TCS Daily


The Worm Turns

By Guoda Steponavicien - May 6, 2005 12:00 AM

EU Competition Commissioner Neelie Kroes argues that antitrust and state-aid regulation in EU countries must be reinforced in order to spur competition. The same idea is rather widely elaborated in the revised Lisbon Agenda for growth and jobs.

True, increased competition is always beneficial for consumers, market development and the general well-being. However, this is only if one is referring to natural, not artificial, competition -- when companies compete for consumers and their money by offering the most desired services at the lowest possible prices. To be sure, some suppliers are more successful in this struggle and gain a bigger number of consumers; some are less so and have only a small market share. Remember that market shares are constantly changing and no victory is ever final. This is especially true of fast developing services such as telecommunications. A popular new service, technology or scheme of payment can substantially change the range of leaders, despite the efforts of the regulator and without an infusion of taxpayer money.

Mistrust of market competition is often fueled by the fact that some operators gained their market share at a time when competition was legally restricted due to monopoly rights granted to one player. This incumbent operator (as a rule -- in fixed telephony) enjoys a competitive advantage due to historical legacy. As in all other sectors, a concept of dominant operator is used. Domination in the market (according to the EU's competition legislation, this means having 40 percent of the market share) implies additional obligations towards other market players -- compliance with which is closely controlled by the regulator.

The present paradigm of telecommunications regulation in the EU could be called a concept of "efficient competition" based on ex ante regulations of so called SMPs -- operators holding significant market power. A business is considered to be an SMP "when either individually or jointly with others, it enjoys a position of economic strength affording it the power to behave to an appreciable extent independently of competitors, customers and ultimately consumers".

From a technical point of view this change in competition policy from dominant to significant market power could be considered merely a reinforcement of the former principle. Seeking to avoid abusive behavior of overly strong market participants, only one operator (or their group) was regulated before; under the SMP scheme, several operators are seen as being able to abuse consumers and thus are regulated. However, from an economic point of view this is a fundamental change in competition policy.

First of all, it diminishes a popular argument about the unfair starting conditions of the incumbents and other operators: now, every market participant, even the newest one, can be recognized as a potential abuser and thus restricted. Second, significant market power, as compared to dominant power, is a rather softly defined concept, which leaves the decision to the regulator. Third, while the obligation for the dominant operator in essence used to be its price control (the so called price cap), for the SMP it also means its activity control: obligation to connect to the infrastructure, obligation of non-discrimination, obligation to proof costs and so on.

All of this raises two major questions for the present framework of telecommunications regulation policy and practice: first, why to regulate and, second, what undertakings to regulate.

As the framework directive describes, the goal of regulation is "to ensure that users derive maximum benefit in terms of choice, price and quality; ensure that there is no distortion or restriction of competition in the sector, encouraging efficient investment in infrastructure and promoting innovation and encouraging efficient use and ensuring the effective management of radio frequencies and numbering resources."

The last goal, no doubt, should be in regulators' hands. However, in a market economy most of other goals used to be pursued by companies competing for the consumer. By definition, the goal of every economic undertaking in the market is to ensure maximum benefit for the user and efficient allocation of resources (investment, innovation). As for distortions and restrictions of competition, it is not clear what these might be. If we talk about legally granted exceptions (like monopolies) or legal restrictions on innovations, the regulator's obligation is to identify them and take them away. However, if market distortion is understood as natural differences of the market share, then we have an artificial market.

Services are never identical in an actual market and can't be so. So are benefits for users. Measure the benefits of different user groups over different time spans, and they all will differ. No one can achieve ultimate maximum benefit -- there is always a trade-off between immediate and future achievements, between favoring one or another type of clients.

Free competition in the market ensures distribution of these trade-offs: some operators prefer cheap and simple services to reach a large number of customers; some, investments to enhance the quality of services the next year; others, innovations in entirely new technology which (at high risk) will pay back in the long run. When the regulator steps in and starts "organizing" competition, the trade-offs are distributed according to the regulator's view and ability to measure. As in all cases of administrative distribution, the ability to measure is based on averages. Therefore, firstly, an artificial evening out of the operators' behavior is unavoidable. Secondly, some types of users can be entirely at a disadvantage. The first consequence leads to less choice for consumers, weaker competition and slower development of the market. The second consequence is just unfair.

According to the SMP definition, efficient competition is not in place when an undertaking or a group of them can act independently from competitors and consumers. This definition looks simple and even logical. However, if we look at the criteria for SMP recognition, we end up where we started: competition is when companies compete in the market...

SMP recognition is closely related to the definition of the market. According to the recommendations of the European Commission, 18 separate markets are distinguished in electronic communications. Each of these markets is analyzed by national regulators and SMPs are named for each of the market. This differentiation of the electronic communication market is another feature betraying the artificial nature of such reasoning -- do consumers buy e-communication services from x or y number of markets? Do suppliers engage in z different fields of activity? No, both consumers and suppliers simply communicate electronically in this world around us, while the regulators under detailed EU-wide regulations construct an alternative world with numerous sub-markets and trace each sign of domination through them. It may be appropriate for a post-modern virtual thinking, but economically it is infeasible

Those who have not forgotten yet the taste of a real apple should also remember that real apples sometimes have worms. A worm in the apple is not a pleasant surprise. But no consumer of real apples would think to report to some state agency blaming the gardener for this worm. It's because consumers have a choice -- a good-smelling apple with taste, though not perfectly round, red and whole; or a round, red and whole apple, but entirely artificial. Those who have ever tasted a real apple and understand the choice, vote for the former.

The author is Vice-President of the Lithuanian Free Market Institute.

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