"When a government becomes powerful, it is destructive, extravagant and violent; it is an usurper which takes bread from innocent mouths and deprives honorable men of their substance for votes with which to perpetuate itself." - Cicero
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Telecom Derangement Syndrome

During my hiatus from blogging, Telecom Derangement Syndrome (TDS) seems to have afflicted some normally sensible members of the blogosphere, most notably David Farrar. I expect members of Parliament and other shameless manipulators such as John Campbell to take advantage of the public's lack of understanding of how goods and services are created. I also expect the left to whole-heartedly support any attack on a large and successful company. But there are some people I expect more of. I did wonder if David became infected after spending too much time hanging out with those unsavoury characters at Internet NZ, but TDS is too widely spread for that to be the explanation.

It is probably too late, but I should at least attempt a cure. Peter Cresswell has posted extensively on this, but despite being absolutely correct in his conclusions, ultimately he isn't going to persuade anyone outside his ideological cocoon. He would oppose the government stepping in to block a merger between Telecom and Vodafone, for example, despite all sensible people knowing such a merger would almost certainly result in a net economic loss to the country.

I'm not going to use the term 'monopoly' because it means too many different things to different people. For the sake of argument, I will accept:

• Telecom has a dominant market share in wire connections to end users of telecommunications, via the 'local loop'


• Telecom charges its customers a price for the local loop that is higher than what the price would be if there were perfect competition


• That the above two statements are likely to remain true for at least the medium term

You can form your own opinions about whether these are true but it isn't necessary to refute them in order to debunk the 'unbundling' proposal. There is a very basic economic truth that seems to be ignored by TDS sufferers and it is this:

Prices above the 'perfect competition' price are entirely normal and acceptable in a free market system.

Such prices are necessary to justify the risk of making the investment in the first place. Suppose the 'safe' rate of return I can get is 8% and there is a more profitable venture available but it carries a 20% risk of failure. At a minimum, I need that venture to produce a 10% rate of return over the long term in order to be worthwhile. In practice, at some point competitors will enter the market who are willing to accept a rate of return closer to 8% so I actually need a rate of return substantially higher than 10% over the intervening period to cover the risk. If the 'perfect competition' price was forced on me from the outset by regulation I would never have invested at all and neither would anyone else. All Telecommunications is an especially risky sector because capital investments can so easily become redundant due to advances in technology.

Without the ability to set prices higher than the notional 'perfect competition' price, there is no rational basis for investing at all.

The existence of prices above the 'perfect competition' price act as a signal that gains in utility may be made through further investment. My competitor will recognise that he can charge less than me and still do better than putting his money in the bank. This gives him an incentive to invest and provide services at a price that leaves both him and his customers better off. If Telecom's competitors are truly being overcharged for access to the local loop then it will be profitable for them to develop alternative access. I am not suggesting that every house should have two sets of phone wires. Telecom would prefer to drop its prices rather than let this happen. But the fact it has not happened suggests one of two things: either the price charged is close to a competitive rate, or Telecom's competitors simply find it more expedient to lobby politicians for favours than to engage in honest commerce.

If there is a shortage of some valuable commodity (in this case bandwidth), prices increase and so demand drops to match the available supply. These higher prices motivate suppliers to produce more of the commodity. The price then falls back again. This is not even Economics 101, it is plain common sense.

If the government is determined to regulate the local loop, they can still do so in a way that doesn't discourage investment if they either buy the local loop from Telecom or at least compensate them for lost profits.

The sheer lunacy (or brilliance, depending on your political allegiances) of Labour's proposal is this:

They cite the (claimed) shortage as a justification for using regulation to force prices down. As we have seen, the regulations will of course prevent the shortage being resolved and make it worse, thereby justifying even more regulation. Eventually it will get so bad they will claim the market has failed and the whole thing should be nationalised and investment decisions made centrally by the Minister. It's a socialist politician's dream and everyone else's nightmare.

Why not 'unbundle' TradeMe?

Probably the best way to illustrate the local loop issue is by comparison with another successful New Zealand company, TradeMe. The following familiar sounding points should be noted:

• TradeMe has a dominant market share in online transactions in second hand goods


• Trademe charges its customers above what the price would be if there were perfect competition


• That the above two statements are likely to remain true for at least the medium term

Again, you can form your own opinions about whether these are true. They all seem more plausible to me than the corresponding statements about Telecom.

So anyway, why not 'unbundle' Trademe? Put up a screen on the Trademe homepage where people can continue to TradeMe or go to a competitor side instead. Force them to share their customer data or even transaction data. Maybe make them share the data on an ongoing basis so that any item offered on TradeMe is also visible on the competitors' sites. What's the difference in the justification for this and what is being done to Telecom?

There are two main ways to argue they are different: through the practical ability of competitors to take market share away, and through the means by which the dominant market share was arrived at.

On the first point, TradeMe is in an extremely strong position because their business involves widespread interaction between customers. Sellers benefit by going to where most of the buyers are, and vice-versa. Once a high market share itself becomes a feature that customers desire, competitors find it very tough going. I would bet that TradeMe will be the dominant player in online (and all) second-hand trading long after the local loop has been rendered redundant by wireless or fibre networks. My sense is that this is the primary justification people have for unbundling - that practical considerations mean effective competition is impossible. If so, then the same is even more true for TradeMe.

The second point is at least a possible argument against Telecom because they bought the local loop, whereas TradeMe built its customer base from scratch. However, the price Telecom shareholders paid the government for the local loop was determined with both parties fully informed of the situation. The negotiated price reflected the fact that Telecom would be able to charge above the perfect competition price as long as its competitors failed to get their act together. In addition, Telecom accepted substantial handicaps relative to its competitors such as the duty to provide rural phone services at prices far below cost.

Of course, the real difference is that there is no widespread media-fuelled public dislike of TradeMe. Why people dislike Telecom is a subject for another day, but I would really love to see a comparison of the quality of service Telecom customers get today compared with the horrible state of the phone network when the government ran it via the Post Office, and a comparison of inflation adjusted prices in both cases.

TradeMe, by contrast, is a massive virtual clearinghouse for stolen goods. If a burglar steals your DVD player, instead of waiting for the police to show up and then making little or no effort to recover it, you're more likely to find it by hunting around on TradeMe. All of the honest trading is valuable of course and, overall, TradeMe is probably providing a net public benefit - but nothing like the benefit that the public has received from the privatization of Telecom. For the xenophobes out there, TradeMe is now foreign-owned so that is no longer a difference.

In summary, there's no basis for seizing unbundling the local loop while that evil monopoly TradeMe is out there shameless abusing their dominant market position to fleece innocent New Zealanders of their hard-earned dollars.

Tell-tale signs you may have TDS:

1. You claim that reducing the ability to profit from investments will encourage further investment
2. You claim the way to alleviate a shortage is to force prices down through regulation
3. You are puzzled when, unable to raise prices due to government interference and unwilling to throw good investment capital after bad, companies choose to implement rationing as a last resort.
4. You cite Telecom's foreign ownership as a justification for seizing its assets
5. You claim, despite knowing better, that profitability is calculated by dividing net profit by turnover
6. You blog on Telecom establishing a call centre in the Philippines, not because you think it genuinely blogworthy or because you are racist, but merely in the hope of building support for your views among the anti-Asian bigot demographic
7. With broadband at $27 per month wholesale, you still insist that low uptake is caused by a lack of competition
8. Given two possibilities: (a) you have misjudged the situation (b) Labour is displaying good economic sense, you choose (b)
9. You attack Telecom on your blog at every turn and then dismiss people who disagree on the grounds of 'weak empirical work', lack of academic vetting or because the person is 'passionate about the subject'

Anyone with three or more of the above symptoms should consult an economist without delay.