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Quiggin, J. (1998 ), 'Competition hangups', Eureka Street 8(4), 23-4 .

Date created: 20 April 1999

Last modified: 20 April 1999

Maintained by: John Quiggin

The process of telecommunications 'reform' introduced by the Labor government in the 1991 Telecommunications Act was completed in June 1997. It is now clear that the reforms were fundamentally misconceived and have failed to deliver the promised benefits.

The basic idea of the reform was to replace the public telecommunications monopoly with a competitive market. Reform was to proceed in two stages. The first was to create a full-scale competitor for Telecom Australia (renamed as Telstra) through the sale of the ill-starred satellite network Aussat. The competitor, which took the name Optus, was expected to compete with Telstra across the full spectrum of local, national and international phone services. A third firm, Vodafone, was encouraged to enter the digital mobile telephone market with a promise that the analog phone network, owned by Telstra but shared with Optus, would be phased out by the year 2000. (The oddity of compulsorily closing down one segment of the industry to promote competition in another escaped notice.) Optus was given five years in which to establish itself as a viable alternative to Telstra. During this period, a special regulator, Austel was established to control the telecommunications industry.

The second stage of the reform was to develop a fully competitive market. Initially, the government contemplated retaining some control through the issue of new telecommunications licenses in 1997. However, this relic of interventionism was abandoned, with a decision to allow unrestricted entry from 1997 and to replace Austel with general regulation through the Australian Competition and Consumer Council (ACCC).

In the short term, Telstra was subjected to price caps ensuring that the steady annual decline of 5 per cent per year in real telecommunications prices, achieved under the old public monopoly, would be maintained. However, it was expected that, by 1997 at the latest, the pressure of competition would eliminate the need for such regulation. Privatisation was not part of the policy but it was implicit in its design. Why should a government which had sold off airlines and banks own an enterprise in a competitive telecommunications industry?

The Coalition government made privatisation an explicit rather than an implicit part of the policy, but otherwise made only marginal adjustments. Although rural voters were already furious about the prospect of losing the analog service, with no digital replacement in view, the new telecommunications minister Richard Alston, argued that the need to keep faith with Optus and Vodafone was paramount. The government that invented the idea of 'non-core' promises to electors could not afford to break its promises to big business.

In 1998, it has become apparent that the policy of telecommunications competition has failed to deliver the benefits claimed for it. For most people, competition is little more than a slogan. Telstra still dominates nearly all components of the telecommunications market. Optus has gained around 20 per cent of the market for long-distance services, and a little more in the international and mobile markets, but has failed completely in its attempts to enter the local call market. Despite some brave rhetoric, Optus has settled into the role of junior partner in a comfortable duopoly. Vodafone has done poorly in the digital mobile market and has failed completely elsewhere. The post-1997 entrants have been even less impressive, collectively accounting for less than 10 per cent of the market.

As a result, Telstra was able to report to its public and private shareholders in 1998 that 'the pressure of competition has been considerably less than expected'. The only real constraint on Telstra has been the maintenance of price caps through regulation. Price cap regulation ensures that, on average, customers are no worse off under competition than they would have been under a continued public monopoly. This average conceals wide variation however. Under public monopoly, prices declined steadily across the board. Under price cap regulation, there has been very little reduction in 'standard' prices for residential users. Telstra has met its price cap by offering discounts, designed to appeal to those customers considered most likely to switch to Optus. Customers in the bush, and others in whom Optus showed no interest, got nothing. Although this process of 'rebalancing' is in part a response to competition, it is also the policy that would maximise Telstra's monopoly profits even in the absence of competition.

The most obvious failure of competition has arisen through the duplication (and in the case of digital networks, triplication) of infrastructure. As part of the thrust towards 'network competition' Telstra and Optus raced to roll out parallel pay-TV networks consisting of a hybrid of coaxial cables and optic fibres (hybrid fibre-cable). While the streets of suburbs in Sydney and Melbourne were disfigured by Optus cables running side by side with Telstra's underground network, the smaller state capitals, and the bush, got no service at all. Meanwhile, Telstra, Optus and Vodafone erected three networks digital mobile phone towers overlooking schools and homes while offering no digital service in rural areas.

A pay-TV network is only as good as its content, and duplication was the rule here as well. With the commodification of sport, the emergence of duplicate rugby league competitions, financed by the rival pay-TV networks, was scarcely a surprise. The creation of Murdoch's Super League competition required abrogation of contracts on a large scale, but thanks to competition policy, this was no problem. The Federal Court ruled that, because they prevented the emergence of a rival to the existing Australian Rugby League, such contracts were anti-competitive and therefore unenforceable.

The rush to duplication ended abruptly with the introduction of unrestricted competition in June 1997. The cable rollouts stopped, the rival rugby leagues negotiated a truce, and the expansion of the digital networks slowed to a crawl. Telstra and Optus were willing to waste billions of dollars on technically unnecessary facilities in order to secure their strategic position for the period of deregulation. 

The failure of network competition reflects the fact that most telecommunications networks, are natural monopolies. That is, the services concerned are most efficiently provided by a unified network with a single owner. It is very difficult to achieve competitive market outcomes in industries with a large component of natural monopoly. It is for this reason that telecommunications and similar services have historically been provided by government in most countries. Where, as in the United States, there are ideological objections to public provision, private monopoly providers have been tightly regulated. The advocates of competitive reform relied on arguments suggesting that, thanks to technological change, the concept of natural monopoly has become obsolete. Such arguments generally reflect wishful thinking rather than objective analysis. Some aspects of telecommunications, such as long-distance telephony, have indeed become more competitive as a result of technical change, but the convergence of pay-TV, telephony and computing has the potential to create monopolies on an unprecedented scale. The expensive manoeuvring being undertaken by global players like Rupert Murdoch and Bill Gates as well as by telecommunications firms with dominant positions in national markets reflects the rich rewards that will be reaped by those who emerge with control over these monopolies. If technology is not simply to enrich a few monopolists, continued regulation will be necessary.

The failure of competition undermines the central economic argument for privatisation; that it is inappropriate for government to own one firm in a competitive industry. Telstra will remain a dominant firm with its profits being determined primarily by government regulation rather than competitive forces. In this situation, control is better exercised directly through public ownership than indirectly through regulation.

There remains the claim that privatisation yields a fiscal 'pot of gold' for governments. The metaphor is more appropriate than many of its users realise. The apparent financial benefits derived from privatisation are exactly like the 'fairy gold' that is said to crumble away overnight. Tricks of accounting can make it appear, in the short term, that governments benefit from privatisation. But the long-term effects have been unfavorable in almost every case. The first major privatisation undertaken in Australia, that of the Commonwealth Bank, illustrates this point.

Between 1991 and 1996, the government sold its shares in the Commonwealth Bank prices between $5.40 and $10.00 per share, yielding sale proceeds of approximately $6.5 billion. Assuming all of this money had been used to reduce debt, the interest saved in 1997 would have been about $400 million, and some of that would have been recouped in income tax. In the same year, the shareholders of the Bank received fully franked dividends in excess of $800 million, without taking account of retained earnings of around $400 million. The loss to taxpayers associated with privatisation was well over $600 million in 1997 alone. There has been no year since privatisation commenced when interest savings exceeded the profits foregone, and the loss seems likely to grow even greater in the future.

The situation of Telstra is, at least superficially, more complicated since a higher proportion of Telstra's profit is reinvested. This implies a smaller flow of dividends to government in the short run, but more rapid growth in the long run. In reality, the choice of whether to pay dividends or to reinvest earnings is largely a matter of accounting convenience. To assess whether the sale of Telstra is a good deal for the government, it is necessary to compare the savings in interest on public debt that can be realised through privatisation.

Assuming a sale price of $45 billion, the government could reduce its interest payments by about $2.5 billion per year this year (and every year into the future) by selling Telstra and using the proceeds to repay debt. The government's would lose its claim to two-thirds of Telstra's earnings. This year, the value of this claim would be $2 billion and the government would be ahead by $500 million. But Telstra's profits have been growing rapidly and the market obviously expects that this growth will continue, whether or not Telstra is fully privatised. A conservative assumption is that Telstra's profits will grow in line with nominal GDP, that is by around 5 per cent per year. On this assumption, the short-term net benefit to the government would disappear within five years, to be replaced by a steadily increasing stream of losses. This would be consistent with past experience -- there has not been one major privatisation in Australia where the government has made a profit, relative to the alternative of retaining ownership.

There remains the question of whether privatisation will increase Telstra's efficiency and profitability. In many respects, Telstra is already acting like a private corporation. For example, whereas public sector employees were formerly seen as being immune from dismissal, Telstra has shown itself to be willing to retrench staff whenever this would increase profit, or simply to match arbitrary 'benchmarks' applied by investors in telecommunications enterprises. In other areas such as, the abandonment of service to rural areas, Telstra will cut services unless it is prevented by regulation from do so. The main effect of privatisation would be to strengthen the forces pushing for more cuts in services.

The vision of the future held out by the advocates of telecommunications reform has not materialised. A more realistic forecast is that users of telecommunications will be divided into three classes. Business users with the capacity to switch between telecommunications suppliers will receive services at their marginal cost of provision (almost nothing). Urban residential users will be a captive market, forced to pay all the fixed costs of the telecommunications network through higher connection fees. The poor and those in remote areas will be cut off. Meanwhile, profits that once flowed to the public as a whole will flow to those, predominantly in the top 20 per cent of the income distribution, who can afford to buy shares.

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