The conflict between the European Union’s policies regulating the telecommunications industry and its long-run vision of the information society was the central theme of a lunchtime meeting organized by CEPR at ECARE, Université Libre de Bruxelles, on 26 June. Paul Grout suggests that present and proposed EU regulation will hamper progress towards an information superhighway and slow down the convergence of networks since it is not in sympathy with the wider vision. He argues that the EU should be more positive in encouraging wider pricing flexibility while retaining transparency, should attempt to reduce member state discretion and ensure the appropriate application of EU competition rules, rather than favour simple pricing rules. Paul Grout is Professor of Economics at the University of Bristol. His talk was based on his article ‘Promoting the Superhighway: Telecommunications Regulation in Europe’ in Economic Policy No. 22.

Telecommunications and electronic information transmission is one of the most dynamic and innovative industries today. Network costs and conveyance prices are declining rapidly and volumes are growing as the industry continues to displace alternative forms of transmission and entertainment. Yet, despite the rapid innovation and development, the market is one of the most closely and heavily regulated.

A European superhighway will not happen overnight. Instead, it will develop over time as the market tests products, discovers the potential scale of interest and is led by public demand. For this to happen smoothly there will have to be a transition, through the supply of more and more sophisticated value added services. Initially, for the majority of users this will be on existing networks. Those products that succeed will develop the demand for additional bandwidth amongst consumers and help point the way forward for future investment. Legal and regulatory restrictions can either ease or hinder this process.

A key feature of telecommunications is the presence of fixed and common costs that have to be recovered across a range of services. Some products are able to bear a significant contribution whereas for other products the market will be destroyed if they have to carry the average share. There is a wide range of services which are technically viable but economically very sensitive to market prices. Clearly, flexibility in pricing is essential if convergence is to be achieved and value added products are to develop rapidly on basic networks. In this sense pricing flexibility brings a very long-run external benefit, with international spillovers, that goes far beyond the short- and medium-term benefits to each member state associated with telephony pricing.

Recent and proposed European regulation is, however, moving the community in the opposite direction. For example, Article 12.2 of the recent directive of the European Parliament on Open Network Provision (ONP) states ‘Tariffs for access to and the use of the fixed public telephone networks shall be independent of the type of application which the users implement, except to the extent that they require different services and facilities’. Each member state can interpret this as it sees fit and it is clear that a narrow interpretation could hinder the development of value added services. In addition, the EU is favouring uniform mark-ups on services to cover the fixed and common costs, which also operates against pricing flexibility.

The regulatory process proposed by the EU provides little harmonization, since the speed of development in each member state will depend on their interpretation of the regulations. A wide interpretation of Article 12.2 will favour progress on the main networks while a narrow interpretation will lead to limited development of new services and the fragmentation of provision as operators attempt to bypass the consequences of the regulation by using private circuits and other arrangements. A more sensible option would be to simultaneously encourage flexibility in pricing and to limit the scope for variance between member states.

Clearly there are limits to the flexibility that should be permitted. One must have non-discrimination to avoid a national regulatory authority protecting its own operators and social objectives are likely to involve some degree of cross subsidy between customer types. In addition, European Competition Law already imposes restrictions on pricing flexibility.