Talk Is Cheap

While diplomats bicker over telecom trade rules, new technologies are shattering protectionist barriers.

"Dial the world. Talk Forever. Never Pay Long-Distance." This is the sales pitch for Digiphone, a software package that lets personal computer users talk to people across the country or around the world for the price of a local call. The software bypasses the long-distance telephone network by converting voices into digitized data that can be transmitted over the Internet to another computer or telephone. With software firms like Digiphone and VocalTec, a European businessman who travels regularly to U.S. cities could maintain a relatively inexpensive dial-up Internet access account in the United States that would allow him to make calls back to Europe at a fraction of the usual cost. On the flip side, American business travelers in Europe could call the United States for a third of the normal charge by dialing up the Internet through a pan-European access provider such as EUnet or Pipex.

Such possibilities were the subject of the first annual Internet telephony conference, Dialing the Net. Held in London last April, the meeting highlighted Internet entrepreneurs who are creating new markets that are intrinsically borderless. It illustrated how new technology and consumer demand are transforming telecommunications, overcoming barriers to competition, and undermining old monopolies.

In Geneva, meanwhile, trade negotiators from 53 countries were talking about opening the $500 billion telecommunications market to competition. After countless hours of negotiations under the auspices of the World Trade Organization, they failed to reach an agreement by the April 30 deadline. The United States refused to sign because a "critical mass of countries" had not agreed to match its offer to open the U.S. market. A complete collapse of the negotiations was narrowly avoided by extending the deadline until February 15, 1997, with talks to resume in July.

With or without a WTO agreement on telecommunications next year, the global information society will continue to emerge, monopolies will be broken up, and American firms will continue to play a dominant role in the process. The fact that the WTO has been forced to the sidelines in one of the most dynamic and important growth industries suggests that Republicans and Democrats alike have exaggerated the organization's importance. Pat Buchanan and Ross Perot have told us we should fear an all-powerful WTO inimical to U.S. interests, while the Clinton administration has acted as if the WTO were the only force working in favor of a more open trading system. But in this case, technology and market trends are proving to be far more powerful.

The real loser in the telecommunications talks is the WTO. It was created by the 1993 Uruguay Round of the General Agreement on Tariffs and Trade to carry on the work of opening world markets and to provide a mechanism for peacefully resolving international trade disputes. But the failure of the telecommunications talks has raised new questions about the WTO's ability to handle this mission. Three key sets of negotiations left over from the Uruguay Round (telecommunications, financial services, and maritime services) have either failed or been postponed in the past year. And the world trading community is holding the United States, the main architect and proponent of the WTO, responsible for the setbacks.

In the telecommunications talks, the U.S. government claimed the right to refuse licenses to foreign-owned companies that want to operate international services out of the United States but whose home countries do not provide "equivalent competitive opportunities." Trade officials have argued that if the United States opens its market unilaterally and removes the remaining foreign ownership restrictions in telecommunications, it will lose the leverage needed to open foreign markets. They have also indicated that the insistence on tit-for-tat market opening is part of a broader shift in U.S. trade policy toward bilateral reciprocity. The United States, according to acting U.S. Trade Representative Charlene Barshefsky, has "made the decision that trade agreements must be reciprocal in character….We expect foreign markets to be as open to our goods and services as ours is to them."

Sounds fair. But the "let them in only to the extent they let you in" position is based on a zero-sum logic that conflicts with our own experience in telecommunications. It exaggerates the role of government while underestimating the far more powerful roles that technology and consumer demand are playing in breaking down barriers to competition.

The U.S. experience is instructive because it demonstrates both the benefits of unilateral liberalization and the rapid breakdown of monopoly once a breach in the wall of protection occurs. For more than a century, the telecommunications industry was controlled by monopolies that limited competition at the national and international levels. The system started to crumble with the court-ordered breakup of AT&T in the 1980s, which touched off a revolution in innovation and competition. The changes culminated in the sweeping reform package signed into law by President Clinton in February, which promises to eliminate most of the remaining barriers and open the local service market to competition.

The United States has broken down the barriers to competition in most of the telecommunications sectors, without seeking reciprocity or requiring its trading partners to make equivalent moves. In the process it has created one of the most open telecommunications markets in the world, forcing American firms to be competitive. U.S. telecommunications companies are the most sought-after partners for international business alliances, in large part because of their experience in an open market.

Deregulation and liberalization also increased the depth and size of the telecommunications market, offsetting declines in the market share of incumbent firms. Telecommunications service revenue has been increasing as a percentage of GDP for OECD economies with competitive markets. In Japan, New Zealand, the United Kingdom, and the United States, the OECD found that employment by new service suppliers and users has largely offset jobs shed by incumbent telecommunication monopolies. Despite downsizing in the United States, domestic employment in the telecommunications industry has increased by 54,000 during the past two years.

Competition has brought lower prices, improvements in the quality and diversity of services, and more than $2.5 billion in savings to U.S. consumers. These benefits, in turn, have given U.S. commercial users a competitive advantage over their rivals in international markets. As users in the United States enjoy innovative data services and a 50 percent reduction in the price of long-distance services, their rivals in Europe, where telecommunications monopolies continue, have been forced to bear significantly higher costs. In Germany the cost of telecommunications services such as high-speed leased lines is five times as high as in the United States and twice as high as in Britain. For large commercial users in Germany, these prices can raise telecommunications costs (e.g., dial-up circuits, national leased lines, international leased lines, and telex lines) to 30 percent of total revenue–double the proportion in the United States.

To keep pace with their American rivals, European telecommunications users have started demanding not only lower prices but also the advantages of advanced services, such as audio conferencing on demand. The globalization of major user markets such as financial services further intensified demands for cost-effective communications systems and increased internal pressure for reform. As a result, the European Commission has targeted national monopolies for elimination. The commission is pushing privatization and foreign competition in an effort to upgrade Europe's second-rate telecommunications infrastructure and boost economic growth.

Thus, moves to open markets here have helped open foreign markets as well. The interdependence stems not from heavy-handed reciprocity demands but from market forces and global competition. Indeed, reciprocity demands could actually retard liberalization if other countries defer market-opening moves to gain bargaining power at the negotiating table. Furthermore, the argument for reciprocity clouds the debate by implying that those who do not open their markets gain at the expense of those who do. This is clearly not true from the perspective of telecommunications users, which include businesses whose ability to compete is impaired by poor service and artificially high costs.

The benefits from opening telecommunications markets worldwide will be substantial. According to estimates from the Institute for International Economics in Washington, D.C., consumers stand to gain more than $1 trillion from lower rates, better service, and improved technology. But open markets do not hinge on U.S. tactics in the WTO negotiations. The strongest forces pushing for liberalization are not even at the table. Consumer demands and new technologies are tearing down barriers that have protected telecommunications operators from domestic and foreign competition. National governments from Argentina to Australia are opening their telecommunications sectors to competition and dismantling state-owned monopolies. More than 50 privatizations are under way or have been announced.

In developing countries, infrastructure and capital needs are driving the shift toward open markets. In Asia alone, according to the Asian Development Bank, more than $200 billion will be needed during the next decade to bolster the telecommunications infrastructure. The demands far exceed domestic capital pools and the abilities of local firms. Foreign direct investment therefore has become the most important source of financing for developing countries. Leon Brittan, the European trade commissioner, notes that "developing countries have never been as receptive as they are today to the message that foreign direct investment is not a threat but a positive tool for economic growth, bringing capital, technology, and management expertise."

Even advanced economies like Singapore, which has been reluctant to open its telecommunications market, are being forced by technology and market trends to accelerate their plans to open their markets to domestic and international competition. Europe has been forced by its own infrastructure crisis to break the stranglehold of public monopolies faster than anyone believed possible just three years ago. Under European Union rules, all telecommunications services and infrastructure must be open to competition by January 1, 1998–the date that the WTO's telecommunications agreement would go into effect.

Last year the European Commission ordered the EU's 15 member states to allow alternative networks used by cable companies, railways, and other utilities to compete against state-run monopolies, except in voice telephony, after July 1, 1996. The utilities or third parties may use the networks for private corporate services, mobile communications, and data services. In the past, a firm such as British Telecommunication in Germany could offer these services only by leasing capacity from Deutsche Telekom. The recent EU decisions allow new telecommunications operators to bypass the lines owned by state phone companies and lease lines from alternative providers. After January 1998 they will be permitted to supply voice services as well.

Monopolies and barriers to competition still exist, but the price of sustaining them is rapidly rising. Insulated from competition, monopolies have failed to develop the flexibility and cost discipline necessary to respond to user demands for customized telecommunications solutions, mobility, and new services such as Internet access. At the same time, their inflated profit margins (more than 40 percent) have attracted the attention of new competitors seeking to exploit the opportunities presented by unmet consumer demands and the revolution in networking technologies.

High international rates for telephone calls have stimulated a rapidly growing market for cheaper alternatives. System integrators, for example, buy long-distance capacity in bulk and then offer services to telecommunications users at large discounts. U.S. international long-distance resellers offer call-back services to multinational firms or their customers abroad. Call-back services in effect export competition to markets dominated by state-owned monopolies or inefficient suppliers by shifting the origin of a call. Customers are typically given a "trigger" number that they use to call a computer in the United States, hanging up before the connection is made. The computer then calls back, offering an American dial tone that can be used to call anywhere in the world. Depending on the destination, call-back operators can save their customers more than 50 percent on international calls. In the last year, call-back traffic has grown by 63 percent, and by the end of the year more than 100 American companies may be providing the service. Governments in Argentina, China, South Korea, and Malaysia have tried without success to stop it. When Uganda tried to block all calls to the Seattle area code where Kallback is based, The Economist reports, the company simply routed the calls through a different area code.

Converging technologies are blurring the boundaries between regulated and unregulated industries, allowing competition between firms that previously did not compete. In the past, there were separate networks for different types of traffic (voice, data, video). But with the digital revolution and deregulation in the United States, integrated service networks are emerging that include voice as one component in a bundle of applications. Regardless of what happens in Geneva, both foreign-and American-owned telephone companies are therefore being forced to compete against cable, satellite, and computer companies. New technologies have also cut the price of admission and encouraged a new generation of start-ups to enter the converging information and communications sector.

The Internet promises to be the most disruptive new technology. It is rapidly eliminating the importance of distance between nations, closing the gap between computer and voice communication, and giving corporations a cheaper alternative for traditional telecommunications services. In contrast to the telephone industry, it has not been protected or burdened with regulators trying to manage its growth. It has instead grown in response to user demands, with an exploding base of more than 50 million worldwide.

U.S. negotiators couldn't have asked for a better partner in the cause of opening markets. The Internet will hit exactly those markets, such as international telecommunications services, where profit margins have been kept artificially high by the lack of competition. On transatlantic connections 50 percent of the traffic is for fax messages, which are digital and therefore suited for Internet transmission. CallWare Technologies, a Salt Lake City company, is already selling software that makes international voice mail a local call. Internet-based call-back schemes are also starting to emerge. CallWare is working on a plan that would allow traveling managers connected to a U.S. computer via the Internet to command the computer to call another U.S. number over the phone line and then transfer that phone call to wherever they are located, thereby bypassing the high rates charged on outbound voice calls by monopolies in Asia and Europe.

Companies such as Digiphone and the Israeli firm VocalTec are pushing the Internet frontier beyond e-mail to include real-time, two-way voice conversations. The quality of the voice calls over the Internet is still inferior to those placed through traditional phone lines, but the technology and underlying infrastructure are rapidly improving. With Netscape and Microsoft racing against each other to add real-time voice capabilities to their Internet products, voice service may become a standard feature of software packages for surfing the Internet as early as 1997.

Internet phones are just the beginning. More and more companies are converting telephone traffic to digital data and sending it through private networks to cut telecommunications costs. Universities like Cornell are considering whether to replace their telephone systems with much cheaper systems that deliver multimedia over data networks. Sun Microsystems has announced plans to abandon the expensive global network that it leases from phone companies such as MCI and Sprint, instead connecting its scattered offices through the Internet.

The networking revolution is not limited to the United States. One of the most significant developments in Europe during the past year has been the growing importance of alternatives to the public telecommunications network. Hermes Europe Railtel, a consortium of railway companies financed by George Soros, is investing a reported $1.2 billion in a trans-European network that will allow it to sell its excess capacity to phone companies, corporations, and phone start-ups. It will be the first major network that doesn't rely on patching together leased fiber from telecommunication monopolies. Utilities such as RWE, Veba, and Viag also offer private corporate services on their backbone systems.

With competition for corporate users on the rise, monopolies may lose 40 percent of their market and 70 percent of their profits. Leased line prices for data and long-distance services are already falling and may drop as much as 10 percent a year as competition increases. A recent survey of 120 major corporations by IBM and The Economist Intelligence Unit found that the increasing availability of service alternatives is expected to hold down telecommunications costs even as the demand for voice and data traffic dramatically increases.

Foreign firms are expanding the base of competition and upgrading the information infrastructure in Europe and Asia. Cable and Wireless, a British firm, and Global One (Sprint, Deutsche Telekom, and France Telecom) are investing millions to develop Internet services in Europe and Asia. UUNET, one of the largest U.S. Internet access providers, plans to buy communication links in Europe from Hermes Europe Railtel BV. It has a 40 percent equity stake in EUnet Germany, the largest Internet access provider in that country, and in 1995 it purchased Unipalm PLC, the leading Internet provider in Europe. Other firms such as IBM are designing and operating private networks around the world. The IBM Global Network is one of the largest Internet service providers in the world, offering high-speed line connections with more than 600 dial-up points in 50 countries. With network costs becoming less sensitive to distance and a growing web of global alliances creating new forms of market access, geographic boundaries and corporate nationalities are becoming less relevant.

While negotiators have been arguing over the official rules of market access in Geneva, telecom operators in the OECD economies have been making some of their own as they rush around the globe gathering partners and stitching together a network to supply the information and communication needs of multinational corporations. This supercarrier race has been marked more by competition among U.S. long-distance providers than competition between U.S. and foreign-owned firms. MCI has joined with British Telecom to form the Concert venture. Sprint has the Global One venture, while AT&T has a loose network of alliances with local carriers through World Partners, which includes 16 telecommunications carriers that provide services in 31 countries in the Asia-Pacific region, North America, and Europe. In Germany, the largest telecommunications market in Europe, North American companies are playing an especially prominent role. The major ventures include Thyseen-Bell South; DASA-Northern Telecom; Viag Interkom-British Telecom, Veba-Cable and Wireless; and an alliance of CNI (Mannesmann-Deutsche Bank), AT&T, and Europe's Unisource.

These alliances are just the tip of a rising global information economy characterized by new patterns of international exchange and a dense web of public and private networks crossing industry and national borders. Market access continues to be a critical issue, but while the negotiations in Geneva could help, they are not the most important piece of the puzzle. Recent trends highlight the growing importance of marketplace developments relative to public institutions in setting the de facto rules of the game.

The official rule-making process takes, on average, more than 10 years, whether for a domestic agreement (the U.S. 1996 Telecommunications Act) or a multilateral accord (the Uruguay Round Agreement and the pending WTO telecommunications deal). Contrast that experience with the rapid development of the Internet. Written off just two years ago as a plaything of the technical elite, the Internet is redefining the rules and the very nature of the telecommunications industry. Less than two months after the Telecommunications Act was passed, long-distance and local phone companies were lobbying the FCC to change the definition of a telecommunications carrier and stop "unfair competition" from innovations like Internet telephony.

With technology blurring the lines between industries, it is no longer clear where the lines should be drawn, or if they even can be drawn. Should Microsoft, Netscape, or Internet access providers be regulated as telecommunications carriers in the domestic and international arenas? Should voice services delivered over what used to be simple data networks be treated as enhanced services that are not regulated, or should they fall in the heavily regulated category of basic services? Definitions may ultimately matter very little. By the time an official decision is made, the marketplace will probably look fundamentally different. An industry rule of thumb is that one human year is equal to about five Internet years.

In this chaotic world of converging markets and rapidly changing technologies, government should do what it can to promote a uniform, stable framework of rules. The United States failed at this task last April in Geneva. According to the U.S. Trade Representative, 33 governments "have indicated that they are prepared to commit to fair rules of competition. This is an unprecedented development in a global market that is still dominated by inefficient state-owned monopolies." But instead of seizing the opportunity to anchor these commitments to a multilateral system of rules that would have improved the access of U.S. telecommunications firms, the United States walked away from the negotiations.

In doing so, the Clinton administration also lost a strategic opportunity to strengthen the WTO and put to rest nagging questions about America's commitment to the multilateral liberalization process. Congress was already skeptical about what the United States would gain from the WTO. Senate Majority Leader Bob Dole further encouraged distrust with his proposed "three strikes and you're out" commission, which would review WTO rulings and recommend that the United States pull out after it finds three it doesn't like. Other countries are also responsible for the WTO's setbacks–Malaysia and Indonesia did not even make liberalization offers in the telecommunication talks–but their decisions do not carry the same weight as those of the United States.

The success of international agreements like the Uruguay Round, which created the WTO, depends largely on the level of support from their most powerful members. The U.S. government spent seven years convincing the international trading community it needed a global free trade watchdog. It also seems to think that the WTO can serve American interests: Twelve of the 18 disputes pending before the WTO were initiated by the United States. But if the United States wants a credible WTO around to handle its complaints against offensive trade practices and to shape the global framework for the marketplace being created by converging technologies, it needs to stop playing around with reciprocity games. Countries that choose not to open their markets do so at their own expense. If the U.S. government cannot demonstrate its faith in the benefits of competition based on its own experience, especially when current trends so overwhelmingly favor U.S. interests, what other government will? Periods of momentous change and opportunity reward those who not only talk about what needs to be done but who lead by example.

Cynthia Beltz ([e-mail]) is a research fellow at the American Enterprise institute in Washington, D.C.