rates are moderate and it is possible, that the US is on the way to a less competitive environment than Europe and that so far, the industry structure may have mitigated negative effects (MARCUS, 2005). Further, Marcus notes that the vertical regulation lacks technological neutrality and a rigorous framework for economic analysis.

Conclusion
This article has discussed the need and options for the regulation of access networks in NGN and provided early case study evidence on the regulation of the evolving networks. We argue from a technical perspective that multiple parallel infrastructures of the same technology are unlikely because of scale economies, and that high-speed networks may exhibit a competitive advantage over lower-speed networks because of vertical product differentiation. Further, we

Regulation of NGN: Structural Separation, Access Regulation, or No Regulation at All?

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suggest two market scenarios for access networks that may result from convergence: either a single market containing all access networks, or two markets, one for "normal" bandwidth and one for "high" bandwidth, whereas we conclude that market failure is likely to prevail in all markets that include high bandwidth networks. We observed a wide range of regulatory trajectories in different countries, gravitating towards three models: unregulated competition, access regulation, and structural separation. The relation between technical market conditions, e.g., the degree of infrastructure competition, is shown by the case studies on the "dense" IT countries, the Netherlands and Korea. Furthermore, we showed that regulators take different stances on promoting incumbents' access network investments and on protecting competition, as seen in the different regimes in the Netherlands and the USA. We conclude that NGN access networks still need regulatory oversight with instruments against price and nonprice discrimination. These instruments need to be handled deliberately to support efficient investment. Ex ante access regulation may be attuned to a wide range of cases. Structural separation can supplement access regulation where the potential for infrastructure competition is low. Deregulation may be appropriate under high infrastructure competition among multiple, equally capable infrastructures. While our approach provides early and specific case study evidence, further empirical research is needed extending the sample to provide a more comprehensive picture of regulatory reactions, e.g., their relation to structural variables such as population density and urbanization and to understand the success of the different regulatory regimes in the evolving NGN world.

Acknowledgement
The authors thank Andreas Brenck, Achim Czerny, Johannes Fuhr, Scott Marcus, Kay Mitusch, Stephan Steglich, and two anonymous referees for their comments. Any remaining errors are our own.

References
ARCEP (2006): Very high-speed - Points of Reference and Outlook.http://www.art-telecom.fr/ fileadmin/reprise/dossiers/fibre/slides-fttx-prog-101106ang.pdf, retrieved: 10.12.2007. BAAKE P., HAUCAP J., KUHLING J., LOETZ S. & WEY C. (2007): Effiziente Regulierung in dynamischen Markten, Baden-Baden. BAKER J.B. (2007): "Market Definition: An Analytical Overview", Antitrust Law Journal, Vol. 74/1.

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CAVE M. (2006): "Six Degrees of Separation: Operational Separation as a Remedy in European Telecommunications Regulation", COMMUNICATIONS & STRATEGIES, Vol. 64, pp. 89-103. CAVE M., CORREA L. & CROCIONI P. (2006): "Regulating for Non-Price Discrimination The case of UK Fixed Telecoms", Centre for Management under Regulation, Working Paper. CRANDALL R.W., SIDAK G.J. & SINGER H.J. (2002): "The Empirical Case against Asymmetric Regulation of Broadband Internet Access", Berkeley Technology Law Journal, Vol. 17, pp. 953-987. DE BIJL P.W. & PEITZ M. (2007): "Innovation, Convergence and the Role of Regulation in the Netherlands and Beyond", TILEC Discussion Paper no. 2007-016. ERG (European Regulators Group): (2007a): ERG Opinion on Regulatory Principles of NGA. (2007b): Supplementary Document to the ERG Opinion on Regulatory Principles of NGA.

European Commission (2007): Annex 1 to the European Electronic Communications Regulation and Markets 2006 (12th Report). FCC: (2003): Triennial Review Order, Wireline Competition Bureau. (2004): Order on Reconsideration, Wireline Competition Bureau. (2005): Notice of Proposed Rule Making in the Matter of Appropriate Framework for Broadband Access to the Internet over Wireline Facilities, Wireline Competition Bureau. (2007): Trends in Telephony Service. Industry Analysis and Technology Division, Wireline Competition Bureau.

FRIEDEN R. (2003): "Adjusting the Horizontal and Vertical in Telecommunications Regulation", Federal Communications Law Journal, Vol. 55 / 2. CANS J. & KING S. (2003): "Access Holidays for Network Infrastructure Investment", Agenda, Vol. 10/2, pp. 163-178. GUTHRIE G. (2006): "Regulating Infrastructure: The Impact on Risk and Investment", Journal of Economic Literature, Vol. XLIV, pp. 925-972. HENDRIKS P. (2007): "The Road to All-IP. VDSL - The way to Next Generation Networks", WIK International Conference, Konigswinter, 21.03.2007. ILIC D. & KULENKAMPFF G. (2007): "VDSL Roll out in Germany: An Assessment of its Economic Feasibility", 18th European Regional ITS Conference, Istanbul. KPN (2007): KPN Wholesale, www.kpn-wholesale.com, retrieved: 05.12.2007. LEE K.O., KIM S.K., CHUNG T.S. & KIM Y.S. (2007): "Reference Model of Broadband Convergence Network in Korea", Asia-Pacific Conference on Communications 2007, Bangkok. MARCUS J.S. (2005): "Is the US Dancing to a Different Drummer?", MPRA no. 2514. NCA (National Computerization Agency Republic of Korea) (2006): Informatization White paper 2006.

Regulation of NGN: Structural Separation, Access Regulation, or No Regulation at All?

21

NERA (2007): Ofcom's Strategic Review of Telecommunications and BT's Undertakings, NERA Economic Consulting. OECD: (2005): Next Generation Network Development in OECD Countries, O.F.E.C.- O.A.D. (2007): OECD Broadband statistics: 1h. Broadband penetration, historic, top five OECD countries for June 2007, retrieved: 08.02.2007. (2004): Strategic Review of Telecommunications - Phase 2, consultation document. (2005a): Final statements on the Strategic Review of Telecommunications, and undertakings in lieu of a reference under the Enterprise Act 2002. (2005b): Next Generation Networks - Future arrangements for access and interconnection. (2005c): Notice under Section 155(1) of the Enterprise Act 2002. (2006): The Communication Market 2006. (2007): Future broadband - Policy approach to next generation access. (2006a): "Is Two Enough?", Economic Policy Note, Vol. 6. (2006b): "KPN's Next Generation Network: All-IP", Issue Paper. (2006c): "KPN's Next Generation Network: All-IP", Position Paper.

Ofcom: -

OPTA:

POIKSELKA, M., MAYER, G. & KHARTABIL, H. (2005) The IMS. Hoboken, NJ. REYNOLDS T., KELLY T. & JIN-KYU J. (2005): "Ubiquitous Network Societies: The Case of the Republic of Korea", International Telecommunication Union (ITU). SHAKED A. & BUTTON J. (1982): "Relaxing Price Competition Through Product Differentiation", Review of Economic Studies, Vol. XLIX, pp. 3-13. TARDIFF T. (2007): "Changes in industry structure and technological convergence: implications for competition policy and regulation in telecommunications", International Economics and Economic Policy, Vol. 4/2, pp. 109-133. WAR (Wissenschaftlicher Arbeitskreis fur Regulierungsfragen) (2005): Stellungnahme zum Projekt Glasfaserausbau des Zugangsnetzes der Deutsche Telekom AG. WEY C., BAAKE P. & HEITZLER S. (2006): "What rules for IP-enabled NGNs?", ITU Workshop on Next Generation Networks, Geneva, 23-24.03.2006.

Endnote
1 The term "Next Generation Access Network" refers to broadband access networks. We include all access network technologies in our analysis and therefore refer to "access networks in NGNs".

2
Why Stovepipe Regulation No Longer Works: An Essay on the Need for a New Market-Oriented Communications Policy
Randolph J. May*
Ten years since enactment of the Telecommunications Act of 1996, the telecommunications industry has undergone profound technological and marketplace changes. In this article, the author argues that the current statute regulates communications services, denominated as telecommunications, information services, cable, mobile, or the like, differently. These services increasingly compete against each other in the marketplace. This differential treatment occurs because the existing statutory service classifications are based almost entirely on outdated techno- functional constructs that force regulators to make metaphysical regulatory distinctions. Competition and convergence in the marketplace have undermined this so-called "stovepipe" regulatory scheme of the 1996 Act. It
* President, The Free State Foundation P. O. Box 60680 Potomac, MD 20859 United States, E-mail: [email protected]

© 2006 Randolph J. May. This article was originally published in Federal Communication Law Journal, Volume 58, No. 1, Jan 2006. Reprinted with permission. Source: findarticles.com

Why Stovepipe Regulation No Longer Works: An Essay on the Need for a New Market-Oriented Communications Policy

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is time for the existing "stovepipe" model of regulation to be confined to the dustbin of the history of communications policy. In its place, Congress should adopt what is called a new Digital Age Communications Act, a market-oriented regime that would employ antitrust-like principles focusing on marketplace competition and the enhancement of consumer welfare to determine whether there is a need for regulatory intervention.

I. Introduction
As we approach the ten year anniversary of the enactment of the Telecommunications Act of 1996 ("1996 Act"),1 a fairly broad consensus has emerged that the existing "stovepipe" regulatory framework contained in the statute is woefully outdated and an impediment to the development of sound communications policy.2 So, Congress is beginning to consider whether new communications legislation is needed to supplant the 1996 Act. In light of the profound technological and marketplace changes that have occurred in the last decade, especially those attributable to the accelerating proliferation of digital technologies and services, any new legislative reform effort should include an examination of the division between federal and state regulatory authority, the amalgam of subsidies known as the Universal Service system, and management of the spectrum. But there is nothing more important to the project to conceive a new act than the replacement of the existing statute's stovepipe regulatory model with a new framework that reflects today's digital age competitive marketplace realities. Indeed, this effort has to be at the heart of any serious effort to write what one might call a new Digital Age Communications Act. The purpose of this brief essay is to show why a replacement regulatory regime is needed. Its purpose is not to prescribe what the new model should look like, although I will conclude by suggesting that some form of market-oriented model should be adopted.

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II. The Existing Regulatory Framework: Vertical Stovepipes Based on Techno-functional Distinctions
Stovepipe regulation refers to the fact that (1) the act contains definitions for variously denominated communications services, such as "telecommunications," "information services," "cable service," "mobile service," "broadcasting," and "open video system," and (2) different regulations apply depending upon a service offering's classification. Hence, the stovepipes, or vertical "silos" or "smokestacks" as some prefer, refer to the distinct sets of regulations that attach to a service offering once it is classified under one definition or the other. The existing stovepipe regulatory framework no longer makes sense. With a bit of poetic license, you might say the fires of the digital revolution have destroyed the stovepipes. In any event, the point is that the old stovepipe paradigm, with its origins rooted in the original Communications Act enacted in 1934 ("1934 Act"), is now obsolete. The current regime is obsolete because the statutory definitions found in the 1996 Act that are the foundation of the existing regulatory model rest upon what I have called "techno-functional constructs."3 These techno-functional constructs simply no longer work well in a digital world. 4 These particular techno-functional constructs are necessarily implicated in many of today's most hotly contested regulatory battles, for example, those involving the statutory definitions of "telecommunications" and "information service." Telecommunications is defined as "the transmission, between or among points specified by the user, of information of the user's choosing, without change in the form or content of the information as sent and received."5 An information service is "the offering of a capability for generating, acquiring, storing, transforming, processing, retrieving, utilizing, or making available information via telecommunications . . . but does not include any use of any such capability for the management, control, or operation of a telecommunications system or the management of a telecommunications service."6 Now, these definitions are nothing if not grounded firmly in techno-functional constructions: transmitting information among points "specified by the user,"7 "without a change in form or content," "generating," "storing," "processing," "retrieving," "transforming" information, and so on.8

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Think for a moment about the meaning these words convey. What does it mean to say "transforming" information, or transmitting information between two points "without change in the form or content" of the information? For example, I send you an instant message, or "IM," typing a letter in one font on my keyboard. As a result of your or my terminal settings or Internet Service Provider's protocols, the letter appears on your screen in another font, or without the smiley face I attached to it. Has there been a change in form or content of the information sent or received? Has there been a transformation of the information? This surely is the stuff of digital age philosophers. That is why, in early 2004 in connection with thinking about the then just-over-the-horizon but sure-to-come fights regarding the new Internet telephony, or Voice over Internet Protocol ("VoIP") services, I referred to the distinctions to be suggested and argued for purposes of regulatory classification as metaphysical. Certainly, the statute's definitions are in accord with Webster's definition of metaphysics: (1) "of or relating to what is conceived as transcendent, supersensible, or transcendental;" (2) "highly abstract or abstruse;" (3) "expressions of attitudes about which rational argument is impossible."9 In fact, so convinced was I of the importance of hastening an understanding that the current techno-functional regulatory regime rested on collapsing ground that I could not resist dashing off a brief commentary entitled, only half facetiously, The Metaphysics of VoIP.10 It is not only the telecommunications and information service stovepipes which rest on techno-functional constructs. Consider the statute's "mobile services" definition, which includes terms such as "a regularly interacting group of base, mobile, portable, and associated control and relay stations . . ." and so on.11 The definition of "cable service" turns on whether the transmissions are "one-way," and either "video programming" or "other programming service ," and whether any "subscriber interaction" is required for the selection of such video programming.12 Whether a transmission is "broadcasting" or not depends on whether radio communications, which itself turns on whether the transmission by radio is of writings, signs, signals, pictures, and sounds of all kinds, "intended to be received by the public," are disseminated, whether "directly or by the intermediary of relay stations."13 However serviceable these definitional constructs may have been at an earlier time, when analog systems were by far the prevalent communications transmission mode, they no longer are serviceable in a world in which digital

26

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technology is rapidly displacing analog. The old saying "a bit is a bit is a bit" really does have important implications from a regulatory policy perspective. It is economically, if not technically, infeasible to distinguish among voice, data, and video bits that travel along in the same communications stream. In other words, "[o]nce all communications are reduced to bits and bytes, all media will constitute substitutes for one another, and attempts to segment markets based on the means of conveyance will become increasingly problematic."14 I do not mean to deny the regulators' ingenuity or their good intentions in creating these definitional constructs, or in striving to render them serviceable for as long as possible. Take the FCC's landmark Computer II proceeding from the early 1980s. 15 It was then, when data processing capabilities and communications services first were becoming intertwined in nascent online applications such as e-mail and data retrieval, that the FCC created the regulatory distinction between basic and enhanced service. And it was this distinction that was carried over into the 1996 Act in the form of the current "telecommunications" and "information services" definitions.16 In essence, a basic service was pure transmission capacity while enhanced services were applications with computer processing capabilities dependent upon telecommunications to be carried from one place to another.17 The FCC's purpose in creating this new distinction was salutary: if the new online services had been classified as just another form of basic communications, the services would have been subject to public utility-style regulation under the common carrier mandates of Title II of the 1934 Act.18 The FCC thought, correctly, that online services could and would develop on a competitive basis, and therefore, should be free from the economic regulation to which common carriers were subject.19 Acting under the constraints of the 1934 Act, the FCC's Computer II decision was sound policy. Online services, from the early CompuServe and Prodigy services, to the upstart America Online, and on through the birth and spread of the ubiquitous World Wide Web, did indeed flourish on an unregulated basis. Without any real controversy, Computer IPs "basic" and "enhanced service" definitions were embodied in essentially the same form in the 1996 Act as "telecommunications" and "information services."

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III. The Problem: Digital Technology and Abundant Bandwidth Undermine the Stovepipes
What once may have been wise policy, and manageably serviceable, in a predominantly narrowband communications environment is much more problematic today as broadband networks become more ubiquitous. Recall that in the narrowband world, at least as a matter of shorthand, we could, commonly if not universally, equate voice with telecommunications, data with information services, and video with cable service. For a long time, limited bandwidth in the narrowband world masked the inherently problematic nature of the separate techno-functional boundaries upon which both the 1934 and 1996 acts' regulatory boundaries rested. The abundant bandwidth of broadband networks, which enables fast-growing services such as Internet access and VoIP Internet telephony to be technically and economically viable, tugs mightily at the regulatory mask. Is high speed cable modem Internet access service "cable," "telecommunications," or an "information service"? The FCC deemed cable modem service an unregulated information service under the 1996 Act's definitional scheme. In June 2005, a divided Supreme Court handed down a decision in National Cable & Telecommunications Association v. Brand X Internet Services, which reversed an appeals court decision holding that cable modem service is a combination of "telecommunications" and "information service" potentially subject to public utility-type regulation.20 What about the high speed Digital Subscriber Line ("DSL") Internet access services offered by the traditional telephone companies? Until September 2005, when the FCC finally reclassified it as an unregulated information service not long after the Brand X decision was handed down, 21 DSL was classified a regulated telecommunications service. Next, consider the VoIP Internet telephony services. The FCC has ruled that pulver.com's "Free World Dialup" ("FWD") service, which is a "computer-tocomputer" voice application that does not use ordinary telephone numbers or originate or terminate calls on the public switched network, is an information service.22 Following the 1996 Act's formulation, the FCC concluded that FWD "is an information service because FWD offers 'a capability for generating, acquiring, storing, transforming, processing, retrieving, utilizing, or making

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available information via telecommunications.'"23 The FCC added that the fact that FWD happens "to, among other things, enable members to talk over the Internet,"24 rather than, for example, play video games, does not affect its characterization as an information service. How does the FCC classify the VoIP offering by Vonage, a company that bills itself as "the broadband telephone company"? 25 Vonage's Digital Voice customers, who must have access to a broadband connection to subscribe, make calls that use ordinary telephone numbers and may either originate or terminate on the public network. The FCC recently acted to preempt state economic regulation of Vonage's Digital Voice and other VoIP services with similar characteristics, such as those offered by cable companies, by ruling that they are interstate services.26 Pointing to its already initiated rulemaking regarding VoIP and other IP-enabled services, the FCC refrained from addressing the classification of Vonage's Digital Voice and similar services for federal regulatory purposes. But note that the FCC did point out that Vonage's service "resembles the telephone service provided by the circuit-switched network."27 In its IP-Enabled Services rulemaking notice, the FCC explains how the greater bandwidth of broadband networks encourages the introduction of services "which may integrate voice, video, and data capabilities while maintaining high quality of service."28 Then, in a truism, the FCC adds: "t may become increasingly difficult, if not impossible, to distinguish 'voice' service from 'data' service, and users may increasingly rely on integrated services using broadband facilities delivered using IP rather than the traditional PSTN (Public Switched Telephone Network)."29 At the end of 2004, there already were almost thirty-eight million high-speed broadband Internet connections in service, an increase of 34% during just that year. 30 Analysts project that as soon as 2009 there will be twenty-seven million VoIP lines in service.31

IV. The Consequences: Comparable Services are Regulated Differently under the Stovepipe Regime
But does it matter that, according to the FCC's own characterization, Vonage and other providers of similar Internet telephony services that "enable [users] to talk over the Internet"32 and "resemble"33 what we used to call POTS, or "plain old

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telephone service," may be regulated very differently? Does it matter that broadband Internet access services provided by cable television and telephone companies (and perhaps soon to be provided by satellite and power companies) may be regulated differently, even while they already compete vigorously with each other? Of course it matters. Providers of telecommunications services are generally subject to price and entry regulation as common carriers; information services providers are not.34 Telecommunications services may be required to be unbundled so that competitors may access the unbundled network elements at regulated rates.35 Information services are not subject to mandatory access requirements. Telecommunications services are subject to certain social obligations, such as universal service contributions and tax payments, from which non-telecommunications services presently are exempt.36 Telecommunications services also are subject to certain health and safety mandates. For example, telecommunications services must provide enhanced 911 ("E911") service, and are subject to disability and wiretap capability requirements that are not generally applicable to nontelecommunications services.37 Cable operators are subject to certain regulatory obligations that do not apply to non-cable services, such as obtaining a local franchise and paying local franchise fees.38 States and localities impose different rights-of-way obligations and fees, depending on how a service is classified.39 Thus, services that are comparable, at least from the consumers' perspective, and that compete head-to-head against each other in the marketplace, are subject to different regulatory requirements based solely on how the service offerings are classified. For example, despite the fact that cable operators have had close to twice as many broadband Internet access subscribers as do the telephone companies,40 until very recently the broadband offerings of cable and telephone companies were subject to very different regulatory regimes.41 In short, the existing service classifications based upon techno-functional characteristics have little or nothing to do with how consumers perceive the services or the marketplace position of the service providers.

V. The Solution: A New Market-oriented Market Paradigm
It should be obvious that a new regulatory framework is needed for communications policy. My purpose here has been to provide the background and context for understanding why a new paradigm is needed rather than to

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offer any detailed prescription for such regulatory framework. Nevertheless, in concluding, some general thoughts about the direction such change should take may not be out of order. First, what should be avoided is a new framework that just substitutes one set of techno-functional constructs for another. For example, MCFs Senior Director for Global Policy and Planning, Richard Whitt, has proposed that policymakers "adopt a comprehensive legal and regulatory framework founded on the Internet's horizontal network layers."42 He identifies four layers - content, applications, logical, and physical - that he claims comprise the Internet's architecture.43 He urges that public policy be formulated to respect the integrity of the distinct layers for purposes of determining whether regulation is needed of providers of services within the layers.44 Whitt then suggests that the two lower layers, the logical and physical, should be targeted for discrete regulation based on his claim that significant market power resides in these layers.45 The physical layer roughly corresponds to the network facilities of the cable, telephone, satellite, wireless, and other companies that transport information. The logical layer roughly corresponds to the software codes and protocols, such as Transmission Control Protocol/Internet Protocol ("TCP/IP"), that interface with the physical layer below and the applications and content layers above. Whitt calls this proposed layers model "a horizontal leap forward."46 But turning stovepipes on their side is not necessarily a leap forward; rather, it is an invitation to stultify the continued evolution of our physical networks and the service applications that may be integrated into such networks. It is difficult to predict, especially in a technologically dynamic environment, how network platforms, or the Internet, really an interconnected network of network platforms, will evolve on a technical or functional basis. Today's seemingly discrete Internet layers may be obsolete, or at least meaningfully altered, tomorrow. What is needed is a new market-oriented model that breaks with the past, not a replacement regime based on just another set of techno-functional constructs.47 A market-oriented model that employs antitrust law or antitrust-like principles would focus on the structure of the marketplace: whether individual service providers possess market power that should be constrained by some form of regulation, and whether such constraints generally should be applied in the form of ex ante proscriptions or more narrowly-tailored ex post remedial orders.

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Such a market-oriented model would put the focus on the consumer - and consumer welfare - where it belongs, not on distinctions grounded in particular technology platforms or arcane functional characteristics that have little to do with existing marketplace realities. It would greatly reduce the opportunities for regulatory gaming that are inherent in the current regime. Thus, under this approach, comparable services ("substitutable" services in antitrust parlance) from the consumers' perspective would not be subject to differential regulatory treatment just because they are delivered over different technology platforms or employ different functional bells and whistles. By the same token, comparable services might be subjected to differential regulatory treatment if there is a market-oriented reason to do so in order to enhance consumer welfare. After all, any regulatory regime ultimately should be judged based on whether or not it advances or impairs marketplace competition and promotes consumer welfare, not on whether it advances or impairs the prospects of particular competitors, or protects the jobs of current regulators.

Endnotes
1 2 Telecommunications Act of 1996, Pub. L. No. 104-104, 110 Stat. 56 (codified in scattered sections of 47 U.S.C.). See, e.g., James B. Speta, Deregulating Telecommunications in Internet Time, 61 WASH. & LEE L. REV. 1063 (2004); Richard S. Whitt, A Horizontal Leap Forward: Formulating a New Communications Public Policy Framework Based on the Network Layers Model, 56 FED. COMM. L.J. 587 (2004); Christopher S. Yoo, New Models of Regulation and Interagency Governance, 2003 MICH. ST. L. REV. 701. Randolph J. May, Calling for a Regulatory Overhaul, Bit by Bit, CNET NEWS, Oct. 19, 2004,http://news.com./Calling+for+a+regulatory+overhaul%2C+bit+by+bit/ 2010 - 1028_3-5415778.html. Christopher Yoo has put it this way: "Gone are the days in which each communications technology could be regarded as occupying a separate regulatory silo. The impending shift of all networks to packet-switched technologies promises to complete the collapse of any remaining attempt to base regulation on differences in the means of transmission." Yoo, supra note 2, at 714 (citation omitted). 47 U.S.C. § 153(43) (2000).

3

4

5

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6 7 8

§ 153(20). §153(43). § 153(20). The definitions found in the 1996 Act of "telecommunications" and "information service" essentially track the "basic" and "enhanced" services definitions developed in the Federal Communication Commission's ("FCC") landmark Computer II proceeding to distinguish between regulated transmission services and unregulated online services employing computer processing. Second Computer Inquiry, Final Decision, 77 F.C.C.2d 384 (1980) [hereinafter Computer II]. They have been interpreted by the FCC to extend essentially to the same functions so that all of the services the FCC previously considered to be "enhanced services" are "information services." See Implementation of Non-Accounting Safeguards of Sections 271 and 272 of the Communications Act of 1934 as amended, First Report and Order and Further Notice of Proposed Rule Making, 11 F.C.C.R. 21905, paras. 102-04 (1996). WEBSTER'S THIRD NEW INTERNATIONAL DICTIONARY 1420 (1993). Randolph J. May, The Metaphysics of VoIP, Jan. 5, 2004, CNET NEWS,http://news.com.com/The+metaphysics+of+VoIP/2010-7352_3-5134896.html. For anyone interested in immersing him or herself more deeply in communications law metaphysics, I suggest reading some of the orders in the FCC's almost decadelong effort to settle on a classification of protocol processing and protocol conversion services. To begin such a metaphysical feast, sample Federal-State Joint Board on Universal Service, Report to Congress, 13 F.C.C.R. 11501, paras. 49-52 (1998) [hereinafter Federal-State Joint Board] (dealing with the struggle to classify services under the 1996 Act's definitions and the FCC's Computer II regime). 47 U.S.C. § 153(27). 47 U.S.C. § 522(6) (2000). §153(6). Yoo, supra note 2, at 714. Computer II, supra note 8. See id. and accompanying text. Id. paras. 95-97. Id. para. 114; see also IP-Enabled Services, Notice of Proposed Rule Making, 19 F.C.C.R. 4863, para. 25 (2004) [hereinafter IP-Enabled Services] ("Providers of 'basic' services were subjected to common carrier regulation under Title II of the Act. . . . [T]he Commission declined to treat providers of enhanced services as 'common carriers' subject to regulation under Title II of the Act.") (citations omitted). See Computer II, supra note 8, para. 101; Speta, supra note 2, at 1084.

9 10

11 12 13 14 15 16 17 18

19

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20

Inquiry Concerning High-Speed Access to the Internet Over Cable and Other Facilities, Declaratory Ruling and Notice of Proposed Rule Making, 17 F.C.C.R. 4798 (2002), vacated in part and remanded sub nom. Brand X Internet Servs. v. FCC, 345 F. 3d 1120 (9th Cir. 2003), rev'd and remanded, National Cable & Telecomm. Ass'n. v. Brand X Internet Servs., Nos. 04-277 and 04-281, 2005 US LEXIS 5018 (June 27, 2005), 125 S.Ct. 2688 (2005) [hereinafter Brand X]. See Appropriate Framework for Broadband Access to Internet Over Wireline Facilities, Report and Order and Notice of Proposed Rulemaking, 20 F.C.C.R. (forthcoming 2006), 236 Comm. Reg. (P & F) 944 (2005). Petition for Declaratory Ruling that Pulver.com's Free World Dialup is Neither Telecomm. Nor a Telecomm. Serv., Memorandum Opinion and Order, 19 F.C.C.R. 3307 (2004), available athttp://hraunfoss.fcc.gov/edocs_public/attachmatch/ FCC04-27A1.pdf [hereinafter Pulver.com Petition]. Id. para. 11 (citing 47 U.S.C. § 153(20)). Id. para. 19. Vonage Home Page,http://www.vonage.com. Vonage Holdings Corp. Petition for Declaratory Ruling Concerning an Order of the Minn. Pub. Utils. Comm'n, Memorandum Opinion and Order, 10 F.C.C.R. 22, 404 (2004), available athttp://hraunfoss.fcc.gov/edocs_public/attachmatch/ FCC-04-267A1.pdf [hereinafter Vonage Petition]. Id. para. 4. IP-Enabled Services, supra note 18, para. 16. Id. See Press Release, FCC, Federal Communications Commission Releases Data on High-Speed Internet Access Services (July 7, 2005) (explaining that the number of high speed lines in service at the end of 2004 reported to be 37.9 million). net2phone, 2005 Annual Report 3 (2005), available athttp://web.net2phone.com/ about/investor/2005 A R.pdf. See Pulver.com Petition, supra note 22, para. 19 and accompanying text.

21

22

23 24 25 26

27 28 29 30

31 32 33 34 35 36

See Vonage Petition, supra note 26, para. 4. See IP-Enabled Services, supra note 18, paras. 24-25. Id. para. 26. See generally Federal-State Joint Board, supra note 10; see also IP-Enabled Services, supra note 18, paras. 63-66.

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37 38

See IP-Enabled Services, supra note 18, paras. 26, 45-60. See 47 U.S.C. §§ 541, 542 (2000) (authorizing local governments to award franchises for the provision of cable service and to require payment of franchise fees). See National Telecommunications and Information Administration, 50-State Survey of Rights-of-Way Statutes,http://www.ntia.doc.gov/ntiahome/staterow/rowtableexcel.htm. See Press Release, FCC, supra note 30. See supra notes 20-21 and accompanying text. See Whitt, supra note 2, at 591. Id. at 592. Id. Id. Id. at 587. What is also needed is a slimmer, more efficient, and more accountable regulatory agency with jurisdiction over communications, in other words, a transformed and reformed FCC. But that is another story unto itself. See Randolph J. May, The FCC's Tumultuous Year 2003: An Essay on an Opportunity for Institutional Agency Reform, 56 ADMIN. L. REV. 1307 (2004).

39 40 41 42 43 44 45 46 47

3
The Relationship between Regulation and Competition Policy for Network Industries†
David Newbery*
One of the central questions facing the regulatory and competition authorities is whether to delegate the regulation of the potentially competitive elements of the utility to specialised regulatory agencies, or whether they should be solely subject to normal competition laws enforced by the competition authorities - often referred to as 'light-handed regulation'. The EU, has always placed more emphasis on the application of competition law, and has sought to make sector regulation consistent with general competition law. This is most clearly evident in the 2003 EU Communications Directives which required considerable changes on the British approach to telecoms regulation. The paper discusses the appropriateness of this approach for telecoms and electricity, in which facilities-based competition is possible. Regulators must first determine whether markets are effectively competitive or suffer from Significant Market Power (SMP). Only in the latter case is ex ante regulation warranted, and only
* Professor of Economics and Fellow of Churchill College, Cambridge University, UK. E-mail: [email protected]

© 2006 D. M. Newbery. All rights reserved.

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if it is necessary, justified and proportionate. The paper considers how this approach works in the case of mobile call termination, and the implications of restricting regulation solelyto the market experiencing SMP. Electricity does not fit comfortably into this approach, it may be necessary to retain advantages for electricity, where information and continuing market surveillance are desirable, and where it may be necessary to modify market rules in a timely and well-informed manner.

Introduction
The deregulation movement that started in the United States was intended to remove detailed government control from otherwise competitive markets. The theory of regulatory capture expounded by Stigler (1971) and Peltzman (1976) argued that most industrial regulation was designed to protect incumbents against competition from entrants and had the effect of legalising monopoly power to the detriment of consumer welfare. Transport deregulation followed, most notably after Alfred Kahn's move to the Federal Aviation Administration and the subsequent deregulation of airlines. Normal competition policy would replace the detailed regulatory control exercised by state-level and federal regulators. It is hard to see why naturally competitive industries like trucking should ever be subject to economic regulation, given that trucks meet the required safety and environmental standards. Similarly, the theory of contestability suggests that mobile assets like aeroplanes do not need to be protected against competition nor regulated to prevent excessive prices. In short, where competitive markets can work, they should not be subject to economic regulation, but only to normal competition law. The situation is radically different for network utilities, where the network is typically a natural monopoly, delivering essential services to the mass of the voting consumer population. Electricity grids, gas distribution networks, local telephone networks, water and railways all share this property. Modern societies will not tolerate the unimpeded exercise of market power over such essential facilities. Network builders typically need rights to build networks, and local or national jurisdictions will only grant such rights in exchange for regulatory

The Relationship between Regulation and Competition Policy for Network Industries

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powers over prices and quality. Private investors will be reluctant to sink expensive capital investments without some assurance that they will not subsequently be prevented from charging remunerative prices. The only solution under private ownership is regulation. If such regulation is not credible, adequate investment will not be forthcoming and state or municipal supply will be the only viable default option. Cost-of-service (or rate-of-return) regulation evolved in the United States over nearly two centuries in response to legal challenges to clarify the nature of property rights and place restraints on regulatory activism. When Britain came to privatise British Telecommunications (BT) in 1984, it was recognised that BT would have overwhelming market power in local telephone services, and for a considerable period very substantial market power in longdistance telephony. Regulation was clearly required, and Professor Littlechild was commissioned to propose a suitable form of regulation. Littlechild designed price-cap regulation as the natural solution to moving from an overwhelmingly concentrated market to what was anticipated to become a competitive telecommunications market in due course (Littlechild, 1983; Bartle, 2003). Price-cap regulation has the attractive property of simulating the competitive market even in the presence of market power. In the United States, the Modified Final Judgement of the AT & T case in 1984 suggested that at least long-distance telephony might evolve to become a competitive industry. Long-distance telephony was no longer a natural monopoly with the advent of microwave transmission, the huge increase in capacity provided by fibre optic cables and the rapid fall in the cost of micro-electronics and switching capacity. This raised the question why telecoms should be subject to a sector-specific regulator, rather than being subject to normal competition law. Instead of imposing a price-cap, competition authorities could fine companies holding dominant positions in any market if they abused their market power by charging excessively high prices. The threat of penalties would, on this theory, deter utilities from exercising their market power, while minimising intrusive and costly regulation. The case for minimising regulation is powerful. The US evidence suggests that regulation evolves in response to pressures from special interest groups. On this view regulators are invariably captured, and use their regulatory powers to

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redistribute rents rather than to drive down costs and benefit consumers. The theory of asymmetric information suggests that just as redistributive taxation is distortionary and therefore costly, so attempts to redistribute cost savings from utilities to consumers will produce inefficiencies and deadweight loss. Regulatory inefficiency does not end with overpricing or inefficient supply. Hausman (1997) argues that one of the most costly consequences of traditional cost-of-service regulation is the delay hindering the introduction of new services, caused by concern that these new services might be cross-subsidised from the captive customer base. Hausman gives two examples - voice messaging and cellar phones. AT & T originally wished to offer voice messaging in the late 1970s, which the FCC delayed until 1988, when it was immediately introduced. The estimated consumer surplus generated is estimated at US $ 1.27 billion per year by 1994, so the ten-year regulatory delay cost billions of dollars. Hausman further argues that a possible ten-year regulatory delay in introducing mobile phones might have cost consumers cumulatively as much as $ 100 billion, large compared with the 1995 US global telecoms revenues of $ 180 billion/year. Avoiding unnecessary regulation is therefore to be desired. New Zealand was the first country to follow this logic when it came to liberalise its telecommunications market on 1 April 1989 (Bollard and Pickford, 1996). The state telephone monopoly that had been corporatised as Telecom in 1987, was sold in 1990 to a joint venture between local investors and the two American companies, Bell Atlantic and Ameritech, without establishing an independent regulatory body. The company was required to disclose financial and pricing information, and the "Kiwi share" obligation required Telecom to provide free local calls for residential customers and to not increase the (uniform countrywide) rental charge faster than the rate of inflation. It also provided an undertaking to ensure that interconnection would be provided to competitors on a "fair and reasonable basis". Clear Communications negotiated a long-distance access agreement with Telecom and entered the market in April 1991. By 1995, Clear had 21% of the domestic long-distance market and 24% of the international calls market. Shortly afterwards, Clear attempted to reach an agreement to access Telecom's local loops in order to be able to provide a local call service, but negotiations broke down. The matter at issue was whether Telecom could set the access charge

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using the Efficient Component Pricing Rule of Baumol (1983) and Willig (1979), which included the lost profit of Telecom, or whether, as Clear argued, the access price should be based on avoidable cost. Clear took Telecom to court for claimed abuse of its dominant position. The High Court supported Telecom's application of the Baumol-Willig rule but found that Telecom had indeed impeded entry. Both companies appealed and in December 1993 the Court of Appeal upheld the dominance finding but found against the Baumol-Willig rule. The case was finally appealed to the Privy Council in Britain, who accepted the original High Court judgement and supported the Baumol-Willig rule. Their argument was that if the monopoly price element (Telecom's lost profit from each call carried by Clear) was objectionable, then it was open to the government to control those monopoly profits directly under the provisions of the Commerce Act. The case is justly famous, both because it illuminated the economic principals of the efficient component pricing rule, and because it demonstrated the major drawback of relying on competition law, namely the time and cost involved in resolving disputes. The case started in 1991 and the government did not resolve the issue until July 1995. In 2001 the government passed a Telecommunications Act which obliges the Commerce Commission to resolve access disputes, to monitor the regulatory regime, and to recommend changes to the list of regulated services. It was not until April 2003 that the Commerce Commission, acting under the requirement of the Telecommunications Act, published an issues paper consulting on whether access to the local loop should be regulated.1 New Zealand appears to be following an evolutionary path in clarifying the role of regulatory agencies, starting from a minimalist position, but responding to the need to resolve disputes quickly and to restrain market power more effectively than appears possible under the normal provisions of competition law. There are similar lessons to learn from the early experience of telecoms regulation in the UK. When BT was privatised in 1984, it faced a single smalllicensed rival, Mercury, that was granted protection against entry until at least 1991. Although BT's services to final customers were subject to price-cap regulation, access agreements between BT and Mercury were left to commercial negotiation. Mercury, like Clear in New Zealand, immediately disputed the terms offered by BT and appealed to OFTEL, the telecoms regulator. Economists rapidly established that interconnection agreements between symmetric network

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operators, each of which had sole ability to terminate calls to its subscribers, would lead to agreements that were at or above the profit-maximising level. The fact that both operators might speedily agree access charges was no guarantee that these charges would be in the public interest. Fortunately, access agreements between very asymmetric players might break down as the dominant player attempted to exclude his competitor, and in such cases disputes would come to light, as with Clear and Mercury. Since then, the theory of access pricing has been developed (Armstrong, 1996, 1998; Laffont, Rey and Tirole, 1998a, 1998b) so that interconnection is now recognised to be an area of regulatory scrutiny, if not regulatory control.

Implicit versus Explicit Regulation of Natural Monopolies
New Zealand and Germany lacked regulators for at least some network monopolies until recently.2 In effect, the network owners were subject to implicit rather than explicit regulation - they could pursue profits providing they did not violate competition legislation, and specifically did not abuse their dominant position. This raises the question whether there are important differences between implicit and explicit regulation, and whether in particular there are additional advantages to implicit regulation (apart from avoiding the drawbacks of regulation already noted). Utilities might argue that any action that does not breach the rules of explicit regulation is legitimate. Poorly designed or incomplete regulation (for example, failing to address issues of quality) may then lead to unsatisfactory outcomes. Utilities might believe that the concept of abusing dominance was more encompassing and could include any outcome that damaged consumers compared to the counterfactual of a competitively supplied service, where consumers could choose according to quality and price. In that case implicit regulation might seem to have advantages. The question is interesting but hard to answer. Poor regulation can normally be improved, although in some jurisdictions this might require new legislation that would be very hard to pass.3 On the other hand, utilities might argue that abusing dominance was narrowly interpreted as unreasonable high pricing or unjustified discrimination. If there is no case law on other aspects, such as supplying unsatisfactory quality, then it might be hard to address such problems. There is a further and important point demonstrated in Germany. The justified

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(average) price for using a network will be the average cost, including a normal return on, and depreciation of, the capital. Valuing the capital in the network is therefore central to network regulation, and has been highly contentious in Britain (Newbery, 1997). The problem is whether to value the assets at historic cost, the privatisation sales value, or at written-down modern equivalent asset value (to take the most obvious alternatives). The differences can be profound: for water the sales value was £6 billion but the written down modern equivalent asset value was estimated at more than £100 billion. In Britain, decisions by the regulator are typically appealed to and settled by the Competition Commission, thereby gradually building up suitable precedents. Without that process and the consequential development of case law, the courts examining whether prices were defensible or not might reach economically unsatisfactory conclusions, or might, particularly if the same competition authorities were involved as in regulatory dispute resolution, reach the same conclusions, but far more slowly and expensively.

The Evolution of Liberalisation Towards Structural Reform
Telecommunications was the first network utility to be privatised in the UK, and the first to be liberalised in the United States, in both cases for good reason. The underlying case for liberalising network industries is that it allows competitive pressure to be put on sleepy monopolies, and restricts cross-subsidies that frequently take the form of a tax on competitive medium-sized industry to subsidise domestic consumers (and sometimes politically powerful large business). In the case of telecoms, where technical progress is rapid, competition is the best way of identifying winners and enabling them to replace losers. It is also easier to sustain telecoms as a private regulated utility than with most other utilities, as there is less difficulty in designing a system of regulation that will be credible and therefore sustainable. While the United States had strong Constitutional protection of regulated utilities, reinforced by extensive case law and underpinned by Administrative Law (Levy and Spiller, 1996), Britain had a sovereign Parliament that was free to change laws, and hence to threaten the stability of any legal arrangements. The essence of credible regulation is that the private investor should have confidence that his sunk investment will not be subject to regulatory opportunism, by, for

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example, reducing regulated prices to non-remunerative levels. The temptation to act opportunistically is counterbalanced by the threat of the utility to not invest if it finds the regulatory compact has been broken (Gilbert and Newbery, 1996; Newbery, 2000). In the case of telecoms, the rate of growth of demand is high, the need for investment in new technology continuous, and the expertise of the telecoms company in managing the software and equipment critical. All these factors give the utility strong bargaining power in the repeated game between regulator and utility. Telecoms industries are, however, atypical of other network utilities, in that liberalisation normally retains the initial industrial structure, with entry taking place by competing networks that require interconnection. The United States was relatively unusual in that AT & T agreed to its own break-up into Regional Bell Operating Companies (RBOCs) and the long-distance AT & T, reflecting the earlier functional organisation of the company and the vast size of the United States (Temin, 1987). BT was allowed to retain its local exchanges with their local loops as well as its long-distance network and international lines; a model followed in most modest-sized countries. Even in the United States, competition took place between different interstate networks, each of which had to interconnect with an RBOC. In that sense, long-distance networks had ceased to be natural monopolies, although they continued to be regulated by the FCC. The quest for increased competition in the United States led to the gradual restructuring of regulation in the privately owned but regulated natural gas industry. The gas industry appeared ideally suited to competition, with over 8,000 producers, the 40 largest of which accounted for 57% of 1990 gas production. They were connected to more than 1600 Local Distribution Companies through 44 major interstate pipeline systems and hundreds of smaller pipeline companies (IEA, 1994). Despite the obvious prospect of competition in supply, wellhead gas prices were regulated, creating huge inefficiencies after the oil price rises of the 1970s. The subsequent collapse of the market as long-term contracts were signed at the peak of the oil price boom created excess capacity in pipeline networks, ideal conditions for the introduction of competition (IEA, 1994). Various Federal Energy Regulatory Commission orders from 1984 on finally unbundled and restructured the industry to one of third party access that facilitated active competition.

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As with the privatisation of BT, Britain was slow to learn the importance of competition for enhancing performance, and thus also slow to realise the importance of restructuring utilities to achieve effective competition. In the case of BT, the legislation had at least envisaged a review of the duopoly in 1991. The Duopoly Review recommended full liberalisation of entry, which duly occurred. By 1995 there were over 150 operators licensed to compete with BT, including 125 cable TV companies who could offer telephony with cable, of which 80 were actually providing service, (Bell, 1995). Rapid entry was followed by substantial consolidation, but cable companies now have more than half the broadband market. The failure to create a more competitive structure at privatisation and the delay in allowing competition led Armstrong, Cowan and Vickers (1994) to the judgement that 'the duopoly policy has been detrimental to development of competition, and its main beneficiary has been BT itself (p.240). Unfortunately, the American liberalisation experience (in both gas and telecoms) was not exploited when British Gas was privatised as a vertically integrated monopoly in 1986, although Vickers and Yarrow (1988, p267) criticised the failure to introduce competition. Under intense regulatory pressure, supported by the Office of Fair Trading and via references to the Monopolies and Mergers Commission, British Gas was persuaded to first functionally unbundle the competitive services from the natural monopoly networks, and then finally to break up the company into competitive and monopoly parts. The latter, Transco, in turn sold off storage activities and finally merged with the already unbundled electricity National Grid Company, consolidating the regulated energy networks in one company. Even here, regulatory activism has attempted to replace regulated prices by market mechanisms of auctions, first for storage, and then for scarce entry capacity from the beach-head (to which gas is delivered by various oil and gas companies using their own pipelines). Fortunately, by the time the Electricity Supply Industry (ESI) came to be privatised in 1990, the message of restructuring to introduce competition before privatisation had finally been learned.

Unbundling the Competitive Services
The new conventional wisdom is that network utilities should be unbundled, with the potentially competitive network services under separate ownership from the natural monopoly network, so that the network owner has no incentive to favour

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its own service provider. Such vertical separation of network service from the network risks losing economies of scope and hence raising costs. In the case of electricity and gas, these economies of scope appear small compared to the potential efficiency gains, but in the case of telecoms this is less obvious. The operator of a switched network has to create end-to-end connectivity and at the same time calculate the cost of the call in order to bill the customer. The design of switches to route and record such information have natural synergies that would take considerable investment and design to replicate at comparable cost in unbundled form. In those parts of the network where economies of scale are not significant (long-distance, international) facilities-based competition is feasible and now fairly standard, but where there are important natural monopolies (arguably still in the local loop), vertical integration between call delivery, billing and network ownership is still common. Positive steps to overcome the advantages of incumbency are then required (such as number portability and carrier pre-selection). The attraction of ownership unbundling is two-fold - it allows competition to give companies better incentives to drive down costs, and it also offers the prospect of removing costly regulation. The new wisdom of "competition where feasible, regulation where not" suggests that regulation should be confined to the natural monopoly elements, typically the networks, with network services subject only to competition law. Indeed, in transcribing the EU Electricity Directive 96/92 into national legislation, some Continental countries adopted this approach. Britain followed an earlier and different path. The difficulty of creating credible regulatory structures through primary legislation led the designers to propose licences that would contain the important regulatory details. These licences had the force of contracts, enforceable through the courts. They could only be changed by mutual agreement between the utility and the regulator, or if the regulator found that continuing the existing licence conditions unchanged would be against the public interest (normally at the periodic price control review). The regulator could then propose a licence modification (normally a change in the level of the price cap for the start of the next regulatory period, and/or a change in the X-factor in the RPI-X formula). This could either be accepted or appealed to the Competition Commission - an alternative costly to both utility and regulator, and hence to be avoided if possible.

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Licences were clearly central to the British style of price-cap regulation of the network natural monopolies, but were also retained for the potentially competitive network services. Their licence conditions typically contained rules of market behaviour, and provided for information disclosure to the regulator, who was thus able to exercise a market surveillance role. The position now is that, after the New Zealand experience, it is widely accepted that ex ante regulation is required for network natural monopolies, but there is less agreement whether such regulation is required for network services, or under what circumstances and in what form such regulation might be desirable.

Regulating Network Services
Regulatory design in Britain, the United States and in the EU has followed quite different routes. In the United States, utilities were already for the most part investor owned and regulated as vertically integrated franchise monopolies, under existing legislation. To take a good example, the Federal Energy Regulatory Commission, FERC, has extensive powers under the 1935 Federal Power Act. Individual States have devolved regulatory powers, but FERC has astatutory obligation to ensure that wholesale prices are "just and reasonable". This gives FERC considerable powers to intervene if liberalisation fails to deliver satisfactory outcomes. Britain, as already noted, had to design a system of regulation at short notice and evolved a system of licences. Where the industry was liberalised or restructured, the major companies were typically required to hold licences. On the Continent, competitive services were frequently subject only to normal competition legislation. The Single European Act mandated the European Commission to propose policies to bring about a single market in gas, electricity, transport and telecommunications. The Commission has been remarkably successful in issuing Directives with that intent, and is following a strategy that builds on existing articles of the Treaty of Rome and therefore already have been incorporated into each member state's legislation.

Applications to Regulating Telecommunications
The four EC Communications Directives that came into force on 24 April 2002 are an instructive example of how this process works for delivering a single market in telecommunications operating under a consistent regulatory framework. The Commission Guidelines on market analysis explains how they

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will work (CEC, 2002). The new regulatory framework requires that "the markets to be regulated are defined in accordance with the principles of European competition law." (Guidelines, para 4). Later on it notes that "to ensure consistency, these guidelines are based on (1) existing case-law of the European Court of Justice concerning market definition and the notion of dominant position within the meaning of Article 82 of the EC Treaty and Article 2 of the merger control Regulation; ..." (para 24). The four directives are the Framework Directive, the Access and Interconnection Directive, the Authorisation Directive, and the Universal Service Directive, which member states are required to implement from 25 July 2003. The Framework Directive requires National Regulatory Authorities (NRAs) to conduct market reviews and to determine which markets shall be deemed to be effectively competitive, and which markets are susceptible to ex ante regulation. A market is effectively competitive when no operator in that market possess Significant Market Power (SMP), which is newly defined in Article 14 of the Framework Directive to be equivalent to the competition law concept of dominance: "An undertaking shall be deemed to have SMP if, either individually or jointly with others, it enjoys a position of dominance, that is to say a position of economic strength affording it the power to behave to an appreciable extent independently of competitors, customers and ultimately consumers."4 The final stage is that the Commission issued a Recommendation identifying "those product and service markets in which ex ante regulation may be warranted." (CEC, 2003, para 2). This sets out criteria for identifying markets where regulation may be warranted: high and non-transitory entry barriers, those whose structure does not tend towards effective competition within the relevant time horizon, and those where the application of competition law would not adequately address the market failure concerned (para. 9). "It is considered that markets that are not identified5 in the Recommendation will not warrant exante regulation," (Guidelines, para 29). The Recommendation then defines 18 markets that NRAs are required to review. The Guidelines "requires NRAs to ensure that the measures they impose on SMP operators under Article 16 of the Framework Directive are justified in relation to the objectives set out in Article 8 and are proportionate to the

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achievement of those objectives." Later, (at para. 118) "the means used to attain a given end should be no more than what is appropriate and necessary to achieve that end." The cumulative effect of these Directives is to limit regulation to those markets where competition law would be inadequate, and then further to restrict the scope of regulation to the minimum justifiable level. Whereas the American approach is to gradually relax an all-encompassing ability to regulate, the European approach is to propose the minimum degree of regulation that could be justified in a court of law. The British approach started rather closer to the American concept in normally requiring network services to hold licences (except for some new and small entrants). Each approach reflects the evolutionary history of utility ownership and regulation. The United States had evolved a system of regulation that was then enshrined in Acts, Britain had to design a system ab initio, while the European Commission had to seek consensus among countries with very different patterns of ownership, utility duties, and central government control, starting from the pre-existing EC Treaty and its competition law. Despite the limitations that consensus-seeking might suggest, one can argue that this approach has attractions for harmonising telecommunications markets, where companies not only need to communicate across borders but where mobile (cell-phone) operators also frequently operate in many European countries. One can draw a distinction between the classic and 'post-modern' network utility. In the classic network utility, the network is a natural monopoly subject to limited technical progress and supplying a mass service. In the 'postmodern' network utility facilities-based competition is possible, failure of a single network may not be critical, innovation is important, and services supplied are useful rather than essential. In the first case, regulation is inevitable, while in the second case, competition law has potentially strong attractions and should be given maximum scope. Competition law, not regulation, should be the default option for post-modern utilities. The interpretation of Significant Market Power, or SMP, in a post-modern utility needs to take account of the dynamics of technical progress. The concept of single dominance involves balancing a number of considerations, no one of which is likely to be decisive by itself. Thus market shares are themselves not

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conclusive, although there is a presumption that SMP is unlikely with a market share of less than 25%, and likely with a market share of more than 50%. 6 Normally a share of 40% or more would be required, but in addition the analysis should allow for market shares that are fluctuating, markets that are emerging and/or rapidly growing, and should be suspicious of persistently high market shares. Barriers to entry through control of infrastructure, essential facilities, because of economies of scale or scope, and exercised by vertical integration, would suggest a greater possibility of exercising SMP.

Mobile Telephony
All of these qualifications to relying on market shares alone apply with considerable force in determining whether Mobile Network Operators (MNOs) have SMP in any of the relevant markets. Thus in Britain there were four MNOs in 2002, and five in 2003, with subscriber market shares that fall close to or below the threshold for dominance of 25%. The markets were initially unregulated (although all MNOs had licences), were clearly very dynamic, growing at very high rates, and most of the MNOs were not making profits. Nevertheless, Oftel monitored the various telecoms markets (both mobile and fixed-line), and in particular those markets experiencing SMP. In March 1998, the Director General of Telecommunications (DGT, i.e., the regulator) referred the then two largest MNOs (Cellnet and Vodafone) and BT to the Monopolies and Mergers Commission relating to call termination charges (MMC, 1999). The DGT considered that the MNOs were able to set the termination charges without significant market pressure, that as a result they were excessive, and should beregulated to be cost-reflective. Each MNO has an effective monopoly in delivering calls to customers on its network, as at present there is no commercially feasible alternative way in which different networks can compete to deliver calls to any particular mobile customer. In addition, because the calling party pays rather than, as in the United States, the receiving party pays, the call recipient has little incentive to choose an MNO who offers lower call termination charges.7 The market for mobile call termination is therefore an effective monopoly and exhibits SMP. The DGT also argued that BT's retail charges for fixed-to-mobile calls ere not adequately restrained by competitive pressure, as BT carried 83% of fixed-tomobile call minutes from residential users and 66% from businesses. As

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the cost of fixed-to-mobile calls was still a modest share of total bills, BT was not under enough competitive pressure to moderate these charges, and hence also possessed SMP in the fixed-to-mobile call market. As a result, the profit BT was making on fixed-to-mobile calls was far higher than on other comparable calls. As BT was subject to price control for other services where it was deemed to have SMP, it was natural to propose a price-cap for BT's fixed-to-mobile calls. The more interesting question was whether there should be a separate price cap for fixed-to-mobile calls, or whether to include fixed-to-mobile calls in the basket of services subject to an overall price cap. The latter arrangement has the attraction that (provided the basket is base-weighted) the utility has the correct incentives to choose the most efficient or Ramsey pattern of prices (Armstrong, Cowan and Vickers, 1994, p81). The MMC rejected placing fixed-to-mobile calls in the existing price-cap basket, as they were concerned that BT might be tempted to favour its then-subsidiary, Cellnet, and instead proposed a separate price-cap on BT's retention (i.e., the profit it made on fixed-to-mobile calls). At the time of the 1998 inquiry, Vodafone and Cellnet between them had 72% of total mobile subscribers, which had fallen from 100% five years earlier (MMC, 1999, p 147). The DGT therefore concluded that the two new entrants should be left unregulated (apart from the standard licence conditions), and they were not referred to the MMC, and not included in the proposed call termination charge price cap. This price cap would run until 2001/02. In July 2000, Oftel began a review of competition in mobile termination to see whether the markets still experienced SMP. By then the two new entrants had secured half the market. Oftel concluded that there had been no technological change making call termination contestable, and the continuation of calling party pays reduced any competitive pressure that might exist on call termination. Oftel therefore concluded that each of the four MNOs had SMP in their respective markets for call termination, and proposed a new price cap for call termination charges. The MNOs appealed and the DGT referred the case to the Competition Commission (the successor to the MMC) in January 2002.8 The case took a year, and spanned the publication of the EC Telecommunications Directives. These Directives required Oftel to review the telecommunications market listed in the Recommendation. Oftel published its own guidelines in August 2002, although it did not publish its Review of mobile

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wholesale voice call termination markets: EU Market Review until 15 May 2003, after the publication of the Competition Commission report (CC, 2003). By then there were five MNOs, one of which, called 3, was planning to roll out a 3G network later in 2003.9 Oftel's Review concluded "that each Mobile Network Operator ("MNO") in the UK has significant market power in a separate market for voice call termination on its network, and in the case of 3, wholesale 2G voice call termination provided to its subscribers, and can be expected to have market power for at least the next three years." The Competition Commission agreed with Oftel that the MNOs had SMP, that mobile call termination charges were excessive, and, as in the earlier inquiry, that the most appropriate remedy was a price cap on the call charges. The issue then resolved into how that price cap should be set. MNOs offer three services, subscription, associated with owning a hand-set, making and receiving calls. It is possible to measure the Long-Run Incremental Costs (LRIC) of providing each of these services, but pricing at LRIC would not cover the fixed and common costs of the mobile network. Even a competitive market would therefore have to mark up prices above LRIC if it were to break even. The MNOs argued that the admittedly high mark-up over long-run incremental costs of termination was used to subsidise hand-sets, which stimulated the development of the market and accelerated penetration. This in turn created beneficial network externalities to all callers (fixed as well as mobile), as it increased the number of people they could call and hence increased the value of each network. The combination of Calling Party Pays (CPP), which facilitated hand-set subsidies and pay-as-you-go, dramatically increased the rate of market growth compared to the US approach of Receiving Party Pays (RPP), so that Mexico decided to switch from RPP to CPP in 1999, and then experienced an acceleration in market growth. Such network externalities had been recognised in the earlier MMC inquiry and justified an additional subsidy financed by call termination. The main issue was how to allocate the fixed and common costs (including internalising this network externality). The Competition Commission supported Oftel's recommendation that these costs should be financed by an equi-proportional mark-up on all LRICs. The MNO's argued for a Ramsey mark-up, which all parties accepted would be efficient if applied to all three mark-ups.10 Ramsey mark-ups would be inversely proportional to market demand elasticities, and as

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these were lower for call termination than the other services, would justify a higher termination mark-up. Oftel argued that,11 "even if termination charges were set at the Ramsey level, there would be no guarantee that MNOs would set their (unregulated) retail prices at the Ramsey levels. In Oftel's view the key reason is that the retail market for mobile services is not effectively competitive. If the retail market were perfectly competitive and if termination charges were regulated at the Ramsey level, it would be expected that firms would set Ramsey retail prices. The intuition is that in a perfectly competitive market firms are forced by competitive pressure to set prices that maximise consumer surplus." The Competition Commission defended equi-proportional mark-up on essentially two grounds: that it was not fair to fixed-line callers to have a higher mark-up on mobile call termination, the benefits of which would flow back to subsidising mobile use, and that in any case the evidence for establishing the relevant demand elasticities was not sufficiently robust to justify a departure from equi-proportional mark-ups. The MNOs then appealed to the High Court for a Judicial Review. A judicial review of a Competition Commission case is essentially a test that the Commission had followed due process and given reasoned arguments for its conclusions, and does not as such normally reconsider whether the contestants' arguments were more compelling. Justice Moses delivered his judgement in favour of the Competition Commission on 27 June 2003. The case is interesting in showing the effect of this competition law approach on regulation, but it also raises some important and not properly resolved issues. On the positive side, although the case was brought before the Telecommunications Directives came into force, Oftel was already conducting its market analyses and basing its case for regulation on very similar principles, particularly in defining markets and determining whether they suffered from SMP. Second, the idea of confining regulation only to those markets suffering from SMP and leaving other markets to competition law has now been accepted. From 25 July 2003 telecommunications licensing was abolished in the UK (and the rest of the EU) as a direct consequence of the new EU communications regime. Licenses will be replaced by General Conditions made under the British Communications Bill (which had not then been passed into law). 12 Third, regulation now has to be justified in relation to the objectives of the Directives, proportionate, and no more than that appropriate and necessary to achieve that end, as the Guidelines cited above requires.

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The theoretical disagreements relate to how regulation should be designed to be compatible with competition policy.13 Article 13(2) of the EU Access Directive (2002/19/EC) requires that "National regulatory authorities shall ensure that any cost recovery mechanism or pricing methodology that is mandated serves to promote efficiency and sustainable competition and maximise consumer benefits." An economist would interpret this as requiring, if possible, the regulation to simulate the effects of a competitive market. For a lawyer like Justice Moses matters were more complicated: "...the term 'maximum economic efficiency' is itself protean. ... The concept involves value judgements ... As Professor Geroski of the Competition Commission says, at paragraph 175 of his first statement, there is no unique definition of economic efficiency and no necessary dichotomy between efficiency and the principles of equity which the Commission sought to apply." (Moses, J. 2003, at para 122). This argument seems somewhat disingenuous. Competitive markets deliver efficiency, not equity or fairness. Equity is better pursued by explicitly designed redistributive taxation, and under reasonable assumptions (set out in Diamond and Mirrlees, 1971), taxation should not distort pre-tax market prices, except for correcting for externalities. Under additional and also reasonable assumptions taxes on goods and services should be uniform, with redistributive taxes concentrated on income. This optimal form of redistributive taxation leaves relative market prices exactly as they would have been under competition with no taxes. In practice, it is more effective to redistribute real income through the expenditure side of the budget. 14 More to the point, the spirit of the Communications Directive and, more generally, of achieving consistency between competition policy and regulation, is that regulation should only be employed where markets do not deliver competitive outcomes. Where regulation is required it should attempt to produce the result that markets would have delivered if they had been competitive. To return to mobile call termination, economic principles provide useful guidance for setting the price cap to simulate the effect of a competitive market. First, the efficient way of recovering fixed and common costs is Ramsey pricing for all the various services, in which the mark-up over LRIC is inversely proportional to market demand elasticities. Second, in a market where subscribers must choose between different suppliers to purchase the whole range

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of bundled services, effective competition in all service markets would force the suppliers to charge Ramsey prices for each service offered (i.e., subscription, making and receiving calls). Third, termination is a bottleneck service and thus not subject to the same competitive pressures as subscriptions and calling. Mobile operators can raise termination charges to fixed operators who are subject to regulation and unable to exercise countervailing power, and will have incentives to do so if the surpluses above cost thereby generated can be applied to fund competitive activities against other mobile operators. Mobile operators also have incentives to raise charges to each other, since this disadvantages callers from other networks and encourages them to switch networks to the MNO charging the higher termination fee. This tends to overreward mark-ups on termination relative to the efficient level. As a result, competitive forces will not ensure that MNOs set termination mark-ups to either fixed or mobile operators at Ramsey levels without regulation. Finally, new subscribers confer a network externality on existing mobile and fixed line subscribers, which they will undervalue in making the subscription decision. There is therefore a case for subsidising subscription relative to the incremental cost, and this adjustment forms part of the identification of appropriate Ramsey mark-ups. If the remaining mobile markets are competitive, and if call termination charges are regulated at the Ramsey level, then all mark-ups would be set efficiently as though all services were competitive. Oftel disputed that the retail market for mobile services was competitive in its submission to the Competition Commission, but also accepted in its Market Review that the retail market was effectively competitive, in the sense that no MNO has SMP. That does not mean that the market corresponds exactly to the textbook definition of perfectly competitive (which, inter alia, requires constant or decreasing returns to scale, ruled out by the very need to recover fixed and common costs by a mark-up). It does mean that there are good reasons for not regulating that market. This raises an important philosophical point. A welfare economist might argue that given one instrument (the mark-up in the regulated market), and one objective (maximise social welfare subject to private ownership, i.e., a profit constraint), the mark-up should take into account all market failures, including possibly imperfect competition in the mobile retail market. The whole thrust of

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the Communications Directives is that regulation cannot be justified if markets are deemed effectively competitive. That would seem to imply that regulators should not be able to leverage their authority to regulate some markets into other markets that are not subject to regulation (because they do not exhibit SMP). As regulation is costly (particularly in dynamic markets), it is only justified where there is no suitable competition law remedy. Competition law does not aim to make all markets perfectly competitive by assuming that it is costless to intervene, but leveraging regulation into other markets to improve their workings would seem to come very close to trying to achieve efficiency in these other markets which are almost, but not quite, competitive. Another way of putting the same point is that the key principle of British regulation of network utilities is that competition should be encouraged where possible, and where natural monopoly precludes this, regulation should mimic the effect of competition. Price-cap regulation was developed precisely for this reason. Once it is accepted that Ramsey pricing would in fact mimic the workings of competitive markets for bundled services, it would follow that Ramsey pricing is appropriate (indeed, required) for the service (termination) that requires regulation. The principle has the additional advantage that as competition develops in the unregulated markets (through the market maturing, under competition from new services such as 3G, or as a result of competition policy), there is no need to re-adjust the form of regulation in the call termination market.

Assessment on Regulation and Competition Policy in Telecoms
The Communications Directives have had a considerable impact on the form of telecoms regulation in Britain by ending the licence regime, and restricting the scope of regulation to markets suffering from Significant Market Power, and then only where regulation is required to achieve efficiency and sustainable competition. The evidence from telecoms liberalisation is that competition is indeed the key determinant of performance (Newbery, 2003) and so it seems natural to ensure that regulation does not impede the workings of otherwise competitive markets. The next question is whether the same approach would work as well for other network utilities. The most challenging such utility is theelectricity supply industry, where, in contrast to telecoms, liberalisation is viewed with increasing scepticism in Europe and North America.

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Electricity Regulation and Competition Policy
Electricity markets differ in one obvious way from telecoms markets. Telephone users wish to speak to a particular person, whereas electrons are anonymous and are equally attractive from any source. This distinction makes vertical integration much less important.15 The fact that economies of scope between generation, transmission and distribution appear small suggests that it is desirable to separate the potentially competitive generation and supply (or retailing) functions from the natural monopoly high and lower tension networks. These networks should then be regulated The updated Energy Directive (2003/54/EC), which came into effect in August 2003, requires member states to set up national regulatory authorities, and to impose regulated Third Party Access on transmission and distribution. The traces of earlier objections from some member states remain in that the regulator can either set tariffs ex-ante or publish the methodology under which they can be set. Nevertheless, the principle that charges for using the networks should be regulated has now been widely accepted. The relevant question is whether the potentially competitive segments of generation and supply should be dealt with under normal competition law, as in many countries, subject presumably to tests of significant market power, or whether they should be subject to stronger regulatory controls. Where the generation market is dominated by an incumbent, as in France (where the state-owned EdF controls about 95% of generation), or in Belgium (where the private company Electrabel has a similar share), it is clearly easy to demonstrate SMP. Tacit regulation, in which the threat of an investigation for abuse of market power, may then be sufficient. Many electricity markets are, however, characterised by the largest generator having less than 40% of the market, while still remaining fairly concentrated. The concept of single dominance is then not sufficient, and something more inclusive is required. Under Article 82, a dominant position can be held by one or more undertakings ('collective dominance'). The jurisprudence on establishing collective dominance is still evolving, but it is now accepted that "a dominant position may be held by two or more economic entities which are legally and economically independent of each other." (Guidelines, 3.1.2.1). The Court of First Instance gives as an example of conditions conducive to collective dominance: "the relationship of interdependence existing between the parties to a tight oligopoly within which, in a market with the appropriate

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characteristics, in particular in terms of market concentration, transparency and product homogeneity, those parties are in a position to anticipate one another's behaviour and are therefore strongly encouraged to align their conduct in the market, in particular in such a way as to maximise their joint profits by restricting production with a view to increasing prices." (Case T102/96, Gencor v. Commission [1999] ECRII-753). This list of conditions conducive to collective dominance maps almost exactly on to the characteristics of wholesale electricity markets. Consider as the leading example the English Electricity Pool, set up as the wholesale market for England and Wales at the time of restructuring and privatisation in 1989/90. The Pool continued until it was replaced by the New Electricity Trading Arrangements in 2001. The Pool was a compulsory, day-ahead, last-price auction in which generators had firm rights to transmission but no firm obligations to generate. Generators submitted bids the day before and the System Marginal Price (SMP) was set each half hour as the bid price of the most expensive unconstrained generation unit called on to operate. Unconstrained generators were all paid the same SMP plus a capacity payment, making up the Pool Purchase Price, PPP. Generators available but not dispatched also received the capacity payments, while constrained generators received their bid price, if they were required to generate within an import-constrained zone and bid above the SMP, or their lost profit (SMP less bid price) if they were in an export-constrained zone. The prices for each half-hour were published by 5pm the day before so that consumers could adjust any consumption decisions in the light of these prices. The Pool prices were overlaid with financial contracts to reduce risk. The typical contract was a two-sided Contract for Differences (CfD), with a strike price s for a volume M MWh of electricity. If the Pool price were P in that time period, the buyer paid P per unit to the Pool and (s-p)M to the company issuing the contract, thus effectively ensuring delivery of the contracted quantity of electricity at the strike price. The generator similarly received p per unit dispatched from the Pool, but was assured of receiving in total the strike price per unit contracted. It is readily proved that the best bid for a fully contracted generator is the marginal cost of generation, m. The generator would receive (s-m)M total profit if he generated, and a larger amount, (s-p)M, if p < m and he were not called to generate. At privatisation, the Central Electricity Generating Board of England and Wales had been unbundled into a separate transmission company, National Grid, two fossil-fuel generating companies, National Power and PowerGen, and

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a nuclear generating company, Nuclear Electric, which remained in public ownership until 1996. The two fossil generating companies set the price of electricity in the Pool over 95% of the time in the first four years, but as they had been sold almost fully contracted, they had little incentive to raise prices until they came to renegotiate the contracts over the next three years. As the original contracts expired and had to be renegotiated, so they raised the prices relative to the rapidly declining fuel prices. Fig. 1 shows the evolution of the wholesale electricity price. The cost of generating by coal and gas are also shown, so the margin of the price over the short-run avoidable fuel cost is readily seen. The prices are yearly moving averages of the half-hourly pool prices or the quarterly fuel prices, and are deflated by the Retail Price Index to the 2001 price level. The line with diamonds gives the Hirschman-Herfindahl Index (HHI), defined as the sum of the squared percentage shares of coal-fired plant capacity (which set the price most of the time until 1999) owned by different companies, read on the RHS scale. An HHI of 5,000 represents a symmetric duopoly, and the initial concentration was somewhat higher than this as National Power was 50% larger than PowerGen. Fig. 1 Evolution of the Wholesale Electricity Market in England and Wales

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The half-hourly and daily prices were dramatically more volatile than these annual average figures, and the numerous price spikes attracted particular attention. The early Pool inquiries by the Director General of Electricity Supply, the electricity regulator, found that the price-cost margin was justified (Offer, 1992), but by 1994, it was clear that the continuing fall in coal prices was not leading to a comparable fall in the Pool price. The subsequent inquiry concluded with a price cap on the annual average Pool price, to be ended by the sale of 6,000 GW of plant, as shown. That sale lowered concentration (from an HHI of just under 5,000 to just under 3,500), but did nothing to reduce the price-cost margin. Part of the explanation was that the plant had been sold under a leasing arrangement to the buyer, who had to pay £6/MWh for each unit sold. The defence of this was partly one of sharing risk (as the payment is only made when the plant successfully sells electricity) and partly to pay for the sulphur credits handed over with the stations, but had the effect of raising rivals' costs, encouraging them to support a high bid-price strategy in the Pool. The Electricity Pool up to mid-1998 would seem to satisfy most of the criteria for collective dominance that would be likely to lead to tacit collusion. The market was concentrated (HHI above 3,000) and transparent (all prices were published the day ahead, and anyone could subscribe to Pool data giving the bids of each participant for each day). It was mature (with very low rates of growth); the product, electricity, was homogenous, produced by firms with similar or even identical plant and hence very similar cost structures. These costs were also transparent (mainly fuel costs whose prices were published). The demand elasticity was very low (even for those large customers who faced the Pool price), while a large fraction of electricity was sold at prices that were kept constant over periods of a year, despite huge variations in half-hourly prices.16 The only criteria for likely collective dominance that the Pool failed to satisfy was that barriers to entry were low, and indeed entry was rapid. However, entry was by gas-fired plant running on base-load with contracts to distribution companies, and mostly bid a zero price into the Pool. They therefore did not participate in price setting. Over time the increase in capacity would undermine the prospects for tacit collusion, but the impact was gradual and not noticeable for the first seven years. The other evidence to examine for tacit collusion is whether the prices remain high even when costs fall, and that was certainly the case. Fortunately, the extraordinary wealth of data about bidding behaviour in the Pool makes it

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possible to test for tacit collusion directly. Sweeting (2001) does this using bid data from each firm to see whether their bids are best responses to the bids of other firms. Fig. 1 divides up the time since privatisation into the relevant periods. During the first, from 1990-94, the duopolists offered to supply more at each price than would have been individually profit maximising, so if they were tacitly colluding it was to drive the prices lower, not higher. This is consistent both with the high initial contract coverage, and of tacit regulation. The duopolists might have reasoned that the exercise of market power would attract adverse regulatory activity, as it finally did in 1994. The two years of price control demonstrated the considerable ability of the companies to meet the price cap to within 1% despite a huge price spike caused by the loss of a nuclear station at the time the French decided to import 2,000 MW instead of, as normal, exporting 2,000MW to England. The period following the end of the price cap until 1998 was a period in which each of the three firms appeared to be individually profit maximising, without any need for collusion (given their considerable individual market power). Finally, the last period for which Sweeting had data covers the period of rapid sales of generation plant by the incumbents, as they traded horizontal market power for permission (granted by the relevant Government minister) to vertically integrate into supply. During this period concentration fell rapidly, sparecapacity increased, and bidding behaviour was consistent with tacit collusion to reduce supply at each level of price. There was a strong motive for this, as the generators wished to sell their plant for the highest price, and to do that they needed to convince prospective buyers that margins would remain high despite the excess capacity and falling market concentration. Once the sales had been made, the new owners, less familiar with the previous market game, bid more aggressively and competitively, thus undermining collusion and causing the price-cost margin to collapse.

Addressing Cases of Collective Dominance
Electricity wholesale markets thus exhibit characteristics that are likely to support collective dominance, and specifically allow prices to remain well above competitive levels, even when the market does not appear to be particularly concentrated. In some cases (1996-8 in Britain) high price-cost margins can be sustained even without tacit collusion, given the technical characteristics of

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electricity. These include the very low demand elasticity, the inability to store electricity, and the effect of transmission constraints in fragmenting the market. If the capacity is not instantly available to deliver into a constrained region, then the generators operating in that region can demand extremely high prices. Even relatively unconcentrated markets can exhibit collective dominance, as the English Pool demonstrated for a brief period after 1998. Competition authorities ought therefore to be able to establish collective dominance for many electricity markets. On the Telecommunications Directive model, it would then be open to argue that regulation were required to address the problem, if there were no better solution. The obvious competition policy remedy would be to require companies to divest generation capacity in order toreduce market concentration. There are difficulties with this structural solution, and attractions in retaining licence conditions for generation and supply. The obvious difficulty with structural remedies is that the burden of proof must be set reasonably high, if competition law is not to chill the very driving force of competition, which is the pursuit of profit. It is one thing to deny a merger that might increase concentration to the point that there were real concerns about future collective dominance, and quite another to move in the opposite direction, and argue that an existing industrial structure is suddenly inappropriate. There is good evidence that on average mergers destroy total shareholder value, and since they rarely increase competition, that must mean that they typically reduce social value. The burden of proof is then on the merging partners to demonstrate otherwise. In the present case, the burden of proof would lie squarely with the competition authorities, and might be difficult to establish. The main problem of establishing an abuse of a collectively dominant position is to define the counterfactual of normally competitive behaviour. In electricity, variable costs are only half the average cost, the balance being the return to the very substantial fixed capital, as well as the fixed operating costs. A competitive market would need very high prices as the margin of spare capacity reduced, to compensate for prices being close to variable costs when capacity were adequate. Some commentators have argued that there are severe market failures on the demand side, in that final consumers cannot collectively exhibit their willingness to pay for the right degree of risk of loss of load (Stoft, 2002). Competitive wholesale markets may therefore under-provide security of supply

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without additional institutional requirements. The English Pool had a capacity payment to encourage adequate reserves, but that was criticised for distorting the market (Offer, 1998). The initial proposals for the US Standard Market Design (for electricity markets) required Load Serving Entities to contract up to four years ahead for adequate capacity (i.e., enough for peak demand plus the specified reserve margin). Large electricity generating companies argue that market power provides the ability to finance and hold adequate reserve margins, and leads to less price volatility and hence more politically sustainable outcomes than a market as fragmented, competitive and un-remunerative as the British market after 2000. There the combination of initially excess capacity and fierce competition caused the bankruptcy of a number of generators. The largest single generating company, British Energy, that holds all the privately owned nuclear plant had to be bailed out by the Government to prevent a similar fate. In response, generators have withdrawn capacity, causing concerns that there would be power shortages in Winter 2003/4. The reserve margin fell from over 32% to under 17% within a very short space of time, although the forward prices then induced mothballed plant to be returned to service and no shortages occurred (Roques, Newbery and Nuttall, 2005). On this view, too much competition is undesirable, and market power is required to deliver secure supply. There are further problems, for if prices are above variable costs, the question is over what time period the profits should be averaged to determine whether average prices are above average total costs. Plant lasts 30 or more years, so a run of a few years of low prices might require rather high prices for an extended period to compensate. The generators under investigation could also argue that if there were a short-run problem of high prices, free entry would correct the problem, as the market is contestable. There are other obvious problems with the competition policy route to creating workably competitive electricity markets. Where the industry was initially in public ownership, it was presumably open to the Government to restructure to increase the number of competing generation companies. If anything, most Continental governments moved in the opposite direction, consolidating previously separate companies to create 'national champions', as in Spain, and

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as was proposed for the Netherlands (but fortunately resisted). Where generation companies were privately owned, as in Germany, there was little or no resistance to proposed mergers that rapidly concentrated the European electricity industry (Codognet et. al., 2002). The contrast with the United States is also instructive. European countries lacked the duties and powers available to the Federal Energy Regulatory Commission, FERC, under the 1935 Federal Power Act. FERC has a statutory obligation to ensure that wholesale prices are "just and reasonable". If an electric utility wishes to sell at market-determined wholesale prices, this will be allowed providing "the seller (and each of its affiliates) does not have, or has adequately mitigated, market power in generation and transmission and cannot erect other barriers to entry."17 Even then, the authority to sell at market-determined prices can be withdrawn and replaced by regulated prices if there is "any change in status that would reflect a departure from the characteristics the Commission has relied upon in approving market-based pricing."18 FERC therefore assumes that market pricing is "just and reasonable" so long as it is competitive. The reason for its concern to ensure that prices remain competitive is that any FERC-approved form of pricing greatly restricts the competition authorities from intervening. At the same time, existing antitrust laws are relatively powerless to enforce competitive outcomes in the energy industry as "the antitrust laws do not outlaw the mere possession of monopoly power that is the result of skill, accident, or a previous regulatory regime. ... Antitrust remedies are thus not well-suited to address problems of market power in the electric power industry that result from existing high levels of concentration in generation." (DOE, 2000, cited by Bogorad and Penn, 2001). This last point is particularly telling, and suggests that structural remedies may be difficult to secure. If competition policy lacks the power to restructure (except in egregious cases of abuse), the next recourse would seem to be a regulatory solution. Britain provides an example, where the Director General imposed a price cap on wholesale prices until the companies divested some plant to improve competitiveness. Price caps on markets where prices are supposed to be determined by supply and demand only work if there is substantial market power, and the ability to moderate the supply price in the face of effectively a perfectly elastic demand schedule. However, the Califomian electricity debacle of 1999-2000 demonstrates

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that poorly designed price caps can make matters far worse when there is genuine shortage combined with market power (Joskow and Kahn, 2002; Wolak, 2003). There are also problems where trading takes place in multiple markets (e.g. bilateral, OTC and balancing markets as well as power exchanges), and where the power exchange only handles a few percent of total production. Capping one market when there are uncapped close substitutes is likely to have perverse effects. The English Pool price cap applied to the annual average price, so some of these problems were avoided, and the fact that all electricity had to be traded through the Pool made the prices capped representative, avoiding the bypass problem. Regulators, mindful of the Califomian lessons and the limited coverage of electricity wholesale markets in most countries, are likely to be wary of simple price caps. The Latin approach to market power is to require bids into wholesale markets to be cost-justified (i.e., subject to audit), and to be maintained for lengthy periods (possibly indexed to relevant fuel prices). That is the approach followed in Chile, where generation is relatively concentrated (Bitran and Serra, 1998; Heller and McCubbins, 1996). System operators in some US power pools reserve the right to substitute cost-based bids for market bids if the latter lead to an inefficient dispatch, or clear signs of market power. There are several problem with this approach. The market design has to find a method of paying for, and charging consumers for, capacity. The resulting price formation rapidly becomes a regulatory artefact rather than a competitive market, with the players optimising against the regulatory price rather than competing to deliver best value. In concentrated markets the results may be less bad than unregulated price formation, although the latter might at least attract entry with the prospect of eventually reducing concentration. A preferable alternative might be to require that generators be willing to offer contracts at prices related to the average cost of new entrants. That has the attraction of leaving the spot market to reflect supply and demand, while encouraging consumers to seek contracts where they are more attractive than relying on the spot market (i.e., when the spot market has prices higher than the entry price). The higher the degree of contract cover demanded, the less the incentive of the generators to exercise market power in the spot market. Wolak (2001) has suggested this as a remedy for market power in California.

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The other alternative is to retain the licenses that the Telecommunications Directives abolished, recognising that electricity differs in important ways from telecoms. License conditions can require detailed operating information to be supplied to the regulator for better market surveillance, and can also impose additional restraints. Thus British generators above a certain size were required to offer for sale plant that would otherwise be scrapped, to ensure that the scrapping was not used to reduce capacity to increase prices above the competitive level. Grid codes in some countries specify rules for proper market behaviour and are clearly important. They may be an adequate substitute for licenses, although much depends on the institutional arrangements for modifying and enforcing them.19 Licenses can be used to prevent companies vertically integrating or having interests in related activities (such as transmission or distribution for generation companies), and to include more restrictive interpretations of market abuse than normal competition legislation. Again, Britain provides an interesting and salutary example. Fig. 1 shows that although market concentration was falling quite rapidly by 1999, the price-cost margin remained high. In May 1999 Ofgem (the gas and electricity regulatory agency) published a decision document about price spikes in the Pool during winter 1998/99, warning that it would continue to monitor prices. In July 1999 Ofgem investigated the high prices at the beginning of that month. Ofgem was concerned about the limited competition in price setting despite the increase in the number of generators selling through the Pool (from 8 in 1990 to 38 in 1999). The gas-fired plant of the new entrant Independent Power Producers did not compete at the margin and only rarely set prices (3 percent of the time in 1998/99). Three companies (National Power, PowerGen and Eastern) set Pool price 86 percent of the time in 1998/99. Ofgem expected the recent divestments to increase competition in price setting, but remained concerned about the ability of certain generators to influence the price setting mechanism (Ofgem, 1999). In October 1999 Ofgem concluded that a Market Abuse Licence Condition (MALC), better known as the "good behaviour condition", needed to be introduced into the licenses of the seven generators most likely to have market power. This provided that "The Licensee shall not engage in conduct, whether alone or with one or more other undertakings, which amounts to an abuse of a

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position of substantial market power in the determination of wholesale prices for electricity under the relevant trading arrangements." Possible examples of such abuse would be price bidding strategies, capacity withholding, manipulation of complex market rules and using the influence of contractual positions. To minimise regulatory uncertainty about the operation of the condition, Ofgem issued Guidelines about its interpretation. These provided that a Licensee will be regarded as having a position of substantial market power if it has the ability to bring about, independently of any changes in market demand or cost conditions, a substantial change (over £30 million) in wholesale electricity prices. Substantial changes in price might refer to a few very large effects or a series of lesser ones. For example, it would include a change of 5 percent for more than 30 days (1440 half hours), or 15 percent over 10 days (480 half hours) or 45 percent over 160 half hours (3 1/3 days), all within a one year period (Ofgem, 2000a). It is worth noting that the required increase in prices would amount to about one-third of one percent of turnover in the wholesale electricity market. After a lengthy discussion process lasting until April 2000, five generators consented to the condition: Magnox Electric, TXU Europe (formerly Eastern, the purchaser of the 1996 divested coal-fired plant), Edison Mission Energy, National Power/Innogy and PowerGen. Two generators (AES and British Energy) did not consent, and Ofgem referred them to the Competition Commission in May. Ofgem argued that other possible remedies and developments (further divestment or revised generation market structure, modification of Pool and NETA rules, the introduction of NETA itself, the Competition Act 1998 and Financial Services Regulation) would not suffice to prevent such abuse. This was because of the specific conditions of electricity: the need to match demand andsupply instantaneously, the non-storability of electricity and the limited demand side response. Shortly afterwards, Ofgem carried out its first investigation under the market abuse condition, in the licence of Edison First Power (Ofgem, 2000b). The company had withdrawn 480MW of capacity from the system. Ofgem concluded that the company had substantial market power, which it had exploited to the detriment of consumers. Specifically, the continued withdrawal of capacity was

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not justified on the basis of avoiding losses, and had materially increased prices in the Pool and the forwards markets. This was to the detriment of over 200 large customers purchasing electricity on Pool-related terms, and other respondents were harmed by the increase in Pool Uplift. Because the company announced that it would return the capacity to the system, Ofgem took no further action. The Competition Commission published its decision in December 2000 and rejected Ofgem's requirement that AES and British Energy's licences be modified to include the MALC (CC, 2001). The Competition Commission was critical of Ofgem, noting that it did not define the relevant market and did not demonstrate that it would be profitable for either company to attempt to exercise market power by withdrawing capacity. AES had a long-term contract with TXU that made reducing output unprofitable, while 90 percent of British Energy's potential output came from inflexible base-load nuclear power plant. The Competition Commission considered that a condition prohibiting abuse of market power "would cause uncertainty, because of the difficulty of distinguishing between abusive and acceptable conduct, and would risk deterring normal competitive behaviour." (CC 2001, 1.12). "We are mindful of the disadvantages of a broad, effects-based prohibition ... such a prohibition would not be suitable for dealing with manipulation of market rules." (para 1.18). "We see manipulation of the market as conduct for which a sufficient remedy would in principle be the modification of the market rules or mechanisms." (para 1.13).

Assessment of Regulatory Policy in Electricity
There is no doubt that a specialist energy regulatory authority is valuable in dealing with the natural monopoly networks, as the new EU Energy Directive recognises. The issue is whether generation and supply should also be regulated or whether normal competition law is adequate. The AES and British Energy case is instructive. The case required a time extension as the Competition Commission found it very difficult to understand the complexities of the wholesale electricity market, even though Ofgem supplied a large amount of explanatory material. Electricity market surveillance is a critical element in ensuring that market participants do not abuse positions of collective dominance, and such surveillance requires timely information that is commercially sensitive and not normally made available without a licence (or grid code) condition making it a

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condition of operation. Market surveillance needs to be a continuing activity if market participants are to be assured of non-abusive behaviour, and it needs to be analytically well-founded if market rules found wanting are to be improved. All this suggests that the energy regulatory authority should take on the task of market surveillance, and should be adequately empowered to monitor the relevant markets, and make rule changes. Competition authorities are likely to be far less well-equipped to do this, and will be far slower to act. The Californian electricity industry went from crisis to claimed bankruptcy in the space of a few weeks, while FERC made regulatory decisions that, according to an expert witness "allowed a manageable problem to develop into an economic disaster" (Wolak, 2003). Whether regulators need additional powers in addition to being able to make rule changes will depend on market circumstances. Britain suggests that the ability to impose conditions (price caps, cost-based contracting or even costbased bidding) might be a useful lever to achieve market restructuring, although in the hands of a less trusted regulator might discourage private investment in generation, which might be far worse than accepting some market abuse.

Conclusions
Post-modern utilities like telecoms, in which facilities-based competition is possible, lend themselves to the approach laid out in the EU Telecommunications Directives. Regulators must first conduct market reviews to determine whether markets are effectively competitive or suffer from Significant Market Power (SMP). Only in the latter case is ex-ante regulation warranted, and then only if it is necessary, justified and proportionate. Electricity does not fit comfortably into this approach, in part because the wholesale market is more likely to suffer from collective dominance than the single firm dominance that allows for an easier determination of SMP. Licence conditions are no longer needed under the Telecommunications Directives, but appear to retain advantages for electricity, where information and continuing market surveillance are desirable, and where it may be necessary to modify market rules in a timely and well-informed manner. Competition policy remedies are likely to be too slow in electricity, where rapid, knowledgeable and intelligent actions may be necessary to avoid very costly outcomes. That said, one should not underestimate the difficulty of ensuring that wholesale electricity markets work well, in delivering competitive

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outcomes that are sustainable in the long run. FERC, with extensive powers under the 1935 Federal Power Act, failed to avoid the Californian crisis, and Ofgem's Market Abuse Licence Condition was found unsuitable for at least some of its target clients. The fall in concentration coming after excess entry induced by the earlier exercise of market power caused a collapse in British wholesale electricity prices and a subsequent withdrawal of plant that halved the reserve margin and has caused concern for supply adequacy in the winter months. All this suggests that ensuring workable competition in electricity supply continues to remain a challenge to regulators and competition authorities.

References
Armstrong, M. 1996, 'Network Interconnection', DPET 9625, Southampton. Armstrong, M. (1998), 'Network Interconnection in Telecommunications', Economic Journal, 108 May, 545-564. Armstrong, M., S. Cowan and J. Vickers, (1994) Regulatory Reform - Economic Analysis and British Experience, Cambridge: MIT Press. Bartle, I. (ed.) (2003) The UK Model of Utility Regulation: A 20th anniversary collection to mark the 'Littlechild Report' - retrospect and prospect, Bath: Centre for the study of Regulated Industries. Baumol, W.J., (1983) 'Some subtle pricing issues in railroad regulation', International Journal of Transport Economics, 10: 341-55. Baumol, W.J., J.C. Panzar, and R.D. Willig, (1982) Contestable markets and the theory of industry structure, Sydney and Toronto: Harcourt Brace Jovanovich, Academic Press. Bell, A. (1995) 'The Telecommunications Industry 1994/95, ch 5, pp 93-104 in CRI Regulatory Review 1995, ed. P. Vass, London: CIPFA. Bitran and Serra, (1998), 'Regulation of Privatized Utilities: The Chilean Experience', World Development, Vol.26, No.6, pp.945-962. Bogorad, C.S. and D.W. Pernn (2001), 'Cost-of-service rates to market-based rates to price caps to ?!#?#!?', The Electricity Journal, May, 61-72. Bollard, A. and M. Pickford (1996) 'Utility regulation in New Zealand', London: Institute of Economic Affairs Lectures on Regulation. CC (2001), AES and British Energy, Report 453, London: Competition Commission. CC (2003), Mobile phone charges inquiry, London: Competition Commission.

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CEC (2002), 'Commission guidelines on market analysis and the assessment of significant market power under the Commission regulatory framework for electronic networks and services', Official Journal, 11.7.2002. CEC (2003), 'Commission recommendations of 11 February 2003 on relevant product and service markets within the electronic communications sector susceptible to ex-ante regulation in accordance with Directive 2002/21/EC of the European Parliament and of the Council on a common regulatory framework for electronic networks and services', Official Journal, L 114/45-49; 8.5.2003. Codognet, M-K., J-M. Glachant, F. Leveque and M-A. Plagnet (2002) Mergers and Acquisitions in the European Electricity Sector, Paris: CERNA, Ecoles des Mines. Diamond. P.A. and Mirrlees, J.A. (1971) 'Optimal Taxation and Public Production, Part 1: Production Efficiency' American Economic Review, 61(1), 8-27. DOE (2000) Horizontal Market Power in Restructured Electricity Markets, US Department of Energy Office of Economic, Electricity and Natural Gas Analysis. Hausman, J.A. (1997), 'Valuing the effect of regulation on new services in telecommunications', Brookings Papers: Microeconomics, 1-38. Heller and McCubbins, (1996), 'Politics, Institutions and Outcomes: Electricity Regulation in Argentina and Chile', Policy Reform, Vol. 1, pp. 357-387. IEA (1994) Natural Gas Transportation: Organisation and Regulation, IEA/OECD, Paris. Joskow, P. and E. Kahn (2002), 'A quantitative analysis of pricing behavior in California's wholesale electricity market during summer 2000', Energy Journal, Dec, pp 1-35. Laffont, J-J, P. Rey and J. Tirole, 1998a, Network Competition: Overview and Non-discriminatory Pricing, Rand Journal of Economics 29(1): 1-37. Laffont, J-J, P. Rey and J. Tirole, 1998b, Network Competition: Price Discrimination, Rand Journal of Economics 29(1):38-56. Levy, B and P. Spiller (eds.) (1996) Regulations, Institutions and Commitment, Cambridge: CUP Littlechild, S. (1983) Regulation of British Telecommunications profitability, London, HMSO, reprinted in Bartle (2003). MMC (1999) Cellnet and Vodafone, London, Monopolies and Mergers Commission. Newbery, D. M. (1997) 'Determining the Regulatory Asset Base for Utility Price Regulation', Utilities Policy, 6(1), 1-8. Newbery, D.M. (2003) 'Privatising network utilities', mimeo, Cambridge (paper for CESifo conference on privatisation, Cadenabbia, Oct 31-Nov 3, 2003). Offer (1992), Review of Pool Prices, Office of Electricity Regulation, Birmingham, December 1992. Offer (1998) Review of Electricity Trading Arrangements: Background paper 1 - Electricity Trading Arrangements in England and Wales, February, Birmingham: Office of Electricity Regulation.

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Ofgem (1999) Rises in Pool Prices in July: A Decision Document, October, London: Office of Gas and Electricity Markets. Ofgem (2000a) Introduction of a 'market abuse' condition into the licences of certain generators, Ofgem's initial submission to the Competition Commission, May, London: Office of Gas and Electricity Markets. Ofgem (2000b) Ofgem's investigation of Edison First Power under the market abuse licence condition: Initial Findings, July, London: Office of Gas and Electricity Markets. Oftel (2002) Otel's market review guidelines: criteria for the assessment of significant market power, London: Oftel, 5 Aug. Oftel (2003) Review of mobile wholesale voice call termination markets: EU Market Review London: Oftel, 15 May. Patrick, R.H. and F.A. Wolak (1999), 'Customer Response to Real-Time Prices in the England and Wales Electricity Market: Implications for Demand-Side Bidding and Pricing Options Design under Competition' in Crew, M. A., (ed.) Regulation under increasing competition. Boston; Dordrecht and London: Kluwer Academic, p 155-82. Peltzman, S. (1976) 'Toward a more general theory of regulation', Journal of Law and Economics, 19:211-240. Roques, F.A., D.M. Newbery and W.J. Nuttall (2005) 'Investment incentives and electricity market design: the British experience', Review of Network Economics, 4 (2), 93-128. Stigler, G.J. (1971) 'The Theory of Economic Regulation', Bell Journal of Economic and Management Science, 2:3-21. Stoft, S (2002). Power System Economics, New York: Wiley-Interscience. Sweeting, A. (2001) 'The effect of falling market concentration on prices, generator behaviour and productive efficiency in the England and Wales electricity market', MIT Department of Economics. Temin, P., with Galambos, L. (1987) The fall of the Bell system: A study in prices and politics, Cambridge; New York and Sydney: Cambridge University Press. Vickers, J. and G. Yarrow (1988) Privatization: An economic analysis, Cambridge: MIT Press. Willig, R.D. (1979) 'The theory of network access pricing', in H.M. Trebing, ed. Issues in Public Utility Regulation, Michigan State University Public Utilities Papers. Wolak, F.A. (2001) 'A comprehensive market power mitigation plan for the California electricity market', California ISO Market Surveillance Committee, Apr. 24 available from http: //www. Stanford. edu/~wolak Wolak, F.A. (2003) 'Diagnosing the California Electricity Crisis', The Electricity Journal, Aug/Sep, 11-37.

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Endnotes
†

Paper presented at the conference in tribute to Jean-Jacques Laffont in Toulouse on 30 June 2005. The article was originally written for the conference How should competition policy transform itself? Designing the new competition policy , 20 November 2003, in Japan. See Network, Issue 14, August 2003, published by the ACCC, Melbourne, Australia. At the date of the conference, Germany still awaited the final passage of the relevant legislation setting up an electricity regulator, but this was anticipated by July 2005. Chile is a notable example, see Bitran and Serra, (1998), Heller and McCubbins, (1996). EU Framework Directive 2002/21/EC, Official Journal, 1L 108/33-49, 24.4.2002. as having SMP. The US Department of Justice applies a screen based on the Hirschman-Herfindahl Index, based on the market shares of all participants (and equal to the sum of the percentage market shares, with 10,000 representing a single firm). Markets with HHIs above 1,800 attract attention, and this number could be reached by one firm with 40% share, and two firms of 10% shares each, all the rest being small. Some users (particularly businesses) are concerned to choose a network offering lower termination charges to those whose calls are valuable to the recipient (friends, customers, etc), and networks compete by charging lower on-net (i.e. calls originating and terminating on the same network) than off-net calls. Such price discrimination actually provides an incentive to raise off-net termination charges as these raise rivals' costs, and so further reduce competitive pressures to moderate call termination charges. The author should declare an interest in that he was at the time of writing an advisor to Vodafone in its case before the High Court. Before then, the MNOs were using second generation ('2G') technology, but all five companies had secured spectrum in earlier auctions, and were preparing to introduce third-generation or 3G packet-switched (always on) technology, with greater bandwidth and data handling capability. Oftel set out its views in Ramsey Prices and Network Externalities: Dr. Rohlfs' Analysis, 23 May 2002: "Ramsey prices, including the implications of externalities, are relevant in theory. But for practical reasons they are unlikely to provide a reliable basis for setting regulated charges." In "Ramsey pricing - Oftel's response to letter of 4 July" dated 12/7/2002.

1 2 3 4 5 6

7

8 9

10

11

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12

Oftel published a consultation document on continuing licence conditions after 25 July 2003 until the new law come into effect athttp://www.oftel.gov.uk/publications/ licensing/2003/cont0703.htm There are other significant disputes to do with matters of fact, of which the most important is the size of the fixed and common costs, which in turn relates to the extent of economies of scale in mobile networks. Subsidising goods consumed by the poor normally leads to a larger subsidy to the rich, who buy more of the good, whereas equal lump-sum transfers (in kind or in cash) avoid this drawback. There is a similar distinction between the circuit-switched networks used for voice telephone, where end-to-end continuous real-time connectivity is required for service quality, and packet-switched networks for data and internet, where vertical integration is no longer so valuable. Customers holding CfDs nevertheless had an incentive to respond to the Pool price, as the contract were financial and would involve payments regardless of actual consumption. Patrick and Wolak (1999) find very low price-elasticities (on average - 0.025) even for large customers facing Pool prices. Heartland Energy Services, Inc, 68 FERC • 61,223, at 62,060 (1994), cited by Bogorad and Penn (2001). Heartland 68 FERC at 62,066, cited as above. The English Pooling and Settlement Agreement is a case in point, as it was a multilateral contract that could only be changed by mutual agreement, and over which the regulator had limited powers. It proved so difficult to adapt that it was eventually abolished by primary legislation which also replaced the Pool with the New Electricity Trading Arrangements. The new Balancing and Systems Code has a properly designed procedure for making modifications.

13

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4
Infrastructure-Based Versus Service-Based Competition in Telecommunications
Jörg Kittl*, Martin Lundborg** and Ernst-Olav Ruhle***
Unbundling of the Local Loop (ULL) has seen quite different "success stories" in the various countries across Europe. Although the obligation for the provision of ULL was implemented in the regulatory framework early and mostly parallel to other means of liberalisation, national implementation has been rather heterogeneous. One question of decisive importance for National Regulatory Authorities (NRAs) was whether to foster service- based competition in the first phase of liberalisation or to focus on infrastructure-based competition. The different NRAs chose to head down different roads. This article analyses whether the strategy of NRAs has had any mid-term effect on the economic welfare created in the communications markets. It indicates that infrastructure-based competition has a positive effect on innovation.
* Senior Consultant, Area Manager Middle East & Africa, SBR Juconomy Consulting AG, Büro/Office, 1010 Wien, Parkring 10/1/10 Österreich/Austria. E-mail: [email protected] ** Consultant, Area Manager Middle East & Africa, SBR Juconomy Consulting AG, Büro/Office, 1010 Wien, Parkring 10/1/10, Österreich/Austria. E-mail: [email protected] *** Consultant, Area Manager Middle East and Africa, SBR Juconomy Consulting AG, Büro/Office, 1010 Wien, Parkring 10/1/10, Österreich/Austria. E-mail: [email protected] © 2006 Jörg Kittl, Martin Lundborg and Ernst-Olav Ruhle. Reprinted with permission. Source: www.ssrn.com

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Moreover, infrastructure-based competition appears to be more important for business customers than for residential clients. On the other hand, service-based competition lowers call prices and appears to be more important to residential markets. The results of this study point out the importance of a balanced approach to both types of policies.

1. Introduction and Types of Competition
The issue researched in this paper goes back to the fundamental questions discussed when markets for telecommunications services were opened up, namely what kind of competition delivers more favourable results - infrastructure or service-based competition? Today, this is still (or again) an intensively debated issue as far as policy changes, new business models (for example, virtual operators) and new - especially broadband - technologies are concerned. Regulatory policies in numerous countries have developed in very different ways. The issue of unbundling was raised in the United States in 1996 (CRANDALL, 2005, p. 7). Prior to that point the competitive landscape had developed mainly through indirect access and resale in voice telephony markets (VOGELSANG, 2005, 2002). European countries followed a joint approach to market opening. Some of the countries started before the joint policy took effect, notably with indirect access for international calls (for example,. Sweden in 1993).The UK was an exception with its duopoly policy, which was implemented as early as the 1980's. When the 1998 framework was implemented in the member states 1 many countries saw the emergence of operators offering voice communication based on interconnection. Many incumbents criticized this approach as arbitraging.2 Whereas interconnection was a fundamental part of the joint framework, access competition through unbundling local loops was compulsory only after its introduction by EU legislation at the end of the year 2000.3 With that step, further business models have arisen based on line sharing, bitstream access and most recently "naked DSL", for example. 4 The move towards all-IP networks and the ability to interconnect/get access to such NGNs extends the debate to net neutrality (See NICHOLLS, 2006; VON SCHEWICK, forthcoming 2007).

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These different types of business models have re-launched the debate as to what sort of competition is sustainable. This debate also has to be seen in the light of the contents of the European framework, according to which national regulatory authorities should encourage efficient investment in infrastructure and promote innovation.5 The discussion is now centring on terms like "ladder of investment", "emerging markets" and "access holidays". Today's regulatory framework already offers several ways of fostering competition and regulators have chosen different strategies in the past to open up the communications markets. Companies have also chosen different strategies to enter the markets, based on the economic principles laid down in regulatory decisions. These various regulatory means ("toolbox") for opening markets and networks have become intensively debated issues between former monopolists, regulatory bodies and competitors. The main point has been whether infrastructure or service-based competition would lead to lower prices, more differentiated and innovative products and improved services for consumers. The cost of regulation is an additional point (ELLIG, 2005). A frequently discussed concept is the ladder of infrastructure competition, which argues that new entrants may enter the market based on a wholesale product where they only cover minor elements of the value chain (such as resale) and then - once the customer base grows and financial means become available move on to "higher rungs" of the ladder. This implies that operators supply more elements of the value chain themselves by building their own infrastructure and acquiring only the residual infrastructure from the incumbent's wholesale department. This includes a move for the operators from service to infrastructurebased competition. Hence, by implementing this ladder, both infrastructure and service based competition is promoted (VOGELSANG, 2005, p. 58).

2. Empirical Analysis
In order to answer the question, whether infrastructure or service-based competition should be promoted by NRAs, we first examined which countries followed which type of policy. This paper focuses on the EU-15 countries (the countries belonging to EU before May 1st, 2004) since these EU members all had a similar regulatory framework. The categorization between service and infrastructure-based competition (specifically in light of the issue of ULL) in this

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paper is based on the principle that, from an economics point of view, the replication of the local loop does not make sense 6 and therefore only the use of the last mile is a relevant differentiating factor between service and infrastructurebased competition. If an operator needs more elements of the access network than only unbundled local loops, as is the case, for example, with bitstream access or simple resale, we consider this kind of competition as service-based competition.7 The selection of the EU -15 implies that the toolbox at hand for the regulators has been largely the same and that NRAs have had the opportunity to focus on infrastructure-based competition (mainly ULL) or service-based competition (resale, indirect access,8 etc.). We divided the countries into two different clusters based on statistics regarding the success of the different regulated products and the date of introduction for these products, as well as the ECTA Broadband Scorecard. Group 1: infrastructure-based competition has been the main objective of the NRA visible in its policy and decisions. Group 2: the NRA has focused on service-based competition to a greater extent. For clustering, this papers looks at main indicators describing the performance of competition in order to identify the type of policy NRAs have pursued.9 This method is based on the assumption that NRAs are following definedregulatory goals and policies by using the toolbox to foster the two different policy types either implicitly or explicitly.10 For the empirical study, it is further assumed that the intentions of the NRA have had a direct impact on market development, i.e. NRAs are successful in the implementation of their policies and that this is impacting market development. Using these indicators, countries are clustered according to whether they have focused on infrastructure or service-based competition. The first indicator assesses how successful infrastructure based competition has been by describing the competitors' markets shares11 with respect to access line competition and the proportion of service-based competition (resale and bitstream access) of all wholesale products.12

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The second indicator uses the competitors' market shares of local loops (both, line sharing and fully unbundled loops) and the market shares of all competitors in broadband markets (measuring the success of competitors). The third indicator measures the success of competitors in broadband markets in relation to their share of the retail market. By looking at the proportion of infrastructure-based competition and thereby excluding CATV, the same analysis can be conducted for the DSL-market only, which gives us the fourth indicator. A second way to quantitatively measure regulatory policy is by examining the date at which different wholesale products were introduced. Our research looked at the regulatory situation at the beginning of the millennium, as it takes some time from the introduction of the wholesale products until an outcome can be measured as far as competition in the retail markets is concerned. We used the dates of introduction of ULL and carrier (pre)selection services as the fifth indicator. Annex I contains the result of this clustering.

3. The Effects of Regulatory Policy on the Competition Situation
3.1 Price and Penetration as Measurements of Competition and Innovation
The study aims to determine which regulatory policy has had the greatest impact on competition with respect to measurable effects with regard to service or infrastructure-based competition. The clustering of countries is based on the analysis in the previous chapter. This chapter examines the output of regulatory policies (with the help of the clusters). Regulation is put in place in order to generate positive welfare effects where marketsa alone would not tend to perfect competition. The problem is how to measure these welfare effects, as they can occur as consumer surplus, producersurplus, societal gains (i.e., increased tax income, better working conditions, etc.). The main aim of liberalisation in the EU was to increase overall welfare through lower prices, enhanced consumer choice, innovative products, etc.13 Therefore, we examined the welfare effects measured by the state of competition, which is defined through the price situation. This is based on the assumption that more competition reduces prices in the market.

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Competition can also increase consumer welfare without reducing prices. This is achieved by innovation. Therefore, we also examine if there are differences in terms of innovation in countries according to regulatory policy. A typical assumption is that the innovation and penetration rates of new services and technologies correlate (see, for example, McNARY, 2001; ERG (03), 2005). Therefore, we measured innovation by the penetration rates of broadband uptake, as well as the uptake of ISDN.14 The statistical method chosen is the ttest.15 As the variance of the two clusters have different values for the variances, we carried out the heteroscedastic t-test.

3.2 Effects on Competition and Innovation
Based on the indicators for penetration rates, price competition, price development from 2000-2004, as well as prices corrected with PPP (purchasing power parity), the outcomes on competition and innovation were calculated. The results are shown in the table in annex II. The test also includes prices adjusted for PPP. These results are more or less the same in terms of the prices before the adjustment, so the adjustment does not make any difference. By comparing the computed mean values of the two groups, we conclude that prices are lower and penetration rates are higher in those countries with predominantly infrastructure-based competition. By using the t-test, we derive that the results are significant in most cases.16 Result 1: countries with predominantly infrastructure-based competition have lower overall prices and higher penetration rates and thereby more innovation. Furthermore, there are higher penetration rates on average in countries with infrastructure-based regulatory policies, although these results are only significant for broadband markets, but not for ISDN. There is a risk of auto-correlation in this case, since the countries were clustered partially by the penetration rates, but as other factors were considered as well, this risk has been reduced. Result 2: analysis of penetration rates tends to indicate that infrastructure-based policies foster higher penetration rates. With regard to price levels in 2004, these are lower in countries with infrastructure-based policies. The results, however, are not significant for the residential baskets. The differences between the clusters are especially high for business customers.

Infrastructure-Based Versus Service-Based Competition in Telecommunications Result 3: there is an indication that infrastructure-based competition is of greater importance to business customers than to residential customers.

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When looking at the prices in 2005, however, according to the 11th implementation report of the EU Commission, the results are - with one exception - no longer significant. When considering monthly rental charges for business customers alone, it is significant that prices are much lower in countries with infrastructure-based competition. As for OECD baskets and monthly rental for residential customers, prices are still higher in countries with service-based competition, but the results are no longer significant. The changes which took place between 2004 and 2005 are elements of a long term process. Hence, a trend towards price harmonisation did emerge between the two clusters during the period 2000 to 2004 - although these results are not significant according to the t-test for the monthly rentals and for the national business and residential basket. Result 4: price differences between countries with mainly service-based and infrastructure-based competition are diminishing throughout Europe. In the period 2000 to 2004, the monthly rental went up by almost 30% on average in countries with service-based competition, while prices in countries with regulation focusing on infrastructure-based competition increased by only 3.9% (business customer) and 8.8% (residential customers). The increase in monthly rental prices was over-compensated by far in those countries with service-based competition. In fact, the prices for OECD baskets (which also include monthly rental) decreased by 12-16% over the same period in countries with service-based competition. In those countries with more infrastructure-based competition, OECD baskets decreased only slightly. This indicates that service-based competition is more important for residential clients, while infrastructure-based competition is more important for business customers. Result 5: there are clear indications that tariff rebalancing has gone further in the countries with service-based competition than in those with infrastructure-based competition.

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3.3 Critical Remarks
Some comments regarding the methods used in this study are called for. In order to carry out the study, binominal clustering of the countries was effected. There are naturally measurable differences within the two clusters in some cases and conducting statistical tests with a binominal independent variable is not optimal. The alternative would have been to rank the countries. Since it is very difficult to measure "better or worse" strategies, the significance of the results would not have been higher, since the clustering would only have been more arbitrary. Another problem derives from the role of CATV, which has existed all of the time and has had a positive impact on competition, but has hardly been influenced or promoted by regulation. Therefore, assessing the impact of this alternative infrastructure with intermodal competition correctly is difficult. The same holds true for countries that have opened up markets at different dates and with other policies than those within the harmonized EU framework such as the UK. Policy changes, as well as different liberalisation starting points, can nevertheless influence the significance of the results, as, for example, the outcome of regulation in earlier years in the UK might still have an impact on communication markets. Moreover, the sample sizes are rather small and the variances are in several cases are large, which is a problem in terms of the significance of the results. The results in this study consequently need to be considered with care and it is advisable to verify the results in future research by other methods or larger samples.

4. Analysis and Discussion
Following on from the results, this section addresses issues in direct relation to the topic, especially in current regulatory discussions. The main findings are summarized in boxes within the text.

4.1 Types of Competition
The empirical study has shown that infrastructure-based competition has led to significantly lower access costs and call tariffs for business customers and, to a slightly lesser extent, for residential customers in its early stages. However, call

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tariffs, as well as access costs for fixed line services (monthly line rental) have risen after a decrease for both customer groups slightly again over time in countries with infrastructure-based competition. On the other hand, where service-based competition is fostered, infrastructure-based operators try to compensate for the loss in variable turnover from call prices by sharply increasing line rental prices. This is done either by tariff rebalancing and/or by including call prices in the price of the rental ("bundling", "optional tariffs"). Sharply reduced tariffs for call prices mostly overcompensated for the line rental increases. Compared to infrastructure-based countries, call prices saw an overall steeper decline in service-based countries. An interesting aspect can be observed in recent periods. Overall price structures in service-based and infrastructure-based countries tend to conform to each other and the differences begin to diminish. From our point of view, this can be traced back to the fact that most countries started with fragments of the ladder of investment and with the introduction of additional rungs, while market players have invested in further rungs. The benefits of both strategies are now beginning to evolve and compensate for the negative aspects of the other reduced access costs from infrastructure-based competition are starting to be linked to low call tariffs from service-based competition. The task facing NRAs is to render all rungs of the ladder of investment operational in order to increase customer welfare. Conclusion: with a stepwise introduction of the ladder of investment NRAs can focus on a specific liberalisation strategy. But only complete implementation of the ladder of investment will bring full customer welfare. Infrastructure-based competition has led to lower prices. Competitors will undertake investment in their own infrastructure, only if the return justifies that investment. Therefore, business customers with a high impact on return on investment are those entities that benefited most from infrastructure-based competition. Residential customers often benefit from the investment made for business customers as the incremental costs for introducing residential offers are low once business offers exist. Furthermore, residential customers contribute to economies of scale and scope, and justify the additional investment in the residential market. This reduces both costs and, indirectly, the prices of the

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services. On the other hand, ULL-operators have incentives to raise prices once competition is reduced. Only a limited number of ULL-operators is able to survive in a market place, as sunk costs and necessary economies of scale reduce the ability and willingness of other players to enter the market. The market could consequently end up in a situation of oligopoly. In such a situation of imperfect and restricted competition, ULL operators have strong incentives to collude and raise prices as the lockin effects for consumers are significant. In this situation, service-based competition could help to keep prices low if introduced as a complement to infrastructure-based competition. Products like indirect access and resale limit the flexibility of the ULL-operator to raise prices and are an efficient means of fostering competition with respect to end user prices.17 Conclusion: the complementary introduction of service and infrastructure-based competition limits the negative outcomes of either and supports the development of the positive elements of both liberalisation strategies. Although, intramodal competition is not reflected in this study, one has to bear in mind the effects of such competition. Especially the different cost structures and the different technologies involved create some room in which competition can develop. NRAs need to be aware of the regulatory interdependence created by intermodal and intramodal competition. If one side of competition, i.e. one type of market player, is regulated, but the other side is not, the question arises whether this leads to a distortion of competition (such as the non-regulation of CATV-networks).18 Conclusion: technology neutral regulation is a means of limiting the risks of distortions of intermodal and intramodal competition.

4.2 Management Decisions and their Influence on Investment in Infrastructure
As far as the influence of the NRA's decisions on how to open up the market to competition are concerned, the influence of operators must not be overlooked, as it is them who decide on the investments made. The following list contains key factors that influence management decisions.

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4.2.1 Time to Market
The liberalisation period was rather short, making time to market a key factor. In countries like the UK, France or Germany it was evident that once a clear decision was taken by the NRA on a specific access product, market players could focus on that product immediately (if the product seemed capable of forming the basis of a sound business plan). From this, we can derive the importance of the decision made by NRAs regarding access products for the market.

4.2.2 Product Differentiation
During the liberalization process, the first goal of a company was to gain market share. The easiest way of achieving this was to duplicate the incumbent's products and offer similar products at a reduced price. Therefore, it is sometimes proposed to set lower prices for products at lower rungs of the ladder of investment. This would raise competitor's profits and give them the possibility to gather a customer base and to invest in infrastructure. NRAs then raise prices for low rung products of the ladder over time to incentivise investments in access products of higher rungs and to "force" competitors to invest in infrastructure. Yet one has to bear in mind that this proposal may distort competition for late entrants. Climbing the ladder of investment should be a possibility at all times as competition may not necessarily be carried out via pricing, but also via product differentiation.

4.2.3 Innovation
In telecommunications, mainly new technologies enable innovative services. Infrastructure-based companies form the basis of such innovations as they have control over the development and use of the infrastructure. The "enabler" of such new technologies can therefore either be new entrants or existing operators who place additional investments. One has to bear in mind that wholesale, especially access, obligations are not a priori preventing investment if access conditions are set at a competitive level and prices enable sufficient returns on investment. Therefore, wholesale obligations may even foster competition, penetration rates and the introduction of innovative services and technologies. This should be the case when the access obligations and thus the returns on investment of the wholesale business are neutral (economically) compared to the retail business.

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Conclusion: market liberalisation follows the clear path of a product life cycle in competitive markets. Regulation paves the way for investors to enter markets and the products they intend to introduce.

4.2.4 Pricing
To be able to make the ladder of investment operational it is necessary that prices in wholesale markets for the different products are consistent but also that there are clear rules for migration from one product to another (ERG (05)23, 2005, exec. summary). "The imposition by national regulatory authorities of mandated access that increases competition in the short-term should not reduce incentives for competitors to invest in alternative facilities that will secure more competition in the long-term." (Recital 19 of Access Directive). This means that NRAs need a long term view of their decisions. Disruptive changes in prices of products or conditions belonging to the ladder of infrastructure would automatically lead to a distortion of competition and discrimination either against first movers or late entrants. Higher prices over time would incentivise a stop of investment of new entrants and lead to a "closed user group" of first-mover-entrants with initially lower costs of entry (ELLIG, 2005). We have seen (especially in France, the UK and Germany) that companies tend to invest in those access products that are available under defined conditions to be able to enter the market as quickly as possible and under a secure framework of conditions established by the NRA (BERGMAN, 2004). If NRAs want to incentivise the market to move towards infrastructure-based competition, a consistent pricing structure with regard to the ladder of investment is a pre-condition. Only under consistent conditions, investments are allocated efficiently. If companies see any additional profit in climbing the ladder of investment, they will do so. Therefore, the ladder of investment shall also allow for possible migration processes from one rung of the ladder to the next .19 Conclusion: a consistent pricing structure with regard to the ladder of investment is a prerequisite. To incentivise operators to climb the ladder, prices have to be set so that higher profit margins are possible for investments higher up on the ladder of investment. It is also necessary to implement effective migration rules.

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With trend towards more competition law-based instead of sector-specific regulation, the consistent pricing within the ladder of investment may not be upheld as NRAs will remove access obligations for certain rungs of the ladder. Therefore the consistency within the pricing structure of the ladder may be distorted. This will automatically cause some distortions for those companies that are just starting to climb the ladder of investment. It has to be clearly stated that under competition law, prices may include additional cost components compared to pure cost oriented prices. Therefore, significantly higher access prices under competition law should not automatically mean that there is abuse in the pricing strategy as the underlying cost principles are different. Conclusion: the trend towards more competition law instead of sector-specific regulation could distort the consistency of prices within the ladder of investment. This, in turn, may have a significant economic impact on the business models of alternative operators.

4.3 Impact of New Investments on New Infrastructure (Access Holidays)
An issue receiving increased interest lately is the topic of access holidays and (closely related) emerging markets: Following the idea of the new regulatory framework from 2002 (European Commission, 2002) whereby competition law shall gain a more prominent role and sector-specific regulation shall gradually be reduced, former monopolists as well as some new entrants have argued in favour of granting access holidays for these investments, especially when referring to new access possibilities like Fibre to the Home (FTTH) or UMTS. The basis for this argument is laid down in recital no. 15 of the recommendation on relevant product and service markets (European Commission, 2003, recital 15). The idea behind that argumentation is best described by Joseph Schumpeter (SCHUMPETER, 1918) where the interplay of invention as creative destruction and imitation leads to more competition. The aim is to foster innovation and to allow these companies to have some first mover advantages and therefore also a certain kind of (innovative) monopoly over a certain period of time. Technological innovation and the rollout of new networks are accelerating in Europe. The EU Commission's recommendation on relevant product and service markets has defined markets that are susceptible to ex ante regulation. With

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markets and technologies changing quickly, the question arises whether and how to apply regulation to these markets .20 A more flexible approach than today's policy needs to be implemented in terms of the time and process for market definition, analysis etc. Otherwise, regulation will be too rigid to cope with the rapid technological changes of the future .21 Thus, the market is confronted with a steadily changing situation and NRAs are not empowered to consistently resolve new market problems. NRAs and the new framework will have to deal with the rigid idea of technological neutrality in the context of new markets. The market is already faced with inter and intra modal competition. This can be seen in the broadband market, where DSL operators, CATV-broadband operators and UMTS data card operators compete with each other. But it can also be seen in voice markets, where voice telephony is offered over traditional analogue/ISDN access lines, via indirect access or by mobile operators and VoIP services providers. In that area of potential conflict between traditional and new technologies NRAs will have to find a balance between regulation and the open market. The EU commission has initiated a discussion of a revision of the current and the potential introduction of a new regulatory framework to become effective by 2009-2010 .22 It is clear that access holidays will reduce competitors' ability to offer products and services to consumers. This study shows that this will have negative effects on prices and penetration rates, if neither infrastructure nor service based competition is in place to be able to cut prices and drive penetration, and thus, innovation. This paper clearly shows that in order to maintain competition, service as well as infrastructure-based competition needs to be in place to maximise consumers' benefits. Therefore, regulatory holidays for operators with significant market power who invest in emerging markets shall not be implemented. In order to financially consider the high risk of investment undertaken by operators with significant market power in new and innovative technologies, this is best achieved by allowing these companies an appropriate return on investment, which contains sufficient reward for the risks taken. Thereby, consumer interests are not harmed, the investing operator has enough incentives to invest and long-term competition can be enabled through access obligations.

Infrastructure-Based Versus Service-Based Competition in Telecommunications Conclusion: access holidays will reduce consumer benefits. In order to create incentives for operators with significant market power, NRAs must consider the the specific risks related to the investments in emerging markets in making their decisions.

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5. Summary
With the European Information society "i2010" initiative (European Commission, SEC(2005) 717) Europe has started an ambitious project. A recent study has shown the positive impact of the European regulatory framework on the new member states, which joined EU on the May 1st 2004 (HABERFEHLNER et. al., 2006). The present study considers EU15 member states and shows that the integrated approach to the information society is partly "on track". We have seen the different modes of infrastructure and service-based competition strategies harmonize as a growing number of countries enable competition on all rungs of the ladder of investment and the different market players diversify their market strategies. With this, prices tend to harmonize and Europe is stepwise developing towards a single market, which can be seen in the leveraging effects of the different strategies on prices. As infrastructure-based competition leads to higher innovation and penetration rates, NRAs should foster inter and intramodal infrastructure-based competition when applying the framework. With convergence and new technologies like broadband and VoIP emerging, access at the levels of networks, services, applications and devices and own infrastructure and thus ULL will become increasingly important for operators to be able to have the possibility to differentiate their products from those of competitors and to attract new customers. There are clear signs that infrastructure-based competition is more important to business customers and service-based competition is more important for residential customers. Therefore, if the majority of consumers are also to be able to benefit from competition then both liberalisation strategies will have to be in place - in a balanced approach. The study has also shown that infrastructure-based competition does have an immediate (downward) effect on prices, which tend to remain stable afterwards. Under such circumstances, less tariff rebalancing will occur and alternative operators could refrain from investment in new infrastructure. On the other hand, service-based competition leads to significant tariff rebalancing in those parts of

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the value chain that are exposed to competition to a lesser extent. So these markets end up with higher access prices. In order to be competitive with infrastructure-based competition service-based competition needs much higher decreases in call prices to compensate for the increase in access costs. On the other hand, if infrastructure-based competition alone is introduced, the risk of collusion remains in the sense that competitors only compete in the access market while increasing prices for other services. Hence both regulatory strategies are required. These results are consistent with the theory that price competition will take place in those parts of the value chain that are exposed to competition. In most countries all rungs of the ladder of investment are now in place as regards the traditional network topologies. It seems that there is no pure and single way towards competition, but that markets need a healthy mixture of both, service-based and infrastructure-based competition. NRAs should consequently act in a stringent way regarding all rungs of the ladder in their pricing decisions. The market will react according to the strategic impact of the decisions made by NRAs, thus still relying on sector-specific regulation.

References
BANERJEE A. & DIPPON C. (2006): "Communications Regulation and Policy Under Convergence: Advancing the State of the Debate", Paper presented at the 16th biannual ITS conference Beijing, June. BERGMAN M. (2004): Competition in services or infrastructure-based competition?, Swedish Competition Authority and Stockholm University, September. CAVE M.: ---- (2003): Remedies for broadband services.http://www.itst.dk/static/Konferencer %20og%20seminarer/EC-Experts%20Broadband%20_cave.pdf. ---- (2004): "Making the ladder of investment operational", Paper presented to the European Commission, November. CRANDALL R.W. (2005): Competition and Chaos, Brookings Institution Press, 2005. European Commission: ---- (2002): Commission guidelines on market analysis and the assessment of significant market power under the Community regulatory framework for electronic communications networks and services (2002/C 165/03), 11 July.

Infrastructure-Based Versus Service-Based Competition in Telecommunications
---- (2000): Commission Staff Working Document, "Europe's Liberalised Telecommunications Market - A Guide to the Rules of the Game", October 18th. ---- (2005): Communication from the Commission to the Council, the European Parliament, the European Economic and Social Committee and the Committee of the Regions, "i2010 - A European Information Society for growth and employment", {SEC(2005) 717}. ---- (2003): Recommendation on relevant product and service markets within the electronic communications sector susceptible to ex-ante regulation (C(2003) 497), 11 February. European Parliament:

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---- (2002): Directive 2002/21/EC of the European Parliament and of the council of 7 March on a common regulatory framework for electronic communications networks and services (Framework Directive), Official Gazette, no. L 108/33, April 24th. ---- (2000): Regulation no. 2887/2000 of the European Parliament and of the Council on Unbundled Access to the Local Loop. ECTA (2005): ECTA Broadband Scorecard Q2/2005. ERG: ---- (2005): ERG (05) 23, Broadband market competition report, May 25th. ---- (2005): "Revised ERG Working paper on the SMP concept for the new regulatory framework", ERG (03) 09rev3, September. FLAMM K. (2005): An analysis of the determinants Telecommunications Policy Reseach Conference, October. of broadband access,

HABERFEHLNER K., LUNDBORG M., PÖTZL J., RUHLE, E-O. & LICHTENBERGER E. (2006): "Central and Eastern European countries way towards the Lisbon targets - ICT as driver for economic and social development", in: Piepenbrock/Schuster (Eds.): Telecommunications Markets in Central and South Eastern Europe - Market Developments and Regulatory Frameworks. HENTEN A. & SKOUBY K.E. (2005): "Regulation of local loop access", ITS Europe Conference, September 4-6th, Porto. ITU: ---- (2001): ITU regulatory implications of broadband workshop - ITU new initiatives programme, May 2-4th. ---- (2001): "Italian Case Study", April 26th. ELLIG J. (2005): "Costs and Consequences of Federal Telecommunications and Broadband Regulations, a Working Paper in Regulatory Studies", George Mason University, February. McNARY R. (2001): The Network Penetration Effects of Telecommunications Privatization and Competition, Stanford University.

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NICHOLLS R. (2006): "Interconnection of next generation networks - a regulatory perspective", Paper presented at the 16th biannual ITS conference Beijing, June. OECD (2003): "Developments in local loop unbundling", DSTI/ICCP/TISP(2002)5/FINAL, 10th September. Piepenbrock/Schuster (Eds.): (2003): Anreize für Infrastrukturinvestitionen bei der Zusammenschaltung in der Telekommunikation. SCHUMPETER J.A. (1918): Theorie der wirtschaftlichen Entwicklung. VOGELSANG I.: ---- (2005): "Resale und konsistente Entgeltregulierung", WIK Diskussionsbeitrag, no. 269, October. ---- (2002): "Theorie und Praxis des Resale-Prinzips in der amerikanischen Telekommunkationsregulierung", WIK Diskussionsbeitrag, no. 231, January. VON SCHEWICK B. (2007): "Towards an Economic Framework for Network Neutrality Regulation, 5 J. on Telecomm. & High Tech L". (forthcoming).http://ssrn.com/ abstract=812991.

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Annex 1
Indicator 1 Indicator 2 Indicator 3 Indicator 4 Indicator 5 Completed Introduction of Access in Mid Indirect (1) 2000 Introduction of LLU (0 = after 2001; 1 = before 2001; 2 = before 1999 Conclusi on 2 1 2 2 0 0 1 0 1 0 ? --- (2) ? ? ? --? (4) ? ? (5) --2 0 1 1 1 ? --? ? ? (6)

Fixed Broadband Retail Lines Market Shares of Competitors Percenage Infrastructurebased Competitors of All Competotors (Incl. CATV)

85% 45% 100% 73% 3% 50% 72% 38% 50% 83% 52% 100% 65% 16% 75%(3) 53% 5% 0% 46 46 100 % % % IRL 0,1% 22% 0,1% 31% 35% 7% 100% F 7,0% 23% 7.0% 52% 61 56 50 L 1,2% 10% 1,2% 26% % % % 59 25 100 % % % NL 8,1% 0% 8,1% 56% 100% 100% 100% P 0,9% 8% 0,9% 21% 92% 36% 50% S 5,5% 14% 5,5% 60% 82% 52% 100% SF 8,2% 10% 8,7% 36% UK 79 68 50 0,3% 65% 0,3% 54% % % % 39 2 50 % % % ? = Service based policy; ? = Infrastructure based policy; --- = Indecisive
1.

A 3,4% 17% 3,4% 65% B 0,3% 21% 0,3% 49% D 5,3% 9% 5,3% 13% DK 5,5% 12% 5,5% 36% E 1,7% 25% 1,7% 44% EL 0,1% 49% 0,1% 60% I 4,9% 15% 4,9% 30%

The status is based on four categories of indirect access: carrier selection for local calls, carrier preselection for local calls, carrier selection for national calls, carrier preselection for national calls. Each category is weighted by 25%. Belgium, Greece, Luxembourg and Portugal were excluded as no allocation could be made. Completion for local calls in November 2000.

2. 3.

Percentage Infrastructurebased Competitors of All Competotors (Excl. CATV)

Proportion of BSA and Resale

Proportion of ULL and LS

Proportion of ULL and LS

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4.

The categorisation of Italy is due to the delay of the introduction of a standard offer for ULL and the early introduction of indirect access. In addition, the Italian NRA has focused on the introduction of a wholesale broadband product. (Source: OECD Report "Developments in Local Loop Unbundling", DSTI/ICCP/TISP(2002)5/FINAL, from September 10th 2003, pp. 22 and 45; ITU Regulatory Implications of Broadband Workshop - ITU New Initiatives Programme - May 2-4th 2001 "Italian Case Study", April 26th 2001, p. 15) The categorisation of France is due to the aim of the NRA to foster infrastructure competition, as well as the success of line sharing (Source: OECD Report "Developments in local loop unbundling", DSTI/ICCP/TISP(2002)5/FINAL, from September 10th 2003, pp. 39f; ERG "Broadband market competition report", ERG (05)23, May 25th 2005). The results for the UK are very significant, which may seem astonishing as the UK has fostered infrastructure competition in earlier years, thereby referring to the fact that the UK market was opened up with the duopoly policy as early as the 1980s. These results are based on the situation in the new millennium, indicating that UK regulatory policy has evolved from infrastructure-based to service-based competition.

5.

6.

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Mean Infrastructure Based Service Based 8,1% 5,9% 9,2% 31,21 64,52 39,88 94,90 0,036 -9,4% -11,9% 27,4% 28,6% 17,14 17,54 86,80 38,2 32,02 66,34 41,01 97,35 Variance Infrastructure Based 0,16% 0,02% 0,4% 17,96 145,91 33,90 240,29 0,4% 0,5% 1,6% 2,0% 5,20 2,94 139,77 26,97 28,31 190,50 49,70 331,29 Service Based 0,08% 0,03% 0,1% 15,96 52,67 22,17 188,78 1,0% 1,8% 4,1% 5,4% 15,84 9,84 295,70 22,7 44,26 157,71 74,58 344,79 P 0,017 0,003 0,154 0,283 0,042 0,360 0,045 0,049 0,275 0,062 0,146 0,307 0,026 0,267 0,838 0,192 0,044 0,229 0,040 Significance Significance Significance Conclusions Significance Significance

Penetratio n Rate s

Penetration broadband Penetration DSL Fixed ISDN penetration 2004 National residential basket National business basket Residential OECD composite basket Business OECD composite basket basket Business OECD composite basket Incumbent's basic monthly PSTN rental charge for business customers Incumbent's basic monthly PSTN rental charge for residential customers Residential monthly rental Business monthly rental Average monthly expenditure (composite basket), business Average monthly expenditure (composite basket), residential National residential basket National business basket Residential OECD composite basket Business OECD composite basket

14,2% 10,4% 14,2% 28,36 50,31 36,82 74,32 0,9% 3,2% -3,8% 3,9% 8,8% 14,90 12,92 75,83 38,83 26,75 47,69 34,71 70,34

Prices 2004

Significance Incumbent's basic monthly PSTN rental charge for business Significance Residential OECD composite basket -1,1% -16,3%

Significance National business

Prices 2005

Price Changes between 2000 and 2004

Significance Incumbent's basic monthly PSTN rental charge for business

Prices 2004 for Adjusted PPP

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Endnotes
1 See the implementation reports from the EU commission with respect to the development of competition:http://europa.eu.int/information_society/topics/telecoms/ implementation/index_en.htm However, for these business models, the issue of efficient infrastructure investment can also be discussed in relation to the different levels of the network hierarchy where interconnection takes place and the extension of investment in double, single and local interconnection over time as a stepwise extension of alternative networks, see Piepenbrock/Schuster (Eds.): Anreize für Infrastrukturinvestitionen bei der Zusammenschaltung in der Telekommunikation, 2003. Regulation No. 2887/2000 of the European Parliament and of the Council on Unbundled Access to the Local Loop:http://europa.eu.int/ISPO/infosoc/ telecompolicy/en/regullfin-en.pdf. Compared to directives, which have to be transposed into national law, regulations are directly "enforceable". CAVE, 2004. It seems that some countries are following the approach of the ladder of investment; see ERG (05)23, 2005, Annex A "Country Studies":http://erg.eu.int/doc/publications/erg_05_23_broadbd_mrkt_comp_annex_a_p.pdf See, for example, Art. 8 para. 2 of the Framework Directive: Directive 2002/21/EC of the European Parliament and of the council of March 7th 2002 on a common regulatory framework for electronic communications networks and services (Framework Directive),Official Gazette, no. L 108/33 of April 24th 2002. CAVE, 2004, p. 8. This assumption may be debated in light of the NGN discussion (see VON SCHEWICK) and the development of competition in the USA in recent years after major parts of the unbundling regime was abolished, see CRANDALL. In our opinion the fact of complete ownership alone does not constitute a relevant means of differentiation. The demarcation point between service-based and infrastructure-based competition is often contested. The Danish regulator, for instance, considers only the full replication of the whole infrastructure including the last mile as infrastructure-based competition and all forms of network access as service-based competition; see: HENTEN& SKOUBY, 2005, p. 2. The triennial review in the USA also changed the picture of regulation and the assessment of the contribution of service versus Infrastructure-based competition. We are aware that this classification can be critical for those companies who invest in certain, but not in all parts of the infrastructure. Whereas a pure reseller can be easily allocated to service-based competitors, this is more difficult with indirect access operators and backbone providers, for example. Furthermore, we are aware that regulators might view their policy classification in a different way. We have consequently defined clear cut criteria whereby policy can be evaluated.

2

3

4

5

6

7

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9

Due to size limitations, the full results of the empirical study cannot be displayed here, but a longer version of the paper with all details can be downloaded from:http://www.psc-ag.biz. For example, because the national Telecom Act contains a preference for a specific type of policy. We do not consider any other factors that could affect broadband penetration. For further information see FLAMM, 2005. ECTA Broadband Scorecard Q2/2005 (downloadable under www.ectaportal.com) and calculations of Piepenbrock Schuster Consulting AG. Commission Staff Working Document, "Europe's Liberalised Telecommunications Market - A Guide to the Rules of the Game", from October 18th 2000.http://europa.eu.int/ISPO/info-soc/telecompolicy/en/userguide-en.pdf See, for example, VON SCHEWICK with respect to different forms of innovation and their assessment with regard to the discussion on network neutrality. Confer tohttp://www.statsoft.com/textbook/stathome.html, "The t-test is the most commonly used method to evaluate the differences in means between two groups. For example, the t-test can be used to test for a difference in test scores between a group of patients who were given a drug and a control group who received a placebo. Theoretically, the t-test can be used even if the sample sizes are very small (as small as 10 for example; some researchers claim that even smaller n's are possible), as long as the variables are normally distributed within each group and the variation of scores in the two groups is not reliably different." There is one critical remark to be made though, and that is because of the relatively large variances. The reason for these variances is the small sample of countries included in the study. It is therefore advisable for the results in this study to be validated in future research using additional methods to those applied here. However, the results by comparing the means and the variances by using the t-test are nevertheless strong and, in several cases, achieve a confidence interval of 95%, so that the results in this study are to be seen as significant. On the issue of complementary products and foreclosure in the NGN world (with respect to competition in the service and application layers) see VON SCHEWICK (forthcoming, 2007). A similar question was raised in a decision by the Dutch Competition Court, which annulled an NRA decision on mobile termination market analysis and remedies, thereby stating that regulation of the fixed market had led to the loss of any counterveiliing buying power against the mobile networks. On the aspect of static versus dynamic competition and the last mile problem involved see also BANERJEE & DIPPON, 2006.

10 11 12 13

14 15

16

17

18

19

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20

The German NRA recently launched a consultation on the concept of "new" markets, their definition and potential regulatory treatment:http://www.bundesnetzagentur.de/enid/22bf816986c04634a7aed1b666c5315c, 0/Regulierung_Telekommunikation/Neue_Maerkte_2jg.html For an overview see:http://europa.eu.int/information_society/policy/ecomm/tomorrow/index_en.htm and on emerging markets:http://europa.eu.int/information_society/policy/ecomm/doc/info_centre/public_consult/ review/130706reviewpresentation.pdf, pp. 17-27.http://europa.eu.int/information_society/policy/ecomm/tomorrow/index_en.htm

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5
Market Openness and Trade Liberalisation in Brazil: Financial and Telecommunications Services Sector and Intellectual Property Rights Deliverables†
Umberto Celli*
The paper intends to assess the existence in Brazil of particular internal and external constraints in the telecommunications, banking and insurance services, as well as with respect to enforcement with certain obligations under country's Intellectual Property Rights Law (IPR) and the WTO TRIPS. It is submitted that such constraints need to be removed so that Brazil can deeper its integration in the global economy.

Introduction
The Brazilian economy has especially throughout the last two decades faced a number of challenges and made several attempts to achieve a high sustainable rate of economic growth. There are positive signs to suggest that the country is eventually on its way to reach such target. Part of such improvement in Brazil's
* Professor of International Law, Faculty of Law - University of São Paulo, Largo São Francisco, 95 Prédio Anexo, São Paulo, São Paulo 01005-010, Brazil. E-mail: [email protected]

© 2008 Umberto Celli. All rights reserved.

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economy is the result of trade liberalisation programmes and regulatory reforms carried out in some crucial sectors, such as the telecommunications and banking and insurance services. However, even in those sectors there still exist particular constraints (internal and external) that need to be better addressed. Additionally, despite the fact that Brazil adopted in the early stages of the WTO a modern Intellectual Property Rights law (IPR), as a practical matter, internal enforcement of such IPR law is still not satisfactory. The objective of this article is to assess these Brazil's particular constraints to deeper its integration in the global economy. It will describe the environment and market openness of Brazil with respect to telecommunications, banking and insurance services and IPR.

Telecommunications Services
A. Regulatory Domestic Issues
The Constitutional Amendment No. 08, dated August 15th, 1995, marked the first important step towards the liberalisation and opening of the telecommunications services in Brazil. By eliminating the State monopoly on the sector, the Amendment paved the way for the privatisation of companies belonging to the Telebrás system and the creation of a regulatory agency (Anatel) to oversee the opening of the market. A new regulatory framework was then established by Law No. 9,472, of July 16, 1997 (General Telecommunications Law - "LGT"). The LGT set out the basic principles and guidelines for regulating the sector, among others: (i) expansion and universal access; (ii) competition; and (iii) the autonomy of Anatel.

I. Expansion and Universal Access
Following the privatisation in 1998, 1 the expansion of services increased significantly. From 1998 to 2003 the number of installed fixed telephones jumped from 22 million to almost 40 million, public pay telephones from 589 thousand to 1.35 million, and cellular phones from 7 million to more than 40 million. Investments in infrastructure, notably in the fixed telephony, amounted to US $ 40 billion in this 5-year period (Celli & Santana, 2004).

Market Openness and Trade Liberalisation in Brazil: Financial and 99 Telecommunications Services Sector and Intellectual Property Rights Deliverables Over the last years, despite the vigorous investment allocated to the fixed telephony, the expansion of lines seems to have stagnated, while the number of mobile phones, especially pre-paid phones, doubled: it rose from 46 million in December 2003 to 92 million in May 20062 and by the end of year achieved 100 million.3 Foreign investment especially made by new players in the market, such as the Italian operator TIM, has significantly contributed to such expansion and an increase of competition, which clearly yielded benefits to consumers. A careful assessment of the above figures shows that the universal access program is indeed being implemented, but mainly through the expansion of prepaid mobile phones. The reason for this is concerned with costs for users. While it is feasible to hold active a pre-paid mobile phone for only US $ 2 per month, users will spend approximately US $ 17 on a basic subscription plan for a fixed line.4

II. Competition and Technological Convergence
Even after the privatisation of the sector, certain limitations to a free competition system remained in place, albeit for a short period. A duopoly regime (i.e., former incumbents and new entrants in the market) and restrictions concerning services area applicable to fixed and mobile operators alike persisted up to 2001. As of 2002, a deregulation process was initiated given that most of former incumbents have accomplished their target plans (universal access). A full liberalising agenda was eventually set up in 2003. Although this transition period from a state monopoly to a regulated free enterprise system can be deemed on the whole very successful, competition was not (and has not been yet) implemented as expected. Disputes concerning interconnection (including those stemming from agreements with internet service providers) and infrastructure sharing (especially the last mile access through the "unbundling") among fixed line operators were frequently noted. Anticompetitive practices by a few operators (especially by former incumbents providing local calls services), such as discriminatory prices and cross subsidies (price squeeze), were not satisfactorily controlled by Anatel. Further, conflicts among fixed local services and mobile services providers regarding operations of pre-paid mobile phones were also frequently observed.

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Contemporaneously with this process, radical changes were taking place in the telecommunications international market, which inevitably would reverberate in Brazil. The most remarkable trend is the movement towards concentration of the market. Due to its impressive growth the mobile sector was the first to be affected. Some analysts think it has reached its peak and is headed for stagnation. According to the Mobile Operators National Association (ACEL), there is not enough scale in the country for four or five providers. In spite of this, in a recent auction carried out by Anatel, OI (former Telemar) secured the right to operate in the State of São Paulo and will directly compete with Vivo, Claro and TIM. These analysts still take the view that only two or three operators will ultimately dominate the market.5 Even the fixed telephony market seems not to be immune from such concentration trend. OI is likely to acquire Brasil Telecom (which operating area is Southern Brazil), should the changes proposed by Anatel (as a result of huge governmental pressure) to the General Concession Plan are approved and eventually enacted by a governmental decree.6 This movement towards concentration is due mainly to the convergence of technologies. The technological evolution has led to the convergence of telecommunications services, fixed and mobile, radio and TV broadcasting, and all sorts of electronic communication, such as Pay TV and multimedia. A number of technologies are converging into one technology. The internet combines and turns all types of communications into a simple service on a computer screen. The mobile services, originally conceived to transmit wireless voice, are currently used to connect internet and radio, to send text messages (Short Message Service), and to capture images and receive radio and TV programs, among others (Cordovil, 2006). Current digital infrastructure is merging so fast that within a couple of years a new kind of TV, the IPTV, will be provided via broad band internet in several ways, such as wireless networks, telephone lines or satellite. In this scenario, the conflict of interests which emerged between, on one hand, telecommunications service providers, and on the other, open and Pay TV operators, was inevitable. Recently, two major telecommunications operators, Embratel (Telmex) and Telefonica, acquired equity in Brazil's two

Market Openness and Trade Liberalisation in Brazil: Financial and 101 Telecommunications Services Sector and Intellectual Property Rights Deliverables largest Pay TV operators, Net Serviços (Globo Group) and TVA (Abril Group), respectively. Given that the convergence of technology allows for a sole operator to provide a variety of services, such as telephony, Pay TV, high speed access to Internet, wire or wireless broad band services using the same infrastructure, partnerships, mergers and acquisitions among electronic communications operators (radio, open and Pay TV) and telecommunications services providers (fixed and mobile) seem inexorable.7 Although these corporate movements, which in the case of Embratel (Telmex) and Telefonica are part of their global plans to form international strategic alliances, will benefit consumers as operators will be conceivably able to provide much broader and cheaper services options, Anatel is concerned that a new monopoly will arise in the sector, this time a private one. The difficulty is that the current regulation in force, especially the LGT, 8 is outdated and, therefore, will not be adequate to face this new dynamic of the market. Based on such an obsolete regulation, Anatel still assesses and evaluates companies' activities (and what is worse, their recent merger and acquisition movements) by classifying the sectors in which they are licensed according to technologies. It is imperative that major modifications of this regulatory framework are made especially involving amendments to and adaptations of the LGT and other relevant regulations to make them more in line with new technological requirements. Moreover, a Communication Law regulating open and Pay TV, Internet and telephony would be of utmost importance for the improvement of such a regulatory environment. Anatel should regulate competition without classifying operators in a segmented manner (e.g., fixed telephony operators, mobile operators, Pay TV operators, etc.). Since the technological convergence is already a fact, regulations cannot overlook it. A balanced and updated regulatory framework would allow Anatel and antitrust authorities to better oversee the market by restraining anticompetitive practices and protecting users. Sensitive to such new environment, Anatel has recently submitted to public consultation a proposal on a General Plan for Updating the Telecommunications Regulation in Brazil ("Proposta de Plano Geral de Atualização da Regulamentação

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das Telecomunicações no Brasil" - Consulta Pública No. 22, dated June 16th, 2008 - "PGR"). The purposes of the PGR are, among others, to: (i) stimulate sustainable businesses models; (ii) increase broad band access; (iii) increase the use of telecommunications services and networks; (iv) diversify the offer of telecommunications services in order to meet specific market segments, especially by means of increasing services converging offers; (v) assure adequate level of competition in the provision of services; (vi) expand Pay TV services to distribution of content; (vii) establish a competition model with favourable conditions to the use of shared networks and multiplicity of access; (viii) simplify regulation in view of convergence; and (ix) stimulate occupation of networks and internetworks communication.

III. Autonomy of Anatel
All of the changes proposed above will be vain or simply will not be put into practice if Anatel continues to lose its autonomy vis-à-vis the government. In 2003, the government announced its disagreement with the degree of autonomy enjoyed by the regulatory agencies, including Anatel. A draft Bill, which substantially weakens the role, functions and powers of regulatory agencies, was then submitted for public consultation. Despite the strong and vigorous opposition to it by a number of relevant market players (which eventually made the government step back from its plans to get it passed by Congress) political interference with Anatel's activities increased dramatically. Nomination of Anatel's Board of Directors has been made via political rather than technical criteria. Anatel's budget was significantly reduced. This resulted in a number of key skilled officers leaving the agency. The government has recently signalled a change of view on this issue. It seems inclined to eventually accept the role and autonomy of all regulatory agencies, such as Anatel. Apparently, it has given support to a Bill pending before Congress which is intended to confer constitutional status and protection on budgets and financial and administrative autonomy of regulatory agencies. It is unclear at this stage whether such Bill will ultimately pass into law.9 Without modernizing its telecommunications regulatory framework and effectively conferring upon Anatel the required autonomy, it is unlikely that private investors will regain the necessary confidence to further invest in the Brazilian market.

Market Openness and Trade Liberalisation in Brazil: Financial and 103 Telecommunications Services Sector and Intellectual Property Rights Deliverables

B. Negotiations in the WTO
Brazil has been adopting defensive positions regarding the negotiations of the telecommunications services in the WTO. In 1996/1997, the country took part in the negotiations on basic telecommunications and subscribed to the Fourth Protocol, under which it undertook to immediately liberalise certain sectors of the market (such as the value added services, MTN.GNS/W/120), and to move gradually in other areas (such as the abolition of restrictions on foreign capital, the elimination of monopoly in the fixed telephony and the assumption of obligations under the Reference Paper).10 In 2001, an improved offer was tabled, under which the country undertook to fully liberalise mobile and fixed telephony (the latter by 2002) and to adhere to the Reference Paper (albeit with three restrictions). Nevertheless, the offer was rejected by the United States, Japan, Hong Kong and the European Community since their request concerning the abolition of the prerogative granted to the Executive Power under the LGT (to review foreign equity participation policy in telecommunications service providers) had been left out (Celli, 2006). 11 In view of this, Brazil withdrew its offer. Despite the absence of any commitment under the GATS Telecommunications Annex and the Reference Paper, Brazil autonomously carried out its reasonably open privatisation and liberalisation program (at least as regards Mode 3 of GATS). There are no major restrictions to foreign companies and investments.12 In the Doha Round, Brazil's revised offer (tabled in June 2005) contains commitments covering all basic telecommunications subsectors. In Modes 1 (cross-border supply) and 2 (consumption abroad), such commitments were kept unbound and in Mode 4 they made reference to the general horizontal restrictions inscribed in Brazilian legislation in force. In Mode 3 (commercial presence), the following restrictions were inscribed: (i) the Executive Power's prerogative referred to above; (ii) licenses are issued only to companies headquartered in Brazil, incorporated in accordance with Brazilian law, and directly controlled by Brazilian companies; and (iii) preference given to Brazilian satellites whenever they provide commercial, operational and technical conditions similar to those provided by foreign satellites (Celli, 2006).13

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Following the Hong Kong Ministerial of 2005, a number of plurilateral meetings took place. In March 2006, Brazil was asked to table a new revised offer on telecommunications services. On the basic telecommunications subsectors, demandeur Members requested commitments in all services Modes. In Mode 1, the elimination of certain national treatment restrictions was solicited, as well as certain market access requests, such as the commercial presence requirement. In Mode 3, the following requests on market access were made, among others: (i) no limitation as to the number of services providers (quotas, suppliers with exclusive rights or geographical restrictions regarding services area); (ii) the possibility of effective and direct control by foreign companies of subsidiaries. Demandeurs requested again that Brazil fully adopt the Reference Paper provisions. When and if the Doha negotiations are effectively reassumed, Brazil will certainly be compelled to improve its offer. At this stage, it is unlikely that significant offers will be made in Mode1. In Mode 3, any improved offer should contain as a minimum the following market access commitments: (i) consolidation of the liberalisation process; (ii) amendment of LGT in order to eliminate provisions which allow the Executive Power to review foreign equity participation policy in telecommunications services providers (even if this provision in practice only means that the Government might under certain exceptional circumstances adopt restrictive measures); (iii) full elimination of geographical restrictions for the rendering of services (there are no major restrictions related to the number of operators nor suppliers with exclusive rights); (iv) the possibility of effective and direct control by foreign companies of their subsidiaries in the country; (v) no preferential treatment for Brazilian satellites; and (vi) the abolition of restrictions concerning foreign satellites (which segment capacity must be traded through a local legal representative rather than directly by the holder of relevant landing rights). Additionally, Brazil should adopt the Reference Paper provisions insofar as they do not conflict with policies of national interest.

Financial Services
A. Regulatory Domestic Issues
In the second half of the 1990's, amid a hostile and unstable scenario surrounding a number of international financial crises,14 the financial system as a whole needed to be strengthened. In this regard, the Brazilian government

Market Openness and Trade Liberalisation in Brazil: Financial and 105 Telecommunications Services Sector and Intellectual Property Rights Deliverables chose to adopt a conservative strategy aimed at broadening the scope of prudential regulation, implementing international standards and reorganising the market through direct and indirect interventions (Mirandola, 2006). The government created three restructuring programs for the banking market, to wit: (i) a Program of Incentives to Restructure and Strengthen the National Financial System (PROER); (ii) a Program of Incentives to Reduce the Participation of Federal States in Banking Services (PROES); and (iii) a Program to Strengthen Federal Financial Institutions (PROEF). Other regulatory reforms with the purpose of adopting internationally recognised accountancy rules, best practices in supervision and international prudential rules were also adopted on the basis of Basel I norms. Accordingly, the reforms had an indisputable prudential bias. Limited and controlled opening was allowed as a means of obtaining new money from sound international players, internalising financial technologies and inducing national players to adopt international best practices to compete with national players. Such opening though was not intended to increase competition, lower prices or improve the quality of services. Its main purpose was to gain access to international capital markets, increase liquidity and signal a reduction in the level of hostility to foreign firms. It was definitively not designed to be a generalised privatisation and liberalisation program. This attitude may help explain the reticence of Brazil to effectively take on liberalisation commitments within the WTO (Mirandola, 2006). The Brazilian National Financial System is composed of three (3) types of institutions, to wit: (i) insurance companies; (ii) financial banking institutions; and (iii) financial non-banking institutions. Such institutions are regulated by a number of agencies linked to the Ministry of Finance, the most important of which being the National Monetary Council ("CMN"). Under the CMN are the following regulatory agencies responsible for implementing CMN policies: (i) the Central Bank of Brazil; (ii) the Securities Commission; (iii) the Private Insurance Superintendence ("Susep"); and (iv) the Complementary Retirement Funds Secretariat. This classification of institutions differs from the one adopted by the W120,15 under which financial services are divided into two (2) subsectors (insurance and banking services) and sixteen (16) services. In the case of insurance, only the

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classification of reinsurance and retrocession coincides with the one contained in the W120. As regards banking services, Brazil follows the W120, except that a distinction is made between financial and non-financial institutions. No other WTO Member has a similar system. This different criterion has also been a significant obstacle when it comes to negotiations in the WTO. As regards the provision of services by financial banking institutions, the following requirements are noteworthy: (i) a presidential decree is necessary to authorise the establishment of foreign financial banking institutions, which must be incorporated under the form of corporations; (ii) only Brazilian banks are allowed to supply investment funds management services to governmental entities; (iii) top managers must be Brazilian residents; (iv) all banking services are closed to cross-border consumption;16 (v) restrictions (from a foreign business perspective) regarding the provision of auxiliary financial services, such as advisory and financial data processing services; and (vi) pension funds cannot be invested abroad. The market's biggest financial institutions continue to be the state-owned Banco do Brasil and the private Bradesco and Itaú. Foreign participation increased modestly especially with the entry of Spanish institutions, such as Santander.17 While Santander, which acquired Banespa (a former state bank owned by the State of São Paulo) has been consolidating and improving its position on the market, the giant American Bank (Bank of Boston) decided to leave the country and was purchased by Itaú. Such a decision was taken as a result of an international restructuring of the Group outside Brazil (the group was purchased in the United States by Bank of America). The sales were not related or due to the local regulatory environment). The Brazilian Government has recently introduced a plan aimed at improving access to capital and credit especially by the poorest sections of society and this might lead to increased competition, lower prices and improved service quality. It remains to be seen whether this policy will generate growth as expected. Insurance regulations are still significantly restrictive vis-à-vis foreign services providers, insofar as: (i) goods in circulation must be insured by companies based in the country; (ii) insurance contracts with foreign insurance companies are only allowed under very special cases, such as when a Brazilian company lacks the necessary financial resources, or if the transaction is deemed to be of

Market Openness and Trade Liberalisation in Brazil: Financial and 107 Telecommunications Services Sector and Intellectual Property Rights Deliverables national interest and is especially authorised by Susep; (iii) there is excessive bureaucracy regarding insurance contracts made in foreign currencies; and (iv) a specific presidential decree is required to authorise foreign companies to establish in the country. A significant step towards the opening of the insurance sector was recently taken with the entry into force of Complementary Law No. 126, of 15th January, 2007 "Law No. 126". Law No. 126 abolishes the State monopoly on reinsurance exercised by the Brazilian Reinsurance Institute ("IRB"). Under Law No. 126, foreign reinsurance companies will be allowed to operate in the local market. The reinsurance market will operate with three (3) types of reinsurance companies, to wit: (i) the local reinsurer, which must be effectively based in the country and subject to capital requirements and other rules currently applicable to reinsurance companies. The local reinsurer will be given sixty per cent (60%) preference on all reinsurance transactions carried out in the Brazilian market within the next three (3) years and forty per cent (40%) over the subsequent period. The IRB will continue to exercise its activities as a local insurer; (ii) the admitted foreign reinsurer, which must have proved financial and economic capabilities to carry out transactions with Brazilian insurance companies and will be subject to solvency assessment pursuant to criteria established by Brazilian authorities. The admitted reinsurer must open an account in foreign currency, linked to Susep, and set up a representation office in the country; and (iii) the eventual foreign reinsurer, which need not set up a representation office in the country but solely be registered with Susep. In addition to being subject to the financial, economic and solvency conditions applied to the admitted foreign reinsurer, transactions conducted by the eventual foreign reinsurer will be subject to a certain limit to be determined by relevant authorities. The opening in the reinsurance market is expected to increase competition, reduce reinsurance prices and attract capital, which should ultimately benefit consumers.

B. Negotiations in the WTO
Brazil is one of the few WTO Members which has not ratified yet the GATS Fifth Protocol. The state monopoly on reinsurance was said to be the main obstacle for such ratification. Now that such an obstacle has been removed, it is expected that the Protocol may be eventually ratified.

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Offers so far tabled by Brazil regarding financial services could be summarised as follows: (i) there is no commitment in Mode 2; (ii) no commitment in Mode 1, except for advisory and research services for the insurance sector; and (iii) in Mode 4 all financial services are subject to severe horizontal restrictions. In Mode 3, the following restrictions to the commercial presence of foreign operators are noted: (i) a requirement of presidential decree for both banks and insurance companies; (ii) no branches allowed (companies must take the form of corporations in accordance with Brazilian relevant laws and regulations); (iii) there is a monopoly on labour accidents insurance; (iv) there are restrictions to insurance of traditionally international activities, such as transportation and freight related to the international trade.18 In 2005, an improved offer shows commitments to liberalise the reinsurance sector and reduce certain horizontal restrictions. In the 2006 plurilateral meetings, demandeurs requested more transparency of laws and regulations and faster licensing procedures. Their main demands were: (i) ratification of the GATS Fifth Protocol; (ii) removal of restrictions on reinsurance; and (iii) the elimination of the presidential decree requirement coupled with the need to set up subsidiaries under the form of corporations. Any Brazilian improved offer should therefore contain at least the following commitments: (i) more transparency of regulations; (ii) improvement of licensing procedures; (iii) reduction of horizontal restrictions; (iv) in Mode 4, abolition of certain restrictions regarding visas and working permits; and (v) the elimination of the presidential decree and subsidiaries requirements. In the short term, no commitments in Mode 1 for financial services are anticipated.

Intellectual Property Rights: Patents, Trademarks and Copyrights
A. Regulatory Domestic Issues
Once the TRIPS came into force, internal laws concerning IPR were amended and enacted to conform to TRIPS standards of protection. This included the Industrial Property Rights Law - Law No. 9,279/96 on patents and trademarks, among others, and the Copyrights Law - Law No. 9,610/98. It is widely acknowledged that such Laws are in strict conformity to the TRIPS. Back in 2000/2001, the Brazilian government threatened to compulsorily license certain patents on medications on the basis of provisions inscribed in article 71

Market Openness and Trade Liberalisation in Brazil: Financial and 109 Telecommunications Services Sector and Intellectual Property Rights Deliverables of Law No. 9,279/96. At that time, the consistency of article 71 with TRIPS provisions (especially vis-à-vis its article 8) was challenged by a few WTO Members. The 2001 Doha Declaration on Public Health, though, is deemed to have dissipated any doubts as to the adequacy of article 71 to the TRIPS provisions. While from a strict legal and formal perspective, Brazilian IPR laws contain the required degree and standards of protection, the performance of the Brazilian authorities in enforcing such laws leaves much to be desired. The Patent and Trademark Office (INPI) has been traditionally inefficient and unprepared to assess the numerous protection requests of patents and trademarks, especially those filed by international corporations. Additionally, the National Council for the Piracy Combat (CNCP), linked to the Ministry of Justice, has been extremely lenient in taking effective action to crack down on piracy. In a recent research conducted by a reputable international chamber of commerce, Brazil ranks among one of the world's worst countries when it comes to assuring effective protection against piracy. 19 If Brazilian authorities persist in failing to assure protection to these rights, the country will face growing difficulties in attracting high technology investments, i.e., private sector will be discouraged from investing in research and development in the country. It is to be expected that innovative companies, especially those engaged in the software sector, will take more proactive measures, such as lobbying the authorities to see enforcement efforts improved.

B. Negotiations in the WTO
Brazil has been explicitly signalling that it is not willing to take part in any negotiations that could result in increasing the level or degree of protection already contained in the TRIPS or diminishing its flexibilities or safeguards. On the contrary, it is pursuing a way of lessening or making certain TRIPS provisions more flexible. Put into other words, Brazil's strategy has been to maintain or increase space to adopt public policies, such as the one concerning public health and medications (Rosenberg, 2005). Such targets obviously clash with the objectives of developed countries which want to see the degree and standards of protection gradually augmented. Thus, any advance on the negotiations would require a sort of "compromise formula" among developing countries, such as Brazil, and developed countries, such as

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the US, the European Community and Japan in particular. A "compromise formula" or trade-off could involve, on one hand, certain concessions by developing countries (Brazil, in particular) as to increasing harmonization, for instance, of patent rights protection, and, on the other, the creation of instruments and mechanisms aimed at effectively promoting the access of developing countries to new technologies (e.g., investment incentives for technology transfer built into OECD tax codes) and increasing cooperation so that developed countries may share information to stimulate innovation in developing countries. In this regard, it is widely recognised that without access to new technologies, the gaps and asymmetries between developed and developing countries will never diminish.

Final Remarks
Brazil's growth potential in the future will strongly depend on certain changes to its domestic regulatory framework on telecommunications and financial services, as well as to its foreign trade policy for these sectors. As regards the former, certain amendments to and adaptations of the LGT and relevant regulations to make them more in line with new technological requirements are imperative. Moreover, if Anatel is not given the required autonomy, it is unlikely that private investors will regain the necessary confidence to further invest in the Brazilian telecommunications market. Brazil will certainly be compelled to improve its offer in the WTO. In Mode 3, any such improved offer should contain, among others, the following market access commitments: (i) consolidation of the liberalisation process; (ii) amendment to LGT in order to eliminate provisions which allow the Executive Power to review foreign equity participation policy for telecommunications service providers; (iii) full elimination of geographical restrictions for the rendering of services; and (iv) the possibility of effective and direct control by foreign companies of their subsidiaries in Brazil. Additionally, Brazil should adopt the Reference Paper provisions insofar as they do not conflict with policies of national interest. With respect to financial services, a significant step towards the opening of the insurance sector was recently taken with the entry into force of Law No. 126. Law No. 126 abolishes the State monopoly on reinsurance exercised by the IRB and allows foreign reinsurance companies to operate in the local market. Any

Market Openness and Trade Liberalisation in Brazil: Financial and 111 Telecommunications Services Sector and Intellectual Property Rights Deliverables Brazilian improved offer in the WTO should contain at least the following commitments: (i) more transparency of regulations; (ii) improvement of licensing procedures; (iii) reduction of horizontal restrictions; (iv) in Mode 4, abolition of certain restrictions regarding visas and working permits; and (v) the elimination of the presidential decree and the requirement that subsidiaries must take the form of corporations. Brazil's potential in the coming years will also depend on certain improvement to its IPR system. The INPI's structure should be modernised in order to process more efficiently the numerous protection requests of patents and trademarks filed mainly by international corporations. Moreover, if Brazilian authorities persist in failing to crack down on piracy, the country will face growing difficulties in attracting high technology investments. In the WTO, Brazil should pursue a "compromise formula" or trade-off with developed countries. Such trade off could involve certain concessions as to the increase of harmonization, for instance, of patent rights protection, and the creation by developed countries of instruments and mechanisms aimed at effectively promoting the access of developing countries to new technologies.

References
Books, Journals and Papers
CELLI, Umberto & SANTANA, Cláudia. Telecomunicações no Brasil: Balanço e Perspectivas. Revista de Direto Administrativo, No. 238. Rio de Janeiro: Renovar and Fundação Getúlio Vargas, 2004, p. 3. CELLI, Umberto, org.. Comercio de Serviços na OMC. Curitiba: Juruá, 2005, p. 132. CELLI, Umberto. Condições para as negociações do Acordo sobre o Comércio de Serviços ("GATS") na Organização Mundial do Comércio (OMC), in Revista de Direito de Informática e Telecomunicações, vol. 1, No. 1. Belo Horizonte, Fórum, 2006, p. 176/177. CORDOVIL, Leonor. A convergência nas telecomunicações e sua influência no Direito da Concorrência, in Revista de Direito de Informática e Telecomunicações, vol. 1, No. 1. Belo Horizonte, Fórum, 2006, p.88-90. MIRANDOLA, Carlos Maurício Sakata. Financial Services Universalisation and International Trade: broad public policies and the relation between regulation and liberalization. IDCID Working Paper Series - Study Group on Trade Negotiations in Services, June 2006, p. 9/10, available at www.idcid.org.br. OLIVEIRA, Jorge Amâncio et alli. Serviços, in O Brasil e os Grandes Temas do Comércio Internacional, THORSTENSEN, Vera, JANK, Marcos S., org.. São Paulo, Aduaneiras, 2005, p. 141/142.

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ROSENBERG, Bárbara. Propriedade Intelectual, in O Brasil e os Grandes Temas do Comércio Internacional, THORSTENSEN, Vera, JANK, Marcos S., org. São Paulo, Aduaneiras, 2005, p. 292/293.

Documents
Fórum Serviços Brasil - 1° Relatório Setorial de Serviços Financeira (First Sectorial Report on Financial Services), Prospectiva Consultoria Brasileira de Assuntos Internacionais, September, 2004, p. 9.

Newspapers
Jornal Folha de São Paulo.

Endnotes
†

This article results and is updated from a paper commissioned by the OECD in 2007. The author is grateful to Ralph Lattimore for his invaluable omments. Major European operators played an important rule in this process by having acquired a significant share of the Brazilian telecommunications market. See Conjuntura Econômica, vol. 60, No. 08, Fundação Getúlio Vargas - FGV, August, 2006, p.07. Valor Econômico on line, www.valoronline.com.br, access on December 19, 2006. Since the stagnation or fall in the growth and expansion of fixed lines is mostly due to low income of users, the Brazilian government has recently conceived the so-called social or popular telephone program, which, in order to be effective, shall depend on subsidies. It remains to be seen whether such subsidies are to come from the government itself or from the operators. The Spanish Telefonica, which is already one of Vivo major shareholders together with Portugal Telecom, has recently acquired equity in the Italian TIM, another evidence of such market concentration trend. Current General Concession Plan prevents the operator of certain concession area from operating in other areas. According to the proposed changes, operators will be allowed to operate in at least one area in addition to its own concession area. Embratel, in addition to operating fixed telephony, currently controls a wireless fixed telephony operator, Livre (former Vésper), and is controlled by the same shareholders of the mobile operator Claro, the Mexican Telmex. In order to face the growing competition by Telmex/Embratel, Telefonica Group, which already had a stake in the mobile operator Vivo, has just been licensed by Anatel to operate DTH.

1 2 3 4

5

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Market Openness and Trade Liberalisation in Brazil: Financial and 113 Telecommunications Services Sector and Intellectual Property Rights Deliverables

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The Brazilian communication regulation is currently an actual patchwork. Apart from the obsolete LGT and the Cable Law (1995), a chapter of the old Telecommunications Brazilian Code of 1962 regulating radio and TV broadcasting is still in force. The recently launched Growth Acceleration Programme (PAC) also contains a draft Bill on the autonomy of the regulatory agencies. There are also studies on the possible replacement of Anatel by a more encompassing agency named Communications National Agency - Anacom. The PGR also reinforces the role and the autonomy of Anatel. The Reference Paper and the Telecommunications Annex contain complementary rules to GATS related to competition and interconnection. See also CELLI (2005), p. 135, and OLIVEIRA et alli (2005), p. 141/142. With the exception of the also obsolete Cable TV Law of 1995, which establishes that 51% of operators' equity must be controlled by Brazilians or Brazilian companies. See also Carta de Genebra: newsletter on the WTO and the Doha Round. Brazilian Mission to the WTO, 5, No. 2, p. 28/30. Among them, Mexico (1995); Ásia (1997); Russia (1998); Brazil (1999); and Argentina (2000). The WTO classification for services. Except for the acquisition by Brazilians of certain regulated or authorised foreign financial products, such as the Brazilian Depository Receipts (BDRS). HSBC has also relatively recently established in Brazil and has been gradually increasing its market share. See Fórum Serviços Brasil - 1° Relatório Setorial de Serviços Financeira (First Sectorial Report on Financial Services), Prospectiva Consultoria Brasileira de Assuntos Internacionais, September, 2004, p. 9. See in this respect Folha de São Paulo Newspaper, 30th January, 2007, p. B9.

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6
China's Present Regulatory Approach in the Broadband Access Sector - Its Generation and Its Effects on Competition
Zhong Liu*
This article gives a detailed introduction to the generation of China's present regulatory approach in the broadband access sector and analyses its effects on competition. Before the generation of China's Present Approach, regulatory lag had resulted in broadband enclosement which had brought about a lower usage of fiber capacity in feeder and distribution sectors, excessive duplication in the drop sectors, exclusive contracts between operators and real estate developers, and conflicts between employees of different operators. China's present regulatory approach in the broadband sector was generated through the June 2001 Circular issued by the Ministry of Information Industry, which prohibits exclusive contracts and limits the number of firms in both the Network of Residence markets and the Metropolitan Access Network markets,and the
* An independent Telecom Strategy and policy, Research Fellow, Economics, in School of Law, George Mason University, US. E-mail: [email protected]

© 2008 Zhong Liu. All rights reserved.

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subsequent geographic separation of China Telecom decided by the State Council, which was completed in 2002. The HerfindahlHirschman Indexes indicates that China's Present Approach has sustained the strong dominant power respectively exerted by the present China Telecom Group in southern China and by the present China Netcom Group in northern China. The sustained dominant power is one of the factors which help explain why the broadband access penetration progress of China is not as good as those of most OECD countries and why the broadband access penetration progress is not as good as penetration progress respectively in fixedline and mobile sectors of China itself during the same period.

1. Introduction
One of objectives of reform in China's telecommunications industry was pronounced as breaking up the monopoly and introducing competition.1 The history of reform and restructuring in China's telecommunications industry broadly speaks so. The industry had been overwhelmed by the Ministry of Posts and Telecommunications (MPT, hereafter), which run and operated telecommunications network through its operational arm - Directorate General of Telecommunications (DOT, hereafter), and its provincial arms - Posts and Telecommunications Administration (PTAs, hereafter). Since 1993, companies which are not affiliated with the MPT have been permitted to enter value-added services market. The most prominent one is Ji Tong Communications Company Limited (Ji Tong, hereafter) which was debuted in 1993. In 1994, China United Telecommunications Corporation (China Unicom Group, hereafter) was granted a full service license, representing the introduction of competition into the basic telecommunications service markets. However, China Unicom Group had not constituted a significant challenge to the incumbent, not least because the MPT and the PTAs played a role of both regulator and operator, and because the scale of the then incumbent was far bigger than these new entrants and because the then incumbent set a series of barriers in the interconnection field to these new entrants (see Xu and Pitt, 2002 about China's telecommunications reform).

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Thereafter, the top policymakers decided to separate regulation from operation. March 1998 saw the formation of the Ministry of Information Industry (MII, hereafter) which takes over the regulatory responsibility of the telecommunications industry from the previous MPT. However, the MII's provincial arms - the independent Communications Administrations (CAs, hereafter) were not completely reorganized until approximately December 2000. May 2000 witnessed the separation of the network and telecommunications business run by the former MPT into four business lines: wire-line, mobile, paging and satellite communications. The DOT was renamed the China Telecommunications Corporation which runs and is restricted to wire-line business. China Mobile Group was also established in May 2000 and assumed the operation of the mobile arm previously owned by the DGT. China Satcom was incorporated and runs the satellite communications. The paging arm was transferred to China Unicom Group. PTAs dissolved with the founding of CAs in late 2000 (see Xu and Pitt, 2002 about China's telecommunications reform). After the above round of reform and restructuring, the then China Telecommunications Corporation (called pre-geographic-separation China Telecom, hereafter) was still a monster with almost 98.9% of total landlines, and with revenue in 2001 4.77 times that of the second biggest operator with a fixed line license - China Unicom Group, to say nothing of the then newly incorporated China Network Communications Shareholding Company Limited one of predecessors of the present China Netcom Group. Against this background, the then China Telecommunications Corporation was divided again into a northern part and a southern part. This geographic separation was completed in May 2002. The assets of the northern part including 10 provinces (including autonomous regions and municipalities, hereafter) and 30% of the nationwide long-haul transmission assets and international communications capacity were merged with China Network Communications Shareholding Company Limited and Ji Tong Communications Company Limited to form the present China Network Communications Group Corporation (the present China Netcom Group, hereafter). The assets of the southern part including 21 provinces (autonomous regions and municipalities) and 70% of the nationwide long-haul transmission assets and international communications capacity constituted the present China Telecommunications Corporation (the present China Telecom Group, hereafter). Both are allowed to operate nationwide wire-line telecommunications networks.

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The above is a general and short introduction to China's reform and restructuring in the telecommunications industry. As policymakers claimed, its overall objective is to break up the monopoly and introduce competition. While the big picture is clear, whether policies have achieved its objective in each sector deserves investigation. This article is designed to give a detailed introduction to the generation of China's present regulatory approach in the broadband access sector and analyses its effects on competition. It divides into four sections. The following section introduces why policymakers made the relevant policies which constitute the China's Present Approach and what these policies are. Section 3 analyses the effects of China's present Approach on competition and last section concludes this paper.

2. The Generation of China's Present Approach
2.1 The Early Competition and Regulation of the Dial-up Internet Access
The first physical connection of China's computers with the Internet happened on 14th September 1987 (ISC2 and CNNIC,3 2003). Since then, a few networks applying the Internet Protocol have been built and extended in China's universities and research institutions. As an incumbent always does, the then MPT and its provincial arms - PTAs, did not realize the challenge represented by these burgeoning networks. Until as late as September 1994, the MPT and PTAs had not started the construction of their own networks employing Internet Protocols. In January 1995, the MPT and PTAs began their commercial Internet access services to the public in two cities - Beijing and Shanghai. Before January 1996 when the backbone of CHINANET was completed by the then DGT of the MPT, there had been no commercial Internet services provision nationwide for residential subscribers in China (ISC and CNNIC, 2003). The initial charges for dial-up Internet access were extremely high. The recurring cost of Internet access for subscribers included two parts. The first part was the charge of the dial-up call over Public Switched Telephone Network (PSTN, hereafter) by which a user's terminal connected to the dial-up server of a relevant Internet Service Provider (ISP, hereafter). The price of this kind of call was regulated by the MPT and was charged by the pre-geographic-separation

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China Telecom which then de facto monopolized the PSTN nation-wide. The second part was the market-based charge of the Internet connection service which was paid to the relevant ISP. One of the upstream inputs of any ISPs is the trunk lines that the ISP had to rent from the pre-geographic-separation China Telecom to connect the switches of the pre-geographic-separation China Telecom with their own access servers. Another input is the dedicated line which connects the ISP with the Internet backbone. Since the incumbent dominated or even monopolized the upstream markets and the charges for these inputs were extremely high, competing ISPs were not able to constitute a significant challenge to the affiliated ISPs of the incumbent. In the years leading to the independence of CAs, the PTAs, which run the networks of the pre-geographic-separation China Telecom in individual provinces, played a conflicted role of both operator and regulator. The tactics of the pre-geographic-separation China Telecom were to squeeze their rivals economically by maintaining higher charges for upstream inputs which new entrants had to purchase from it, and technically to delay the delivery of these upstream inputs. By so doing, the then pre-geographic-separation China Telecom, though it was a latecomer, occupied the dominant position in the Internet access market nationally. Shortly after independent CAs were set up, the MII and the National Development and Reform Commission (NRDC, hereafter) jointly issued a circular on 22 December 2000 (December 2000 Circular, hereafter).4 The circular cut the regulated tariff of a call for dial-up Internet access from 0.08 or 0.11 to 0.02 Chinese Yuan per 3 minutes, down 75% or 81.8%, and furthermore a flat-rate was encouraged. The charges of trunk lines were reduced by a total of 55.6% from 4,500 to 2,000 Chinese Yuan per line. For dedicated lines, the rent was greatly reduced also. For example, the charge for a dedicated line of 34Mbps within a service area was reduced 78.8% from 75,310 to 16,000 Chinese Yuan per month. The circular demanded that operators meet the requirements stipulated in the circular no later than June 2001. The reduced tariff for calls for dial-up Internet access directly reduced the costs of subscribers, thus increasing demand. The decrease in charges of trunk and dedicated lines created a more level playing field for competition between the affiliated ISPs of incumbents and other competing ISPs.

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2.2 The Period of "Broadband Enclosement"
2.2.1 Factors Stimulating the Broadband Enclosement Come into being
The period from late 2000 to the middle of 2001 is called the period of broadband enclosement in China. At that time, the pre-geographic-separation China Telecom had finished spitting off its mobile arm which had become a full independent firm - China Mobile Group - but had not started another break-up in which it would be separated into southern and northern parts. The pregeographic-separation China Telecom was then an incumbent nationwide, which occupied more than 99% of the fixed line market. The predecessors of the present China Netcom Group - China Netcom Shareholding Company and Ji Tong Communications Company Limited were new entrants nationwide. Several factors drove this broadband enclosement. First, the late 1990s saw global Internet over-exuberance with over-investment in the dot-com and Internet infrastructure sectors. One of reasons for this Internet over-exuberance was that it is intrinsically very difficult, if not impossible to forecast demand (see Liu, 2006; Liu, 2007). Overestimated demand or overoptimistic estimates of pace of development resulted in overinvestment into dot-com and broadband infrastructure. The over-exuberance also spread into China. A lot of firms attempted to jump on this bandwagon as capital markets were sympathetic. Second, firms which were interested in broadband sectors had recognized that the wire-line drop sectors would remain non-competitive anyway in China's setting. Whoever enters this market first will possess the first-mover advantage, creating a barrier for another provider. However, even if new entrants build the drop sectors, they have to interconnect with the Internet backbone networks through feeder and distribution sectors. It was in this period that the competition in the Internet backbone networks, conveyance networks and distribution and feeder sectors entered into a new stage. Since the incorporation of Ji Tong in 1993 and China Unicom Group in 1994, both of them had invested a lot to build backbone networks. In particular, by 2000 China Unicom Group had already built a nationwide Internet backbone network. The then China Netcom Shareholding Company also started building its own Internet backbone network. In the split-off from the fully integrated China Telecom, China Mobile Group had got its portion of fibre networks. It, too, started constructing its own Internet

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backbone network in order to develop its mobile Internet services. That meant that new entrants had several competing Internet backbone networks to interconnect with, which removed to a great extent one of the barriers for new entrants. In terms of the conveyance networks, and distribution and feeders sectors, competition had developed since China Mobile Group and China Unicom Group built fibre networks not least in order to connect their own radio bases with their mobile exchanges. This has gradually eroded the dominance of the pre-geographic-separation China Telecom in this market. Another important factor with regard to the feeder and distribution sectors stemmed from the December 2000 Circular already mentioned above. In the December 2000 Circular, the MII and NDRC decreased the regulated charges of dedicated lines. These dedicated lines might be rented by new entrants from the incumbent to use as a basis for constituting their transmission networks in the distribution and feeder sectors. Competition or pro-competition regulation in the Internet backbone network, conveyance network, and distribution and feeder sectors had created a better environment than before for new entrants. Third, another relaxation of regulatory restraints in 1993 by the then MPT allowed non-MPT operators to enter value-added service markets. The Telecommunications Regulations of People's Republic of China enacted by the State Council in September 2000 classifies the telecommunications services into two categories. The first category is basic telecommunications services, which refer to services providing public network infrastructure, public data transmission and basic voice communication. The second category is value-added telecommunications services, which refer to services providing telecommunications and information by using public network infrastructure (see an English translation of this regulation in Xu and Pitt, 2002). Up to the issue of the MII's June 2001 Circular which will be discussed later, the Internet access service had been categorized by the MII (or its processor - the MPT) as a value added service which encounters much lower policy barriers than basic telecommunications services. By the late 1990s, there had been already more than 300 ISPs and more than 1,000 Internet Content and Application Providers (ICAPs, hereafter) in China (ISC and CNNIC, 2003). Those ISPs which had provided dial-up Internet access services turned their attentions to broadband access services. Meanwhile, policymakers, especially regulators, had not recognized the necessary regulatory distinction between dial-up Internet access and broadband access, and

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consequently had not changed the classification, still regarding the broadbandaccess-relevant drop sectors as one part of a value added service. Consequently the MII did not impose ad hoc limitations on any operators as to the entry of drop sectors. This created a much free legal environment of entry.

2.2.2 Strategic Behaviour of New Entrants and Incumbents in Broadband Enclosement
During the period of broadband enclosement, the overall goal of strategic behaviours of both new entrants and the incumbent was to seek exclusive operation in Real Estate Property Management Areas (REPMAs, hereafter) thus securing enclosement. In essence, it was to create or maintain the granular monopoly, one REPMA by one REPMA. As already mentioned, the incumbent at that time was nationally the pre-geographic-separation China Telecom which had not yet started its later geographical break-up. For the purposes of this analysis, new entrants are divided into two categories. The first category refers to those who had had long haul fibre networks, or those that secured the permission or gained acquiescence of regulators to build longhaul fibre networks, including China Mobile Group, China Unicom Group, the then China Netcom Shareholding Company and Ji Tong. Great Wall Broadband and the then China Railcom (later renamed China TieTong Group) are also in this category. The second category refers to those participants that had not previously entered the telecommunications field. They are usually small and each of them covers a very limited number of REPMAs. Beijing Blue Wave Wan Wei Broadband Network Service Co. Ltd., and Chengdu TaiLong Communications Shareholding Company Ltd., are two examples, representative of this group of new entrants. Apart from having no ad hoc limitations on any operators as to entry, three other regulatory policies were relevant and have remained effective up to the present date. The first one is that the government does not regulate retail charges for broadband access products provided either by the incumbent or by new entrants. The second is that the government does regulate the charges of dedicated lines which may be rented by new entrants from the incumbent as substitutes for self-provisioned feeder and distribution sectors. The third is that there has not been a mandated local loop unbundling arrangement in China. After a more detailed analysis, it can be shown that there were seven kinds of situations at the granular levels during the period of broadband enclosement.

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The First Situation
The first situation occurred where the incumbent had extended its local loop into the apartments of subscribers (developed areas) and where there was no competition between the incumbent and new entrants of any category either in drop sectors, or in distribution and feeder sectors. The incumbents enjoyed monopolistic rents.

The Second Situation
The second situation existed where the incumbent had extended its local loop into the apartments of subscribers and where competition between the incumbent and new entrants of the first category had developed usually in the fiber-based feeder and distribution sectors. This was frequently the case in developed areas. Theory demonstrates that under a structural asymmetry in which an incumbent integrates non-competitive and competitive sectors while new entrants operate only in competitive sectors, and under the private information which is drawn independently from some cost distribution of each firm, the incumbent will have an incentive to impose higher access charges in order to preclude the entrants, even on some occasions when entrants are the more efficient distribution and feeder sector operators. If so, there is a loss of social welfare (Armstrong, Cowan and Vickers, 1994, pp. 144-5). In the broadband access case, that means a lower usage of optical-fiber capacity in the distribution and feeder sectors.

The Third Situation
The third situation occurred where there had not been any infrastructure previously in the drop sector but there was competitive provision usually in fiber-based feeder and distribution sector. This is frequently the case in greenfield areas or redeveloped areas. Without the intervention of the third parties such as real estate developers, the incumbent and new entrants of both categories often both attempted to build the drop sectors in involved REPMAs in order to become the first comer. This resulted in excessive duplication. Compared to the fourth situation, this had rarely happened because real estate developers had had strong incentives to intervention before the issuing of theJune 2001 Circular which prohibited the exclusive contracts.

The Fourth Situation
This situation is similar to the third situation. Both the incumbent and new entrants of both categories sought to monopolize the involved REPMAs by signing exclusive

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contracts with the real estate developers or real estate management firms involved to permit them to build their own drop sectors and monopolize the market. Under the terms and conditions of these exclusive contracts the real estate developer concerned could get a share of the returns. However, this kind of exclusive contract precludes the right of choice of the end subscribers, resulting in the loss of social welfare. The second issue is that it is unclear whether such a contract is legal or not because of different interpretations of the various relevant laws. Thus, even if an exclusive contract was already entered into, another operator who questioned the legality of the exclusive contract may duplicate the drop sectors with the argument of providing more choices to end subscribers.

The Fifth Situation
Some new entrants who had not been in the telecommunications industry in the past were eager to enter and so seized the chance to become an entrant of the second category. Usually they had some connections with relevant real estate developers. They built the drop sectors in advance and provided broadband access service to residents. There was no competition in the feeder and distribution sectors, they had to rent a regulated dedicated line from the incumbent at the regulated rate. One of the tactics of the incumbent in this situation was to try to squeeze these new entrants out of the market by lowering the retail price. The second one was to duplicate the drop sector with a claim of deference to the choice of end-subscribers.

The Sixth Situation
A new entrant of the second category built the drop sector and there were competing providers in the feeder and distribution sectors. The entrant who built the drop sector formed a close alliance with an operator of the distribution and feeder sectors, be it the incumbent or one of entrants of the first category. The outcome was that this alliance monopolized the REPMAs concerned as a whole.

The Seventh Situation
The new entrant of the second category who built the drop sector allowed all feeder and distribution providers to connect with the drop sector under the terms and conditions it set. In essence, feeder and distribution providers had to pay an access charge. The new entrant has an incentive to seek a monopolistic rent which ultimately is transferred to the end subscribers. Second, because

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competition in the feeder and distribution sectors is not yet perfect, this may lead to the situation of so-called double marginalization with a price higher than would be set by an integrated firm or even higher than the monopoly price (Armstrong, Cowan and Vickers, 1994).

2.2.3 Impacts of Broadband Enclosement
To begin with, competition in the period of broadband enclosement resulted in a fall of charges for broadband access products broadly. The local branches of the then incumbent - the pre-geographic-separation China Telecom started to provide DSL products in Guangdong, Shanghai and Chengdu in 2000. But the retail price was exceedingly high. A subscriber had to pay one-off charge of 100 Chinese Yuan for connection, and 200 Chinese Yuan for terminal test plus 300 to 500 Chinese Yuan per month subscription (ISC and CNNIC, 2003). It was the entry of competitors that forced the pre-geographic-separation China Telecom to decrease its ADSL charges. In 2000 and the first half of 2001, the then China Netcom Shareholding Company, Great Wall Broadband and Blue Wave wan Wei Broadband aggressively entered the broadband access market chiefly by employing Ethernet technologies. So did many other entrants of the second category. In response, the pre-geographic-separation China Telecom started to deploy its own Ethernet broadband access and provision ADSL broadband access as well. Its subscription rate fell quickly to 100 to 150 Chinese Yuan per month. Consequently the number of ADSL subscribers grew quickly also (see Table 1).

Table 1: China's ADSL Development in 2001 and 2002

ADSL (Thousands) June 2001 December 2001 June 2002 December 2002 50 235 707 2,220

Growth Rate 370% 201% 214%

Source: Translated from ISC and CNNIC (2003, p205) by this author

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Second, while competition was up, excessive duplication of the drop sectors ballooned in the period pf broadband enclosement. In order to become the first comer and "enclose" potential subscribers, some new entrants invested aggressively in networks, over-promoted their products and overreached their coverage. For example, according to an introduction on the website, Great Wall Broadband as a whole had had more than 30 branches all over China in major cities and had contracted with 15 million subscribers up to June 2003. But in fact its network only covered 4 million. Among these, 2.1 million had access to the Internet but only 0.4 million were paid subscribers.5 Third, the exclusive agreements that were generated in the period of broadband enclosement between operators and relevant real estate developers excluded the entry of other competitors who in turn inflicted their revenge by duplicating network in the supposedly exclusive REPMAs, sometimes so forcefully that it even resulted in stand-up fights between employees of different operators. Fourth, in both feeder and distribution sectors, a lot of fiber capacity was left unused as explained in the above-mentioned second situation. The MII realized the negative aspects of the impact of broadband enclosement and regarded them the outstanding issues as it commented in the first chapter of the Guidelines of Telecommunications Development of the Year of 2002 of P.R. of China: "Driven by direct and indirect economic interests [in 2001], some telecommunications operators and those non-telecommunications firms without licenses invested blindly and constructed telecommunications facilities in a way incongruent with stipulations. These activities have resulted in the duplication of telecommunications networks, left a lot of resources unused, wasted a lot of funds, and even impeded telecommunications security. They have had a series of bad influences on national economic construction, telecommunications development and the progress of informationalization" (DGP - MII,6 2002, p10, translated by this author).

2.3 The China's Present Approach
One response from the MII to the impact of broadband enclosement and one decision by the State Council led to the generation of China's Present Approach.

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2.3.1 The June 2001 Circular
The response of the MII was to clarify the services involved in order to reduce and control the negative impact of broadband enclosement. The MII issued the Circular of Undertaking Trials of Network of Residence which includes two attachments on 1 June 2001 (called the June 2001 Circular, hereafter).7 Before then, the MII had looked upon the drop sector, distribution and feeder sectors as a monolithic market. The organic market development in the period of broadband enclosement indicated that the drop sector on one side, the feeder and distribution sectors on the other could be separated commercially in the market process. In the circular, the MII acknowledged this for the first time in its official documents and consequently termed them respectively the network of residence (zhu di wang, in Chinese; shortened as NoR hereafter, which is the drop sector) and the metropolitan access network (cheng yu wang, in Chinese; shortened as MAN hereafter, which includes the distribution and feeder sectors together). It is implicitly acknowledged that NoR and MAN could be run by operators independent from each other in terms of ownership. Second, in the June 2001 Circular, the MII clarified that the NoR service is a kind of network access service and belongs to the category of basic telecommunications services. However, the method of granting licenses of provision for the NoR services shall be undertaken with reference to that of granting value-added services. All firms except the international-interconnectionpermitted commercial operators (IIPCOs, hereafter) must now apply anew for licenses from the CAs involved in order to enter the NoR market. Third, the MII ordered that subject to approval of the CAs involved, all firms except IIPCOs should stop the construction and operation of NoRs except in 13 trial cities. That means that operators who were allowed to build and operate NoRs nationally were reduced to: the then national incumbent (the pregeographic-separation China Telecom), China Mobile Group, China Unicom Group, China Satcom, Great Wall Broadband, Ji Tong, and the then China Netcom Shareholding Company. In total, legally there were seven operators that were allowed to run nationally but only five that had national coverage at that time.

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Fourth, except for IIPCOs, no other operators can enter the MAN market even in the 13 trial cities. In other words, they have to purchase MAN capacity from one of the IIPCOs. At that time (in 2001), the pre-geographic-separation China Telecom (or the present China Telecom Group and present China Netcom Group after geographic separation completed in 2002, as incumbents) led the MAN market with a growing competition from China Unicom Group and China Mobile Group. Fifth, the circular stipulated that the end subscribers have the right to choose the MAN provider, and that NoR providers must provide equality of access conditions to other MAN providers. However, there are no further measures to guarantee equality of access such as operational, accounting and functional separation between the arm running NoR and other arms of the incumbent. Neither is there local loop unbundling stipulation with a mandated access charge by regulators. Thus, the so-called equality of access is not enforceable and has never been enforced so far. It was said that the June 2001 Circular aimed to explore a set of managerial polices for broadband access. The trials were scheduled to be completed in June 2002. In 2002, the MII decided to postpone a decision for another year. At the point when this dissertation is being written, the MII has not announced whether or not it intends to terminate. In so doing, nationally except for trial cities, the MII restricted both NoR providers and MAN providers to IIPCOs only, i.e. the incumbents and the new entrants of the first category. In trial cities, as compared with before, the MII and the CAs raised the entry barriers in the NoR markets for the new entrants of the second category and regulated the market by restricting the number of firms.

2.3.2 The Geographic Separation of China Telecom
Five months later after the issuing of the June 2001 Circular, another break-up of the pre-geographic-separation China Telecom into southern and northern parts was announced by the State Council and subsequently was completed in May 2002. The goal of this breakup is to introduce competition in wider markets much beyond broadband access. But it has implications for broadband access. Relevant to this discussion is the fact that after this round of

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reform and restructuring, the number of IIPCOs has further been decreased. Two erstwhile new entrants - Ji Tong and China Netcom Shareholding Company were merged into the present China Netcom Group, the present incumbent in northern China.

3. Effects of China's Present Approach
3.1 The Characteristics of China's Present Approach
The characteristics of China's Present Approach could be described as follows: first, it is a kind of direct competition model in essence, both in the NoR and in the MAN. Second, MANs can be separated from NoRs. The number of firms in the MAN is limited and the number of firms in the NoR is limited also. Third, the retail price is unregulated. However, the MAN charges of the incumbents are regulated. On the one hand, this reflects the fact that the MII has correctly recognized that competition has emerged in MANs. Furthermore the MII believes that ultimately an oligopolist competitive market in the MAN is beneficial and envisions that the oligopolist competition in the MAN is attainable by controlling the entry and exit (the number of firms) and by a phased-out charge regulation of the relevant products of the incumbents. On the other hand, the MII mistakenly believed that the NoR market in China is also competitive. However, it is not sure how many firms there should be in that market in an optimal industrial structure. The MII is also not certain how to regulate the interconnection between the MAN and the NoR. This is why the MII has been undertaking trials.

3.2 Analysis of the Impacts of China's Present Approach on Incumbents and Entrants
The present China Telecom Group retains its local loop near-monopoly and its feeder and distribution dominance in southern China. In the north, it is now a new entrant. The present China Netcom Group inherited from the original China Telecom the local loop near-monopoly and its feeder and distribution dominance in northern China. In the south, it became a new entrant. It absorbed the Ji Tong

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and the China Netcom Shareholding Company. Cable operators are again precluded from entering the NoR market as cable operators have not been granted permission to interconnect internationally in the Internet market thus it is not an IIPCO. Since the June 2001 Circular was issued, on a national basis, apart from the cities in trial, new entrants of the second category are no longer permitted. The China Mobile Group, China Unicom Group, China TieTong Group and Great Wall Broadband are the remaining competitors to the two regional incumbents. As to the seven situations identified earlier, the implementation of the China's Present Approach blocks any possibilities from their signing exclusive contracts with real estate developers (the fourth situation) or forming alliances with new entrants of the second category (the sixth situation). It straightforwardly limits the fifth and seventh situations to occur only in the cities in trial. Therefore the seven situations existing in the period of broadband enclosement have been reduced to the first three situations. The first situation does not change. The incumbents still enjoy their monopolistic rents. The second does not change very much. The incumbents maintain their advantages in already developed areas. The third situation remains unchanged. The duplication in drop sectors is not terminated. The limitation of new entrants of the second categories leads to the loss of cooperation between news entrants of the first category and new entrants of the second category. Though it applies to the incumbents, in fact it produces negative externality to the new entrants of the first category and weakens them compared with the incumbents because the incumbents had had the dominant power in both NoRs and MANs. The dominant power of the incumbents may be therefore artificially sustained. The effects of geographical break-up on competition are mixed. The break-up has decreased the scale of the incumbents as opposed to their competitors, weakening the incumbent's capability to raise capital, on the one hand. But at granular levels, both incumbents inherited or retained great regional market power. On the other hand, it might produce an incentive for the present China Telecom Group to avoid challenging the China Netcom Group in northern China in residential markets in exchange for the present China Netcom Group to

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avoid doing so in southern China. In so doing, it might reach a Nash Equilibrium and both may better off. If this is the case, they will roll back the competition in the residential markets which the currently already absorbed Ji Tong and the then China Netcom Shareholding Company had posed before. Recent development has unfortunately demonstrated this conjecture. On March 1, 2007, Financial Times reported on its website, "China's two fixed-line telephone operators [China Telecom Group and China Netcom Group] have sealed a deal intended to limit competition and leave each in control of its core markets, according to a company official and local media."8

3.3 Empirical Evidences
What are the practical effects? This section presents the changes of market concentration which is the most persuasive measure of changes of competition. In addition, it also presents China's broadband access penetration progress, which is indicative of status of competition.

3.3.1 Market Concentration Indicates Sustained Dominant Power
Though the breakdown of broadband access by operators and by technologies has never been published publicly by the MII and other official institutions, the concentration of broadband access in key provincial markets can be still extrapolated from the 2004 annual report of China Netcom Group Corporation (Hong Kong) Limited, the listed subsidiary of, and ultimately controlled by, the present China Netcom Group. China Netcom Group Corporation (Hong Kong) Limited is "a dominant provider of fixed line telephone services, broadband, other Internet-related services, and business and data communications services in six northern municipalities and provinces, namely Beijing Municipality, Tianjin Municipality, Hebei Province, Henan Province, Shandong Province and Liaoning Province in the PRC. The Group also provides telecommunications services to selected business and residential customers in one southern municipality and one southern province, namely Shanghai Municipality and Guangdong Province in the PRC. In addition, the Group operates a network and offers international data services throughout the Asia Pacific countries and regions" (CNC, 2005, p61).

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The market share of broadband access in terms of subscribers of China Netcom Group Corporation (Hong Kong) Limited grew from 86.50% in 2002, in which the geographical separation was completed, to 89.20% in 2003. It even reached 95.80% in 2004 according to its annual report (CNC, 2005, p35). The Herfindahl-Hirschman Index (HHI, hereafter) grew from 7665 to 9195 (see Table 2 and Figure 1). The annual reports of 2005 and 2006 have been published and market share are respectively 87.6% and 87.5% (CNC, 2006; CNC, 2007). However in 2005, China Netcom Group Corporation (Hong Kong) Limited acquired assets of some northern provinces of its parent company China Netcom Group. That means the growth during this periods was not organic. Therefore Figure 1 does not take data of 2005 and 2006 into the analysis. The above figures indicate that China's Present Approach does not promote competition. On the contrary it helps incumbents at least sustain their dominant power in the residential broadband access market. Figure 1: The Market Share of the Present China Netcom Group Corporation (Hong Kong) Limited (2002 to 2004)

Source: Raw Data are from (CNC, 2005); HHI(s) are calculated by this author.

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Table 2: Figures for Broadband Access of Listed Subsidiaries of the Present China Telecom Group and the Present China Netcom Group 2002 2003 2004 China Telecom Corporation Limited ('000) (a subsidiary of China Telecom Group) Broadband Subscribers DSL FTTx+LAN Others 1,718 674 19 28 7,232 5,229 1,975 122 Total 13,838 10,000 3,716 2,411

China Netcom Group Corporation (Hong Kong) Limited (a subsidiary of China Netcom Group) Broadband Subscribers Market Share in its operating 86.50% areas 89.20% 95.80%

Broadband Subscribers ('000) DSL FTTx+LAN Others Total 318.2 258 1.2 577.4 1,990 544.5 0.7 2,535 4,427 1,788 2.5 6,218

Broadband Subscribers at National Level (including non-listed parts of the two groups and others) ('000) DSL 17,420 Others 7,460 Total 11,147 24,880 Source : 1. Figures for China Telecom Corporation Limited and China Netcom Group Corporation (Hong Kong) Limited are in public domain and from respective annual reports of 2004; National data are from the MII website; Table by this author.

2. 3.

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3.3.2 Widening Gap of Penetration Suggests Sustained Dominant Power
Sustained market power may lead to slower progress of broadband access penetration. The progress of penetration is defined as the penetration of a given time minus the penetration of a previous time. Table 3 and Figure 2 indicate that the progress of broadband access penetration in China between December 2002, fives months after the geographic separation of China Telecom was completed and accordingly China's Present Approach was generated, and December 2005 is slow as compared with most of OECD countries. It belongs in the category of "low penetration, slow progress". This suggests that the gap in terms of penetration between China and other leading countries is becoming wider. The progress of broadband access penetration during the above period is only 2.6%. However, during the same period, the progress of fixed-line penetration and mobile penetration are respectively 10.5% and 14.4% in China (Table 4). This may reflects as well the less extent of competition in broadband access sector than in the fixed-line and mobile sectors. In the fixed-line sector during the same period, the regional incumbents faced the heterogeneous competition from two mobile operators, and, to a less degree, the homogenous competition from China Tie Tong. In the mobile sector, two operators competed with each other, and also with the regional incumbent fixed-line operators which has heterogeneous fixed networks and the Personal Handyphone Systems. The latter is a kind of wireless system which has been defined by regulators as the extension of fixed-line network and which has been mandated to reduce the roaming function so as for it to have only limited mobility. Furthermore, it is illustrating to compare the growth rates of different countries in the years when broadband penetrations were around 1.9% (from 1.6% to 2.0%). The growth rate of broadband access is defined as percentage of the increased number of broadband access subscribers in between the previous time and the present time as opposed to the number of the broadband access subscribers in the previous time. Unfortunately, most of economies lack records of broadband access penetration at very early stages when the figure is fewer than 2.0%. From the limited data available, the growth rate of China in the year from December 2003 to December 2004 when penetration was around 1.9% is on the low end of economies which have such records (Table 5).

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Table 3: Broadband Access Penetration Progress in OECD Countries and China (2002 to 2005) Progress 2001 Greece Mexico Poland Turkey Slovak Republic China 0.0 0.1 0.1 0.0 0.0 0.3 21.8 0.6 0.1 Ireland New Zealand Austria Spain OECD Canada Germany Portugal Belgium United States Italy EU15 Japan Australia 0.0 0.7 3.6 1.2 2.9 8.9 2.3 1.0 4.4 4.5 0.7 1.6 2.2 0.9 2002 0.0 0.3 0.3 0.0 0.0 0.9 24.2 2.0 0.2 0.3 1.6 5.6 3.0 4.9 12.1 4.1 2.5 8.7 6.9 1.7 3.4 6.1 1.8 2003 0.1 0.4 0.8 0.3 0.3 1.9 24.8 3.6 0.5 0.8 2.6 7.6 5.4 7.3 15.1 5.6 4.8 11.7 9.7 4.1 5.9 10.7 3.5 2004 0.4 0.9 2.1 0.7 1.0 2.9 25.4 6.3 2.5 3.3 4.7 10.1 8.1 10.2 17.6 8.4 8.2 15.5 12.9 8.1 9.7 15.0 7.7 2005 1.4 2.2 2.4 2.1 2.5 (2002 to 2005) 1.4 1.9 2.1 2.1 2.5

2.6 South Korea 17.2 3.6 Hungary 0.3

5.7 Czech Republic 6.4 6.7 8.1 14.1 11.7 13.6 21.0 13.0 11.5 18.3 16.8 11.9 14.2 17.6 13.8 6.2 6.4 6.5 8.5 8.7 8.7 8.9 8.9 9.0 9.6 9.9 10.2 10.8 11.5 12.0 Contd?.

China's Present Regulatory Approach in the Broadband Access Sector - Its Generation and Its Effects on Competition Contd?. Sweden France Luxembourg United Kingdom Denmark Finland Switzerland Norway Iceland Netherlands 5.4 1.0 0.3 0.6 4.4 1.3 2.0 1.9 3.7 3.8 8.1 2.8 1.5 2.3 8.2 5.5 5.6 4.2 8.4 7.0 10.7 5.9 3.5 5.4 13.0 9.5 10.1 8.0 14.3 11.8 14.5 10.5 9.8 10.5 19.0 14.9 17.5 14.8 18.2 19.0 20.3 15.2 14.9 15.9 25.0 22.5 23.1 21.9 26.7 25.3 12.2 12.4 13.4 13.6 16.8 17.0 17.5 17.7 18.3 18.3

135

Source: Figures for OECD countries are from the OECD website; the raw figures for China are from the MII website; progress calculation and table by this author.

Figure 2: Broadband Access Penetration Progress of OECD Countries and China (2002 to 2005)

Source: Data for OECD countries are from the OECD website; raw data for China are from the MII website; figure is made by this author.

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Table 4: Comparison of Progress in the Fixed-line, Mobile and Broadband Sectors 2002 (%) Fixed-line Mobile Broadband 16.5 15.9 0.3 2005 (%) 27.0 30.3 2.9 Progress (%) 10.5 14.4 2.6

Source: Raw data are from the MII websites; table is made by this author.

Table 5: Growth Rate When the Penetrations are between 1.6% and 1.9% Country Czech Italy New Zealand Australia China Penetration in Benchmark Penetration in Benchmark (%) Yea Previous Year r 1.6 1.7 1.6 1.8 1.9 2004 2002 2002 2002 2004 0.5 0.7 0.7 0.8 0.9 Previous Yea r 2003 2001 2001 2001 2003 Growth Rate (%) 220.0 142.9 128.6 125.0 111.1

Source: Raw data are from the EU, OECD and the MII websites; table is made by this author.

4. Conclusion
This article has introduced the generation of China's Present Regulatory Approach in the broadband access sector. Before the generation of China's Present Approach, regulatory lag had resulted in broadband enclosement which had brought about a lower usage of fiber capacity in feeder and distribution sectors, excessive duplication in the drop sectors, exclusive contracts between operators and real estate developers, and conflicts between employees of different operators. Following investigations of markets, the regulator has correctly acknowledged that in the broadband era, the access network can be demarcated commercially into drop sectors, called the NoRs in China, and the feeder and distribution sectors which are incorporated and are called MANs. It also correctly perceives that the MAN markets are progressively competitive in urban areas. But it thought wrongly that the NoR markets are also competitive in China's settings (see Liu, 2006 and Liu 2007 on why the scale of REPMAs in urban areas is such

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that MAN markets are workably competitive in urban areas and NoRs markets remain less contestable in China's settings). China's Present Approach in the broadband access sector was generated through the June 2001 Circular issued by the MII and the subsequent geographic separation of China Telecom decided by the State Council. The June 2001 Circular prohibits exclusive contracts and attempts to limits the number of firms in both the NoR markets and the MAN markets so as to curb the duplication of NoRs to a good degree. However, simple limitation of the number of new entrants of the second category has put the incumbents de facto in a favored position vis-à-vis the new entrants of the first category. It has relatively weakened the new entrants of the first category by limiting entrants of the second category. The merger of the then China Netcom Shareholding Company and Ji Tong into the present China Netcom Group has rolled back the competition that the then China Netcom Shareholding Company and Ji Tong had posed previously. The immediate effect of China's Present Approach is to have sustained the strong dominant power respectively exerted by the present China Telecom Group in southern China and by the present China Netcom Group in northern China. The sustained dominant power is one of the factors which help explain why the broadband access penetration progress of China is not as good as those of most OECD countries and why the broadband access penetration progress is not as good as penetration progress respectively in fixed-line and mobile sectors of China itself during the same period. The effect of China's Present Approach on competition is not good. However, the effects of the policies implemented previously in the period of broadband enclosement are equally not fitting. Therefore, it is necessary to explore another one. A natural question is whether or not the approach based on access pricing which is (was) employed in developed countries is promising, and if not, what a promising approach is. These have been written elsewhere (Liu, 2006; Liu, 2007).

Acknowledgement
The author wishes to thank Professors Robert Ash, Thomas Hazlett, David Newbery, and Peter Nolan for their comments and the author is responsible for all remaining errors.

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References
Armstrong, M., S. Cowan, and J. Vickers. (1994). Regulatory Reform: Economic Analysis and British Experience. Cambridge, MA: MIT Press. ISC and CNNIC. (2003). zhong guo hu Lian wang fa zhan bao gao [2002] (The Report of Development of the Internet in P.R. of China [2002]). Beijing: Posts and Telecom Press. CNC. (2005). The 2004 Annual Report of China Netcom Group Corporation (Hong Kong) Limited. English and Chinese versions can be found on the website of the company. CNC. (2006). The 2005 Annual Report of China Netcom Group Corporation (Hong Kong) Limited. English and Chinese versions can be found on the website of the company. CNC. (2007). The 2006 Annual Report of China Netcom Group Corporation (Hong Kong) Limited. English and Chinese versions can be found on the website of the company. Liu, Z. (2006). Alternative Approach to Organizing the Wire-line Broadband Access Market for Competition, with Special Reference to Urban China. PhD dissertation, Judge Business School, University of Cambridge. Liu, Z. (2007). China's Telecommunications: Organizing Broadband Access and Competition. London: Routledge (forthcoming). MII (2002). Zhong guo dian xin ye fa zhan zhi dao [2002] (The Guidelines of Telecommunications Development of P.R. of China [2002]). Beijing: Posts and Telecom Press. Xu, Y., and D., Pitt (2002). Chinese Telecommunications Policy. London: Artech House Publishers.

Endnotes
1 2 3 4 5 6 7 8 China in this paper refers to mainland China, hereafter. ISC refers to Internet Society of China, hereafter. CNNIC refers to China Internet Network Information Center, hereafter. The Chinese version of the circular can be found athttp://www.cnii.com.cn/ 20020808/ca90295.htm. Visited at 20:33 on 04 April 2007. Seehttp://tech.sina.com.cn/it/2004-07-18/1821389316.shtml, andhttp://www. gwbnsh.net.cn/about.html (in Chinese) DGT-MII refers to Department of General Planning of the Ministry of Information Industry, hereafter. The Chinese version can be found athttp://sfj.bjsjs.gov.cn/lawstar/temp/ 4570885141aw.htm. Visited at 21:00 on 04 April 2007. Available athttp://search.ft.com/ftArticle?queryText=China Telecom&y=0&aje= true&x=0&id=070301000802. Visited at 21:30 on 04 April 2007.

7
Microsoft and Trinko: A Tale of Two Courts
Spencer Weber Waller*
The paper examines the 2001 opinion of the DC Circuit in Microsoft and the Supreme Court's 2004 opinion in Trinko and compares them as attempts to broadly define the law of monopolization. The Microsoft opinion should stand the test of time as rigorous, intellectually honest, and well reasoned mixture of the law of monopolization. In contrast, Trinko suffers from numerous errors of law, fact, economics, antitrust policy, and contains much unreasoned dictum that extends far beyond its narrow holding about the interface between antitrust and telecommunication regulation. Thus Trinko fails the test of reasoned elaboration, one of the key hallmarks of a legitimate and persuasive judicial opinion.
Two recent opinions have sought to systematize and rationalize the law of monopolization under Section 2 of the Sherman Act. Those cases are Microsoft1 and Trinko.2 They are the most recent word of the D.C. Circuit and the Supreme Court respectively about the core meaning of one of the two basic prohibitions contained in the US antitrust laws. In this brief comment, I will use the debate
* Professor and Associate Dean, Loyola University of Chicago - School of Law , 25 E. Pearson, Chicago, IL 60611, United States. E-mail: [email protected]

© 2006 Spencer Weber Waller. This article was originally published in Utah Law Review. Reprinted with permission. S l b

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over the enduring meaning of Microsoft to argue that the D.C. Circuit in Microsoft has surpassed the United States Supreme Court as the most important and articulate antitrust court and has outshone the highest court in the land in crafting honest and true antitrust doctrine consistent with history, precedent, and policy. Professors Gavil and First are to be commended for their searching inquiry into the ongoing fight over the meaning and legacy of the antitrust litigation against Microsoft, both here and abroad.3 They are right in arguing that the combined effect of the appellate decision on the merits of the case, the subsequent consent decree, and the response of the current Administration to foreign enforcement actions has done little to restore competition and done much to protect Microsoft's durable market from future challenge. While Gavil and First are correct in noting the role of the D.C. Circuit in the piecemeal analysis of the various anticompetitive actions by Microsoft,4 there is still much to admire in the craftsmanship of the opinion. The Microsoft decision of the D.C. Circuit should stand as a landmark in the history of antitrust. It is a thoughtful, scholarly opinion by a court that values and respects the antitrust laws that it was interpreting. This opinion largely succeeded at systematizing and rationalizing a body of law under Section 2, which was often the subject of empty slogans and little analytical heft.5 In contrast there is Trinko. Sometimes there is an opinion that it so profoundly wrong that Mary McCarthy's famous quote about Lillian Hellman comes to mind: "Every word she writes is a lie, including the and a."6 Trinko, is such an opinion. It is not a lie, of course, because the majority of the Supreme Court presumably believe that it to be true and intend it as a binding statement of the law. But it is not true in any normal sense either. Justice Scalia's opinion is wrong on the law, wrong on the facts, wrong as a matter of procedure, wrong as a matter of economics, wrong as a matter of institutional competencies, and a poor contrast with the way Section 2 legal standards have been articulated by courts in antitrust cases since the passage of the Sherman Act. 7 It is also a stunning contrast to the careful thoughtful and systematic way in which the D.C. Circuit analyzed these same principles in Microsoft.

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In this comment, I compare the Microsoft and Trinko opinions as to the core questions of Section 2 of the Sherman Act: monopoly power and exclusionary conduct. While Professors Gavil and First focus on Microsoft's faults, I tend to emphasize its strengths as a well-crafted opinion trying to synthesize complicated areas of the law in a creative but straight forward and intellectually honest manner. It compares well to Trinko's recklessness and less straight-forward attempts to move the law in a dramatic fashion without acknowledging what it is seeking to do. I then rely on the insights of the Legal Process School to evaluate the merits of both opinions as opinions and to reach some very tentative conclusions about how and why the Microsoft opinion is more likely to be viewed and trusted as the definitive word as to the meaning of monopolization under the Sherman Act. While Trinko is profoundly troubling and may be the latest word on this subject, fortunately it is not the final word.

I. Microsoft on Monopoly
The key sections of the 2001 Microsoft decision of the D.C. Circuit speak for themselves. As to the existence of monopoly power, a necessary but not sufficient finding for imposing liability under Section 2, the court noted: While merely possessing monopoly power is not itself an antitrust violation, it is a necessary element of a monopolization charge. The Supreme Court defines monopoly power as "the power to control prices or exclude competition." More precisely, a firm is a monopolist if it can profitably raise prices substantially above the competitive level. Where evidence indicates that a firm has in fact profitably done so, the existence of monopoly power is clear. Because such direct proof is only rarely available, courts more typically examine market structure in search of circumstantial evidence of monopoly power. Under this structural approach, monopoly power may be inferred from a firm's possession of a dominant share of a relevant market that is protected by entry barriers. "Entry barriers" are factors (such as certain regulatory requirements) that prevent new rivals from timely responding to an increase in price above the competitive level.8

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As to the type of conduct that a monopolist must engage in to violate Section2 the court established a series of shifting burdens of proof: From a century of case law on monopolization under § 2, however, several principles do emerge. First, to be condemned as exclusionary, a monopolist's act must have an "anticompetitive effect." That is, it must harm the competitive process and thereby harm consumers. In contrast, harm to one or more competitors will not suffice. "The [Sherman Act] directs itself not against conduct which is competitive, even severely so, but against conduct which unfairly tends to destroy competition itself." Second, the plaintiff, on whom the burden of proof of course rests, must demonstrate that the monopolist's conduct indeed has the requisite anticompetitive effect. In a case brought by a private plaintiff, the plaintiff must show that its injury is "of 'the type that the statute was intended to forestall,' "no less in a case brought by the Government, it must demonstrate that the monopolist's conduct harmed competition, not just a competitor. Third, if a plaintiff successfully establishes a prima facie case under § 2 by demonstrating anticompetitive effect, then the monopolist may proffer a "procompetitive justification" for its conduct. If the monopolist asserts a procompetitive justification - a non-pretextual claim that its conduct is indeed a form of competition on the merits because it involves, for example, greater efficiency or enhanced consumer appeal - then the burden shifts back to the plaintiff to rebut that claim.... Fourth, if the monopolist's procompetitive justification stands unrebutted, then the plaintiff must demonstrate that the anticompetitive harm of the conduct outweighs the procompetitive benefit. In cases arising under § 1 of the Sherman Act, the courts routinely apply a similar balancing approach under the rubric of the "rule of reason." The source of the rule of reason is Standard Oil Co., v. United States, in which the Supreme Court used that term to describe the proper inquiry under both sections of the Act? Finally, in considering whether the monopolist's conduct on balance harms competition and is therefore condemned as exclusionary for purposes of § 2, our focus is upon the effect of that conduct, not upon the intent

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behind it. Evidence of the intent behind the conduct of a monopolist is relevant only to the extent it helps us understand the likely effect of the monopolist's conduct.9 Although I have omitted the relevant citations, the Microsoft decision is respectful of history and precedent, and attempts to set out enduring standards that one could intelligently apply regardless of what side one represented in a particular dispute. It is making law, but in a way that is hard to tell in advance which side will prevail in its application to any particular fact pattern. Indeed if the reader stopped at this point in the decision there would be no way to tell whether Microsoft or the government would win as to any given point of contention. 10 In the real world, Microsoft lost on most Section 2 issues under this test because the government was able to demonstrate anticompetitive harm for most of the defendant's practices and Microsoft could not offer persuasive non-pretextual procompetitive justifications, thus failing the third prong of the court's test.11

II. The Trouble with Trinko12
Whenever I teach Trinko in my basic antitrust class, the students invariably view it as a narrow and peculiar case about the intersection between antitrust and a highly technical form of regulation prescribed in the 1996 Telecommunications Act. They wonder what the big deal is or why I make such a big deal out of a short highly fact specific case. The students are half right. Trinko should have been that type of an opinion, and perhaps it might be if one ignores all the dicta. However, the problem with Trinko is that it offers unfounded and plainly wrong general statements about antitrust law, the operation of markets in the real world, monopoly power, and regulation that supports a political agenda that is being waged in antitrust. This war is being raised in the Administration's treatment of the Microsoft case and the highly political agenda of the Antitrust Modernization Commission.13 As a result Trinko matters. Here are some of the reasons that I tell my students why it matters, how truly radical it appears to be, and how badly it compares to Microsoft.

A. Procedural Tone Deafness
The Trinko majority failed to give consideration of the procedural context of the case which has been critical to the major antitrust cases of the recent past. This failure is oddly inconsistent with the Court's recent treatment in general of the standards for deciding motions to dismiss for failure to state a cause of action.

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The procedural posture of the case has been critical to most of the important antitrust decisions of the past twenty years. In Aspen, the case came to the Court following a full trial on the merits.14 Having conceded the issue of monopoly power and the definition of the relevant market, the defendants nonetheless argued that there was no support for the jury's verdict that they had engaged in unlawful monopolization. The Court rejected these arguments holding the evidence introduced by the plaintiff of harm to consumers and competition, a dramatic change in a long standing course of dealing, the defendant's lack of business justification, ands its willingness to sacrifice revenues to injure a rival were more than sufficient to uphold the jury's verdict. Similarly, in Microsoft, the D.C. Circuit carefully examined the full record of the bench trial in upholding the vast majority of the trial court's findings of fact as justified by the record generated at trial. In the seminal Matsushita15 decision, the Court explored when summary judgment was appropriate in a mammoth antitrust case that alleged a longrunning conspiracy among the entire Japanese electronics industry to price high in Japan and low in the United States in order to drive US competitors out of business. As part of a trilogy of cases setting forth the meaning of summary judgment generally in civil litigation,16 Matsushita held that in the absence of direct evidence creating a genuine issue of material fact as to the existence of an actionable conspiracy, a plaintiff could not defeat summary judgment in aSection 1 without some theory that made economic sense. The Court would not give every plaintiff her day in court for a trial in the absence of direct evidence of conspiracy or reasonable circumstantial evidence or inference that it was more likely than not that the defendants had acted together rather than unilaterally in setting low prices in the United States. The procedural setting similarly was critical to the Kodak case.17 The Court held that, while the defendants had a plausible theory why they did not, and could not, posses sufficient market power to engage in unlawful tying, there was none the less record evidence that they did exercise such power. This required the denial of summary judgment and a trial on the merits. It is of great interest and considerable importance that Justice Rehnquist, the author of Matsushita, joined in the majority opinion in Kodak suggesting that procedure does indeed matter.

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Most remarkably, Trinko is neither a review of a trial record or even a summary judgment case. It is a reversal of the denial of a motion to dismiss for failure to plead a cause of action for which relief can be granted. In this setting, a court may not look beyond the four corners of the complaint, must take all facts in the complaint as true, make all reasonable inferences in favor of the pleader, and dismiss the complaint only if there is no articulable way under which relief can be granted. From Conley v. Gibson18 in the 1950s, to the Leatherman19 decision in 1992, to its most recent pronouncements in Swierkiewicz v. Sorema, N.A. in 2002,20 the Supreme Court has chided lower courts and reversed the dismissal of complaints for misconstruing the concept of notice pleadings and the requirements of Rule 8 and 12(b)(6) governing complaints under the Federal Rules of Civil Procedure. Although the court was entitled to take judicial notice of the results of the prior regulatory proceedings, Trinko reached its result in spite of, not in accordance with, the procedural posture of the case. As Professor Gavil has noted in his own most excellent treatment of Trinko, the Court instead engaged in a far reaching factual inquiry of Verizon's operations and the impact of the proposed case on its business freedom without the benefit of any record whatsoever and substantial disregard for the teachings of civil procedure.21 If the combined result of Trinko and Matsushita is to suggest that antitrust cases are different from other cases with respect to motions to dismiss but the same with respect to everything else, that is a result for Congress to address and not for the Court to decide in passing. The Microsoft court in contrast seems to take procedure quite seriously, even when it appears to limit its discretion as to the outcome on the merits. The appellate court had before it a full record of an extensive bench trial. The appellate court is deferential to findings of fact when supported by the record even when the trial court may have reached conclusions that the appellate court would not have under the same circumstances.22 As a result, the vast majority of the findings of liability are affirmed. Microsoft is also quite harsh when the court believed that the trial court erred in its procedures for conducting the remedy portion of the trial and in connection with the trial judge's ex-parte communications with journalists in the course of the

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trial itself.23 Procedure appears to matter deeply to the D.C. Circuit in reviewing this landmark proceeding and its own procedural posture is impeccable and is exacting in insisting that the trial court comply with its procedural obligations.

B. Non-immune Immunity
The net result in Trinko is a form of immunity for incumbent local telecommunications operators that is inconsistent with the statutory scheme set forth by Congress. Congress sought to both authorize and promote competition in the local telephone market in the 1996 Telecommunication Act. It created a series of new duties for incumbents and at the same time set forth an antitrust savings clause that nothing in the regulatory scheme would affect the application of he antitrust laws.24 Thus, the Court was precluded from holding that the defendant was immune from the antitrust laws because Congress said it was not. The Court nevertheless reached the same result by holding that the defendant's foot dragging can never constitute unlawful monopolization for violation of its duties under the 1996 Telecommunications Act. This is not merely a matter of lack of standing, which was the theory of the concurrence authored by Justice Stevens.25 If the wrong plaintiff had sued, then perhaps a competitor or state or federal government antitrust enforcers could bring a case. But if truly no one can challenge these violations under the antitrust laws, then this is immunity by another name. Perhaps there remains some room for the application of Section 1 of the Sherman Act to the collusive actions of incumbent local operators to preclude entry,26 but then the Court has construed statutory language and Congressional intent as precluding Section 2 liability, but not Section 1, an unprecedented result under either regulatory or antitrust principles. Given that Trinko refers to the regulatory scheme repeatedly as an explanation why antitrust will not be added to the mix, the Court can only be read as imposing immunity in the most circuitous manner possible.

III. Throwing Away Section 2
Once the Court concluded that no antitrust cause of action existed the Court was done. The holding was complete and a court inclined toward judicial restraint would have just signed off. Instead, Trinko embarked on a discursive essay on why monopoly power is an essential ingredient to a market power, why the

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essential facilities doctrine has no application to the situation at hand (and little viability in general), and why courts are likely to do more harm than good in the antitrust area. These are all extraordinary proposition for any court, let alone the Supreme Court, to assert. This section explores the three most important and outrageous assertions in the dicta portion of Trinko.

A. Learning to Love Monopoly
The Trinko decision reframes the standard two-step test for unlawful monopolization in the most extraordinary way. After the standard trope that monopoly power alone is not a violation, Trinko states without any support: The mere possession of monopoly power, and the concomitant charging of monopoly prices, is not only not unlawful; it is an important element of the free-market system. The opportunity to charge monopoly prices-at least for a short period-is what attracts "business acumen" in the first place; it induces risk taking that produces innovation and economic growth. To safeguard the incentive to innovate, the possession of monopoly powerwill not be found unlawful unless it is accompanied by an element of anticompetitive conduct.27 This is the first time that I am aware that any court, let alone the Supreme Court, has chosen to characterize the possession and exercise of monopoly power as "an important element of the free-market system." This is rather the instantiation of the unproven and unprovable Schumpeterian hypothesis that we are all better off in a world of monopolists who rise to power and then toppled in waves of creative destruction.28 Even if true, it is not clear what any of that ringing rhetoric has to do with the facts in Trinko. Verizon is the inheritor of a regulated monopoly whose innovation is many decades in the past, long protected by government regulation, and being challenged for allegedly anticompetitive acts in order to cling to its dominant position by impeding new entry authorized by statute. If the point of antitrust law is to encourage the acquisition and retention of long-term monopoly power then we might as well abandon the entire enterprise of the regulation of competition by law or more broadly the promotion of a

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democratic market economy. It is one thing to say that we tolerate the existence of monopoly power (if not illegally acquired) but scrutinize its exercise to determine what kind of behavior is exclusionary and what is not. It is quite another to worship at the alter of monopoly power. We have come a long way from the days of Alcoa in which monopoly power, while still necessary but not sufficient for a violation, was described by Judge Hand as deadening initiative, depressing energy, and constituting a narcotic. 29 From the debates that preceded the passage of the Sherman Act until Trinko, one can search long and hard before one sees anything close to this love affair with monopoly in either Congress or in the majority, concurring, or dissenting opinions of the Supreme Court in Section 2 cases. Such a discussion was utterly unnecessary in any event, but is likely to shape the interpretation of Section 2 from the shadows in a way that is impossible to reform through legislation or rebut through legal precedent or policy argument. The Trinko court's pronouncements on this score stand merely as a naked assertion of a policy preference that has been rejected since the passage of the antitrust laws themselves. At one place, the Court appears to put its cards on the table and alludes to certain past precedents that appear to support the plaintiff's refusal to deal and/or essential facilities theory. The Court dismisses these venerable precedents as involving: "concerted action, which presents greater anticompetitive concerns and is amenable to a remedy that does not require judicial estimation of freemarket forces: simply requiring that the outsider be granted nondiscriminatory admission to the club."30 Privileging Section 1 over Section 2 of the Sherman Act, or believing concerted action is inherently more anticompetitive than equivalent action by a single entity with similar power, is an equally astonishing assertion with no textual support in the antitrust laws. Both halves of the Sherman Act have equal prohibitions, equal penalties, and equal significance. If one is also inclined to look at legislative history, there is simply no indication that the drafters of the Sherman Act differentiated between these two concepts, or indeed particularly understood that there was a difference.

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Even if one were to take an exclusively economic view of antitrust, it is by no means clear why the opposite view should not prevail. One can equally persuasively argue from economic theory that antitrust principally fears durable market power unaccompanied by substantial efficiencies which is more likely to arise from a single rent-seeking monopolist than from a fragile agreement of competitors seeking to imperfectly duplicate the behavior of a true monopolist in restricting output and raising price.

B. Missing the Essential
Once the court was done praising monopoly power and diminishing the importance of Section 2, it turned to an equally unnecessary, and inherently wrong, discussion of the essential facilities doctrine which the plaintiffs had urged as an alternate theory of liability. Here the court stated in its entirety: This conclusion would be unchanged even if we considered to be established law the "essential facilities" doctrine crafted by some lower courts, under which the Court of Appeals concluded respondent's allegations might state a claim. We have never recognized such a doctrine, and we find no need either to recognize it or to repudiate it here. It suffices for present purposes to note that the indispensable requirement for invoking the doctrine is the unavailability of access to the "essential facilities"; where access exists, the doctrine serves no purpose. Thus, it is said that "essential facility claims should - "be denied where a state or federal agency has effective power to compel sharing and to regulate its scope and terms." Respondent believes that the existence of sharing duties under the 1996 Act supports its case. We think the opposite: The 1996 Act's extensive provision for access makes it unnecessary to impose a judicial doctrine of forced access. To the extent respondent's "essential facilities" argument is distinct from its general § 2 argument, we reject it.31 If anything the court has it backwards. As I will be exploring in future work, the essential facilities doctrine works best as a theory of monopolization when dealing with infrastructure, in the sense that the facility in question is an input which creates such substantial positive externalities downstream that a regime of open access is socially desirable.32 As my colleague Brett Frischmann has noted, this can include traditional commercial infrastructure such as bridges, roads, ports, etc but also other foundational resources such as lakes, ideas, and the

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Internet.33 If the firm controlling the essential infrastructure is not a competitor to those seeking access certain duties to deal has been imposed since common law times under the common carrier doctrine.34 If the firm controlling the essential infrastructure is a competitor of those seeking access and uses that control to maintain its dominance, then, and only then, has the essential facility doctrine come into play as an antitrust concept. Most antitrust cases with any merit that have invoked the essential facilities doctrine have dealt with some aspect of infrastructure. These include the cases dismissed by Trinko as partaking on Section 1 principles rather than Section 2. But the only bridge across the Mississippi, 35 the network of newspapers comprising the Associated Press around the time of World War II, 36 the local phone loop controlled by MCI (and Verizon),37 the transmission lines controlled by Otter Tail Power,38 and under extraordinary circumstances intellectual property rights,39 all nicely fall into this notion of infrastructure in both the technical sense used by Professor Frischmann and in the colloquial every day sense of the word. Interestingly enough, it is Aspen (not Trinko) that is the hardest to justify in these terms.40 The vast majority of infrastructural assets for which open access would be societally valuable are neither wholly regulated (presumably immune under the regulatory statute in question) nor fully deregulated (for which Trinko may concede some application of the essential facility for discriminatory denials by a competing monopolist). Moreover, it is hard to find any truly unregulated facility which is "essential" in the sense required by MCI and its progeny. Even the handful of cases treating sports stadiums as essential facilities may be better explained by virtue of the heavy public subsidization of such facilities making such facilities impossible to duplicate with purely private resources.41 As a result, the courts have dismissed without much ado most essential facilities cases of the purely unregulated unsubsidized type on the grounds that the plaintiff could create their own alternative facility to the dominant firms.42 Most of the good essential facility cases occur in the twilight zone of partial regulation which Trinko appears to have cast into the legal abyss. Take MCI v. AT & T which is generally credited with as the source of the modern version of the doctrine.43 In MCI, the defendant AT & T continued as the regulated monopolist of local telephone service but now confronted competition in the long distance market. AT & T denied MCI access to the local telephone system which was

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necessary to complete the long distance calls over MCI's microwave network. MCI was physically, legally, and practically prevented from building its own local telephone system. AT & T claimed it could not interconnect with MCI because of existing regulatory restrictions and also because of technological and system integrity concerns. The courts found all of these purported justifications to be legally or factually insufficient, and frequently pretextual, and imposed Section 2 liability in substantial part on this ground.44 Most of the verdicts imposing liability under this theory have similarly concerned dominant firms resisting deregulation or misusing partial deregulation in a way that Microsoft court would probably characterize as unlawful monopoly maintenance, but Trinko appears to consider good clean fun. The European Union has in fact done a better job then we have in recognizing this fundamental distinction without citing infrastructure theory by name. In the easy cases, the European Commission and the courts have imposed liability (often using the essential facilities doctrine by name) when the operator of a port or harbor uses its control of that facility to discriminate against a competitor for ferry service or shipping services by denying access to needed berths.45 The European court quite properly refused to require the leading newspaper in Austria to make its delivery network available to smaller competitor that was legally and practically speaking free to create its own network.46 In the harder cases involving overly broad intellectual property rights, the court left open the possibility of liability in extraordinary circumstances.47 Here too, all the cases with any merit appear to fall into the zone of partial regulation where Trinko, if translated into holding and precedent, would eliminate. Even if taken on its terms Trinko's own discussion of the essential facilities doctrine does not lead to the result it claims. Trinko states that "essential facility claims should ?" be denied where a state or federal agency has effective power to compel sharing and to regulate its scope and terms."48 The discussion that follows hardly suggests that there was "effective regulation" in this particular case. For its actions, Verizon was subject to fines totaling $13 million and various reporting obligations. There was (and could not be at this early procedural stage of the case) no discussion of whether this was "effective" in forcing Verizon to live up to its obligations under state and federal telecommunications law. There is every indication that it was not and that Verizon was prepared to occur litigation expenses far in excess of this fine to avoid the one set of penalties that actually would be effective in mandating non-discriminatory access.

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Let's turn the question on its head for a moment. Putting aside antitrust, does Justice Scalia and the rest of the Trinko majority actually think that FCC regulation implementing the 1996 Telecommunications Act is "effective" in any normal sense of the word? Neither Congress nor most commentators think that it is. There is certainly nothing in the numerous past opinions of the Supreme Court on recent telecommunications issues that shows a great deal of faith in the 1996 Telecom Act, FCC regulation, or even regulation in general.

C. Fear and Loathing of Antitrust and Courts
Trinko is replete with a contempt for the judicial process adding any value in the area of the regulation of competition by law. We are cautioned about the possibilities of false positives and urged to be reluctant to bring out the antitrust battering ram unless one is confident that the benefits exceed the costs. This is certainly debatable in principle but also curious because it appears to have little to do with Trinko. The possibility of a false positive is quite low, since no one can seem to find any procompetitive upside in Trinko's foot dragging and interference with competitor access to its local exchange facilities.49 Moreover there is no reason to think that deciding Trinko on the merits is beyond the capacity of the average federal judge. The basic question of whether Verizon was, or wasn't providing access to its competitors on terms less favorable than it did its own local customers is a straight forward question of discrimination amounting to roughly: Is X being treated less favorably than Y? This is a basic binary type of verdict that federal and state courts decide on a daily basis in both statutory and common law cases of civil rights, employment discrimination, common carrier duties, licensing decisions, school segregation, prison conditions, access to health care, and numerous other areas of the law. These are a dime-a-dozen type of decisions that are a far cry of the polycentric multivariate balancing type of cases that legal theory predict that courts are comparatively poorer at deciding.50 If one concludes the courts cannot handle this kind of dispute then most of the federal docket should be discarded in favor of some other institutional dispute resolution mechanism. The courts have proved themselves quite adept at making these sorts of decisions in right to access antitrust cases, whether called essential facilities cases or not. The Trinko court acknowledged that the courts have adequately handled

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such disputes under the rubric of Section 1 of the Sherman Act. 51 When the essential facilities doctrine has been explicitly used by the lower courts, they have been equally adept at sorting out the meritorious cases from the frivolous cases where a competitor could reasonably duplicate the facility in question but simply preferred not to go to the trouble and expense.52 What Trinko did is hold that, in most circumstances, federal courts will never even get the chance to do what they have doing quite well for decades because of a theoretical concern for false positives in the context of a case that did not even raise a credible fear of such an outcome. Trinko further instructs us to be wary of adjudicating liability where adequate remedy can be implemented by the courts. This is a fair concern, again one for which the courts have proved up to the challenge. It is also clear whether Trinko itself raised any serious concern in this regard, certainly in its request for damages. no but not not

Right to access cases and essential facility cases come in all shapes and sizes as do the possible remedies when a violation has been shown. Many of the cases involve nothing more than the award (or the affirmance on appeal) of treble damages. That was the case in Aspen and MCIwhere the court affirmed on liability, but reversed and remanded for a new trial on damages. Even the Trinko court appears to have no problem with a straight forward injunction (at least in the Section 1 context) of "Thou shall not discriminate."53 It is not clear why a similar remedy in a Section 2 case is any more problematic. The complaint in Trinko requested both treble damages and injunctive relief to restore equal access. This is the bread and butter of the federal courts. Imagine the outcry if Trinko's logic was imported to justify abstention by the federal courts from adjudicating racial or employment discrimination cases because of a fear of false positives and a need to defer to other enforcement regimes. One can imagine where problems at the remedy stage in antitrust or other kinds of cases are so massive that a court might be reluctant to adjudicate liability, but it is by no means clear that it has a right to refrain from doing so. In such a worse case scenario, the court could issue a declaratory judgment or a decision on liability and leave the decision as to remedy for another day.54

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Creative solutions are also available. Professor Phillip Weiser has been a pioneer in suggesting a role for state and federal regulators as special masters when implementation of a judicial decree involves day-to-day supervision, complicated pricing decisions, and technical skill beyond the capacities of a generalist federal court.55 If regulatory agencies are so good at promoting the competitive aims of the Telecommunications Act, as is the view in Trinko, why not enlist them at the back end of the process as well? The Court obviously prefers to walk away from such situations entirely, but in doing so could have benefitted from the more creative approach in the final settlement of Microsoft which created a private monitoring structure to implement a settlement far more regulatory in nature than the relief sought by the Trinko plaintiffs.

D. Legal Process Lessons from Trinko and Microsoft
A variety of important lessons can be drawn from comparing Microsoft and Trinko. First, Judge Posner indeed may be correct that there is little or no difference between the Chicago school and the so-called Harvard school of antitrust.56 Trinko has many of the hallmarks of a strong case Chicago school opinion: strong use of theory, dislike of collusion, embrace of market power as a sign of efficient success in the best interests of society, and overall fear of false antitrust positives that would stifle market outcomes allegedly favorable to consumer welfare. The only scholarly support cited in the opinion is the work of Philip Areeda and Herbert Hovenkamp.57 Professor Areeda is considered by most the founding father of the Harvard school and Professor Hovenkamp is the current editor and author of the monumental antitrust treatise begun by Areeda and his colleague Don Turner at Harvard. Part of the Trinko majority on the court included Justice Breyer, who is a former antitrust and regulated industries professor at Harvard Law School itself before his appointment to the federal bench. Justice Breyer is not known as a shy or easily intimidated jurist and presumably would not have joined the opinion if he wished to approach the matter some other way. Indeed, it would have been surprising if he had done so, since Trinko is virtually the living embodiment of Justice Breyer's own opinion on the 1st Circuit in Town of Concord.58

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Nor does there appear to be a strong competing voice on the Supreme Court for Section 2 issues. In Trinko, the concurrence was couched in terms of standing rather than liability so we do not know whether Justices Stevens, Thomas, and Souter would have had anything substantially different to say if they had reached the issues discussed in the main opinion. The key differences between Microsoft and Trinko do not appear to stem from basic political or philosophical differences. There are no substantial political or philosophical differences between the makeup of the current DC Circuit and the Supreme Court. The chief judge of the Circuit (and probable author or main contributor to the opinion) Douglas Ginsburg may be a product of the Harvard Law School faculty, but graduated from the University of Chicago law School, was head of the Antitrust Division during the Reagan administration, and serves on the board of the law and economics center at George Mason University Law School, a school with strong philosophical ties to the Chicago school. Nor do the two opinions differ much in philosophy. Both are anxious to avoid false positives. Both provide defendants with safe harbors of different sorts in defending against Section 2 litigation. Trinko's safety zone for defendants is grounded in the presence of effective regulation that limits the additional utility of antitrust remedies. This could well be right as a philosophical construct, but does not seem to have much to do with the factual setting for Trinko or its procedural posture. Microsoft's safety zone for defendants lies in a burden of proof for plaintiffs to show some likely harm to competition as well as well as the opportunity for the defendant to show that there is a competing efficiency justification that has some basis in both law and fact. Then the plaintiff has the further hill to climb of showing that the harm to competition outweighs the asserted justifications. With all but a few exceptions, Microsoft flunked the second step and was unable to articulate at trial any cognizable pro-competitive justifications for most of its conduct. This is hardly a radical pro-plaintiff approach, although the plaintiffs ultimately prevailed on most aspects of liability. The legal process school from the middle of the twentieth century taught us that how an opinion is written is important. While infrequently applied to antitrust matters,59 this school of judging, pioneered by Professor Hart and Sachs, contended that the most important thing about a judicial decision was the

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process of reasoned elaboration so that the basic tenets of the decision were honestly and thoughtfully laid out for public display and available for application in future cases which would almost never be identical.60 Successful opinions earn the respect of the parties, commentators, future litigants, and the lower courts which have to apply the utterances of the Supreme Court in messy factual and legal situations that were not fully adjudicated in the prior case. Unsuccessful opinions become subject to debate and criticism among commentators and a process of guerilla warfare in the lower courts which undermines their legitimacy until they are eventually repudiated in an "Emperor has no clothes" moment.61 Section 2 has never been a shining example of success from a legal process point of view. Most of the old chestnuts are empty verbal formulations that do not help courts decide hard cases or parties plan their conduct in the real world. 62 Now compare Microsoft and Trinko from this perspective. Which will stand the test of time? Which will garner respect and support from both antitrust enforcers and defenders and the institutions that apply the law? Which will grow in influence until it comes to represent a settled and accepted approach to the law? Which will be undermined by hostile commentators and rebellious lower courts until discarded? The fact that Trinko is the product of the US Supreme Court and that Microsoft is the product of an intermediate appellate court gives Trinko an early lead, but is hardly determinative. Antitrust is replete with federal appellate decisions that have come to reflect settled doctrine far more than the Supreme Court decisions of similar vintage addressing the same topics. Addyston Pipe,63 Alcoa,64 and MCI65 are all decisions have eclipsed their Supreme Court competition for coherent statements of the antitrust doctrine of their time. Trinko obviously will have its greatest impact on the group of cases involving claims against incumbent local exchange companies and has had its intended effect of virtually eliminating such claims. 66 Whatever happens beyond that specific factual setting will depend on how the case is read and applied to the general body of monopolization law. Microsoft has the prestige of the D.C. Circuit, the nearly unique situation of being a unanimous en banc per curiam opinion synthesizing an entire area of law in a massive and complex case, and a three year head start as its assets in the horse race with Trinko.67 A quick check of citations and how the two cases are being used in subsequent litigation shows that for the moment it is just too close to call.

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E. Conclusion
One can gather that I do not think very much of the Supreme Court's opinion in Trinko. While this is certainly true, it is not as a result of any strong disagreement on the merits. The interplay between federal and state telecommunications regulation and the antitrust laws is a complex one about which reasonable people may differ. However, there is much at stake when the Supreme Court or any court opines on a subject. What the opinion chooses to address (or not) beyond the holding and result tends to have great real world consequences. Antitrust opinions matter because they represent the legal philosophy of capitalism. They tend to stick around for a while and are almost impossible to reverse by legislation. Section 2 opinions tend to matter more than most because they are so infrequent and so much turns on them. Trinko's main defect is its attempt to radically redefine the law of monopolization while purporting to uphold established doctrine. It did far more than it had to and did it badly. Justice Stevens's opinion on standing would have sufficed and in the alternative the first few pages of the majority opinion sufficed, once it found greater certainty in the regulatory provisions of the Telecommunications Act. What follows is an ode to laissez faire that is in stark contrast to everything antitrust has stood for since its inception, regardless of one's opinions about the validity of any particular theory or case. In contrast, Microsoft did its job and it pretty well, even if one believes, as Gavil and First do, that it should have done more.

Acknowledgement
The author thanks and gratitude to John Flynn who always kept us focused on what really mattered and how to get there. I appreciate the thoughtful comments on earlier drafts of the manuscript by Brett Frischmann, John Bronsteen, Larry Solan, and Christopher Leslie.

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Endnotes
1 2 3 4 5 6 7 United States v. Microsoft Corp., 253 F.3d 34 (D.C. Cir. 2001). Verizon Communications Inc., v. Law Offices of Curtis V. Trinko, LLP, 540 US 398 (2004). Harry First & Andrew I. Gavil, Re-framing Windows: the Durable Meaning of the Microsoft Antitrust Litigation, __ UTAH L. REV. __ (2006). Id. at __. William L. Reynolds & Spencer Weber Waller, Legal Process and the Past of Antitrust, 47 SMU L. Rev.1811, 1823-27 (1995). Mary McCarthy speaking about Lillian Hellman in a 1980 televised interview on the Dick Cavett show, quoted in Mary McCarthy,http://www.kirjasto.sci.fi/marymcc.htm. The Trinko court is, however, certainly correct in noting that the text of Section 2 does not include theories of leveraging which would impose liability if a defendant used power in one market to some advantage falling short of monopolization or attempted monopolization in a related market. 540 US at 415 n.4. Other jurisdictions have done a better job at addressing this issue under their laws dealing with an abuse of a dominant theory which textually can encompass theories of leveraging if adequately proved. See e.g., Article 82, Treaty Establishing the European Economic Community, as amended. 253 F. 3d at 51. (Citations omitted). Microsoft, 253 F. 3d at 58-59 (Citations omitted). Although beyond the scope of this comment, I would go so far as to argue that the decision can be read as consistent with the theory of justice associated with the philosopher John Rawls who argued that justice requires the selection of rules behind a veil of ignorance in which the decision maker does not know in advance whether the selected rule helps them or hurts them in the real world. JOHN RAWLS, A THEORY OF JUSTICE (1971). See e.g., 253 F. 3d at 63-64 (no justification for certain restrictions in OEM license agreements), 66-67 (no justification for commingling certain computer code and excluding Internet Explorer from Add/Remove utility program), & 71 (no justification for exclusive licenses with Internet Application Programmers). Where Microsoft met that burden, the court did not impose liability unless plaintiff was able to demonstrate that anti-competitive harm outweighed pro-competitive justification. Id. at 67 (no liability for overriding user's choice of browser when necessary technically). With thanks to Eleanor Fox who first coined this alliterative title in a presentation to the American Bar Association. Eleanor M. Fox, The Trouble with Trinko, American Bar Association, Antitrust Section, Spring Meeting 2004.

8 9 10

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This overall agenda is one of the core insights of Professors Gavil and First. Gavil &First, supra note 3, at __. A spen Skiing Co., v. Aspen Highlands Skiing Corp., 472 US 585 (1985). See generally Symposium, Aspen Skiing 20 Years Later, 73 ANTITRUST L. J. 59-268 (2005). Matsushita Elec. Ind. Corp., v. Zenith Radio Corp., 475 US 574 (1986). Celotex Corp., v. Catrett, 477 US 317 (1986); Anderson v. Liberty Lobby, Inc., 477 US 242 (1986). Eastman Kodak Co., v. Image Technical Servs., Inc., 504 US 451 (1992). 355 US 41 (1957). Leatherman v. Tarant County Narcotics Intelligence and Coordination Unit, 507 US 163 (1992). 534 US 506 (2002). Andrew I. Gavil, Exclusionary Distribution Strategies by Dominant Firms: Striking a Better Balance, 72 ANTITRUST L.J. 3, 45 (2004). 253 F.3d at 66. Id. at 97-117. The Telecommunications Act of 1996, Pub. L. 104-104, 110 Stat. 56. The antitrust savings clause is set forth at Section 601(b)(1). 540 US at 416. Twombly v. Bell Atlantic Corp., 425 F.3d 99 (2d Cir. 2005) may be an example of such a reading of Trinko. Interestingly, Trinko is not even cited in this opinion. 540 US at 407. See JOSEPH A. SCHUMPETER, CAPITALISM, SOCIALISM, AND DEMOCRACY 81 - 86 (2d ed. 1942). United States v. Aluminum Co., of Am., 148 F.2d 416, 427 (2d Cir. 1945). Alcoa was the work of the Second Circuit writing as the court of final appeal because of a lack of quorum at the Supreme Court for the case. Here the Court cited United States v. Terminal Railroad Ass 'n of St. Louis, 224 US 383 (1912) and Associated Press v. United States, 326 US 1 (1945) but not Otter Tail Power Co., v. United States, 410 US 366 (1973) the Supreme Court case most applicable to the merits of the Trinko dispute. 540 US at 410-11 (Citations omitted).

15 16 17 18 19 20 21 22 23 24 25 26 27 28 29

30

31

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32

For a more complete discussion of infrastructure theory in these terms see Brett Frischmann, An Economic Theory of Infrastructure and Commons Management, 89 MINN. L. REV. 917 (2005) and Lawrence Lessig, Reply: Re-Marking the Progress in Frischmann, 89 MINN. L. REV. 1031 (2005). Frischmann, An Economic Theory of Infrastructure, supra note 32, at 960. RICHARD A. EPSTEIN, PRINCIPLES FOR A FREE SOCIETY: RECONCILING INDIVIDUAL LIBERTY WITH THE COMMON GOOD 279-318 (1998). If the owner of the facility is not a competitor of the entity seeking access no antitrust liability has been imposed for the denial of access regardless of whether the facility is essential. See I AMERICAN BAR ASSOCIATION, ANTITRUST LAW DEVELOPMENTS (FIFTH) 278 N. 278 (2002)(collecting cases). United States v. Terminal Railroad Ass'n of St Louis, 224 US 383 (1912). Associated Press v. United States, 326 US 1 (1945). MCI Communications Corp., v. American Telephone & Telegraph Co., 708 F. 2d 1081 (7th Cir.), cert. denied, 464 US 891 (1983). Otter Tail Power Co. v. United States, 410 US 366 (1973). IMS Health GmbH & Co. OHG v. NDC Health GmbH & Co. KG (C418/01) [2004] E.C.R. I-5039 (ECJ); Radio Telefis Eireann v. Commission of the European Communities (C241/91 P) [1995] E.C.R. I-743 (ECJ). It is also additional support for Professor Fox's conclusion in a recent article that Trinko is much easier and better case to impose Section 2 liability than Aspen itself. See Eleanor M. Fox, If There Life in Aspen after Trinko? The Silent Revolution in Section 2 of the Sherman Act, 73 ANTITRUST L.J. 153 (2005). HERBERT HOVENKAMP, THE ANTITRUST ENTERPRISE: PRINCIPLE AND EXECUTION 247 (2005). Twin Lab., Inc. v. Weider Health & Fitness, 900 F. 2d 566 (2d Cir. 1990); McKenzie v. Mercy Hospital, 854 F.2d 365 (10th Cir. 1988); Case C-7/97 Oscar Bronner GmbH KG v. Mediaprint [1998] E.C.R. I-7791; [1999] 4 C.M.L.R. 112. See generally Spencer Weber Waller, The "New" Law of Monopolization: An Examination of MCI Communications Corp. v. American Telephone & Telegraph Co., 32 DEPAUL. L. REV. 595 (1983). The court also affirmed liability based on the sham litigation doctrine, but reversed portions of the judgment based on predatory pricing claims, and remanded for a new trial on damages based solely on that conduct found to be unlawful. 708 F.2d at 1166-69. The case subsequently settled for a fraction of the original verdict. See generally II JAMES ATWOOD, KINGMAN BREWSTER, & SPENCER WEBER WALLER, ANTITRUST AND AMERICAN BUSINESS ABROAD §16.4 (1997 & annual supp.).

33 34

35 36 37 38 39

40

41 42

43

44

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46 47 48 49 50

Case C-7/97 Oscar Bronner GmbH KG v. Mediaprint [1998] E.C.R. I-7791; [1999] 4 C.M.L.R. 112. IMS Health GmbH & Co., OHG v. NDC Health GmbH & Co. KG (C418/01) [2004] E.C.R. I-5039 (ECJ). 540 US at 411, citing P. AREEDA& H. HOVENKAMP, ANTITRUST LAW p. 150 ¶ 773e (2003 Supp.). See Fox, Is There Life in Aspen, supra note 40, at 165-66. These type of cases may actually be easier to adjudicate than the full rule of reason type analysis adopted in Microsoft, particularly those cases which reach the final stage requiring an actual balancing of pro- and anti-competitive effects. 540 US at 410 n.3. See infra notes 35-42 and accompanying text. For example MCI distinguished between access to intra-city networks and inter-city networks in which MCI was free to build its own facilities and was not given access to AT & T's existing competitive facilities. 708 F.2d at 1147-50. 540 US at 410 n.3. This is precisely what the Second Circuit did in Alcoa. 148 F.2d at 445-48. Philip J. Weiser, The Relationship of Antitrust and Regulation in a Deregulatory Era, 50 ANTITRUST BULL. xx (2005); Philip J. Weiser, Goldwasser, The Telecom Act, and Reflections on Antitrust Remedies, 55 ADMIN. L. REV. 1 (2003). Richard, A. Posner, The Chicago School of Antitrust Analysis, 127 U. PA. L. REV. 925 (1979). See generally RICHARD A. POSNER, ANTITRUST LAW ix (2d ed. 2001)(discussing degree of consensus in antitrust analysis). Cf. HOVENKAMP, THE ANTITRUST ENTERPRISE, supra note 41, at 2, 35-38 (2005)(citing agreement on general principles but not specific rules for antitrust enforcement). See PHILIP AREEDA& HERBERT HOVENKAMP, ANTITRUST LAW p. 150 ¶ 773e (2003 supp.); Philip Areeda, Essential Facilities: An Epithet in Need of Limiting Principles, 58 ANTITRUST L.J. 841 (1989). Town of Concord v. Boston Edison Co, 915 F.2d 17 (1st Cir. 1990). See Reynolds & Waller, Legal Process, supra note 5. See generally HENRY M. HART, JR. & ALBERT M. SACKS, THE LEGAL PROCESS: BASIC PROBLEMS IN THE MAKING AND APPLICATION OF LAW (William N. Eskridge, Jr. & Philip P. Frickey eds., Foundation Press 1994) (tent. ed. 1958); GARY MINDA, POSTMODERN LEGAL MOVEMENTS: LAW AND JURISPRUDENCE AT CENTURY'S END 33-43 (1995); Anthony J. Sebok, Reading the Legal Process, 94 MICH. L. REV. 1571 (1996) (book review). Interestingly enough, Hart and Sacks used as one of their primary examples an

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58 59 60

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antitrust opinion by the Federal Trade Commission in which they reprinted the actual opinion followed by a version they regarded from a legal process view as a more successful version of the same opinion. HART& SACKS, THE LEGAL PROCESS, supra at 1084-95. 61 In the antitrust area arguably the line of cases dealing with the standards for judging the legality of vertical restraints from White Motors Co., v. United States, 372 US 253 (1963) through United States v. Arnold, Schwinn & Co., 388 US 365 (1967) and then Continental T.V., Inc., v. GTE Sylvania Inc., 433 US 36 (1977) can be characterized as an illustration of this aspect of the legal process argument. Reynolds and Waller, Legal Process, supra note 5, at 1823-27. United States v. Addyston Pipe & Steel Co., 85 F. 271 (6th Cir. 1898), modified and aff'd, 175 US 211 (1899). United States v. Aluminum Co., of Am., 148 F.2d 416 (2d Cir. 1945). MCI Communications Corp., v. American Telephone & Telegraph Co., 708 F. 2d 1081 (7th Cir.), cert. denied, 464 US 891 (1983). See, e.g., Covad Comm. Co., v. Bell Atlantic Corp., 407 F.3d 1220 (D.C. Cir. 2005)(denying petition for rehearing). Compare Brown v. Board of Education, 347 US 483 (1954)(per curiam) in which the Supreme Court labored mightily to craft a unanimous opinion that would have the greatest weight and prestige in the real world.

62 63 64 65 66 67

8
Competition Policy and Market Regulation
M1069 WORLDCOM/MCI
Apostolov Mico*
Presently merger cases are becoming quite important and legal systems produce the needed juridical backbone of the evolution of the market regulation. They are also important for the progress of the economic theory in the competition analysis and policies. This article will give a view of the decisions made by the European Commission, as well as, the US Department of Justice in the merger case of two telecommunication corporations such as WorldCom and MCI. It has one of the most important cases that determined the future development of the telecommunication and Internet industry worldwide. The paper is divided into two major parts: (I) analytical part that takes most of the analysis and (II) theoretical part. The first part is comprised of the analysis of the US Department of Justice and especially FCC that has the authority for such cases. The profound opinion and conclusions of the European Commission of one questionable segment of the telecommunications market,
* Phd. at Sant'Anna School of Advanced Studies, Piazza Martiri della Libertà, 33, Pisa, 56127, Italy. E-mail: [email protected]

© 2006 Mico Apostolov. All rights reserved.

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is the Internet market that creates anticompetitive effects. The second part will give the predominant theoretical concepts used by the antitrust authorities.

Introduction
Nowadays high profile merger cases are becoming quite important and are taken as milestones of legal systems that produce the needed juridical backbone of the evolution of the market regulation. Additionally such cases are equally important for the progress of the economic theory in the domain of competition analysis and policies. This study will give outlook of the decisions made by the European Commission, as well as, the US Department of Justice in the merger case of two telecommunication corporations-WorldCom and MCI. This case was one of the most important cases that determined the future development of the telecommunication and Internet industry worldwide. The main point of the case analysis is to consider the competitive effects produced by such possible merger and the possible solutions in case of anticompetitive outcomes. The methodology used while writing the essay is based on two major parts: (I) analytical part that takes most of the analyses and (II) theoretical part. The first part is comprised of the analyses of the US Department of Justice and especially Federal Communications Commission that has the authority for such cases, as well as, the profound opinion and conclusions of the European Commission (DG Competition) of one questionable segment of the telecommunications market, the Internet market, that creates anticompetitive effects. The second part will give the predominant theoretical concepts used by the antitrust authorities.

I. Analytical Part
1. Federal Communications Commission / DoJ - United States of America
The merger case between WorldCom and MCI was analyzed by Federal Communications Commission (FCC 98-225) and US Department of Justice (DoJ). They prepared document that contains the reasons and the possibilities for and

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against such merger. The study is made in the light of United States market dimensions, but also significant part is dedicated to the international dimension of the merger. The basic feature of the applicant WorldCom on the US market is that it is one of the largest US telecommunications companies (1997 revenues of $7.35 billion) and when added to that the vast international dimension of the company, the result is world prominent position of the company. On the other hand, MCI is the second largest US provider of long distance and international telecommunications services and also has high place on the domestic market.

Markets
Domestic Long Distance Services
In order to be examined the competitive effects of the merger on the product market of domestic long distance services, they have to be defined. According to this study there are two product markets that need to be considered while concluding. The first one is residential customers and small business (mass market), that is comprised of telephone and similar communication services offered to the end users. The second market in question is medium-sized and large business customers (larger business market), that offers services for other companies in the American economy.1 The geographic markets are local and national. The Commission determined more than 600 companies (1996) as market participants on the relevant market for domestic long distance services. But those that make the most of the market are seen through the classification of mass market or larger business market. In the light of the mass market the dominant market participants are AT & T with market share below 50% of the total market, fallowed by MCI, Sprint, LEC, GTE and Southern New England Telecommunications Corp. (SNET). The larger business market consists of mainly the same names AT & T, MCI, and Sprint which hold the predominant part of the market and WorldCom that has, as described, substantial part.2 The analysis of competitive effects was conducted on the grounds of many instruments. They gave results confirm that there will be an increase in market concentration (HHI Index), but they also showed decent, acceptable numbers in

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terms of competition. In addition of the study, the industry market trends seen through the transmission capacity of the new networks, showed barriers to entry, but because of the future impact of the new technology on transmission capacity, the conclusions confirm future healthy competition. Furthermore, there is possibility of WorldCom to lose its characteristic of 'maverick supplier' on the wholesale market. As final conclusion it was estimated "that the merger likely will not impair competition in the domestic, interstate, inter-exchange market. We therefore decline to impose any of the various conditions proposed by commenters."3

US International Services
The US international services' product market is determined by the transport capacities as its main characteristic. The transport makes available the international physical transmission, voice telephony and data traffic that flow through the optical cables. For that reason it is estimated that augmentation of international transport capacity as input of international telecommunications services will moderate "the increase in concentration and prevent any anticompetitive effects."4 In addition, there are three regions as geographic markets: Atlantic, Pacific, and Caribbean/Latin America, which have to be taken in consideration. The market participants are distributed across the geographic regions. The most important is the Atlantic region, where the leading company in respect of telecommunication transports (submarine cables), is Global Crossing wit a market share about 40 percent fallowed by WorldCom (17.2%). As far as the MCI is concerned, the estimations indicate around 6.1 %, which brings the merger to significant market position on the Atlantic's route. The Pacific region is the second most important region where the market is lead by AT & T's 12.1 %. As a comparison the merger companies on this route will have around 9.6 % together, which is rather moderate taken that the market is highly competitive. The last region that has been questioned is Caribbean/Latin American Region on which MCI/WorldCom combined will become second provider of services with around 12.1%, right behind Telecommunications Corp. (Batelco) that has 24.2%.5 At the end, there are final conclusions about the competitive effects of this merger on the market of US International Services. On the mass market as well as on the larger business market it was estimated that MCI/WorldCom 'is not likely' to have significant anticompetitive effect.6

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Local Exchange and Exchange Access Services
The relevant product market for local exchange and exchange access services was split into mass market and larger business market. As far as the geographic market is being analyzed it is vital to stress that "the Commission found that each point-to-point market constituted a separate geographic market "7 defining the market as local, national and regional depending on the point-to-point description. Additionally, the market participants (AT & T, MCI, and Sprint) on the mass market, which is clearly competitive market, control irrelevant parts of the market. On the larger business market the situation is quite similar and the main competitors are WorldCom (never exceeding 6 %, MCI) which is relatively small share and other national and local providers. In terms of analysis of competitive effects the findings show that on the mass market as well as on the larger business market "the merger of WorldCom and MCI ... is unlikely to result in unilateral or coordinated anticompetitive effects."8

Internet Backbone Services
The main element that was obstacle for competition and was extensively analyzed by the European Commission is the market for Internet Backbone Services. The product market is comprised of three key elements: end users, Internet Service Providers (ISPs), and Internet Backbone Providers (IBPs). The geographical distribution of the providers, in the study of the American Federal Communications Commission, is national and worldwide. MCI as market participant has the lead place on this market, and is has both IBP and ISP, which means dominant position on the top-level Internet network and its functioning. Indeed, it is fallowed by WorldCom that has significant role on the domestic market owning three IBPs and majority part of a forth one. What is more it also controls a number of Network Access Points (NAPs) where IBPs interconnect (MAE-East (Washington DC), MAE-West (San Jose), MAE-Dallas, MAELos Angeles, and MAE-Chicago.)9 Without a doubt, the most important consequence of this merger might be creation anticompetitive effects on the internet market, or more precisely the Internet backbone services which are considered to be the chief and predominant

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determinant of the quality and availability of Internet in general. Furthermore, such merger will eventually produce over time increased concentration of assets. Even more, the discussed settlements-free peering from IBPs, will surely be in future important barrier to entry. As a result of such findings MCI proposed a divesture.

2. DG Competition - The European Commission
1. Markets
According to the European Commission on November the 9th 1997 two big American firms in the service industry, WorldCom and MCI, signed an agreement for merging into one company "MCI/WorldCom", which will be managed by WorldCom. 10 WorldCom and MCI are telecommunications companies with main domain of operation - services, functioning on national and international level. The base of the firms is in the United States; however it has subsidies in many of the counties in the European Union.11 The important thing for the European Union, and for the unit in charge of mergers and competition policy DG Competition (European Commission), is to estimate the "community dimension" of the merger, meaning the impact of the fusion of these companies on the competition in the internal market, and to react appropriately according to the Merger Regulation in order to keep the markets in equilibrium. The estimated impact, according to the Merger Regulation, is determined as allocation of turnover on a geographical basis. The methodology used for determination of the future aspects of the contract, showed that WorldCom and MCI each have Community-wide turnover exceeding ECU 250 million. WorldCom and MCI do not have more than two-thirds of their Community-wide turnover in one, same Member State.12 After verifying that DG Competition has authority over the case "within the meaning of Article 3(1)(a) of the Merger Regulation",13 coordination and exchange of information has been established with the Antitrust Division of the United States Department of Justice (DoJ).14 There are two main features of the compatibility with the common market: the carrier services and the internet-related services. DG Competition's testing is focused on the Internet as a main sphere of the study. The suppliers of the Internet services are called Internet Service Providers (ISPs) "offering Internet

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access services on a commercial basis".15 In order, the ISPs, to provide Internet on a wide level they have to interfere between each other and exchange information by interconnection, which can involve either peering or transit services. The structure of the Internet is very important for this case because, as seen later, it will bring the key arguments for the divesture proposed and realized by MCI. So, there are two core levels of the Internet structure: the top-level networks and secondary peering ISPs. The definition of the top-level networks focuses the importance on the transit services' functioning, which indicates limitation to the internet exchanging process: "Traffic which is progressively defaulted to higher level networks will finally end up in the hands of an ISP who has no one else to whom to turn, and must either assume responsibility on its own account for delivering the traffic across peering interfaces, or return it undelivered. These networks are referred to hereon as "top-level networks" or "top level ISPs".16

Market Definition
The product markets that have to be seen are as fallows: host to point of presence access services, internet access services, top level or universal Internet connectivity. The point of presence services and their hosting (maintenance) are considered to have differentiated competition depending on levels of connection that varies form ISP level to low level. In addition, for the second category analyzed as a product market, the internet access services, the parties argued that these services can be easily substituted with other forms of data transmission service, but it does not appear to be such. The specificity of the Internet network is contained in the possibility to be reached by others, also connected on Internet, and the accent is given to the access to connection (barrier to entry), and thus exchange data and information. At the end, when explaining the third product market question rose is: weather "ISPs all compete against one another to provide the same connectivity services, or whether there are any distinct and narrower markets within the sector?"17 As a consequence, the responsible for the case at DG Competition while analyzing the relevant product markets came up with a final conclusion which states that "the relevant market on which the merging parties are active is the market for the provision of top level or 'universal' Internet connectivity". However, there has been an 'evolution of the market definition' that pushes the study in another direction. "The concept of 'top level network' might not represent today's economic reality, insofar as some of the players apparently

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capable of functioning as top-level networks are in fact paying for some or all of their peering. Others may benefit from the peering agreements when no longer will be possible to enter/paid, and therefore their status as top-level networks may be open to question. As a result, the numbers of firms actually capable of offering competitive constraints may be smaller than the concept of 'top-level networks' might imply.18 On the other hand, the rapid development of fiber optics and cable technology projects a way to the future for the smaller Internet providers to offer top level and universal Internet. But, here it must be said that today that is not the case, so that would mean that the process is in early stages and the market definition applied to this merger case is not to be changed, "but the fact that this is likely to happen should be borne in mind as a relevant factor when considering the market power of the parties.19 In response, the parties argued that in case of price increase imposed by hypothetical monopolist, any ISP is capable to divert the internet traffic through consequent peering agreements enlarging the reach of its operation. In addition, they claimed that the ISPs 'in trouble' could tie contracts with other ISPs, and also that all of the operations will not reflect into unprofitable price increase by buying traffic.20

Relevant Geographic Markets
Assessing the relevant geographic markets DG Competition came up with three domains. The first market, corporate and traveler services is defined on national as well as at any other wider level, where as, the second, carrier services is at least regional, but also has international dimension. For the third one, Internet services, the geographic market depends of the level looked upon. So, it can be qualified as local, national, regional or worldwide.21

Competitive Assessment
DG Competition focused on three relevant points while assessing the competitive effects of the merger. The points in question are: carrier services, Internet access services and top level or universal internet connectivity. The market for carrier services on European level (according to the parties) is controlled about 95% by European telephone operators. WorldCom has been trying to set networks in every big city, and MCI has no significant influence. On transatlantic level the company MCI/WorldCom would have around 23% of the US market.22 As far as the

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Internet access services are concerned, the study shows that there is substantial competition at retail level and low barriers to entry. Furthermore, the most important market that needs to be seen deeper is top level or universal Internet connectivity. During the competitive assessment of top level or universal Internet connectivity were used a couple of techniques and methods in order to prove the dominant and unacceptable position of the company to be made after the merger. The data showed that in terms of the number of connections MCI /WorldCom would have around 55% to 68%. In addition, the estimations about possible revenue pointed out 45-55% of the market earnings to go to the newly formed company. The traffic flow was also analyzed with two methodologies. According to the methodology of a hypothetical monopoly MCI/WorldCom would have 75-85% of the traffic flow. However the second methodology based on 12 networks gave rather moderate data, placing the MCI/WorldCom's share around 42-52% of the total traffic flow.23 The Chief Operating Officer of WorldCom stated that" having a big network is a huge barrier to entry for competitors".24 Therefore, the conclusions are that "the combined network would be significantly larger than the size of its nearest competitor (Sprint), on either revenue or traffic flow, bearing in mind that the next competitor, the GTE group, is about half the size of Sprint."25

Impact of Merger on Competition
The impact of the merger on the competition in the domain of Internet is seen as anticompetitive. The authorities claimed that the amalgamation of leading Internet networks of WorldCom and MCI will produce a network that will have magnitude of behaving independently and thus will influence customers worldwide and in Europe. Reinforcement of the market position of the merged company (MCI/WorldCom) can be done by perusing different aggressive strategies and control the market imposing different peering agreements. Moreover, the company could influence the costs and the quality of the Internet services and also could be controlled the quality of the connector's service (peering partner). The growth of MCI/WorldCom will bring possibility for this company to reduce the independence of incumbent competitors and behave independently of its customers. As a response the parties claimed that multi-homing can be used as an alternative. To that the Commission responded with the fact that there is competitive limitation. The possibility of potential competitors was considered and

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the conclusion is that the barriers to entry can be augmented easily for the competitors that want to enter at top-level network. As a result 'the merger might well create a 'snowball effect' in that MCI WorldCom would be better placed than any of its competitors to capture future growth through new customers".26 Having this in mind, the customers might try to act against MCI/WorldCom and contradict, but unless their actions are united there will not be any pressure nor effect on making the situation more competitive.27

3. MCI's Divestiture
MCI proposed divesture that had to reduce or even eliminate the suspicions about the "competitive" crater of the merger. Thus this meant that MCI by merging with WorldCom will lose the Internet business and will have to transfer number of contract to the newly formed company (NewCo - DG Competition or C & W - DoJ) that had to be inevitably sold to a 'purchaser' 28 Furthermore, "NewCo will be an independent business with 100% of the Internet traffic and 100% of the Internet revenues of the iMCI Business."29 During the transaction MCI had to transfer to C & W assets and employees (22 nodes ; over 15,000 interconnection ports; and all the routers, switches, and other equipment dedicated to the backbone... ), ISP customers (1,300 domestic and international ISP customers), as well as, retail customers (Internet service, web-hosting, managed firewall, and Real Broadcast Network services).30 After assessment of the undertakings promised by MCI, there was approval of the merger by DG Competition (European Commission), as well as, by US Department of Justice by authorization of the Federal Communications Commission. Afterwards final exchange of letters and decisions were executed. After the fulfilled divesture the merger has been "declared compatible with the common market and the functioning of the EEA Agreement"31 and that the merger will "will serve the public interest, interest, convenience, and necessity".32

II. Theoretical Part
1. The approach of the European Commission
The European Commission bases its approach on the Council Regulation (EEC) No 4064/89 (amended by Regulation (EC) No 1310/97) of 21 December 198933 and decides to give a pass to the merger after fulfillment the needed

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divesture by MCI. In order to be identified the scope of the merger, it is used the definition of concentration within the scope of Article 3 of the same regulation which states that "a concentration shall be deemed to arise where: (a) two or more previously independent undertakings merge."34 Consecutively to the finding that there is in fact a merger the Commission uses the Article 6(1)(c) to determine that the concentration "falls within the scope of this Regulation and raises serious doubts as to its compatibility with the common market, it shall decide to initiate proceedings."35 The theoretical bases of the methodology of the European Commission were changed with the reform in 2004, when the test was changed into substantive 'carbon test'.36 Until then the Commission, while solving the merger cases, was relying on "the concept of dominance: a merger must be blocked if it creates a dominant position, and therefore would likely result in higher prices, less choice and innovation."37 This test was used in the case of the merger MCI/WorldCom. The economic analyses to explain the case uses the so-called 'tacit collision effects or cooperative effects', meaning that "the merging parties will be able to raise price even without the cooperation of rival firms. This corresponds broadly to the legal concept of single-firm dominance."38 This way of deciding was also known as theory of 'concentrations with conglomerate nature'.

2. The Approach of the US Federal Communications Commission/DOJ
The regulation about dominant position and abuse of a dominant position in the United States is regulated with two acts : Section 2 of the Sherman Act and Section 2 of the Clayton Act (1914) and added to that Robinson-Patman Act (1936) (Europe - Art. 82 (ex. Art. 86) of the Amsterdam Treaty, meaning abuse of monopoly power).39 When determining the thresholds of dominance the antitrust policy in the United States the antitrust authorities are guided by the definition stating that monopoly is "power to exclude competitors".40 The author agrees that the definition used by US is in fact close to the one used by the European authorities. However, when determining the dominance on the market the analyses must go beyond just the market shares and have to be seen other factors that might contribute to the possibility of raising prices by the concentration in question, whereas in Europe high market share is still considered to be enough for accusing of having dominance.

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The Federal Communications Commission in the case of MCI/WorldCom, while determining the market power uses the "antitrust laws, including the DOJ and Federal Trade Commission 1992 Horizontal Merger Guidelines and the April 8, 1997.41 Indeed, the analytical framework for assessing competitive effects is relying on the "1992 Horizontal Merger Guidelines suggest that market shares should be assigned to each firm currently participating in the market and then the pre-merger and post-merger levels of concentration should be calculated, using the Herfindahl Hirschman Index (HHI)."42 However, here must be stressed that future projections of the development of the market must be taken in sight, because the picture which today's market shares create about the competitive position of the concentration is not clearly to be kept in future - the company's competitive importance might be understated or overstated.

Conclusion
It is clear that the US authorities based their findings on a bit more different grounds then their European equivalents. Their approach examines predominantly the effects on the national market, with an attitude of reluctance towards the international dimension, although they recognize that what happens on the international market directly influences the positions of their companies on the regional and the domestic market. The main difference would be the methodology used, which on one hand is more econometric based, but on the other hand, the US authorities give much more weight on the future earnings and expectations of the development of the industry and different segmented markets within the analyzed industry. At the end they come up with more or less the same conclusion as the European Commission about the anticompetitive effects of the merger, so together they coordinated the implementation of the divesture proposed by MCI. When one studies the used methodology and technique of the European Commission, one notices that the European authorities are little bit more vigilant. The possible reasons for acting that way might be many, but manly: the tests, the economic and econometric analyses, unfinished or ever evolving institutional framework, etc. However, the most important is the approach used by DG Competition and that is the concept of dominance. The authorities are primarily concerned about the possible dominant position seen from 'today's perspective', while determining the bottom line of the future developments as not quite secure. They recognize the importance of the future market solutions (in this case the rapid development of technology and most notably fiber optic cables), but they seem to

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be more bias to solutions like 'snowball effect'. That is probably why there was serious need to be enforced a reform of the competition policy and merger regulation, that took place later on. In conclusion it must be said that, both authorities did justify the merger and came up with more or less the same conclusions. Even though the used slightly different approaches, they both were first and foremost concerned about their own interests and areas of influence, so the merger was resolved with a favorable outcome for all major sides involved.

References
Béatrice DUMONT and Peter HOLMES, Competition Policy and Market Regulation, College of Europe, winter 2005-2006, (power point presentation). BUIGUES, P.A. & REY, P., The Economics of Antitrust and Regulation in Telecommunications : Perspectives for the New Regulatory Framework, (2004). COMMISSION DECISION of 8 July 1998 declaring a concentration to be compatible with the common market and the functioning of the EEA Agreement, (Case No IV/M.1069 WorldCom/MCI), p.2. Available at:http://www.europa.eu.int/comm/competition/mergers/cases/decisions/ m1069_19980708_600 en.pdf Council Regulation (EEC) No 4064/89 , 21 December 1989, consolidated text "the merger regulation" Available at:http://europa.eu.int/comm/competition/mergers/legislation/ regulation/consolidated/en.pdf Competition Memo: November 1999 The Airtours case Available at:http://www. crai.com/ecp/assets/Airtours.pdf MEMORANDUM OPINION AND ORDER, Federal Communications Commission, Washington, D.C. 20554, September 14, 1998, p. 15-17 Available at: http://www. fcc.gov/Bureaus/Common_Carrier/Orders/1998/fcc98225.pdf New Merger Regulation frequently asked questions Available at :http://europa. eu.int/rapid/pressReleasesAction.do?reference=MEMO/04/9&format=HTML& aged=0&language=EN& guiLan guage=en

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Kolasky William: What is competition? A comparison of US and European perspectives - The Antitrust Bulletin, Spring-Summer 2004. Gal, Michal S: Monopoly pricing as an antitrust offense in the US and the EC, The Antitrust Bulletin, Spring- Summer 2004.

Publications of Economic Consultancy Agencies
CRA International Available at:http://www.crai.com NERA Economic Consulting Available at:http://www.nera.com

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Main Internet Sourceshttp://www.europa.eu.inthttp://www.fcc.govhttp://www.usdoj.gov/atr/index.htmlhttp://www.ftc.gov

Endnotes
1 MEMORANDUM OPINION AND ORDER, Federal Communications Commission, Washington, D.C. 20554, September 14, 1998, p. 15-17. Available at:http://www.fcc.gov/Bureaus/Common_Carrier/Orders/1998/fcc98225.pdf MEMORANDUM OPINION AND ORDER, Federal Communications Commission, Washington, D.C. 20554, September 14, 1998, p. 19-22. Available at:http://www.fcc.gov/Bureaus/Common_Carrier/Orders/1998/fcc98225.pdf MEMORANDUM OPINION AND ORDER, Federal Communications Commission, Washington, D.C. 20554, September 14, 1998, p. 46 Available at:http://www.fcc. gov/Bureaus/Common_Carrier/Orders/1998/fcc98225.pdf lbid., 47 MEMORANDUM OPINION AND ORDER, Federal Communications Commission, Washington, D.C. 20554, September 14, 1998, p. 50-56. Available at:http://www.fcc.gov/Bureaus/Common_Carrier/Orders/1998/fcc98225.pdf MEMORANDUM OPINION AND ORDER, Federal Communications Commission, Washington, D.C. 20554, September 14, 1998, p. 57-66. Available at:http://www. fcc.gov/ Bureaus/ Common_Carrier/Orders/1998/fcc98225.pdf lbid., p.94. lbid., p. 102. MEMORANDUM OPINION AND ORDER, Federal Communications Commission, Washington, D.C. 20554, September 14, 1998, p. 79-80. Available at:http://www. fcc.gov/ Bureaus/Common_Carrier/Orders/1998/fcc98225.pdf COMMISSION DECISION of 8 July 1998 declaring a concentration to be compatible with the common market and the functioning of the EEA Agreement, (Case No IV/M.1069 - WorldCom/MCI), p.2. Available at:http://www.europa. eu.int/comm/competition/mergers/cases/decisions/m1069_1998 0708_600_en.pdf lbid., p.2.

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COMMISSION DECISION of 8 July 1998 declaring a concentration to be compatible with the common market and the functioning of the EEA Agreement, (Case No IV/M.1069 - WorldCom/MCI), p.3. Available at:http://www.europa. eu.int/comm/ competition/mergers/cases/decisions/m1069_19980708_600_en.pdf lbid., p.2. lbid., p.3. lbid., p.6. COMMISSION DECISION of 8 July 1998 declaring a concentration to be compatible with the common market and the functioning of the EEA Agreement, (Case No IV/ M.1069 - WorldCom/MCI), p.3, point 41 Available at:http://www. europa.eu.int/ comm/competition/mergers/cases/decisions/m1069_19980708_600 en.pdf COMMISSION DECISION of 8 July 1998 declaring a concentration to be compatible with the common market and the functioning of the EEA Agreement, (Case No IV/M.1069 - WorldCom/MCI), p.15. Available at:http://www.europa. eu.int/comm/competition/mergers/cases/decisions/m106919980708600en. pdf lbid., p. 17 COMMISSION DECISION of 8 July 1998 declaring a concentration to be compatible with the common market and the functioning of the EEA Agreement, (Case No IV/M.1069 - WorldCom/MCI), p.17 Available at:http://www.europa.eu. int/comm/competition/mergers/cases/decisions/m1069_19980708_600_en.pdf lbid., p. 18. lbid., p. 19-20. COMMISSION DECISION of 8 July 1998 declaring a concentration to be compatible with the common market and the functioning of the EEA Agreement, (Case No IV/M.1069 - WorldCom/MCI), p.20 Available at:http://www.europa. eu.int/comm/competition/mergers/cases/decisions/m1069_19980708_600_en.pdf COMMISSION DECISION of 8 July 1998 declaring a concentration to be compatible with the common market and the functioning of the EEA Agreement, (Case No IV/M.1069 - WorldCom/MCI), p.21 -26 Available at:http://www.europa. eu.int/comm/competition/mergers/cases/decisions/m1069_19980708_600_en.pdf libd., p.22. libd., p.26. COMMISSION DECISION of 8 July 1998 declaring a concentration to be compatible with the common market and the functioning of the EEA Agreement, (Case No IV/M.1069 - WorldCom/MCI), p.27-29 Available at:http://www.europa. eu.int/comm/competition/mergers/cases/decisions/m1069_19980708_600_en.pdf lbid., p.31.

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28 29 30

lbid., p.32. lbid., p.33. MEMORANDUM OPINION AND ORDER, Federal Communications Commission, Washington, D.C. 20554, September 14, 1998, p. 84-90 Available at:http://www. fcc.gov/Bureaus/Common_Carrier/Orders/1998/fcc98225.pdf COMMISSION DECISION of 8 July 1998 declaring a concentration to be compatible with the common market and the functioning of the EEA Agreement, (Case No IV/M.1069 - WorldCom/MCI), p.45. Available at:http://www.europa. eu.int/comm/competition/mergers/cases/decisions/m1069_19980708_600_en.pdf MEMORANDUM OPINION AND ORDER, Federal Communications Commission, Washington, D.C. 20554, September 14, 1998, p.127. Available at:http://www.fcc. gov/Bureaus/Common_Carrier/Orders/1998/fcc98225.pdf COMMISSION DECISION of 8 July 1998 declaring a concentration to be compatible with the common market and the functioning of the EEA Agreement, (Case No IV/M.1069 - WorldCom/MCI), p.1. Available at:http://www.europa. eu.int/comm/competition/mergers/cases/decisions/m1069_19980708_600_en.pdf Council Regulation (EEC) No 4064/89, 21 December 1989, consolidated text "the merger regulation", Article 3 (1) (a). Available at:http://europa.eu.int/comm/ competition/mergers/legislation/regulation/consolidated/en.pdf Council Regulation (EEC) No 4064/89 , 21 December 1989, consolidated text "the merger regulation", Article 6(1)(c). available at:http://europa.eu.int/comm/competition/ mergers/legislation/regulation/consolidated/en.pdf New Merger Regulation frequently asked questions Available at :http://europa. eu.int/rapid/pressReleasesAction.do?reference=MEMO/04/9&format=HTML& aged=0&language=EN &guiLanguage=en New Merger Regulation frequently asked questions Available athttp://europa.eu.int/ rapid/pressReleasesAction.do?reference=MEMO/04/9&format=HTML&aged=0&la nguage=EN &guiLanguage=en. Competition Memo: November 1999 The Airtours case available at:http://www. crai.com/ecp/assets/Airtours.pdf Béatrice DUMONT and Peter HOLMES, Competition Policy and Market Regulation, College of Europe, winter 2005-2006, (power point presentation), p.7-8 Kolasky William: What is competition? A comparison of US and European perspectives - The Antitrust Bulletin, Spring-Summer 2004, p. 42 MEMORANDUM OPINION AND ORDER, Federal Communications Commission, Washington, D.C. 20554, September 14, 1998, p.11 available at:http://www.fcc. gov/Bureaus/Common_Carrier/Orders/1998/fcc98225.pdf lbid., p12.

31

32

33

34

35

36

37

38 39 40 41

42

List of Cases
Aspen Skiing Co., v. Aspen Highlands Skiing Corp., 472 US 585 (1985). Associated Press v. United States, 326 US 1 (1945). Associated Press v. United States, 326 US 1 (1945). Brand X Internet Servs. v. FCC, 345 F. 3d 1120 (9th Cir. 2003). Celotex Corp., v. Catrett, 477 US 317 (1986); Anderson v. Liberty Lobby, Inc., 477 US 242 (1986). Co., v. United States, 410 US 366 (1973). Eastman Kodak Co., v. Image Technical Servs. Inc., 504 US 451 (1992). Leatherman v. Tarant County Narcotics Intelligence and Coordination Unit, 507 US 163 (1992). Matsushita Elec. Ind. Corp., v. Zenith Radio Corp., 475 US 574 (1986). MCI Communications Corp., v. American Telephone & Telegraph Co., 708 F. 2d 1081(7TH Cir.), cert. denied, 464 US 891 (1983). Otter Tail Power Co., v. United States, 410 US 366 (1973). Twombly v. Bell Atlantic Corp., 425 F.3d 99 (2d Cir. 2005). United States v. Aluminum Co., of Am., 148 F.2d 416, 427 (2d Cir. 1945). United States v. Terminal Railroad Ass'n of St. Louis, 224 US 383 (1912).

Index
A
Access Regulation, 2, 10, 12, 14, 16, 20 Access, 2, 10, 22, 30, 40, 72, 81, 90, 100, 111, 121, 131, 150, 167, 170 Anticompetitive, 102, 141, 144, 148, 164, 167, 172, 175 Antitrust Court, 141 Antitrust Laws, 63, 141, 150, 158, 174 Antitrust Litigation, 141 Antitrust, 24, 31, 63, 102, 140, 145, 150, 155, 164, 174, 176 Assumption, 77, 95, 104 Asymmetric, 39, 41 Competition, 3, 11, 22, 32, 37, 41, 52, 62, 72, 81, 93, 102, 121, 131, 142, 153, 165, 171 Consideration, 145, 167 Consumer Welfare, 24, 32, 37, 79, 155 Convergence, 4, 23, 88, 102 Cross-Subsidised, 39

D
Deregulation, 4, 11, 37, 100, 152 Disintegration, 3, 11 Disseminated, 26 Distortionary, 39 Domestic, 42, 111, 167, 173, 175

B
Bandwidth, 3, 7, 9, 20, 28 Banking and Insurance Services, 99 Broadband, 4, 11, 22, 30, 44, 75, 87, 90, 115, 120, 130 Burdens of Proof, 143

E
Electricity, 37, 45, 57, 60, 71 Enactment, 23, 24 Enforcement, 99, 110, 141, 155 Entry Barriers, 47, 128, 142 Evaluate, 13, 142 Evidence, 11, 19, 39, 52, 55, 61, 113, 142, 146 Exclusionary, 143, 149 Exuberance, 120

C
Communications, 23, 26, 30, 53, 70, 74, 76, 89, 90, 101, 117, 131, 147 Competition Law, 36, 38, 40, 45, 47, 52, 55, 61, 68, 86 Competition Policy, 22, 37, 53, 55, 61, 63, 72, 169, 175

G
GATS, 104, 109, 112 Global Economy, 98, 99

Index

181

H
High-speed Services, 7 Horizontal Network Layers, 31

O
Obligation, 10, 39, 46, 63, 74

P
Penetration, 12, 18, 22, 51, 79, 84, 88, 94, 116, 131, 138 Persuasive, 131, 140, 144 Plaintiff, 143, 145, 147, 149, 151, 156 Policymakers, 31, 118, 121 Pre-geographic, 118, 121, 125, 128 Pre-merger, 175 Prohibitions, 141, 150 Property Rights Law, 98 Protocols, 26, 31

I
Inevitably, 101, 173 Infrastructure, 3, 11, 20, 49, 75, 81, 93, 101, 121, 152 Innovation, 9, 18, 48, 74, 76, 79, 86, 88, 111, 148, 174 Intellectual, 98, 152 Internet Access, 170

J
Jurisdictions, 38, 42, 159

L
Ladder of Infrastructure, 76, 85 Legislative Reform, 24 Long Distance Services, 166

R
Rationalize, 140 Regulation, 3, 10, 22, 30, 40, 53, 61, 70, 81, 90, 103, 112, 121, 140, 153, 165, 174, 176 Regulatory Framework, 25, 31, 47, 70, 87, 90, 102, 111 Regulatory Policies, 79, 122 Replication, 77, 95 Restraints, 38, 65, 121

M
Market Power, 3, 10, 31, 39, 51, 63, 71, 88, 130, 134, 145, 150, 171 Market, 3, 10, 20, 31, 40, 60, 70, 82, 90, 100, 111, 121, 131, 142, 150, 165, 171, 177 Maverick Supplier, 166 Monopolistic, 4, 11, 76, 86, 124, 130, 148 Monopoly, 10, 38, 40, 45, 56, 64, 86, 100, 111, 122, 142, 150, 172

S
Segmented, 102, 175 Stovepipe, 24 Structural Separation, 3, 12, 15, 20 Surveillance, 37, 46, 65, 69 Sustainable, 9, 13, 42, 53, 55, 62, 69, 76, 98, 103

N
Next Generation Network, 91 Numerous, 15, 59, 75, 110, 112, 140, 153

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TELECOMMUNICATIONS: REGULATORY CONCERNS

T
Telecommunication, 3, 13, 18, 140, 165 Telecommunications Services, 30, 75, 99, 102, 121, 131, 166 Telecommunications, 18, 22, 30, 39, 47, 52, 75, 84, 99, 104, 111, 122, 131, 147, 153, 165, 169 Telephone Companies, 28, 30 Termination, 37, 49, 51, 72 Traditional, 29, 39, 87, 89, 151 Trajectories, 3, 20 Transcendental, 26

Transmission, 7, 26, 32, 38, 57, 61, 117, 121, 151, 167, 170 TRIPS, 98, 110

U
Ubiquitous, 17, 28 Unbundling, 11, 45, 75, 91, 93, 95, 100, 122, 128

V
Value-Added, 18, 116, 121, 127

W
Wireless, 3, 8, 17, 31, 102, 113, 134 Wiretap, 30

Snapshot Telecommunications: Regulatory Concerns Significant technological innovations in the telecommunications sector and liberalization policies have encouraged the expansion of markets across the globe. The deregulation of market in turn has led to fierce competition monopolization and consumer vulnerability challenges have compelled the policy makers to adopt a balancing exercise between anti-trust and consumer welfare approaches. Even though the states are lured by the windfall of revenue out of auctioning of spectrum the present thinking is that the public policy must aim at presenting the ownership and control of outer space and more specifically the spectrum of sub serve the common good. In this direction the regulations take different postures on expanding the existing access network and preventing unfair competition in the markets.



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