Regulation vs. Competition in Telecommunications

Leopold Sögner
Department of Quantitative Economics, Vienna University of Economics and Business Administration
Leopold.Soegner@wu-wien.ac.at

Abstract

Standard microeconomics tells us that enforcing competition raises social welfare. Second we know form the theory of natural monopoly regulation that Ramsey-pricing will maximize your welfare function. This article tries to analyze a multiproduct enterprise producing in both, markets with competition and markets without competition. The latter ones are considered to be subject to regulation.

The article starts with a short survey of EU-standards concerning telecommunications. Thus, the first part analyzes the EU-directives concerning competition, cost accounting and regulation. According to EU-directives 95/62 and 92/44 regulating telephony and leased lines respectively, we can see that all non-competition tariffs have to be cost based. This simply means that prices have to be justified by means of a proper cost accounting system. Unfortunately the standards are not very detailed. This has lead to different cost accounting principles in different European countries reaching from simple methods to complex process costing schemes. Actually, this raises the important question of the information needed by the regulating authority in telecommunications.

The next topic deals with the need for an independent regulatory authority. Similar to standards concerning cost accounting, there is no detailed information within the directives how regulation should be done in practice. This means that there are neither standards concerning the degree of independence nor the method of regulation to use. In the next sections these questions will be considered from an economic point of view. The problems also go along with those of cross subsidization and efficiency of a multiproduct firm.

The second part deals with Ramsey-pricing in a multiproduct environment. In this artificial economy there is no competition which means that market entry is excluded. The social welfare function used in all the models is a simple utilitarian, which is the sum of aggregated consumer surplus and the firms' profits. Problems concerning social welfare functions and particularly the consumer surplus are excluded in all my models. Thus, I start with a simple multiproduct model including a one-dimensional technology and a one-dimensional effort parameter.

The maximization leads us to the well known Ramsey or Ramsey-Boiteux formula. The mechanism design or in other words the way regulation is done optimally, is excluded in the models. This may cause a crude assumption because moral hazard is unfortunatly excluded, but the emphasis of this paper is on competition in telecommunications. After that the model is used for a check against the above targets.

In a next step competition is introduced in the model. For simplicity I first assume that there are only two markets, one with competition and one whithout competition respectively. Second perfect competition is supposed, which excludes both collusion and all complications with oligopolies. The solution of this model provides us with a lot of insights into the effects of introducing competition.

In a next step a third product is introduced. This kind of product is also sold to the competitor. Now the problem of cross subsidization becomes very important. Therefore - from my point of view - this kind of model has a lot of empirical relevance. I.e. supplier could be considered offering terrestrial telephony, leased lines and mobile telephony. For simplicity consider that leased lines are only offered to other competitors. These competitors are running businesses in mobile telephony services. Thus, the regulatory framework becomes more complex, because the regulator should guarantee optimal tariffs in the non-competition goods.

In a last step the assumption of a one-dimensional effort parameter will be dropped, which actually means that the supplier can diversify effort in his most profitable way. Of course this generalization will lead to impacts on the regulatory framework, discussed in the last part of chapter four.

The fifth part compares European and Austrian standards with the results of the model. First, I use the model to check against the cost accounting standards. Second, prices of the second model are compared to that of the first one, raising the most important question whether competition increases welfare. Additionally the distribution of the consumer surplus and the profit gained in certain activities are compared. To get some stronger results I assume a CRS technology in the non-regulated sector, implying linear cost functions. The cost function used for the supplier of the regulated services is also linear and heavily related to activity based costing, which means that some subcosts may be observed by the regulating authority.

This article stops by showing some interdependencies between effort, competition, welfare and optimal tariffs. From these results we can gather some results why subcost observation may be rational and why detailed cost accounting information is necessary to avoid cross subsidization within a multiproduct firm. Second, the relationships between effort and optimal tariffs will result in a potential trade-off between socially optimal prices, competition and efficiency in the artifical economy considered above.