CHAIRMAN REED HUNDT FEDERAL COMMUNICATIONS COMMISSION INSTITUTE FOR INTERNATIONAL ECONOMICS Washington, D.C. October 23, 1996 As prepared for Delivery I thank Fred Bergsten and the Institute of International Economics for inviting me to join you this evening. As a major center for research on international economic policy the Institute deserves credit for its many innovative proposals, including the promotion of APEC. Tonight I would like to present the concluding speech in a trilogy entitled "To Build a Global Information Economy and Community". The ideas are conventional economics. The iconoclasm is only their application to telecom. As you might expect, speeches in the trilogy. This also is a conventional approach to a trilogy: have three speeches. The first was informally known as "If Six Were Nine, I wouldn't mind." The theme was that optimal communications policy can best be determined by ascertaining existing traditional policies and then doing the precise opposite. The second speech was about development; and I gave it in Hong Kong two weeks ago. The theme was that the existing methods of building the global information network are by and large dysfunctional at best and pernicious in many cases. They should be junked; or more precisely we should rapidly abandon the accounting rate and monopoly regimes. Today I want to talk about the reformation and revitalization of global interaction so as to permit us to build, as a world community, a global information initiative that will fulfill the dreams of many leaders and thinkers, including but not limited to Bill Clinton and Samuel Morse, Al Gore and Jules Verne, Jacques Santer and George Gilder. As glad as I am to be here, I am told that I am first telecommunications regulator (or deregulator) to address the Institute. Already communications is a $550 billion global industry which is building a vastly bigger information economy as surely as coal and oil built an industrial economy. So why wasn't I invited before? One answer is that telecommunications policy is shrouded in opaque jargon, overwhelmed by false assumptions about natural monopoly, and paralyzed by the vested interests of those committed to the status quo of statism and entry-prohibiting regulation. Another answer is that the acronyms of telecom are just too daunting. Who wants to discuss ADSL,ATM, HFC, IXC, and LEC when you could talk about world trade in terms of auto parts, chips, and roses? And a third answer is that telecommunications policy did not deserve your attention, perhaps until recently, because telecommunications policy people were in cryogenic suspension. We were in a kind of long Midsummer's Night Dream in which we imagined technology policy, economic policy and development policy to be distinct disciplines-- unrelated and inapplicable to each other. Now Titanic changes in network economics and technology are permitting us to get to the Bottom line truths of our policy area. Microsoft has a bigger market capitalization than General Motors. Netscape goes from a garage to a market cap of $4.2 billion. These stories are the history in the making of the 21st century business schools. Without doubt, Bill Gates is the Henry Ford of the information age, although he is a Henry Ford who started by inventing the high cost, high end Lincoln instead of the everyman's Model T. These companies prove, among other things, that networks make wealth. These networks can be any of the five lanes of the information highway: cable, wireless, wire, satellite, and broadcast. All five happen to be in the FCC's jurisdiction. So, if you will permit me a reduction to the point of absurdity, the FCC chairman has the best job in Washington you don't have to get elected to. We are wealth creators. Indeed, we even make money for the US Government. Our auctions of airwaves have raised $25 billion, which actually literally puts us in the Guiness Book of World Records, and makes me the most profit-generating government official since, I think, Genghis Khan. Maybe that's a poor analogy. So we are now bent on building modern, efficient, low cost, high volume networks here in the U. S. It is commonly believed around the globe that if you want your economy to be competitive, and if you want to attract investment, then you need a world class communications network. That is true, according to a MCI/BT survey of business leaders who ranked telecom infrastructure among the top three critical factors for where to invest. Is it a difficult job to get yourself a modern network? Is it like Captain Picard on the new Star Trek (which is already the old Star Trek, my kids tell me) who issued orders by simply saying "Make it so?" And perhaps these networks can just be built by the say so of a few captains of commerce. The Economist magazine, for example, blithely reports that modern communications has erased time and distance. How nice! Make it so! Yet what is often overlooked is that the wonders of fiber and switches are, while declining in cost, nevertheless nonexistent for the greater part of the planet. More than 2/3 of the people in the world have never made a phone call. About half are a day's walk or more away from a telephone. To build a network that in fact would serve all the people of the world is a colossal undertaking. The Pyramids, the Boulder Dam, even the office towers of Shanghai are nothing compared to this effort. The World Bank estimates that more than $300 billion must be spent to build even a rudimentary global communications network. World policy assumes this network is a necessity for world development and then, more or less, advances no sensible solution for the construction of that information network. There is an existing solution. It just isn't a sensible one. It is to impose a subsidy scheme, a tax if you don't mind the word, on international telecommunications traffic in order to obtain the hard currency necessary to build domestic networks. The international telecommunications market is about $60 billion. Over $40 billion of those revenues -- a fairly staggering percentage --might be the subsidies. They go to telephone companies at the end of the call. No one really knows how much is subsidy. The system is hardly measured, much less monitored. At this rate, if the subsidies were used well, in about ten years we could have a worldwide communications network. That might constitute a rational policy for building what Vice President Gore called, in a brilliant speech in Buenos Aires two and half years ago, the Global Information Infrastructure. But it doesn't because the subsidies don't go to a common pool, aren't distributed according to any fair system, aren't necessarily used to build infrastructure, aren't equitably paid in by the world community, and can't continue because we at the FCC won't let U.S. consumers continue to pay the disproportionate part of the subsidies. Already our consumers are paying more than 10% of the subsidies and that percentage is climbing. Indeed American outpayments in the international telephony business, said to be necessary for world telco development, are now up to $5 billion, dwarfing our country's nonmilitary foreign aid budget of less than $2 billion. And even using very generous measures of costs, we are paying countries like Japan close to $100 million per year in subsidies. In our long dream at the FCC we have been fixated overwhelmingly on domestic markets; I suppose it is still true that we focus here at home. But we did so to the detriment of the $60 billion international telecommunications market. that market should be vastly greater than it is in both volume and revenue, and unit prices should not be the average of 99 cents a minute that prevails for U.S. calls to the world, but a number somewhere between one tenth and one fourth that amount. And U.S. prices are low compared to those in the rest of the world. I draw these predictions from, among other sources, the last ten years of competition in long distance in the U.S. where intrastate long distance revenue has increased 78 percent as a result of competition. Intrastate revenue has increased at one and one-hundredth that rate. A genuinely efficient telecommunications network would provide low cost, high capacity services anywhere in the world. We don't have it today. Even in the United States the cost of a minute of domestic long distance service averages about 15 cents per minute. The price could be even lower but we have not yet reformed the charges paid by long distance carriers to local carriers for the completion of a call. The average cost of a minute of international service is over 90 cents. Our FCC studies reveal no reason for the vast difference between the level of domestic and international long distance prices except the absence of competition. We need competition on services between countries. Ultimately we need competition in every country. Otherwise, monopolists will at minimum reduce the efficiency of the global network. (Right now monopolists control 94% of the market outside of the United States.) At worst, when they are from large markets, they can leverage their monopoly at home into anticompetitive behavior in world markets. Take the case of Hong Kong. Hong Kong Telecom (a subsidiary of Britain's Cable and Wireless) has numerous rivals in the domestic phone services market, but it retains a monopoly on international traffic. It charges local Hong Kong customers far more to place a call to the U.S. than it does for U.S. customers to call Hong Kong. Unsurprisingly, Hong Kong customers are flocking to so-called callback services which use technological wizardry to convert Hong Kong calls to the United States into cheaper calls from the United States to Hong Kong. It used to be that the U.S. made two minutes of calls to Hong Kong for every minute from Hong Kong. Now, due largely to callback, the United States sends seven minutes of calls to Hong for every minute received. The Hong Kong tale might simply go down in the annals of unanticipated consequences, but Hong Kong Tel charges U.S. carriers 45 cents for every minute of traffic that they send to Hong Kong. What would be the real cost of terminating these calls in a competitive market? Something closer to 7 cents! And then, Hong Kong Tel's parent company, Cable and Wireless, wants its U.S. telephone subsidiary to serve Hong Kong without restrictions. This means that Cable and Wireless could use its profits from terminating US traffic in Hong Kong to subsidize its market entry in the United States. To be fair to Hong Kong it is a lot better than many other monopoly markets. In 1995 U.S. carriers made a net outpayment of $5.5. billion to foreign carriers for terminating U.S. calls. This figure would drop in half overnight if American carriers simply paid fees even vaguely related to costs. Worse yet, restrictive regulation and monopoly have created an industry divorced from modern marketing and product innovation. No one in the ranks of traditional telephone monopolies seems to have heard about McDonalds: cut the price by 70% from traditional levels and watch the "McCalls" skyrocket. The $60 billion market for international phone services should be $80 or $100 billion, and consumers should pay 50 to 90% less for the service. But we haven't, until very recently, even clearly set the goal of driving the growth of the international telecommunications market. And we haven't,until recently, set ourselves the task of figuring out how the worldwide network -what Nathaniel Hawthorne called the 'great nerve of intelligence" would be built. Hawthorne was writing of course about the telegraph. Note that it did not become the universal medium of communication. That was ultimately because of the age old bugaboo of all dreams: price. A telegraph call through the 19th century cost about a dollar a word. At that price intelligence was too dear for pretty much anyone. And at today's prices of a dollar a minute for international voice traffic, communications is too dear for the planet. To build the global information highway we need to lower price, and watch volumes soar, and as they go up, the networks will be built to accommodate those volumes. In our slumber, not only at the FCC but in other similar institutions worldwide, we tolerated the cartelization of world communications markets. Government regulations decreed that an international phone call should be supplied jointly by two national phone companies. These decrees propped up a cartelized international market structure whose rules are so arcane that they deter scrutiny by experts on international trade and investment. In 1945 American policymakers championed new international arrangements for managing global security and the world economy that blended Wilsonian idealism with a large dose of power politics and domestic politics. They charted the way to practical compromises that launched the world toward creating open, competitive international markets. But international economic arrangements erected after the war also left in place pockets of protected, non-competitive sectors in two important respects: First, the international economic arrangements integrated the world economy through free trade in goods, but rejected free trade in services, in the free flow of investment and in financial matters. In short, they implicitly bifurcated the world economy. The free trade understanding of 1945 granted access to the U.S. market in return for opening imperial trading blocks on a sweeping basis to U.S. exports. However, until the Uruguay Round the GATT virtually ignored the largest single part of the world economy, the services sectors, which even in 1940 employed about half of all Americans. Today, the number is around 75%. This bifurcation reflected a New Deal philosophy that deemed competition to be an unreliable vehicle for advancing the public interest in regard to transport, power, and communications. Regulatory policies cross-subsidized selected groups of consumers, especially in rural America, and unionized labor in the regulated industries, while limiting competition and favoring incumbent suppliers. Second, in international institutions, competition policy took second place to other priorities. At home in the United States the New Deal had resolved the question of how to reconcile economic efficiency and social equity by more frequently than not restraining the market. Not surprisingly, this philosophy spread to international services. For example, the Chicago convention for aviation services and the International Telecommunications Union oversaw rules that assured international services would not upset highly regulated local markets. The 1945 approach to managing the world economy worked well for three decades. But, as the Mckinley Global Institute has noted, once global financial markets began integrating deeply in the 1970s, governments rapidly lost their ability to rely on the traditional mix of economic policies. Since then, policy makers have evolved a new synthesis of development and trade and economic policy -- manifested perhaps best in telcoms -- that might be fairly called not the New Deal, but the New Competition Deal. I would like to illustrate how our telecom policy embodies this New Competition Deal. We hope for a global trade agreement reforming international telecoms and domestic telecom markets, through the WTO or, if necessary, otherwise . We are now for competition instead of monopoly in telecom. We believe domestic competition in telcoms ought to lead to international competition in telcoms. A significant achievement in the past year was the agreement at the WTO talks on basic telecommunications services concerning a set of "procompetitive regulatory principles." Virtually every industrial country has made the principles into part of its market access offer. This commitment is an ingenious innovation that addresses "barriers behind the border" as part of an offer of market access. It creates something like a competition code crafted specifically for the telecoms market. After all of the frustration at the WTO about cooperation on competition policy this is a real plus, and perhaps a hint of what can be done in other industries. Just as significantly, this exercise probably did more to force Europe, Japan, Canada, the United States and other leading countries to understand each other's views on the basic precepts of regulation than anything else in the last few years. One reason for the attention was that the talks potentially have significant economic consequences. The industrial countries making reasonably good offers in the talks constitute almost two-thirds of the world's market for basic telecommunications services. There is nothing like $400 billion on the table to raise the attention level. A successful WTO outcome on basic telecommunications services would imply a far greater chance of success at efforts to tackle other services. A common stumbling block in all these negotiations is the Most Favored Nation Clause. The post-war record on trade attests to the many virtues of MFN. But MFN also opens the way to anticompetitive behavior by monopolists or dominant carriers operating outside effective interconnection rules that can distort competition in our market. And once they can do so freely why should they ever make meaningful commitments on market access? So, it will take thoughtful action to honor MFN while addressing competitive distortions. We cannot, as some of our colleagues in Asia sometimes urge, just tell our carriers to collude against any unruly monopolist who wishes to take advantage of MFN to enter the U.S. market. Nor do we have the discretion granted to bureaucracies in some Parliamentary democracies to just use our best discretion to make things work out. We operate a transparent regulatory process subject to judicial oversight and statutory instruction. So a thoughtful solution to tackling the MFN challenge will have three parts. o A greater level of commitment from more countries, especially from Asia. The more key markets sharing market access commitments, the greater are the benefits to consumers and the greater is the pressure on the remaining monopolists. Asia is our key growth market for international communications services. We have no -- or very weak -- offers from India, Indonesia, Thailand, or Malaysia. The offers of the Philippines and Hong Kong both have serious flaws. And both Singapore and South Korea delay too long in the complete opening of their markets given their sophisticated national economies. o Some realistic method to cope with the potential anticompetitive conduct in the market for international services by national carriers whose home markets are not effectively competitive. I am flexible about how to achieve this objective. I respect other countries' concerns about using measures that are consistent with MFN. But the best route would be to insist on cost based connections between two countries. Competition can normally get us to this end. But when countries don't make competitive commitments at the WTO we may need other initiatives to move these connections toward cost. o A thoughtful approach to resolving the remaining issues concerning private satellite systems, treaty-based international satellite systems (like Intelsat) and the private affiliates of international satellite systems. If we get a WTO deal then we can develop institutional mechanisms in the WTO to continue the refinement of its code of regulatory principles. This is a basic question of institutional design for the WTO. These codes, and their interpretation by dispute settlement panels, need to be informed by our best thinking on competition as developments unfold. Surely there must be a way to accommodate such an activity through the GATS Services Council. In short, the WTO Agreement being negotiated by USTR is a path braking effort to integrate a service sector into the world trading system -- and to do it the right way from the start. This agreement will have as its handmaiden a statement of regulatory principles -- principles like true interconnection policies. These policies will also promote social goals at the same time as they open markets because they create correct incentives for competition and the pursuit of social goals. If we get a WTO deal it must lead to an on-going program of regulatory reform in developing countries who make commitments. This is the other lesson for competitive reform in the New Competition Deal. Insisting on market competition requires serious work on spelling out how the market can also deliver social goals. I recognize that this mix is not intuitive to everyone. We have more than a few skeptics here at home. Our new law permits competitors to share the advantages of the incumbent's monopoly. Given the $250 billion in sunken cost in the telephone company monopolies, this is fair. So Congress, recognizing the economies of scale possessed by the incumbent, decided to jumpstart competition by granting new entrants the right to lease portions of the incumbents' network, the right to connect their subscribers' communications to the incumbent's subscribers, and the right to buy at wholesale the retail services of the existing network. This approach is, we believe, the right microeconomic policy for all countries. It is what we believe should be the basis of a multilateral agreement among all countries. This approach also is a minority view around the world, and certainly is even now being debated in our own courts. It turns out that although economists overwhelmingly agree it is right, judges are not yet unanimously in accord. So some judges and, also, for example, Spain, have a less aggressive approach to ending monopoly than does Congress. In Spain the new Government has declared that it will create a duopoly for two years so that the new competitor can succeed. This is a classic example of the fallacy of confusing the welfare of a competitor with the promotion of competition and economic efficiency. Chile is proof of what can be done to blend competition and social goals.. Chile introduced vigorous competition in telecommunications services but still faced problems in achieving universal service goals in rural areas. Monopoly had failed to achieve service in those regions. Chile decided that competition could. So, Chile created a rural telecom development fund that is financed by a small tax on all Chileans. Entities bid on rural projects to establish communications in previously unserved areas. The telecom authority (Subtel) gives the entity with the lowest bid the authorization to use the funds to build out the network using whatever technology they wish to use. The winning entity does not receive an exclusive right to provide service, so if a competitor decides that it can provide service at a lower rate than the winning bidder, it can do so. The Chilean system has all three elements necessary for an efficient and effective funding mechanism for universal service: it is targeted, competitively neutral, and technologically neutral. And here's the proof in the pudding. Its neighbor, Argentina, has retained regional monopolies in order to build out its network. Guess which country is moving faster toward serving areas previously without telephones? The Chilean example should remind us of yet another lesson. Our concern about equity has to be both local and global. Economists teach us that the more people who use the network, the more valuable it becomes to each user. Within countries this provides a strong reason for promoting universal service. At the global level it should make us realize that the value of the global network will increase as the two-thirds of the world without access to phone service plugs in. To do so, however, we will first have to build networks in addition to addressing their affordability. Sweeping competition is the fastest and most efficient way to build the networks to serve the world. And it will lower the costs of connecting people to those networks. But now that we have as a matter of federal law moved to the New Competition Deal in domestic communications and rejected monopoly -- no more waving to the incumbent, Make It So -- and embraced competition, then the only logical conclusion is that competition does not stop at the border. The domestic and the international market must be competitive. And this means that the barriers to market access that lurk behind national borders have to be addressed. Our new approach to promoting social equity is a logical complement to our growing reliance on competition as the basis for regulatory policy and the accommodation of our economic growth policy to the globalization of the world economy. This November the FCC will for the first time tell the world that the market for international services can be just the same as the one for domestic long distance services. If a foreign country allows effective competition at home the FCC will permit all U.S. carriers to deliver end-to-end services with no accounting rates and no rules restricting market share. We are going to propose rules to lower the accounting rates that subsidize foreign monopolists. We are gong to propose benchmarks for these accounting rates that more closely correspond to costs. And then we are going to instruct U.S. carriers to achieve them. Ending the extravagant accounting rate subsidies on international services will result in less reason for countries to cling so tenaciously to monopoly. And U.S. consumers will stop subsidizing foreign telephone companies. We recognize that developing countries may face adjustment problems as accounting rates drop. We are prepared to work with them if they are committed to competition and the accelerated development of their networks. We also hope that the World Bank will play an important role in defining alternatives to subsidies from the traditionally inflated levels of accounting rates. Even as we reform the rules of the accounting rate system, we are using the WTO negotiations to secure an agreement that will create competition for domestic and international services in the key world markets. We think that it will be easier to reach an agreement at the WTO if the world understands that the United States is creating a new set of rules for its international traffic and accounting rate payments. Finally, reform is a gigantic task. Let's use every tool available. Let's use existing international institutions to advance the dialogue on reform. First, let's get beyond negotiations. Instead let's write a manual. The FCC's interconnection rules ran less than 40 pages. We could write a manual with all the key essentials in ten pages. It would bind no one. But it could enlighten everyone. The same can be done for universal services and international telecom services. Let's find a friendly high level forum, perhaps an OECD Ministerial, where we can turn that manual into a more widely agreed upon document among the regulators of industrial countries. This would also permit countries like Mexico to participate. Second, let's follow a second track of having a slightly larger dialogue between senior regulators of developing countries and those who participated in track one. We should use this to dissect our manual and see how it well it works in developing markets where competition is just emerging. After all, if there are laws of regulatory economics we should follow a cardinal rule of science. Let's examine the data to see if they work. I would like to see the U.S. Government and the private sector take initiatives to sponsor such a dialogue. One vehicle might be our United States Telecommunications Training Institute which is funded by the private sector in cooperation with the U.S. Government. Let's have USTTI bring in some of the best and the brightest senior staff from countries introducing competition. And let's have them spend a week or two with our regulatory manual and our industry to see if the manual would pay off for them. We can use this experience to help us as we try to spread agreement on the "manuals" to other international regional institutions like APEC or the telecommunications organization of the OAS (CITEL). Third, why not have the OECD and the ITU cooperate on selective national policy reviews. Let's have a candid assessment by independent international institutions on how regulation is working in different markets. Call it global regulatory benchmarking. The OECD's International Energy Agency performs a similar exercise for national energy policies. Let's learn from that experience. The conclusion above all, let us resolve that all the specific agreements, conferences and rules have one purpose - we want to create at long last what Nathaniel Hawthorne called the "great nerve of intelligence." - FCC -