Reason Foundation

Reason Foundation

On the Frontier of Deregulation

New Zealand Telecommunications & the Problem of Interconnecting Competing Networks

Milton Mueller
May 1, 1994

Executive Summary

Telecommunications is undergoing a revolution. Despite the apparent revolution in industry structure, the public policy questions raised by the new developments have changed little. The debate revolves around the same two fundamental issues that have haunted the industry since well before the AT&T divestiture.

The biggest problem facing regulators in the new competitive environment has been to adjudicate and coordinate interconnection relationships among competing systems. In most nations, including the United States, these issues have been, or are being, resolved via processes in which regulators have tried to enforce parity between large incumbents and their smaller rivals. One exception to this is New Zealand. There policymakers have attempted to resolve these matters via market transactions alone, relying on open entry and the threat of litiqation under an antitrust law.

The assumption behind most equal-access policies is that, without regulation, inequalities between the incumbents and new entrants constitute a fatal obstacle to effective competition in telecommunications markets. However, the New Zealand experience indicates otherwise. Despite the obvious inequalities in the interconnection agreement, national and international toll competition have functioned at least as successfully as in countries with policies that promote or protect competitors.

Nonetheless, the New Zealand experience regarding interconnection does confirm that an incumbent with virtually universal coverage has nothing to gain from interconnection with a start-up rival in its own territory. New Zealand Telecom had no commercial incentive to arrive at an agreement and possessed all of the ultimate negotiating power.

The cleanest way to rectify this incentive problem—in New Zealand and elsewhere—is through structural reforms— creation of a marketplace in which existing access connections are not under the exclusive control of a single firm— rather than through regulatory oversight. In the case of New Zealand Telecom, this would mean breaking it up into three or four separate companies. Each unit would be based in different territories, but would be authorized to enter all service and equipment markets in the other territories. This is not an American-style divestiture, which was based on artificial distinctions between local and long-distance markets that could only be maintained by arbitrary territorial divisions and legal barriers between various telecom service markets. What is proposed here is the creation of fully integrated telecommunication companies based in separate territories.

A structural adjustment is probably the only way to eliminate the incentive problem in interconnection negotiations. Each divested unit would control some, but not all, of the access required to serve the market. Each would be dependent upon the others to provide universal access. Each would therefore have a real incentive to engage in interconnection negotiations and conclude fair and reasonable terms and conditions. The resulting agreements could be used as templates for other competitors.

Policymakers should attempt to create structures which permit competition to emerge, and then stand back and let the players play. Structural reforms such as divestitute or, less radically, free resale and arbitrage would allow many of the benefits of competitive processes to be set in motion, without branding incumbents as criminally anticompetitive.

The New Zealand experience shows that telecommunications competition is not as fragile as many believe. A new entrant there competed vigorously in the long-distance market despite the inequalities and barriers built into its interconnection agreement.

The growth of wireless alternatives and the convergence of cable television and telephone markets both serve to increase the potential for competition. Most importantly, in the United States, the breakup of AT&T into separate local and long-distance segments and the creation of regional companies capable of entering each other's territories mean that there are a number of powerful businesses capable of bypassing the local exchange. Thus, the monopoly power of local telephone companies in the United States is significantly smaller than in New Zealand. If competition can survive and rates can remain reasonable in New Zealand, where only the most rudimentary forms of oversight exist, the United States, with its multiple layers of voluminous state and federal regulations and antitrust law may be engaged in regulatory overkill in the name of advancing competition.

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