Telecommunications Competition, Rate-Rebalancing, and Consumer Welfare in Nepal

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ABSTRACT

This paper examines two important aspects of telecommunications liberalization as a policy for economic development. The first involves the tradeoff between increased efficiency from competition and the consequences of higher prices for basic services resulting from rate-rebalancing. The second addresses an entrant's ability to provide efficient, high-quality service under the given competitive environment. Using new data from Nepal, we analyze how the introduction of competition in landline and mobile services and subsequent rate-rebalancing has affected the welfare perceptions of residential consumers. We find that while many consumers remain sensitive to prices, competition is viewed as a way to satisfy growing demand for telecommunications services. However, service quality remains a problem, and the incumbent operator has succeeded in maintaining a higher overall level of satisfaction relative to entrants. This suggests that a more aggressive rate-rebalancing strategy may be necessary to fully bring out the benefits of efficient and fair competition.

Keywords: Rate-rebalancing, Telecommunications, Regulation, Consumer Welfare, Nepal

1. INTRODUCTION

Governments have traditionally subsidized basic telephone services by charging above-cost prices for long-distance and international calls, creating prices that are "unbalanced". However, as countries pursue efforts to introduce competition in the telecommunications industry, unbalanced prices create obstacles in the process. Thus, the need for rate-rebalancing becomes increasingly important. Rate-rebalancing describes the adjustment of retail prices among services such that prices reflect their actual cost while allowing a fair market return on investment. The goal of rate-rebalancing is to foster a competitive market where incumbents and entrants are allowed fair market access. At the same time, promoting universal service to the poor and to rural areas is a priority that often poses a challenge under rate-rebalancing.

Rate-rebalancing is a fundamental objective when competition is introduced in former state-owned monopolies such as telecommunications. In a regulated monopoly, subsidies to low-income and rural consumers can be sustained using profits from other services; however, competition tends to spur entry only into profitable services, reducing the incumbent's ability to provide subsidies to fulfill its universal service obligations. Such cream-skimming distorts the market by providing incentives for less efficient entrants to compete against efficient firms (Smith, 1995; Armstrong, 2001). While successful raterebalancing creates viable competition among all services, for a regulator to maintain equity among consumers and firms, it must strike a balance between promoting efficiency and appropriately allocating gains and losses (Quiggin, 1997; Birdsall et al, 2003).

Nowhere has the introduction of competition and rate-rebalancing in telecommunications been more critical than in developing countries that have relied on cross-subsidies by monopoly providers to keep the price of local services affordable. This paper analyzes the effect of competition and rate-rebalancing on consumer welfare in Nepal, a developing country that has recently experienced both rate-rebalancing and competition in its landline and mobile services. Using unique survey data collected among Nepalese residential telephone subscribers, this paper studies how national regulatory policies aimed at increasing efficiency at an aggregate level have affected welfare perceptions at the household level.

2. EFFICIENCY EFFECTS OF RATE-REBALANCING AND COMPETITION

Earlier work on the effects of rate-rebalancing has described its role in creating two overarching effects on social welfare: 1) an increase in overall economic efficiency by reducing market distortions and 2) a reallocation of resources between consumer groups along with a reallocation of resources between incumbents and entrants. Specifically, Martins-Filho and Mayo (1993) analyzed how universal service obligations that force operators into serving unprofitable areas create market distortions that reduce the social benefit that such policies aim to achieve. Following this work, Wolak (1996) found only a minimal impact of rate-rebalancing on low-income customers in the U.S. Yet, the costs of telecommunications services constitute a significantly larger share of household income in developing countries. While subsequent papers by Cronin et al (1997), Cremer et al (2001), and Birdsall et al (2003) address the social welfare effects of rate-rebalancing using various empirical methodologies, this paper emphasizes its effects on developing countries where affordability concerns play a dominant role in policymaking. Next, we characterize the efficiency effects of rate-rebalancing using a simple model.

Consider two services, local line rental and long-distance, served by a single regulated monopoly. Figure 1 shows the market demand and average total cost curves for local and long-distance services. Assuming that the firm chooses its profit-maximizing quantity and price, the resulting outcome is one where prices are 'balanced' between services, and the firm earns a modest profit (as allowed in a rate-of-return setting) for each service. Now assume an unbalanced case. If the price of local line rental is reduced to [P.sub.U.sup.LL] (in Figure 1a), the resulting increase in demand and subsequent costs causes profits for local line rental services to decrease relative to the balanced case. To keep the operator financially viable, the regulator would need to raise long-distance prices (in Figure 1b) such that profits rise enough to offset lost profits from local line rental in addition to adjusting for lower demand for long-distance as prices rise.

[FIGURE 1 OMITTED]

In sum, under the unbalanced structure, long-distance services subsidize local services. From the operator's perspective, it is performing equally under both scenarios, and is able to offer lower local rates. For the regulator, it can achieve universal service objectives without affecting operator profits. However, this argument in favor of unbalanced prices wanes when competition is allowed. Even without considering the effects of competition, consumers are affected by unbalanced prices via high prices for long-distance. Low-income customers benefit from lower local line rental prices while wealthier customers who typically make more long-distance calls pay more. While some would support this outcome, it is interesting to note that [P.sub.U.sup.LL] LL (in Figure 1a) actually subsidizes many customers who do not need to be …