(Reprinted from HKCER Letters, Vol. 8, May 1991)
International Telecommunications in Hong Kong:
A Reply to John Ure
John Ure's comment on my monograph was surprising in several respects. The argument contained almost no defense of Cable and Wireless's exclusive license per se. Indeed, Ure seems to concede that international rates are higher than they need to be, and that competition would be desirable. The thrust of his argument is that the accounting rate system subverts the possibility of effective competition in international telecommunications. If this is the main point he has to make, then I am gratified that there is so little distance between our positions.
The obstacles to competition raised by the international settlements process have been greatly exaggerated. This is true not only of Ure's piece, but also of Hong Kong Telecom's public responses to the monograph. Indeed, the HKCER monograph itself may have contributed to this erroneous impression. I will first review the argument and then show why it is a much less significant problem than its proponents think.
The accounting rate system refers to the way telephone companies reimburse each other for handling each other's traffic. Under this system, countries which receive more telephone calls than they send out receive a settlement payment of a certain dollar amount for every minute of traffic surplus. If Hong Kong calls New York for 9 million minutes a year and New York calls Hong Kong 11 million minutes, then the American carrier must pay Hong Kong Telecom a settlement. The settlement equals half the accounting rate (U.S.$1.175) x 2 million minutes.
As I pointed out in the monograph, the introduction of competition in one country lowers rates on one side of a circuit but not the other. The country with the lower, competitive rates tends to originate more traffic, thus increasing its settlement deficit. Thus, the accounting rate system can be said to "penalize" rate reductions and to reward countries which maintain inflated, monopolistic rates.
However, when I claimed that the accounting rate reductions "penalize" rate reductions, I was referring only to a settlements penalty. I did not mean to imply that the settlements penalty outweighed the social benefits of the rate reductions and competition.
Here is a simple example of why accounting rates do not pose an insurmountable obstacle to rate reductions. Let us say that the accounting rate between country A and country B is $1 per minute. Let us also assume that the actual economic cost of providing telephone service between A and B is $0.30 per minute. The common but erroneous assumption is that A and B must charge at least $1 per minute to cover the accounting rate. This is not true. The only real bottom limit on rates is the economic cost of the service. For example, A or B could charge as little as $0.40 per minute for a call as long as the traffic flow between A and B is in balance. When traffic is perfectly balanced, no per-minute settlement payments are made, and hence the accounting rate is irrelevant -- it need not affect the carrier's rates at all.
What about cases when traffic is not even? Collection rates can still be less than accounting rates. For example, if A charges $0.50 per minute and sends 1000 minutes of traffic to B, but B returns only 900 minutes, we get the following results:
A collects $500($0.50 x 1000 minutes) A pays B ($100)($1 x 100 minutes) Net revenue $400 A's cost: ($300)($0.30 x 1000 minutes) Net profit $100
Thus, carrier A can use a collection rate one half the accounting rate, have a settlements deficit of 10 percent, and still make an operating profit. This is possible because for all of the minutes that are not in surplus, A's charges are clearing enough over his operating costs to more than offset the eventual settlements payment.
Generally, it is carriers with outgoing traffic surpluses, such as Hong Kong Telecom (HKT) and AT&T, who complain about accounting rates and traffic imbalances. They have reason to complain. High collection rates in other countries increase the traffic imbalance. The accounting rate is the per-minute price they pay for the imbalance. It is in their interest to encourage either lower accounting rates or lower collection rates (or both) in other countries. However, the fact that their revenue streams would benefit from such changes does not mean that they are harmed by lower rates on their own end of the circuit, or that rate reductions are counter-productive. True, such reductions might increase the traffic imbalance by 10 percent or even 20 percent. But international collection rates are already so far above the costs of the service that 10 to 20 percent increases in their settlement payments are more than offset by increases in collection revenues.
An obvious case in point is AT&T. AT&T's settlements deficit has ballooned since the early 1980s, but AT&T International Communications Services is in no danger of losing money. Washington regulators and politicians may mutter darkly about a "trade deficit in services," but AT&T is doing just fine.
Hong Kong Telecom International (HKTI) is in a similar position. It also has developed traffic imbalances with many countries over the past five years. Yet its Annual Reports contain some very interesting numbers. They show that each year, the total amount HKT pays to overseas administrations has grown in absolute terms. But if you compare this amount to the total revenues it receives from international telephone service, the ratio of accounting rate payments to total revenues is steadily shrinking.
Allocations to Overseas Administrations
as a Proportion of International Revenues
1985 1986 1987 1988 1989 1990
71% 66% 63% 61% 57% 54%
HKT's outgoing international traffic has been growing so fast, and its margins on that service are so high, that collection revenue growth far outstrips the settlement payments growth caused by traffic imbalances.
Ure's implication that the benefits of competition will be confined to overseas monopolies is thus only partially true. Although the accounting rate regime does give some "windfall profits" to settlement recipients, competition will still have the desired effects of reducing monopoly profits and increasing consumer surplus in the country that introduces it. However, the traffic imbalances caused by unilateral rate reductions increases political pressure on the monopolist countries. In Hong Kong's case, it would force HKT to become a tougher bargainer when setting accounting rates. Consumers would benefit even more as accounting rates are brought down.
Another interesting implication of this argument is that competition in Hong Kong would be in the direct self-interest of China. Lower rates on the Hong Kong end of circuits would increase outgoing traffic to China. The PRC, which has both high accounting and collection rates, would receive far more traffic than it would send out. Thus, it would enjoy a major influx of foreign exchange revenue if competition in international services reduced rates on the Hong Kong side.
There are some other minor mistakes in Mr. Ure's comments. Ure states that competition in international services would reduce the Hong Kong Telephone Company's (the local network) receipts from terminating international traffic. This, he believes, would lead to an increase in local rates. In fact, exactly the opposite is true. More carriers and more competitive international rates would increase the amount of international traffic terminated through Hong Kong Telephone. There is at present no other local network carrier capable of terminating international traffic, and there will not be one for some time. True, some of the large users would bypass the local exchange, but they are already doing this through the use of leased lines. Most, if not all, of the new carriers will rely on Hong Kong Telephone for access to customers, just as most competing long-distance carriers in the U.S. still rely on the Bell companies for origination and termination. The new carriers would probably have to adopt the same revenue division as HKTI. The only possible loss to Hong Kong Telephone would come from a reduction of the subsidy from HKTI. And as I showed in the monograph, the entire subsidy could be eliminated through a simple, gradually phased-in, flat increase of 20 percent.
As for John Ure's argument that the telephone system is a public good, I think this argument has been discredited in the theoretical literature. A pure public good is characterized by nonrivalrous consumption and high costs of exclusion, neither of which is true of telephone service. Ure seems to be referring to the "network externality," which means that the value of a technology or system to one person depends on who else uses it. (Although I cannot make a solid theoretical argument in a forum like this, elsewhere I have shown that the so-called "externality" is really a demand-side economy of scope.) However, the effect of this "externality" can be eliminated by interconnecting the competing carriers. Where interconnection is present, what Ure refers to as the "public good" aspects of the network are retained, and carriers compete on the basis of price and service only.
Ure's attempt to refute my argument that all of the links of a network constitute different services falls rather flat. If John calls his mother from home, it is indeed true that a different service is being provided than when he calls from a public telephone on the street, even if the message is exactly the same. It is obvious to everyone, I think, that if John employs a transportation service to travel from Hong Kong to visit his mother, then the service that he purchases is different (and he will probably pay a different price) than when he starts from Thailand or New Zealand. Likewise, a different communications service is provided when John calls his mother from Hong Kong than when he calls her from London or Chicago. The same difference exists, only on a smaller scale, when the telephone service is in the same city but connects different points.
Dr. Milton Mueller is a research associate at the International Center for Telecommunications Management at the University of Nebraska at Omaha, U.S.A. He is the author of International Telecommunications in Hong Kong: The Case for Liberalization, which has recently been published as HKCER Paperback No.4.