CANADIAN INDUSTRIAL POLICY
Daniel J. Shaw
INFORMATION AGE AND THE CANADIAN ECONOMY
A TELE-COMPETITIVE ADVANTAGE FOR CANADA
POLICY FOR THE NATURAL MONOPOLY ERA
POLICY FOR THE INFORMATION AGE
CANADIAN INDUSTRIAL POLICY
is clearly the agent of change ... The traditional telecommunications
industry and its regulation have been based on structural and economic
assumptions that are rapidly being undermined by technological change
not only in Canada, but around the world.
George Addy, Bureau
of Competition Policy
choice: Lead the world, or be hewers of wire and carriers of bits.
Derek Burney, Bell
Canada International Inc.
Telecommunications and cable
television companies in Canada and elsewhere are undergoing a rapid transformation
in the technologies they use and in the services they can potentially
deliver. No longer do these signal distribution companies rely exclusively
on copper wire or coaxial cable as their primary transmission medium;
increasingly, the backbone of their networks consists of fibre-optic cable,
which carries information on a pulse of light, and wireless systems, which
make use of the electromagnetic spectrum. Together, these innovative technologies
have immeasurably expanded the carrying capacity of the networks, which
can now incorporate interactive two-way voice, video, data and graphics
information forms, converted to and from the digital language of computers,
to provide new services such as video-conferencing, video games, high-capacity
data retrieval and processing, video-on-demand (VOD) and much more. While
voice communications, data communications and entertainment services were
formerly the distinct preserve of, respectively, telephone, satellite
and cable television companies, each can now be provided over the others
transmission facilities. Hence, the dissolution of conventional boundaries
between telecommunications, cable television and computer activities is
paving the way for the convergence of information carriage services over
what has been dubbed the "Information Highway."
These new services present
Canadians and their businesses with many new commercial opportunities,
as well a plethora of new ways of organizing their daily and business
relations thereby sometimes blurring the differences between work,
school and leisure. Furthermore, these sophisticated telecommunications
services are becoming increasingly integral to the efficient and timely
movement of information in the modern business world. They enable companies
to take advantage of, for example, "just-in-time" inventory,
electronic data interchange, airline computer reservation, and electronic
banking and shopping systems. The associated savings from these new services
and administrative practices will undoubtedly contribute to the competitiveness
of the business sector; they will also improve the delivery of government
services, in particular, health care and education, to the public.
In addition, developments
in technology in the transportation sector are fostering the globalization
of commerce. Relatively low-cost transportation and communications have
enabled trade to proliferate beyond the traditional borders of nation-states,
with a disproportionate share of this trade being conducted by multi-national,
or, more correctly, transnational corporations. These companies
investment decisions seem increasingly to be based strictly on economic
grounds rather than on accidents of history and geo-political factors.
Consequently, Canadas business sector is presented with a serious
challenge if it is to remain competitive internationally. The so-called
"Information Revolution" is indeed a double-edged sword.
This challenge is not only
for individuals and their businesses, but also for the federal government.
As the exclusive responsibility for telecommunications and broadcasting
policy in Canada is federal, it is incumbent on the Government of Canada
to provide legislation and policy appropriate to the social, cultural,
political and economic setting of the day. Because of the demise of technologies
characterized by "natural monopoly" conditions and the re-configuration
of telecommunications and broadcasting activities along global rather
than national lines, policy must be re-designed accordingly. Indeed, public
policy must now provide broad, new ground rules for incumbent telecommunications
and broadcast distribution companies as well as for new entrants. The
significance of this policy reformulation cannot be overstated.
If a Canadian telecommunications
company is not competitive in its own domestic market, it is unlikely
to be competitive abroad. International telecommunications is largely
founded on the national infrastructure, which, in turn, is founded on
the local network infrastructure. Thus, the domestic networks make up
an integral part of the domestic information sector and are important
to the continued viability of Canadas business sector as a whole.
This paper, therefore, focuses on providing the Government of Canada with
guidance on industrial policy for the further development of the Information
Highway; the long-term aim is to preserve and enhance Canadas international
competitiveness in telecommunications and broadcast distribution.
INFORMATION AGE AND THE CANADIAN ECONOMY
The "Information Age"
is not just an amazing array of new communications gadgets that are permitting
more and varied discourse about the globe. It affects how people are re-organizing
their lives at work and at home as a consequence of these revolutionary
innovations. The introduction to this paper singled out recent technological
advances that favour the dissolution of boundaries between broadcasting
and telecommunications activities and the globalization of commerce by
transnational corporations. But these innovations are also, in a way,
turning back the clock to pre-industrial days, as some business activities
are once again organized as cottage industries although with far
more strategic forethought put into their design and products than was
the case in the past. Such activities can be grouped under the heading:
"services." This development should not be surprising, given
that the telecommunications and microprocessing innovations have freed
professionals to be more imaginative and productive.
The past two decades have
witnessed the dissolution of many large companies and conglomerates or
their trimming down to more manageable size in the hope of becoming more
productive and profitable. This rationalization has been undertaken in
four ways: (1) companies have shed or spun-off and sold many of their
less compatible divisions and subsidiaries in order to concentrate on
core activities; (2) companies have formed strategic alliances with supplier
and customer companies, whereby the former parent corporation takes on
flagship status, with the supplier and customer companies playing a well-defined
subordinate but supportive role;(1)
(3) companies have reduced the number of middle managers in favour of
reorganizing or contracting out their functions; and (4) companies have
re-engineered their command-and-control coordinating structure to form
a flatter and broader hierarchy, based on teamwork and financial incentives,
that can take full advantage of the creativity and talents of its workforce.
As a direct result of this
corporate reorganization, small business based on professional services
has boomed, creating new industries and new ways of behaving in the process.
On-line information services, computer software companies, multi-media
graphics design, electronic banking, mail-order businesses and a plethora
of new activities are reshaping the commercial landscape. Evidence of
this industrial re-organization can be found in Canadas national
accounts. In 1990, 97.2% of registered businesses had fewer than 50 employees.
Between 1980 and 1990, these businesses grew by 40%, with almost all the
growth consisting of small businesses, and often a single person working
out of the home.(2) In 1994,
services accounted for $349 billion of $532 billion goods and services
produced (valued at factor cost and in constant 1986 dollars), or 66%
of Canadas Gross Domestic Product (GDP).(3)
Services are primarily consumed in the home market; the export of services
has never exceeded 14% of total goods and services exported. Hence, services
constitute a class of lesser-tradeables that are used by the domestic
business sector both as a final consumer end-product and as an intermediate
input contributing to the business sectors competitiveness. This
is particularly true of the "Information-Based Society" services
now arising out of innovations in telecommunications and microprocessing.
are now more important than ever to the competitiveness of Canadas
business sector. From a sheer quantitative perspective, the revenues of
telecommunications and cable television companies amounted to $17.9 billion
in 1994, representing 2.4% of Canadas GDP. Including the information-based
activities of broadcasting and computer services companies, revenues in
1994 totalled $36.8 billion, representing 4.9% of Canadas GDP.(4)
The Information Highway Advisory Council (IHAC) further expanded the periphery
of information-based industries to include telecommunications equipment,
computers and office equipment, instrumentation, microelectronics and
consumer electronics products. This increased the total revenue of information-based
services in 1994 to $50 billion, accounting for 7% of Canadas
GDP.(5) Measured in terms
of employment, telecommunications, broadcasting and computer services
industries productively engaged 277,750 people, representing 2.1% of the
countrys total employment in 1994.(6)
These jobs are disproportionately at the high-end of the skill class in
the economy with an average salary of $44,392 in 1994, well above the
From a qualitative perspective,
the contribution of Canadas information-based industries is equally
impressive. Business activities are now more than ever geographically
dispersed, thereby requiring more intra- and inter-corporate communications
for better coordination and efficiency. Telecommunications enables businesses
to show improved productivity in many aspects of their operations, including
reduced costs for inventory, overhead, marketing, and distribution; decentralized
operations; shortened product development cycles and response times; increased
scope for management; and improved decision-making, job training, product
support, and customer service.(8)
Both quantitatively and
qualitatively, information-based industries contribute to the competitiveness
of virtually all sectors of the Canadian economy. Such industries, with
telecommunications and microprocessing acting as linchpins, transcend
all other industries in the economy to occupy a strategic, if not a key
determinant position in national competitiveness. It would not, therefore,
be a big stretch to predict that the Information Revolution will mobilize
and aggregate human capital ("knowledge") to much the same extent
as the "Industrial Revolution" mobilized and aggregated physical
and financial capital, to bestow advantages on those with immediate access
to this type of capital. Undoubtedly, the individuals who possess the
requisite knowledge will be the principal beneficiaries. Entrepreneurs
that are best able to access, generate, combine, process and analyze information
will capitalize on its rewards. For nations wishing to participate in
this revolution, all that remains is to muster the courage to make the
necessary institutional changes to liberate the activities now made possible
by digitization, computer chip-aided information processing, ATM switching,
and fibre-optic cable and wireless transmissions technologies. For such
nations, the rewards would include a disproportionate gain in high-skilled,
high-paying jobs. For those nations that choose otherwise:
Intellectual capital is
simply the power of the human mind applied to knowledge and enhanced
by information technology. Human intelligence is quickly becoming the
dominant factor of production and the worlds most fundamentally
important market is the market for intellectual capital. Unlike physical
capital, intellectual capital is not tied to geography. Highly mobile,
knowledge workers and information entrepreneurs can move very quickly
from nation to nation and take their companies with them.(9)
Far more than any other
form of capital, intellectual capital will go where it is wanted, stay
where it is well treated, and multiply where it is allowed to earn the
greatest return. Nations that respect the freedom of intellectual capital
and accommodate it will prosper in the global economy. Those that imagine
that this most powerful form of capital can be enslaved or entailed
A TELE-COMPETITIVE ADVANTAGE FOR CANADA
Some industry observers
remind us of Marshall McLuhans vision of a "global village";
others foretell the "death of distance" as a barrier to trade
and commerce; still others predict a borderless world with the demise
of the nation-state. Like many forecasts, these will eventually prove
inaccurate - in relative, if not in absolute terms. They do, however,
provide a window allowing us to envisage how future generations will and
will not organize themselves in the aftermath of the Information Revolution.
Futurists can help by visualizing and defining the forthcoming character
of the Information-based Society, even if they cannot provide an exact
The above three forecasts
are best regarded as occupying one end of a spectrum whose opposite end
predicts the pervasiveness and omnipotence of the nation-state. The truth
will be found somewhere between these poles. Distance one of many
factors contributing to the emergence of the nation-state will
no doubt prove to be a less daunting impediment to trade in the digital
future, but the forces of the Information Revolution have not proven so
powerful as to overcome all the logistical problems of distance and shrink
the world to one political entity. Strong arguments can be made in favour
of selective industrial policies; governments do matter, both when they
get industrial policy right and when they get it wrong. The appropriate
role for government in creating a nations tele-competitive advantage
is therefore worth exploring.
Economic theory is instructive
on this matter. The nations that obtain the highest standard of living
are those that deploy their labour and capital resources on activities
that yield high and rapidly rising levels of productivity here,
there is little debate. Productivity is at the root of a nations
international competitiveness and three widely recognized strategies are
required to maximize it. A nation could exploit its bounty of natural
resources, according to the century-old trade theory of comparative advantage.
A nation could seek to maximize scale and scope economies in manufacturing
and distribution in pursuit of productive and allocative efficiency, according
to the long-standing neo-classical theory of the firm. Finally, a nation
could attain a higher rate of technical progress through fostering innovation
and technological change in activities where it has a competitive advantage,
according to modern growth theory. History shows that Canada, since its
inception, has executed the first strategy with considerable success;
pursued some aspects of the second with varying degrees of success; and
has yet formally to adopt the third strategy in a coherent fashion.
It can be argued that a
national competitive advantage can be created and sustained by both firms
and governments in selective goods and services under the right conditions.
is created and sustained through a highly localized process. Differences
in national economic structures, values, cultures, institutions, and
histories contribute profoundly to competitive success. The role of
the home nation seems to be as strong as or stronger than ever. While
globalization of competition might appear to make the nation less important,
instead it seems to make it more so. With fewer impediments to trade
to shelter uncompetitive domestic firms and industries, the home nation
takes on growing significance because it is the source of the skills
and technology that underpin competitive advantage.(11)
By definition, a national
government must focus its efforts; a country can obtain a competitive
advantage in the production of only a few goods and services, never in
all. Initiatives must look forward, rather than looking backward in the
hope of preserving past activities that have come to be associated with
"a way of life." Furthermore, since it is the firm that competes
in global markets, and not government, it is the firm that should undertake
the principal initiatives in order to obtain a competitive advantage in
international markets. The national governments role should largely
be supportive; it should not pick the winners or losers directly, but
do so indirectly by shaping the institutional structure in which firms
operate in the home market. Indeed:
The proper role for government
policy ... should be to create an environment in which firms can upgrade
competitive advantages in established industries by introducing more
sophisticated technology and methods and penetrating more advanced segments.
Government policy should also support the ability of the nations
firms to enter new industries where higher productivity can be achieved
than in positions ceded to less productive industries and segments.(12)
Unless the government has
a more accurate vision of the future than does the private sector, it
should not arbitrarily subsidize various companies and technologies. Instead,
it should focus on "framework" policies. The failure of some
governments to recognize this basic fact has caused some industrial grants
to go, not to the promising firms and technologies, but to the firms and
technologies best able to work their way through the government grant
Governments have a significant
role in fostering a mature, well-skilled labour force; education, as previously
mentioned, is the quintessential resource of the Information-based Society.
Governments will increasingly be challenged to ensure that their citizens
continuously upgrade their work skills through providing, in partnership
with the private sector, appropriately designed education and labour market
policies for fostering life-long learning.
A principle which we very
readily adopted [ was] ... that life-long learning should be a key design
element in the building of the information highway. What we are really
talking about there is the importance of us being an adaptable society
and a society where each of our citizens has the opportunity to adapt
and to use these tools for his or her advantage.(14)
The Information Highway
has also been identified as a pre-eminent national infrastructure ("infostructure")
capable of having a significant influence on the competitiveness of a
nation.(15) Given Canadas
long history in telecommunications, advanced telecommunications infrastructure,
and well-developed political-economic institutions, the telecommunications
sector would be a prime candidate for creating and sustaining a competitive
advantage for this country. The national governments role would
be to ensure the preservation of the underlying forces that have invigorated
this national infrastructure from the outset.
The productivity of the
infostructure must be upheld and maintained by public policy. It
can be argued that this can be accomplished not by directly favouring
any one firm or technology, but by letting the market decide outcomes.
Legislation for increasing the pool of funds available for creating and
upgrading the Information Highway is one example of government support
that could help create a competitive advantage for Canada. A second example
would be legislation for promoting the rivalry amongst firms vying for
the economic rents flowing to pioneers that deploy successful new technologies
and production processes and commercialize new products and services.
POLICY FOR THE NATURAL MONOPOLY ERA
It should be recognized
that industrial policy affected the telecommunications sector in Canada
and elsewhere almost from its inception. In other words, government involvement
in telecommunications has always fashioned the structure and competitiveness
of the sector in both positive and negative ways. Federal government policy
with respect to telecommunications began with the development of telegraphy,
expanded before the end of the nineteenth century to include telephony,
started to incorporate cable television via broadcast policy in the late-1960s,
and today includes satellite and wireless market segments. While not comprehensive
from the start, an ever-expanding ad hoc industrial policy rolled
out with each new significant advance in the telecommunications sector,
although with decreasing scrutiny and intensity. Each new technology brought
with it an expanding and sometimes overlapping government involvement.
At times, public foray into the sector involved all three levels of government,
taking a form anywhere from light-handed regulation by a quasi-judicial
government agency to extensive micro-management by a provincial Crown
The dominant explanation
for the governments initial move into telecommunications has been
the sectors natural monopoly characteristic. That is, though a great
deal of capital is needed to lay an extensive cable network, construct
numerous call-switching stations and create a variety of support services,
economies of scale are so large that one firm could deliver this service
at far less cost than two or more firms. The avoidance of duplicated infrastructure
is the goal when a second, "cream-skimming" company is enticed
into lucrative market segments. Often piggy-backed on to this technological
phenomenon is the existence of "network externalities."(16)
Governments across the world
therefore made it their policy to grant a monopoly charter to a company
that in return assumed a statutorily imposed universal service obligation.
In North America, after limited competition emerged (approximately 1890-1910),
national governments chose to grant monopoly rights to private corporations
subjected to economic regulation. European countries, in contrast, largely
merged their telegraph and telephone services into their government postal
operations; hence, the PTT acronym appended to their corporate names.
Universal service obligations were complemented by regulations that introduced
cross-subsidy pricing schemes from long distance to local services, from
urban to rural services and from business to residential services.
Mainly because of the threat
from potential competitors in its lucrative central Canada market, Bell
Canada Limited, Canadas first telephone services company, sold its
telephone services in the Maritimes to local interests, re-gaining control
of them in the 1960s.(17)
Prairie provinces, largely dissatisfied with slow development and poor
services offered by Bell Canada, went through a popular uprising that
saw provincial Crown corporations taking over their respective provincial
networks in the 1904-8 period; the exception was the Edmonton market,
which remained in municipal hands until just recently, when it was privatized.(18)(19)
BC Tel and Québec Téléphones, 50% owned by GTE Corporation of the United
States of America ("U.S."), took up operations in British Columbia
and Quebec, respectively.
The history and industrial
organization of the Canadian telecommunications services sector are indeed
interesting. Further investigation suggests that several factors, coming
about both by design and by accident, can explain Canadas excellent
international competitiveness ranking (see Davidson and Hubert (1994)).
Three positive factors are: (1) reliance on private corporations
to operate the networks; (2) largely provincially organized monopolies
rather than one national monopoly; and (3) relatively free and mobile
capital. One negative factor would be the large cross-subsidy pricing
The first factor stems from
the fact that private corporations have a greater tendency than Crown
corporations to foster a management culture with a well-defined bottom-line
approach to operations. A regulator should be able to appropriate a portion
of the resulting production efficiencies and transfer them to consumers
in the more remote communities.
Looking back, the decision
to allow carriers to be privately owned and regulated, rather than government
monopolies, proved wise. The most innovative countries of the world,
in terms of services offered, are Canada and the U.S.; they were among
the few countries that did not historically have government-owned Post,
Telegraph and Telephone companies. ... In addition, governments
insistence that domestic carriers offer service to all of the remote
and sparsely populated areas of the country as a requirement for licensing
challenged carriers by forcing them to be technically innovative in
order to fulfill this difficult task. Creating challenges, rather than
removing them ... fostered a truly competitive environment.(20)
The advantage of regionally
or provincially based monopolies over a national monopoly is two-fold.
First, recognizing that the economies of scale in a telephone network
are largely situated in the local exchange and not between local exchanges,
unit cost advantages are generally exhausted before they reach output
levels of a province (or region, in case of the Maritimes). Therefore,
there is relatively little to be gained from structuring the industry
so as to give a carrier a larger operating jurisdiction than a province.
In fact, in some settings, being larger simply means being more bureaucratic,
which is not conducive to high productivity or competitiveness.
Secondly, having more than
one carrier in the relatively small Canadian market meant that Northern
Telecom (Nortel), the equipment arm of BCE Inc. (Bell Canadas parent
corporation), had to be concerned about signal compatibility much earlier
than did other equipment providers. Moreover, Nortels obligation
to offer its products and services to Bell Canada at a price not exceeding
the best price offered other carriers (most notably Stentor members with
the option of buying from other equipment providers), introduced competition
into the Canadian equipment market and forced Nortel to be more efficient
than foreign equipment providers with a captive domestic PTT market.(21)
This made Canadian telecommunications service providers more competitive
in international markets.
The third advantage of Canadian
industrial policy in telecommunications resulted from the governments
insistence on relatively free and mobile capital to finance the industrys
vast infrastructure. Bell Canada was originally 50% American owned, while
BC Tel and Québec Téléphones remain so today. Access to low-cost financing
for a vastly capital-intensive industry such as telecommunications was
an industrial imperative. Only very recently has Canadian policy become
tentative about the source of the sectors equity capital. At present,
a 20% foreign ownership limit is placed on telecommunications carriers
directly and a further 33% limit is placed indirectly, through a holding
company; thus, foreign ownership levels are capped at 46 2/3% of the voting
stock of a carrier. BC Tel and Québec Téléphones foreign ownership levels
of 50% were grandfathered in the Telecommunications Act of 1993,
however; therefore, this capital constraint has not been binding on them.
Not until the most recent investment in Unitel by AT&T Canada and
Sprint Canadas recent share offering in American capital markets
have these restrictions possibly constrained Canadian competitiveness
in telecommunications or adversely affected it.
The cross-subsidy pricing
policies meant to encourage universal service decrease the competitiveness
of Canadian telecommunications carriers. Statistical studies have shown
that residential demand for local telephone service is relatively price
inelastic compared to demand in the business sector and long-distance
services; thus, the elimination of local service subsidies, it is suggested,
would lead to a minimal or no drop in demand.
The reality is that studies
show that the price elasticity of demand for local service is minus
0.1. That means that you could double the rates and less than one-tenth
of one per cent of the people would drop their service. ... However,
if I reverse the problem, if the price elasticity of demand for long
distance is about one some people say it is 0.8 per cent, some
people say it is one per cent, some people say it is a little more than
one per cent that means that a 10 percent increase in the
price of long distance leads to a 10 per cent reduction in the quantity
demanded. ... So we have it exactly wrong. In other words, we ought
to be putting the high mark-up on local and the low mark-up on long
distance and in fact we are doing the opposite.(22)
Consequently, while the
cross-subsidy schemes may have contributed to a higher market penetration
rate in the past, they are of little value today. Their adverse economic
impact on GDP was estimated at more than $4 billion annually in 1995.(23)
The high market penetration rates in Canada may also be in part explained
by the remoteness of our communities. Sparsely populated high-income countries
such as Canada would naturally have a particularly high demand for telephone
service, which would also serve as a valuable substitute for some transportation
Finally, as indicated above,
technological developments are blurring the boundaries between telecommunications
and broadcasting activities; therefore, an analysis of the impact of industrial
policy on the competitiveness of cable television and direct broadcast
satellites (DBS) companies is warranted. Here, we must be careful to differentiate
between carriers and content providers (broadcasters). The overriding
goal of the Broadcasting Act, the preservation of Canadian cultural
heritage and sovereignty, can conflict with the goal of economic efficiency.
After all, the Act chiefly aims to encourage Canadian programming content
over Canadian airwaves, coaxial cable and DBS. The policy works in the
Our stations have a schedule,
which is 60 per cent Canadian, and 50 per cent of our prime time schedule
is Canadian programming. However, our costs to produce that 60 per cent
of our programming generate only 44 per cent of our revenue. ... For
every dollar spent on foreign programming, a local station earns $1.42
in revenues. For every dollar spent on Canadian programming, we are
only able to generate 88 cents. For example, the CTV network ... detailed
how an hour of Canadian drama cost them $112,500 in licence fees. The
average net revenue for the commercial spots sold in that hour was only
$69,600, resulting in a net loss of $43,000 for a critical hour of prime
time programming. The programs producer made a profit on the program,
but the broadcaster, CTV, did not.(24)
The Broadcasting Act
is predominantly concerned with the content of broadcast programming and
not with its carriage. Cable television and DBS carriers were captured
by the regulatory ambit only because, as distribution channels, they can
have a significant impact on the effectiveness of broadcasting policy.
The government again took advantage of the natural monopoly characteristic
of cable television by granting regional monopolies whose economic rents
were appropriated by the regulator in a number of ways: (1) 5% of
revenues must be re-directed to fund Canadian programming; (2) the added
cost related to carrying a greater number of Canadian broadcasters than
would otherwise be the case; and (3) the loss in incremental revenue
from being unable to distribute non-approved foreign broadcast services.
As in international telecommunications,
non-economic pricing invariably leads to uneconomic by-pass; in this industry,
this would be measured by the size of the so-called "grey" market
- the number of Canadian residences that subscribe to American Direct-to-Home
(DTH) satellite services. This is conservatively estimated at 240,000
homes, representing 2-3% of the Canadian domestic market.
POLICY FOR THE INFORMATION AGE
Past industrial policy in
telecommunications and in broadcast programming distribution in Canada
was somewhat effective because it focused on the underlying factors of
competitiveness peculiar to these industries. Indeed, industrial policies
of the past were principally designed to overcome natural monopoly and
the high capital-intensive nature of telecommunications operations in
order to ensure that consumers were not gouged. Industrial policies were
not allowed to stray too far from this objective in pursuit of other objectives.
Even when economic efficiency was subordinated to cultural heritage and
sovereignty in the Broadcasting Act, the regulator, the Canadian
Radio-television and Telecommunications Commission (CRTC), was constrained
to consider economic factors so as to provide some balance in its decision-making.
Without a doubt, Canadian
industrial policy in telecommunications has been somewhat successful.
The operative question now becomes: will the government modify its industrial
policies in telecommunications and broadcast programming distribution
to meet the new conditions, most notable of which is a rapidly changing
technology base? A period of rapid technological change places different
demands on industrial policy and demands careful consideration of its
By definition, technological
change means that the political-economic landscape is shifting beneath
the nation and that new strategies must be put into place to maintain,
if not improve, our competitive position in the world. Industrial policy
must be flexible so that industry can respond to the forces of change.
Three strategic imperatives for telecommunications and broadcast distribution
could be: (1) that industry regulation shift away from its current emphasis
on economic factors towards an emphasis on social factors, such as copyright,
high-tech theft protection and the maintenance of decent behaviour and
privacy; (2) that capital continue to be relatively free to finance the
completion of the new infostructure at a reasonable cost to society;
and (3) that the pace of R&D and innovation rise to push the nation
into the lead on several technological fronts.
In terms of the first strategic
imperative, technologies in telecommunications and cable television have
matured; they have brought about the demise of natural monopoly.
It is now clear that the
first rationale for regulation the existence of natural monopoly
may no longer be true as the proliferation of communications
technologies and networks continue to evolve. Recent technological advances
in fibre optic technology, in the use of the electro-magnetic spectrum,
and in micro-electronics are reducing the scope for natural monopoly
in local service. More importantly, these technological advances are
rapidly decreasing the costs of switching and transmission, the essential
ingredients of telecommunications networks.(25)
Hence, economies of scale
in the carriage of electronic information have been substantially reduced,
suggesting that competition can now assume the same position in this sector
as in unregulated sectors of the economy, thereby promoting economic efficiency.
Even if these economic developments
in the local telephone services market were questioned, the convergence
of telephone and cable television technologies and services as a result
of the common digital format and the development of wireless telephony
have already brought about duplicative investments in infrastructure.
Hence, expensive capital outlays have not been avoided and lucrative markets
are increasingly being skimmed by new technology-based competitors. Is
there anything to be gained by prohibiting competition in telecommunications
and cable television services?
Industrial policy could
move away from economic regulation towards competition. At this juncture,
it should be noted that regulation is not a perfect substitute for competition
in promoting economic efficiency. While rate-base, rate-of-return ("RoR")
regulation is aimed at keeping tariffs closer to the costs of providing
the regulated services, it is not a good mechanism for controlling other
important economic factors. Real competition, on the other hand, not only
constrains price to cost, it also restrains cost increases and leads to
the adoption of efficient production processes, least-cost input factors
and optimal organizational integration, both horizontal and vertical.
Regulation often fails to perform these tasks adequately. We will consider
four simple examples of regulatory-induced inefficiency. The first involves
the labour input; the second, the capital input; the third, the joint
provision of monopoly and non-monopoly services; and the fourth, matters
of R&D, its innovation and its diffusion.
First, in a regulatory environment
it is easier for management to acquiesce to the salary and job description
demands of workers and unions, since a company without rivals (or whose
rivals prices are controlled by the regulator) can simply pass on
extra labour costs to consumers, without the fear of significant loss
in demand. The benefits of regulation are thus usurped. The Stentor companies
have classified an inordinate number of employees in management positions,
which are outside the collective bargaining process, in order to constrain,
but not eliminate, this distortion. As a result, one can confidently predict
that an inordinate number of middle management jobs in the Stentor companies
are likely to disappear in the near future, if they have not already done
so, as their corporate cultures and managements based on monopoly dominance
adjust to the new economic environment.
Second, under RoR regulation,
profits are enhanced by increasing capital inputs; this encourages an
over-investment in capital equipment and in capital-intensive/labour-saving
technologies, as well as a search for non-optimal sources of financing
(i.e., excessive reliance on debt relative to equity). For example, consider
a community of 100,000 households, where it would be optimal for a telephone
company to invest in 100 first-tier telephone switching centres (i.e.,
1,000 households connected to one switch) with one central local switching
centre. If it costs $100,000 per switch, this local network would require
a capital investment of $10.1 million (101 switches x $100,000). Under
a 15% RoR rule, more profit could be earned if the monopolist were instead
to invest in 200 first-tier switches (that is, 500 households per switch)
to connect to 20 second-tier switches that, in turn, connected to one
central local switch (a system often referred to as aggregation). This
network would comprise 221 switching centres at a total investment cost
of $22.1 million (221 switches x $100,000). Annual prescribed pre-tax
profit under these network configurations would be $1.5 million and $3.3
million, respectively. So RoR regulation will likely lead to an over-investment
in capital equipment and to a very expensive network. This is one of many
reasons why Canada has a "state-of-the-art" telecommunications
infrastructure and provides the highest service quality in the world.
Third, a company providing
monopoly and competitive services using the same physical assets could
assign and misallocate the joint and non-specific overhead costs to the
monopoly services, thereby using its cost information advantage over the
regulator to prey upon competitors.
Fourth, and most important
of all in a rapidly changing environment, R&D is a very expensive
and risky activity that requires a much higher rate of return than other
business activities. It will not pay to invest in R&D if these high
rates of return cannot be attained. Thus, RoR regulation, which restrains
and sometime prohibits these returns, undermines innovation in the industry.
In an unregulated market, by contrast, there will be higher rates of return
for a short time, until competitive forces react; thus, R&D and its
timely diffusion throughout the sector are encouraged.
In advocating a competitive
market structure for telecommunications and broadcast distribution, one
must clearly recognize that economic forces will be put to bear on the
elimination of all cross-subsidy policies. These regulatory policies would
include not only the subsidy from long distance to local services, from
urban to rural services, and from business to residential services, but
also from broadcast distribution to broadcasting. Hence, if the government
wishes to favour the recipients of these subsidies, it might consider
alternative economic instruments.
cross-subsidies are provided to all who subscribe, despite the fact societal
concerns are targeted to those who are classified as "poor."
The result is that we
are subsidizing 75 per cent of the people who are not poor, who can
afford it and would not stop using it if they did not. Besides, I would
challenge you and suggest that most Canadians are not so ungenerous
that, if we had a cash subsidy or a telestamps scheme, they would be
[un]willing to support it.(26)
One might further pose the
question: is it just the service that we wish to subsidize, when there
is also considerable associated technology? The answer to this question
would incorporate the following analysis:
The cost of providing
a universal switch broadband network in Canada is about $30 billion.
That works out to about $1,000 per capita ... Every household would
have to have the equivalent of a 486DX33 or DX66 computer. They would
have to have a large hard drive on it. They would need extensive compression/decompression
technology. At current prices, the minimum would be $1,500, probably
closer to $2,000, worth of hardware in the house beyond the $1,000 to
connect fibre to the last mile.(27)
In response to concern about
"have" and "have not" households emerging from this
Information Revolution, it must be remembered that television took 40 years
to become universal, while the computer is taking over 20. The Information
Highway will likely have at least four generations of technologies, each
of which will eventually supplant its predecessor but with periods of
considerable overlap. The key to universality is to make the latest technologies
available in the schools, which thus become the most advantageous place
for government investment to bring about an information-based society.
One should also recognize
that there is great concern over the viability of existing cross-subsidies
from broadcast distribution to Canadian broadcasting.
The technological tidal
wave coming our way will make it nearly impossible to have a regulatory
framework to protect and nurture Canadian programming as the CRTC has
managed to do in the past.(28)
If the services offered
over cable television and DBS also become individually available over
the Internet or alternative networks at comparable cost, consumers could
"cherry pick" their favourite programming services, thereby
forcing the disassembly of current cable television and DBS service bundles.
The CRTCs ability to demand that cable television and DBS services
bundle their services, to disapprove of competitive foreign services,
and to ensure simulcasting when a program is aired both on an American
and a Canadian service are integral to the cross-subsidy funding of Canadian
programming. The new technologies are indeed a cause for concern to Canadian
broadcasting content. So a direct subsidy ought to be considered.
From a competition and
theory perspective, the optimal [ situation] is to have rates that are
adjusted to reflect, to the extent possible, their true economic costs,
and where there are social policy objectives that do not get reflected
in those costs we should try to devise other means of achieving them,
perhaps by direct subsidies. When I testified before the CRTC last year
I indicated that a direct subsidy by the Income Tax Act is the
way to do it. If the government thinks this is the legitimate public
policy objective, that is one means of doing it.(29)
In terms of the second strategic
imperative, it is estimated that the amount of investment required to
complete the construction of the Information Highway in Canada will be
$30 billion over the next two decades.(30)
To keep pace with competitor countries, reliance on foreign sources of
equity capital will be necessary. Therefore, our philosophy with regard
to Canadian sovereignty should be more concerned with the conduct of capital
and less concerned with its source.
Finally, the third strategic
imperative recognizes that R&D work is the life-blood of a dynamic
industry. The nation that does not innovate, does not have a future; the
nation that does not invest in R&D, follows rather than leads. Despite
notable exceptions within the telecommunications equipment sector, R&D
activity in Canada has always been relatively small. This level of R&D
in Canada is due partly to the fact that all the economic benefits of
such activity cannot be appropriated and partly to the "branch plant"
mentality of some foreign-owned multi-nationals. This latter myopic position
appears to be disappearing, however, as the emergence of a more global
view is transforming multi-nationals into transnational corporations.
Preferential fiscal treatment may be called for to rejuvenate these economically
vital investments and, given the new-found importance of the Information
Highway, special attention could be given to directing existing R&D
funding towards Canadas telecommunications sector.
Addy, George N. "The
Competition Act and the Canadian Telecommunications Industry."
Address to the Institute for International Research Telecommunications
Conference, 29 March 1994.
Addy, George N. Competition
Policy, Regulation and the Information Highway. Unpublished Manuscript.
The Bureau of Competition Policy, Ottawa, 1995.
Amesse, Fernand, Louise
Séguin-Dulude and Guy Stanley. "Northern Telecom: A Case Study in
the Management of Technology." In Steven Globerman. Canadian-Based
Multinationals. University of Calgary Press, Calgary, 1994, p. 421-453.
Bureau of Competition Policy.
Competition Policy, Regulation and the Information Economy. Submission
of the Director of Investigation and Research to Public Notice CRTC 95-130.
Ottawa, January 1995.
Bureau of Competition Policy.
Implementation of Regulatory Framework: Local Inter-connection and
Network Component Unbundling. Submission of the Director of Investigation
and Research to Public Notice CRTC 95-36. Ottawa, January 1996.
Crandall, Robert W. "Managing
the Transition to Competitive Telecommunications Markets." In Steven
Globerman, W.T. Stanbury and Thomas A. Wilson. The Future of Telecommunications
Policy in Canada. Bureau of Applied Research of the University of
British Columbia and Institute for Policy Analysis of the University of
Toronto, Toronto, April 1995, in p. 67-81.
Crandall, Robert W. and
J. Gregory Sidak. "Competition and Regulation Policies for Interactive
Broadband Networks." The Bureau of Competition Policy, Competition
Policy, Regulation and the Information Economy. Submission to the
Public Notice CRTC 1994-130. Ottawa, January 1995.
Crandall, Robert W. "Policy
Principles for Local Competition in Telecommunications." The Bureau
of Competition Policy. Implementation of Regulatory Framework: Local
Interconnection and Network Component Unbundling, Appendix I.
Davidson, William H. and
Ronald D. Hubert. A Telecompetitiveness Infostructure: Enabling a New
Future for Canada. Mesa Research, Sponsored by Northern Telecom, May
Davidson, William H. and
Ronald D. Hubert. Telecompetitiveness and the Wireless Sector: Competition
Without Chaos. Mesa Research, Sponsored by BCE Mobile, May 1995.
DCruz, Joseph R. and
Alan Rugman. "A Theory of Business Networks." In Lorraine Eden.
Multinationals in North America. University of Calgary Press, Calgary,
1994, p. 103-116.
DCruz, Joseph R. and
Alan Rugman. Business Network Theory and the Canadian Telecommunications
Industry. Unpublished Manuscript. University of Toronto, Toronto,
Globerman, Steven. "The
Economics of the Information Superhighway." In Thomas J. Couchene.
Technology, Information and Public Policy. John Deutsch Institute
for the Study of Economic Policy, Queens University, Kingston, November
1994, p. 243-279.
Information Highway Advisory
Council. Connection, Community and Content: The Challenge of the Information
Highway. Supply and Services Canada, Ottawa, September 1995.
Niman, Neil B. "Picking
Winners and Losers in the Global Technology Race." Contemporary
Economic Policy, Vol. 13, July 1995, p. 77-87.
Porter, Michael E. The
Competitive Advantage of Nations. The Free Press, New York, 1990.
Porter, Michael E. Canada
at the Crossroads: The Reality of a New Competitive Environment. Supply
and Services Canada, Ottawa, October 1991.
Thierer, Adam D. "Unnatural
Monopoly: Critical Moments in the Development of the Bell System Monopoly."
Cato Journal, Vol. 14, No. 2, 1994, p. 267-285.
Winseck, Dwayne. "A
Social History of Canadian Telecommunications." Canadian Journal
of Communication, Vol. 20, 1995, p. 143-166.
These alliances make up what has come to be known as a "business
network" since it is a hybrid relationship between a pure market
or pure corporate hierarchy (see, for example, Joseph R. DCruz and
Alan Rugman, "A Theory of Business Networks," in Lorraine Eden,
Multinationals in North America, University of Calgary Press, Calgary,
1994). In an interesting application of a business network to the telecommunications
sector, these authors suggest that the Stentor Alliance might be considered
a "nascent" business network.
House of Commons Standing Committee on Industry, Taking Care of Small
Business, 1994, p. 2.
Bank of Canada, Bank of Canada Review Autumn 1995, Table H4, p. S88.
Statistics Canada, Catalogue 56-001, Cable Television Statistics, 1994,
Table 1, p. 2; Statistics Canada, Catalogue 63-016 Quarterly, Services
Indicators, Tables A2, A3 and C2, p. 23, 24 and 62, respectively;
and Bank of Canada (1995), Table H1, p. S84.
Information Highway Advisory Council, Connection, Community, Content:
The Challenge of the Information Highway, September 1995, p. 5.
Statistics Canada, Catalogue 63-016, Tables A5 (p. 27) and C6 (p. 67);
and Bank of Canada (1995), Table H5, p. S89.
Statistics Canada, 63-016, Tables A6 (p. 29) and C7 (p. 69).
William H. Davidson and Ronald D. Hubert, A Telecompetitiveness Infostructure:
Enabling a New Future for Canada, Mesa Research, Sponsored by Northern
Telecom, May 1994, p. 16-17.
George N. Addy, Competition Policy, Regulation and the Information
Highway, Unpublished Manuscript, The Bureau of Competition Policy,
Ottawa, 1995, p. 9-10.
Walter Wriston, cited in ibid., p. 10.
Michael E. Porter, The Competitive Advantage of Nations, The Free
Press, New York, U.S.A., 1990, p. 19.
Ibid., p. 618.
Neil B. Niman, "Picking Winners and Losers in the Global Technology
Race," Contemporary Economic Policy, Vol. XIII,
July 1995, p. 79.
David Johnston, Proceedings of the Standing Senate Committee on Transport
and Communications, First Session, Thirty-Fifth Parliament, Issue 34,
By infostructure, one means all the elements of a countrys
information communications infrastructure, which would include the capabilities
related to the creation, capture, storage, processing, transmission and
reception of all forms of information.
A network externality arises when a user of the telephone system attaches
more value to a network that incorporates greater numbers of users. In
order to capture this greater consumer valuation, price regulation has
been used to have toll services (long distance services) cross-subsidize
local services in the hope that the others, most notably those considered
"poor," will buy local telephone service and thus add to the
networks size. Cross-subsidy means that the monopoly profits earned
on toll services will compensate the telephone company for providing local
telephone service at less than its cost.
Bell Canada Limited was initially 50% owned by AT&T. It was American-owned
in part throughout most of its history, but American ownership has declined
to virtually nil since the 1970s [see Dwayne Winseck, "A Social History
of Canadian Telecommunications," Canadian Journal of Communication,
Vol. 20, 1995, p. 143-166].
Apparently, the municipality of Edmonton did not want to be involved in
any subsidization of rural services.
The slow and poor telephone service offered the Prairie provinces was
more likely due to poor regulation, however. Inadequate accounting and
compensation for depreciation as determined by the Board of Railway Commissioners
has been singled out as the probable cause [see Winseck (1995), p. 153].
Prairie telephone service under provincial Crown corporations appears
to have been not much different from that in the U.S. Midwest, where telephone
service was provided by private corporations subject to regulation [compare
Winseck (1995), Adam D. Thierer, "Unnatural Monopoly: Critical Moments
in the Developments of the Bell System Monopoly," Cato Journal,
Vol. 14, No. 2, 1994, p. 267-285, and David Gabel, "Competition
in the Network Industry: The Telephone Industry," The Journal
of Economic History, Vol. 54, No. 3, September 1994, p. 543-572.
Michael E. Porter, Canada at the Crossroads: The Reality of a New Competitive
Environment, Supply and Services Canada, Ottawa, 1991, p. 112.
Ibid., p. 106-7.
William T. Stanbury, Proceedings of the Standing Senate Committee on Transport
and Communications, First Session, Thirty-Fifth Parliament, Issue 28,
Ibid., p. 15.; Robert W. Crandall, "Policy Principles for Local
Competition in Telecommunications," p. 3, in The Bureau of Competition
Policy, Implementation of Regulatory Framework: Local Interconnection
and Network Component Unbundling, Ottawa, January 1995, Appendix I.
Michael McCabe, Proceedings of the Standing Senate Committee on Transport
and Communications, First Session, Thirty-Fifth Parliament, Issue 29,
The Bureau of Competition Policy, Supplementation of Regulatory Framework:
Local Interconnection and Network Component Unbundling, Ottawa, January
1995, p. 11-12.
Stanbury (Issue 28), p. 16.
Ibid., p. 5, 7.
McCabe (Issue 29), p. 5.
George N. Addy, Proceedings of the Standing Senate Committee on Transport
and Communications, First Session, Thirty-Fifth Parliament, Issue 30,
Stanbury (Issue 28), p. 5.