How Reding’s ‘nuclear option’ would damage a booming telecoms sector

Article published in the European Voice on July 3, 2008.

Hundreds of billions of euros will be invested in European telecoms over the next few years. Members of the European Parliament voting on the Reding proposals in July should consider whether her “nuclear option” does not risk inflicting serious damage on a booming but brittle, and economically crucial, market.

One of the more unfortunate reforms of late-Thatcherism was to separate the newly-privatised UK railway companies from responsibility for building or maintaining track. The measure theoretically aimed at encouraging competition. But it had unintended consequences, still largely unresolved.

This has not discouraged Viviane Reding, Commissioner for the Information Society and Media, from proposing to deploy what she herself calls « the nuclear weapon » of breaking up former telecoms monopolies throughout the EU. She wants to give national regulators the power to split these into two distinct entities as was done voluntarily by BT in the UK, under pressure from Ofcom.

One new authority would be responsible for managing network infrastructure, and the other for retail services. This reform could seriously disrupt investment in an area which is plainly crucial to the wider European economy.

When monopolies were abolished more than a decade ago operators had to lease parts of their networks to new entrants to the market. This enabled the latter to provide telephone and Internet services without the need to replicate the full infrastructure. There was however little incentive for the former monopolists to provide competitors with services of the same quality as the incumbents use themselves.

Regulators tried various methods to break the logjam, including quality control of wholesale services. In most countries where such measures have been imposed judiciously, they have provided for the emergence of alternative operators sufficiently dynamic to invest in setting up their own networks and to compete directly with the former monopolies. One such example is that of Free in France.

Some legislators like Viviane Reding believe we should go further to prevent discrimination from former monopolies. The weakness of the « functional separation » model she now proposes is that creating fully separate divisions will in practice discourage investment in infrastructure, notably in the fibre-optic network which is set progressively to replace copper in connecting homes to telephone switches.

The deployment of “fibre to the home” (FTTH) is not something that happens automatically. No operator will invest until the sales prospects in a given area are promising enough to make the investment profitable in the longer term. But creating a new artificial structure in charge of the network inevitably breaks off coordination between investment decisions and marketing imperatives for retail services.

What are the incentives for this new entity, such as Openreach in the UK, to make these colossal investments when it will have to share them with everyone? Conversely, the new entrants see less need to invest in their own network – as Free did in France to compete with France Telecom – if they can always rely on the investments made by the network operator.

The record so far is disturbing, though hardly surprising. The deployment of FTTH in the UK is lagging behind several countries such as France, Germany, the US and Japan.

Disregard market logic and the long delays associated with a bureaucracy are inevitable.

Moreover proposing a new monopolistic entity runs directly counter to the arguments used to justify opening telecoms up to competition in the first place. This will also postpone indefinitely replacing sectoral regulation with general competition law, a principle at the heart of the European framework.

Hundreds of billions of euros will be invested in European telecoms over the next few years. Members of the European Parliament voting on the Reding proposals in July should consider whether her “nuclear option” does not risk inflicting serious damage on a booming but brittle, and economically crucial, market.

Martin Masse is an associate researcher with the Institut économique Molinari in Brussels and Paris. He was an adviser to the Canadian minister of Industry on telecommunications issues in 2006-2007.