Rethinking telecommunications regulation: promoting a vibrant and competitive telecommunications sector in Japan.

THE JAPANESE GOVERNMENT HAS a duty to present its citizens with a transparent telecommunications policy rationale that addresses national goals. However, one recent regulatory decision suggests that the regulator, the Ministry of Public Management, Home Affairs, Posts and Telecommunications (MPHPT), is both reluctant and ill-equipped to maintain a competitive telecommunications sector.

In June 2001, the MPHPT revised the Telecommunications Business Law, requiring NTT East and West to set interconnection charges (a per-call fee paid by competitor carriers to route calls over NTT's local telephone network) that were "fair and justifiable in terms of cost," calculated according to a method chosen by the MPHPT, with the long run incremental cost (LRIC) system currently being used to determine these charges.

However, at the end of March this year, the MPHPT decided to approve an increase in the interconnection rates charged by NTT East and West by an average of 5 percent.

The MPHPT's decision is disturbing for several reasons. First, Japan's interconnection rates are already significantly higher than interconnection rates in other first world economies such as the US, UK, Germany and France. Second, raising rates runs counter to trends in other developed economies, where interconnection rates are steadily failing.

For example, interconnection charges in the UK are capped by a formula that ensures charges fall by around 8 percent for the local area and 11 percent for the long distance part of the telephone network each year, ensuring that telephony costs continue to decline. In addition, raising the already high interconnection rates places considerable strain on the telephone companies using NTT's local network. And if the increases are passed on to consumers, they will result in higher telephone costs at a time when economic deflation is pushing down the prices of most goods and services.

The decision of the MPHPT to approve an increase in NTT East and West's interconnection rates is now being legally challenged by a group of New Common Carriers (NCC) concerned about the decision.

My first suggestion to promote a vibrant and competitive telecommunications sector in Japan is further reform of the national incumbent, NTT. The reorganization that took place in 1999 did not result in behavioral change in NTT member companies sufficient to stimulate competition both inside and outside the NTT Group. Further structural reform is needed. One viable option is separation of the local loop (being a monopoly service) from services that are offered on a competitive basis, such as long distance telephone and data transmission services.

Under this scenario, all providers of competitive services in the NTT Group, which I will refer to as "ServeCo," would be customers of the local company, which I will refer to as "LoopCo," in a fashion similar to the way NCCs and ISPs now purchase access to NTT's last mile and access to NTT's local customers.

The two businesses, LoopCo and ServeCo, would have to be independent economic and legal entities without a single holding company. LoopCo would also not be permitted to offer any services that would compete with its own customers (i.e. ServeCo, NCCs, and ISPs). LoopCo would have to be highly regulated because of its obvious control over the local bottleneck. In contrast, little regulation would be required for competitive services provided by ServeCo.

An additional advantage of this structural separation of the local loop would be to solve the perennial problem of NTT East and West discriminating in favor of group companies by removing any incentive by LoopCo to favor "family firms." The regulator could set competitive efficiency improvement targets for LoopCo to ensure that local loop services are competitive.

This idea of competitive and noncompetitive service separation was endorsed by the OECD in April 2001, and is currently being considered in the UK as a means to regulate British Telecom's market dominance of the local loop.

As part of the structural separation of the local loop, the Japanese government should review its relationship with the NTT Group.

Governments are tempted to use their positions in national incumbents to pursue objectives inconsistent with normal shareholder criteria, such as return on investment (ROI), in favor of less tangible objectives such as national security, full employment or prevention of foreign takeovers. In the interests of national and international competitiveness, governments must be prepared to instill market discipline on partially owned companies by exposing them to the forces of the market--and they must refrain from interfering in management decisions.

The Japanese government's relationship with the NTT family of companies is set out in the Nippon Telegraph and Telephone Corporation Act (NTT Act). Among other things, the NTT Act requires the MPHPT to approve NTT's business activities, and indeed NTT submits its operating plan annually to the MPHPT minister for authorization. The Act also requires that the government perpetually hold at least one-third of NTT's shares, and that the NTT parent hold all the shares of NTT East and West, making the government a 33 percent indirect shareholder in the regional NTT East and West telephone companies it also regulates.

In return for structurally separating the local loop of NTT East and West from the remainder of the NTT Group providing competitive services, the government should amend the NTT Act to permit the complete return of NTT to the private sector. It is questionable whether NTT, aspiring to a global leadership position in the telecommunications sector, can become sufficiently efficient, flexible and innovative to compete successfully on the global stage--especially ff it must operate under the constraints of the NTT Act in its home market.

My second suggestion to promote competition is the separation of policy making and regulatory functions, and the streamlining of the policy making process. At present, the MPHPT is responsible for both policy-making and regulation in the telecommunications sector. A small, independent and technology-focused regulator of the kind that has proved so successful in the UK and Asian countries such as Hong Kong, Singapore and Malaysia would be ideally suited to achieving Japan's most ambitious national goals in the telecommunications area.

Currently, several major ministries and agencies play leading roles in telecommunications, IT, broadcasting, the Internet, software, copyright and enforcement of competition policies. The structure and responsibilities of the regulator need to evolve to mirror the evolution of the relevant technologies it supervises. This means a regulator does not maintain artificial distinctions; the forces of technology and markets are blurring, as is seen in the convergence of data and voice, and of broadcasting and Internet-delivered content.

Fixed and mobile telephony is one area where artificial regulatory distinctions are causing distortions in the market. For example, the dominant mobile carrier NTT DoCoMo and the dominant fixed line carriers NTT East and West example are similarly "designated carriers" under the Telecommunications Business Law. However, NTT DoCoMo, does not have to submit to long run incremental cost calculation (LRIC)by the MPHPT to determine its interconnection charges. Interconnecting carriers therefore have much less confidence that the interconnection charge for mobile calls levied by NTT DoCoMo is truly cost-based, and that charges not allowed on the fixed side might not be embedded on the mobile side.

Further, NTT East and West must submit their interconnection agreements to the regulator for approval, while NTT DoCoMo is only required to notify the regulator. Therefore, the regulator has relatively less authority over NTT DoCoMo to require a change in one of its interconnection agreements.

The regulatory issue in this case is about how to regulate voice services traveling over a bottleneck. It matters not whether the medium is metallic or airborne. Creating a regulator independent of policy making bodies would allow the regulator to take a holistic and technologically neutral view and eliminate artificial regulatory distinctions.

While separation of policy making and regulatory functions in itself would not solve the larger problem of excessive political interference in the telecommunications area, it would give operators in the industry confidence that legislation in existence would be implemented--and implemented fairly.

In the past, the Telecommunications Council (the chief independent advisory body of the MPHPT) has kept Japan's telecommunications policy on a steady path toward deregulation and competition. However, in the last year or so, economic difficulties in the telecommunications sector in Japan have caused the MPHPT to reject some of the more aggressive suggestions of the council promoting competition. Some would also argue that the MPHPT has attempted to influence the advice it receives from the Telecommunications Council through a series of dismissals and appointments at the supposedly independent advisory body.

Telecommunications in Japan benefited until recently from significant foreign interest, with landmark investments first from Cable and Wireless, and later from Vodafone. In addition, BT, AT&T, WorldCom, France Telecom, Deutsche Telekom, Equant, KVH and Singapore Telecom, among others, all have a presence in Japan today.

Should nothing be done to change the current regulatory structure of an overburdened ministry that does not sufficiently safeguard against anti-competitive activity, foreign telecommunications companies weighing investments options across multiple market opportunities may not select Japan in the future.

Global telecommunications policy is converging around a set of competitive law principles supported by organizations like the World Trade Organization, the European Union and the US Department of Justice. By not creating an environment in which multiple service providers offer competitive services across many telecommunications sub-markets, with the telecommunications regulator and competition authority maintaining "fair play" among the service providers, Japan is effectively signaling that it does not want to be considered a part of the international leading edge. If the nation opts for a "unique Japanese way"--prompting telecommunications policy globalization to pass Japan by--such independence would be purchased at a high price indeed in terms of Japan's place in the global information economy.

* LISA SUITS

(Rethinking Telecommunications Regulation, page 18) is a graduate of Georgetown University and MIT, where she earned a Masters Degree in telecommunications, technology and public policy. She has spent much of her career in the telecom industry, with a brief stint in the US government's commerce department. She spent five years with AT&T Asia/Pacific and subsequently moved to Cable & Wireless, where she is now the company's vice president of public policy.