Dialogue: Less time spent arguing is more time on the phones

JOHN SMALL* says the recommendations of the telecommunications inquiry are good news for consumers and not all bad for Telecom.

The final report of the Ministerial Inquiry into Telecommunications makes recommendations about the terms on which a wide range of electronic communications services are supplied.

Most of these recommendations are refinements of the light-handed regulatory system New Zealand has used for the past decade. They are aimed at clarifying the ground rules for competition in this most dynamic of industries. If implemented by the Government, these recommendations will help the industry to focus more on the design and marketing of services while spending less time and energy wrangling over the agreements on which these services depend.

The inquiry has also recommended a stronger form of regulation for a small but crucial set of services. Opponents of this proposal have argued that regulation is not justified and say that the industry is already competitive.

This argument probably seems compelling to many people, but it is quite wrong. The fact that we have alternative suppliers of toll calls, for example, tells us nothing about whether the price of toll calls is unnecessarily high.

To understand this point, consider one of the most famous errors ever made by a court. Back in 1956, the United States Supreme Court was considering a case involving cellophane sold by DuPont. The court effectively ruled that DuPont did not have market power in the supply of cellophane because alternatives to cellophane were widely available.

In fact, DuPont had a monopoly on the supply of cellophane and, like any sensible firm in that position, had kept the price high for many years. Because the price of cellophane was so high, entrepreneurs were able to begin selling inferior alternatives, such as waxed paper, pricing these just below the monopoly price of cellophane.

The Supreme Court's error, now known as the cellophane fallacy, was to infer that Dupont lacked market power in the supply of cellophane because it had competitors.

A similar error is now being made in comments on the telecommunications inquiry report. Telecom clearly does have market power in the supply of access through the copper network. Naturally, it uses this power in setting the prices that its rivals must pay to route calls through the network.

This "access" price is an unavoidable cost to Telecom's rivals and must, therefore, be recovered through retail sales. So all retail prices are higher than they would be if Telecom's access prices were regulated.

The fact that we can choose a firm other than Telecom for our toll calls is incidental to the main issue: all of these companies have unnecessarily high costs.

The inquiry's recommendations are not all bad news for Telecom, however. None of the high-growth areas of the firm's business, such as its mobile phone and ISP operations, will be subject to price control if the inquiry's recommendations are implemented.

These have always been the areas on which the company's future profitability depends, and the proposed regulations do not alter that fact. Nor do they in any way compromise Telecom's ability to compete. Rather, they effectively recommend the removal of the subsidy that Telecom receives from consumers through its control of the network.

As New Zealanders well know, economic transitions are painful. The structural adjustments made in the 1980s by the rural community were caused by the removal of subsidies to farmers. At the time, many questioned the wisdom of forcing these changes on the industry that formed the backbone of the economy. Farmers, to their credit, accepted the challenge and have survived very well.

Many people predict that electronic communications will form the backbone of the economy in the future. Because of this, it is vital that our policies promote the creation and uptake of existing and new electronic communication services.

The inquiry has recommended a full set of measures that serve this purpose, and price control is a small but important part of the total package. Telecom understandably does not like this aspect of the proposals, but, just as the farmers did, it will be able to adapt and prosper in the new environment.

* Dr John Small is the director of the University of Auckland's centre for research in network economics and communications.