Telecommunications Reform
by Ksenia Yudaeva

T he Russian government wants to develop the telecommunications sector, mainly through centrally funded and regulated projects, while foreign and Russian experts believe that Russia could converge with the industrial countries more rapidly through market methods, that is, liberalization, competition, and cost-related pricing. China’s positive experience in this area should be instructive to Russia as emphasized during a roundtable organized by CEFIR.

During the last three years the number of telephones in Russia has been increasing by about 3.2 million per year. The telephone penetration rate has reached 26 percent, which is comparable to the level in the CEE countries, for example, 23 percent in Montenegro and Serbia, 26 percent in Slovakia, 27 percent in Lithuania, and 29 percent in Poland, although it is still well below the 70 to 90 percent level in the industrial countries. Dmitry Milovantsev, Russia’s deputy minister of communication and information, presented these figures during the conference on Designing Russia’s Telecommunications Regulatory Reforms: Theory and International Experience.

Mixed Results

According to Milovantsev, the overall volume of sales in the sector in 2002 exceeded $8.5 billion, and independent providers of new services, such as mobile telecommunications and Internet services, accounted for more than half this amount. Indeed, the mobile telephone penetration rate in Russia is now similar, or even higher, than the penetration rate of traditional fixed-line services. The mobile telecommunications market is becoming increasingly concentrated in the hands of three federal providers—MTS, Vympelcom, and Megaphon—which now control about 80 percent of the market. Regional expansion of these companies has resulted in a massive fall in mobile telecommunications prices and a sharp increase in the number of subscribers.

Internet provision is still small—only 8 percent of the population has Internet access—but it is growing: in 2002 alone the growth rate was 39 percent. The government is establishing public centers for Internet access. The new Law on Communications includes Internet provision in the list of universal services, and communities with a minimum population of 500 are entitled to receive public Internet connection centers.

In 2002 the fixed-line industry was reorganized, and seven new interregional companies were formed. In relation to the number of telephone lines, these companies are comparable to companies in other countries, but their market capitalization is small by international standards and foreign investors are staying away. To change this trend the companies need to improve their efficiency, reduce their costs, and lower the amount of cross-subsidization of local calls from long distance call revenues. The latter has been taking place to some extent during the last three years: the prices of local communication services increased 1.7 times, while long distance prices decreased by 15 to 30 percent in real terms. However, the government would like to retain some level of cross-subsidization, and this is why it insists on retaining the monopoly of Rostelecom for long distance services. This is part of the Russian bargaining position at the WTO accession negotiations currently taking place.

The new Law on Communications guarantees nondiscriminatory interconnection access to all operators and rules that interconnection rates are state regulated. The law also stipulates that universal services be provided at an affordable price on Russian territory, and this is to be subsidized from a reserve fund that will pool special nontax contributions by all telecommunication operators. Under the universal services provision every Russian citizen should have access to a pay phone within an hour’s distance. According to Milovantsev, the government believes that the government- implemented universal services plan will allow Russia to reach a level of telecommunications infrastructure in three to four years that would not be possible for 20 years using market solutions.

Regulation or Market?

Peyton Wynns of the U.S. Federal Communications Commission expressed some skepticism about regulators’ ability to outperform the market. In his paper "The Limits of Economic Regulation: The U.S. Experience," Wynns argues that entry, exit, and pricing regulation is usually complicated and tends to benefit incumbent firms while slowing down the introduction of new technologies and new business strategies. A notorious example of the effect of regulated monopoly market structure on the introduction of new technologies is that even though the fax and answering machines were invented in the early 1900s, they were not introduced until the production of terminal equipment was separated from telecommunications service providers.

U.S. experience shows that cross-subsidization, on which the Russian government is so keen to rely, usually does not help bring service to small towns or increase penetration rates. When cross-subsidization was abolished in the United States after the breakup of AT&T, the penetration rate rose from 91.4 to 93.3 percent. In Russia, where families are often geographically dispersed, the demand structure may be similar. Moreover, new technologies such as mobile telecommunication may be more suitable for bringing telephone service to small and remote locations than pay phones, so technologically the government’s universal services plan may not be the most efficient. U.S. experience also suggests that direct subsidies for providing services to small communities are a more efficient and less costly solution than cross-subsidization.

George Rozanski of the U.S. Department of Justice agreed that U.S. regulatory agencies had difficulties finding effective ways of regulating domestic telephony. Regulation remains costly and burdensome and results in highly inefficient outcomes. Regulation proved to be a little more successful in international telecommunications. The current market structure of the Internet seems to reach an efficient outcome without intervention by regulators. Structural merger policy, which prevents the creation of monopolies, is an effective substitute for regulation in this sector.

The European experience in regulation and competition policies in the telecommunications sector leads to broadly similar conclusions to those drawn from American experience, according to Gerard Pogorel (Ecole Nationale Supérieure des Telecommunications, Paris), David Salant (Nera Group, Economic Consulting) and Luis Cabral (New York University), who discussed the issue of state regulation of standards, a problem that is especially relevant to the area of wireless telecommunications. U.S. and EU approaches to regulation of this area are sharply different. The United States relies on market solutions, while the EU stipulates a mandatory standard. The tentative conclusion from the papers presented is that a market-based solution can lead to an economically more efficient outcome in the long run, while mandatory standards may result in faster sector development in the short run.

The Chinese Case

Several WTO specialists criticized the government’s plan to maintain the Rostelecom monopoly for long distance and international services until 2010. Peter Cowhey of the University of California in San Diego pointed out that data transmission, not voice services, is becoming the largest and most important kind of telecommunications service. Delays in the liberalization of service provision may slow the development of the commercial data transmission infrastructure, causing problems for the development of the Russian economy as a whole.

Jonathan Aronson of the University of Southern California stressed the importance of liberalizing telecommunications by looking at the effects of China’s WTO accession on its telecommunications sector. In the 1970s China’s telecommunications sector was underdeveloped. The penetration rate was around 0.43 percent and international connections were available in only a few cities. In 1994 two companies were established to compete with the dominant operator, China Telecom. In 1999 China Telecom was split into four separate corporations: China Telecom, China Mobile, China Paging, and China Satellite. In 2001 China Telecom was further split into regional companies. At the same time the Ministry of Information Industry gave special attention to fostering the development of China Unicom, China Telecom’s main competitor. Because of WTO accession, in December 2001 telecommunications companies were opened to foreign investment. Foreign investors are required to form joint companies with local providers. Upper limits on foreign shares differ for different locations and types of services, but nowhere do they exceed 50 percent.

The restructuring program had an enormous effect. Between 1995 and 2002 the fixed-line penetration rate more than tripled and is expected to grow by more than a factor of five by 2005. The cellular penetration rate closely follows the fixed-line penetration rate. Prices for long distance and international services have fallen sharply and are now comparable with prices in the industrial countries. The Chinese example suggests that more aggressive liberalization and introduction of competition in the sector can produce better results than keeping a state monopoly on long distance services and cross-subsidizing government-regulated universal services provision

Ksenia Yudaeva is policy director and senior economist at CEFIR and a scholar in residence at the Moscow Carnegie Center. Other papers presented at the conference can be found on CEFIR’s web site at http://www.cefir.ru.