(Reprinted from HKCER Letters, Vol. 6, January 1991)
International Telecommunications in Hong Kong:
The Case for Liberalization
The Need for a Review
International telecommunications is vital to the success of Hong Kong's economy. This is particularly true with the rise in the significance of trade in services, especially information- based ones such as finance. Rather than supporting this role, Hong Kong's government imposes large economic and regulatory burdens on international communications traffic.
On the other hand, the telecommunications industry itself has undergone tremendous changes and restructuring in the past decade or two. There has been a growing gap between long- distance rates and costs that has encouraged new entrants to the market. There is also the demand of large business users for specialization and flexibility, which has led to the setting up of private networks. Hong Kong's monopoly license on international services, however, puts it at odds with these changes.
The shift of sovereignty in 1997 presents Hong Kong's telecommunications industry with the opportunity for beneficial economic cooperation between Hong Kong and China, as well as possible constraints for development due to the disparity in telecommunications policies in the two places. A good review of the present telecommunications industry in Hong Kong is both timely and necessary.
Nature of the Industry
The telephone service is actually a combination of many different services. Telecommunications networks have multiple outputs (connections between users), all of which are different. Each pairwise connection or group of connections is a separate service. A network that adds new subscribers or extends itself to new locations is not producing more units of the same service, but different services. The concepts of economies of scale and natural monopoly are thus not appropriate here. The rationale for joint supply or a unitary network is economic efficiency on both the supply and demand sides.
In the early 20th century, local exchange service was relatively cheap while long distance service was costly. In the past few decades, however, major technological advances in long- distance transmission have reduced costs by 90 percent or more. Telecommunications administrators and regulators responded by maintaining high long- distance prices and used some of the surplus to cushion local rates from rising costs therein. Local rates affected a larger number of people and hence rate increases are more visible politically.
The availability of new technology also created a demand for a broad range of new, specializsed services. As a result of the changes in costs and demand, the large users begin to opt out of the public system for private networks, and new competitors to the market are encouraged. It is not so much the ability of the new suppliers to enter the market, but the ability of the users to exit the public network that drives the process. The unitary network began to unravel.
The Current Framework in Hong Kong
The current framework of international telecommunications in Hong Kong started with the privatizsation of Cable and Wireless plc of London (C&W) in 1981. At that time, it split off its operations in Hong Kong into a subsidiary incorporated in Hong Kong: Cable and Wireless Hong Kong (CWHK). C&W agreed to sell 20 percent of the ordinary shares of CWHK to the Hong Kong government for HK$763 million, and in return received a 25- year exclusive license to provide all external telecommunications for the colony.
Although the trend in most of the developed countries is toward the unbundling of the public network, as have happened in the U.S. and Japan, the global strategy of C&W has been the opposite. In the case of Hong Kong, until the mid-1980s, CWHK and the Hong Kong Telephone Company (HK Tel) were separate entities. HK Tel was a locally-owned, regulated utility and had never been part of Cable and Wireless. Between 1983 and 1984, C&W quietly acquired a majority of its stock, then merged it with CWHK in 1987 to form Hong Kong Telecommunications Ltd. (HKT). In 1988, as part of the merger arrangement, shares in HKT were sold to the public. Today, HKT is a holding company with two major owners: Cable and Wireless plc (58.4 percent) and China's state-owned CITIC (20 percent). HKT in turn owns 100 percent of HK Tel and CWHK, and CWHK has been renamed Hong Kong Telecommunications International (HKTI).
C&W holdings throughout the world conform to the same pattern: the integrated telecommunications entity is a partnership between C&W and the host governments. C&W holds the majority of the shares. The participation of the government makes it possible for the integrated firms to obtain long- term licenses giving them exclusive rights to carry domestic and international traffic. The ability to "tax" international usage to finance domestic network development explains the willingness of many governments to grant exclusive licenses.
Despite the large number of countries in which it operates, C&W is still heavily dependent upon its Hong Kong operations for profitability. In 1989, HKT accounted for 58 percent of the C&W group's total revenues and 75 percent of its total profits. In effect, for the past ten years, profits from Hong Kong have financed C&W's global expansion.
One way to assess the reasonableness of international telecommunications rates is to compare the cost of calling another country from Hong Kong to the cost of making the same call in the other direction. Using this standard, Hong Kong's IDD rates may appear to be very competitive. However, most of the corresponding telephone administrations are also monopolies. Their tariffs can hardly be used as the benchmark for reasonable, cost-based rates.
The most valid way to assess the reasonableness of rates and the likely impact of competition is to compare rates with actual costs. Since 1981, while HKTI's international tariffs have been reduced by a maximum of 5 percent annually, the major cost components have been declining by 8 percent to 20 percent a year, giving rise to larger and larger profit margins for HKTI. A report released in 1988 reveals that HKTI's net profit margin stood at an impressive 40 percent in 1983 and increased to an astounding 59.6 percent by the end of March 1988. Such margins are four or five times industry norms. HKTI uses some of its surplus to subsidizse the local telephone company. If that such subsidy is taken out of HKTI's costs and returned to its profits, HKTI's 1988 after- tax profit margin would reached 75 percent.
Liberalizsation is Imperative
Hong Kong is the only major financial and trade center to limit its external telecommunications to one supplier for an extended period of time. Besides posing unnecessarily high rates to consumers, the system taxes some users in order to benefit others, creating a strong incentive for the overtaxed users to leave the public network altogether. The abundance of affordable technological alternatives makes this possible. Some banks and other large multinationals can afford to lease private lines which do not contribute to HK Tel's revenues. Overpricing IDD services thus does not redistribute wealth from the largest and wealthiest users to the smaller and poorer. The real losers are small and medium-sized business and residential users of international facsimile and telephone services.
The government's attempt to encourage competition in local telecommunications by licensing a second network will also be undermined by the pricing distortions in international telecommunications. Such a network cannot offer customers lower international rates since it requires HKTI for international connection, and such rates are set by the HKTI monopoly. At the same time, it cannot offer customers low local rates to compete with the HK Tel since it does not have international revenues to cover the local shortfall.
Permitting competition in international telecommunications would lower international rates and raise local rates. However, the benefit of the former can easily outweigh the loss from the latter for a user. With a local rate increase of 20 percent and IDD decreases of 25 percent, for example, anyone who makes 48 minutes of international calls in a year would benefit from the introduction of competition. As Hong Kong residents become more wealthy and mobile, as telephone penetration in China increases, and as international rates decrease due to liberalizsation, international calling will become more common among Hong Kong residents. This will further extend the benefits of competition.
Liberalizsation without long-distance communications is incomplete and ineffectual. The government should amend the HKTI license to permit open competition in international telecommunications services in 1992. The license was granted under the Telecommunications Ordinance with the provision that the government retains the power to cancel licenses if the public interest so requires. Liberalizsation would also benefit HKT by allowing it to achieve a higher rate of return on local services and keep a higher share of international revenues. And in the long run, C&W might find that its Hong Kong holdings remain considerably safe in a pluralistic telecommunications environment.