Managing the Telecommunications Sector Post Privatization
Administrando el sector de telecomunicaciones después de su privatización
Meeting Challenges with Successful Strategies

I would like to thank you for inviting me to address this group on the very timelyand relevant topic of "Managing the Telecommunications Sector Post-Privatization."
One indication of the scale of telecommunications privatization in developing countries is the fact that the sector raised $31 billion from privatization between 1990 and 1996 - more than any other sector of the economy and one-fifth of all privatization revenues. In some countries privatization has been followed by increases in the scope of telephone coverage and reductions in price. In other countries, the experience of privatization has been more disappointing. What explains the differential effects of privatization? And what can countries do to ensure that they reap the largest possible benefits from privatization? In my remarks today, I am going to argue that competition should be the single most important principle for telecommunications reform. Competition provides the incentives for greater investment and thus expanded service, greater efficiency, and lower prices. Technological advances have extended the potential for competition in the telecommunications sector. In too many countries, however, exclusive contracts and other less obvious barriers to entry continue to support a single private or public monopolist.
Even when these barriers are swept away, regulation will still be necessaryto ensure competition in the telecommunications industry.

TELECOMMUNICATIONS AND ECONOMIC PERFORMANCE

I would like to motivate my discussion of the ingredients of policy reform by briefly explaining why I think telecommunications is so important. In most countries, telecommunications represents only I to 2 percent of gross domestic product. But it is central to the Test of the economy, both in developed and developing countries. In banking and international finance, tourism and travel, commodity exchange, and in all export-oriented manufacturing, economic viability is increasingly dependent on global information and efficient electronic exchange. In a global information economy characterized by intense competition for new markets, telecommunications reform is a vital component of national economic policy.

Information has become a means for firms to identify new opportunities, seize new markets, and to satisfy new needs. Information is vital to corporate survival and it is critical to an economy's viability. In recognition of this fact, in the last two decades,telecommunications policy in many countries has been formulated in the context of far- reaching global strategies. In Great Britain, for example, a liberalized telecommunicationsregime was intended to support and augment London's role as an international financial center.
In the Netherlands national telecommunications policy was formulated to stimulate the development of electronic publishing and to promote Amsterdam as a point of access to Europe for international networks, in direct competition with London. A key objective of Australia's telecommunications policy has been to attract commercial traffic for Southeast Asia and to encourage financial services to locate to Australia.

Unfortunately, the means for being able to be productive in the new global
information economy are very unequally distributed. Both South Asia and Sub-Saharan
Africa have roughly 15 telephone lines per 1,000 people, compared to 640 per 1,000
people in the United States. As one would expect, per capita income is the most
important determinant of telephone coverage. What is remarkable is that fully 80 percent
of the variation in cross-country phone coverage can be explained by per capita income
alone. The binding constraint in most low-income countries is not demand but supply, as
evidenced by the 28 million people worldwide, almost all of them in developing
countries, on waiting lists for telephone lines. The average person has to wait roughly I
year for the installation of a phone line.

Policy, however, can make a difference in terms of coverage. In the last six years
countries as diverse as Malaysia, Vietnam, Jamaica, Hungary, and Sri Lanka have all seen
telephone lines expand rapidly - and even more rapidly than one would expect from their
income growth. Perhaps even more striking evidence for the huge differences in
efficiency and policy is the fact that the huge variation in the cost of local phone calls is
unrelated to per capita incomes. Before discussing what policy can do in order to narrow
these gaps, I would like to briefly discuss the implications of the changing technology of
telecommunications.

THE CHANGING TECHNOLOGY OF TELECOMMUNICATIONS

In the past, telecommunications was viewed as a natural monopoly. Most
countries took the position that the only, or at least the best, way to prevent abuse of
monopoly power was for government to operate the telephone system. The government
prevented the entry of competitors, allegedly on the grounds that would just wastefully
duplicate existing facilities or engage in cream skimming, thus inhibiting the
government's ability to provide service broadly at reasonable prices - often called
universal service.

There was, however, a marked discrepancy between the theory and reality. When
companies have no incentive for efficiency, they are likely to dissipate the economies of
scale in inefficiencies. Although governments claimed that only a monopoly could
capture the economies of scale and scope, many developing countries were paying a
capital cost of $4,000 per line - three or four times higher than the achievable costs.
Inefficiency and underinvestment meant that in all too many instances, universal service
meant universally lousy service, and little or no service to the poor or rural areas.

Low prices ensured low revenues and, given the government's budget constraints,
limited expansion. The low prices generated rents for those who had access. Access was
given by a political process, usually to the powerful, rich, and influential. The ability to
allocate scarce lines bred corruption. Thus, a system allegedly designed to help the poor
and protect consumers did neither. The lack of service inhibited economic growth, since
effective telecommunications is an essential aspect of infrastructure, and an important
complement to private investment.

In retrospect, the most important underlying cause of these problems was not
government ownership, but the lack of competition combined with ineffective
government regulation. In the Philippines, for instance, the private monopoly phone
company maintained low levels of investment and rationed lines in the face of excess
demand - a situation that did not change until the it looked as if competition was
imminent.

In the past, there may have been a technological basis for a single
telecommunications company - telecommunications was a classic example of a natural
monopoly. But today, changes in technology have provided the opportunity for - and I
would say even necessitated - a change in the way telecommunications services are
provided. Satellites have long provided a relatively low fixed cost option for long
distance service. But today, cellular phones, wireless local loops, and even television
cables all provide alternatives even for local service. These alternatives are even more
important in developing countries, many of which do not have extensive landlines. Sri
Lanka, for instance, has four cellular operators and some of the lowest cellular telephone
prices in the world. As a result, it added 56,000 cellular telephone lines between 1993
and 1996 - one-third of the additional lines and one-fifth of the total lines.

REGULATION AND COMPETITION

There is also a growing recognition that the extent of competition is influenced
not just by "natural" factors like technology, but also by government policy.
Technological changes may have undermined the natural monopoly in
telecommunications, but an effective regulatory structure is also required for vibrant
competition in this sector. Even the United States, which has the most competitive
telecommunications sector in the world, is not yet at the point where there is sufficient
competition that regulation can be put aside.

But the point of regulation should be to promote and ensure competition wherever
it is feasible. Indeed, not only is competition feasible in many, if not most, segments of
the telecommunications market, but with new technologies such as satellite telephones,
governments will be able to maintain their monopolies only with repressive measures.

A competitive telecommunications sector opens up a whole new range of
economic possibilities. It permits an enormous flow of private capital. The expansion of
telecommunications does not have to be limited by the current revenues of the
telecommunications monopoly, or the government's ability to borrow. Private capital can
fuel rapid expansion. Competition is also likely to drive down prices - increasing access
for the poor. In many developing countries, entrepreneurs have already demonstrated
their ability to bring telephone services to poor villages. A single phone can serve large
numbers of poor people. In Peru, for instance, Community Telephone Centers serve an
average of 640 low income customers, who use the telephone not only for emergencies,
such as fire and health, but also to search for jobs.

Not only do telecommunications companies in the more advanced countries stand
ready and able to provide these services, competition among these companies makes it all
the more likely that the developing countries will enjoy more of the fruits of these
innovations. But to realize these benefits, the developing countries must ensure that there
is effective competition among these international companies. Each company has an
incentive to try to persuade countries to give them an inside track. There are a variety of
ways in which they have tried to reduce the scope of effective competition.

PRINCIPLES OF REFORM

I believe that we can promote all of the basic objectives - lower prices, increased
efficiency, rapid expansion of services, more universal access, more diversity - by
establishing the appropriate reforms. Such reforms have several key ingredients:

First, there can be no grants of monopoly powers; but we should recognize that in
some segments of the industry, especially in the "last mile," the final interconnection
to the user, it may be some time before competition will arise on its own.

Second, given that there are likely to be important segments in which there is little if
any competition, it is important to have a regulatory structure which both protects
consumers - by making sure that firms with monopoly power do not exercise that
power to raise prices excessively - and that ensures that the monopoly power in one
segment (in the "last mile".) is not leveraged to achieve power over other segments.
Because abusive practices are hard to monitor, regulation may entail structural
separation (between the provider of "last mile" services and other services). Also, an
important goal of regulation should be to ensure access and interconnections.

Third, there is a need for a substantial increase in the levels of investment in
telecommunications infrastructure in many developing countries. These countries
should look to the private sector to provide that investment, and should seek to create
an environment which attracts that investment. An indispensable precondition for
sustained large-scale investment is the institutional capacity of those countries to
restrain arbitrary administrative discretion and to commit in a credible manner to a
stable regulatory process. Without government commitment to regulatory stability,
frequent changes in the regulatory regime can have the same effect as (partial)
expropriation of sunk investments. Private telecommunications operators that are
vulnerable to administrative intervention can be expected to invest less than the
optimal amount, and especially to make disproportionately low investments in
activities characterized by large sunk costs.

Fourth, international service providers and investors are an essential source of
services and financing for the telecommunications sector in developing countries.
Competition for international services and investment, however, is just as essential as
it is in the domestic market.

PRIVATIZATION, THE RIGHT WAY

Finally, there is still enormous scope for privatization. In Sub-Saharan Africa, for
instance, only 25 percent of the telephone lines outside of South Africa are "private." But
for privatization to be beneficial, it must be done the right way.

Private property and competition are the two essential ingredients of a market
economy. The order in which they are introduced, however, is very important. Allowing
private companies to compete with a monopoly state-owned enterprise can put pressure
on it to become more efficient and eventually could lead to its privatization. Both Ghana
and Uganda, for instance, have recently licensed a second national operator in all major
market segments prior to privatizing the government telecommunications company.

But while competition may well lead to privatization, the opposite is not true. To
the contrary, a privatized monopoly will often attempt to use its money and political
influence to stifle reforms, especially ones that threaten to introduce greater competition.
The result will be that rents are transferred from the public sector to the private sector,
with little gain in efficiency, lower prices, or broader service.

This consideration suggests several important principles for privatization:

First, It should be preceded by the establishment of an effective regulatory structure,
along the lines I have just described, to ensure that competition is maintained and
that, so long as competition is limited, there is not monopoly pricing.

Second, wherever possible it should be preceded by the introduction of greater
competition, possibly through the extension of licenses to new private companies or
by splitting up the telecommunications company.

Third, it may be easier to introduce competition by privatizing only part of the
system. Especially promising are moves in some Sub-Saharan African countries to
try to enhance competition by contracting for the purchase of commodity-like aspects
of the system, e.g. lines.

Finally, regulations need to ensure that privatization and monopoly power, whether
exercised by the state or privately, does not restrict diversity. (Regulations may entail
ownership restrictions, again because practices are hard to monitor.)

These measures should precede privatization not just to ensure a more efficient
telecommunications sector, but also in order for the privatization process itself to proceed
smoothly. In the absence of regulatory certainty, the government will not be able to
attain a fair market value for the assets; potential purchasers will insist on a risk premium
to compensate them for bearing this regulatory risk. Also, a change in regulatory
structure may be viewed as a partial expropriation, and thus adversely affect the
investment climate. The political economy consideration I discussed above, that it is
politically easier to introduce competition in advance of privatization, strengthens these
arguments.

IMPLEMENTING TELECOMMUNICATIONS REFORM

The basic principles - competition prior to privatization, and using regulation to
prevent the exercise of monopoly power in one part of a sector from being translated into
a stranglehold over another part of the sector - are very simple and very robust. Many
developing countries, however, have found telecommunications reform extremely
difficult. To be fair, we need to recognize the difficulties of the transition problems.
There are rents associated with the existing monopoly, and these rents often go to the
politically powerful, and some of the rents may even go to finance government activities.
The price structures also involve cross-subsidies, although often the politically connected
and urban dwellers benefit, not the poor and rural inhabitants that are supposed to. There
is a strong argument that the government revenues should be raised in a more transparent
manner, e.g. taxes, and that underserved groups would benefit from direct subsidies,
which are also more transparent as well as being better targeted. Putting these taxes and
subsidies "on budget" reduces the likelihood of funds being diverted for nefarious
purposes.

I do not want to underestimate the importance of transitional issues, but neither
should they be a barrier to change. At the very least, one needs a transition strategy. An
essential ingredient of such a strategy is to allow immediately the entry of "value added"
services, such as cellular telephones - services not now often provided by the parastatal
monopoly. These new value added services can rapidly extend telecommunications to
previously underserved areas. Moreover, the evidence is that these new services are
complements of old line services; they enhance their profitability.

There are, in addition, interactions between the various parts of a successful
transition program: the revenues generated in the process of privatization and by
spectrum auctions may provide revenues to finance the transition and, specifically, to
address another transitional problem that is sometimes raised, stranded costs.

But for most developing countries, the transition costs are small compared to the
gains from pursuing an aggressive telecommunications policy. Given the low levels of
investment, with the vast majority of citizens currently unserved or underserved and with
few enhanced services available, the developing countries will experience relatively little
disruption and other transition costs from adopting aggressively pro-competitive national
policy frameworks. There is every reason to believe that such policies will lead to more
investment, more and better service, and lower prices. And because of the strong
complementarity between telecommunications and other investment, it will stimulate the
overall growth of the economy.