Telecommunications and electronic information transmission form one of the most dynamic and innovative of modern industries. Network costs and conveyance prices are declining rapidly and volumes are growing as the industry continues to displace alternative forms of transmission and entertainment. Yet despite the huge innovation and development, the market is one of the most closely and heavily regulated.

European telecommunications is about to enter a dramatic new phase of development. The Commission’s decision to liberalize most telecoms markets on 1 January 1998 is a key first step in this process, and there appears to be little fundamental disagreement about the end point of the development process: mass interactive information conveyance on a broad scale – in other words, the information superhighway. What’s more, the EU has provided a sensible vision of what is necessary to sustain and develop the wider aspects of the information society.

However, the shape and speed of transition of European telecoms networks from these first steps of liberalization to the full information superhighway will depend critically on EU regulations. A recent paper by Paul Grout argues that existing and proposed EU regulations will hamper this development and slow down the convergence of networks since the regulations are not in sympathy with the wider vision.

A European ‘I-way’ will not happen overnight: it will develop over time as the market tests out products, discovers the potential scale of interest and is led by public demand. For this to happen smoothly, there will have to be a transition through the supply of more and more sophisticated value-added services. For the majority of users, this will be initially on existing networks. Those products that succeed will develop the demand for additional bandwidth among consumers and help point the way for future investment. Legal and regulatory restrictions can either facilitate or hinder this process.

A key feature of telecommunications is the presence of fixed and common costs that have to be recovered across a range of services. For this reason, telecoms pricing is a particularly complex problem, and simple blanket pricing rules are rarely sensible. Some products are able to bear a significant contribution to fixed and common costs. For example, throughout Europe, international calls bear a high proportion of these costs. Indeed, estimates of prices designed to achieve pure ‘efficiency’ objectives suggest that for larger users in Europe, fixed (i.e. rental) charges should be doubled and national and international call prices almost halved.

At the same time, the market for other products will be destroyed if they have to carry an average share of costs. For example, at existing European tariffs, a two-hour movie carried over the most basic system would cost over 80 ecus (£65) if charged at standard national rates; using broad band for better quality, it could cost over 2,500 ecus (£2,000). This is an extreme example of the range of services that are technically viable but economically very sensitive to market prices.

Flexibility in pricing is clearly essential if convergence is to be achieved and value-added products are to develop rapidly on basic networks. In this sense, pricing flexibility brings a very long-term external benefit, with international spillovers, that goes far beyond the short- and medium-term benefits to each member state associated with telephony pricing.

But recent and proposed EU regulations are moving in the opposite direction. For example, Article 12.2 of the recent Directive of the European Parliament on Open Network Provision states that ‘Tariffs for access to and the use of the fixed public telephone networks shall be independent of the type of application which the users implement, except to the extent that they require different services and facilities.’

Each member state can interpret this as it sees fit, and it is clear that a narrow interpretation could cause considerable hindrance to the development of value-added services. In addition, the EU is favouring uniform mark-ups on services to cover the fixed and common costs. This also operates against pricing flexibility.

The regulatory process also offers little harmonization in that the speed of development in each member state will depend on its interpretation of the regulations. For example, a wide interpretation of Article 12.2 will favour development on the main networks. In contrast, a narrow interpretation will lead to limited development of new services and the fragmentation of provision as operators attempt to bypass the consequences of the regulation by using private circuits.

Grout argues that it would be more sensible to encourage flexibility in pricing and to limit the scope for variability between member states. This could be achieved by being more prescriptive on the role of pricing flexibility and reducing the discretion of member states on the interpretation of pricing rules (possibly with conditions based on the openness of individual member states’ markets). For example, subject to the appropriate application of EU competition policy, regulation should favour larger network price caps as a general principle unless there are genuine fears of predatory pricing behaviour.

There are clearly limits to the permitted degree of flexibility. There must be non-discrimination to avoid a national regulatory authority protecting its own operators, and social objectives are likely to involve some degree of cross subsidy between customer types. Furthermore, EU competition law already imposes restrictions on pricing flexibility. Policy-makers face a difficult conflict: flexible pricing policies are needed to spur the growth of the information superhighway, but to avoid predatory behaviour, Articles 85 and 86 should be enforced vigorously, albeit in a manner sympathetic to the specific features of telecommunications.

Grout believes that EU policy is currently moving in the wrong direction: on the one hand it promotes procedures that favour inflexible pricing systems, while on the other it allows too much member state flexibility within these guidelines. The solution, he contends, does not lie in the application of simple pricing rules but instead in the promotion of flexible pricing rules combined with transparency and appropriate interpretation of EU competition policy. The way forward involves a complex balance, but at present there is a fundamental conflict between Europe’s short-term telecoms regulations and its long-term vision of the information society.