European Business and Politics Final

THE EU LIBERALIZATION PROCESS OF THE TELECOMMUNICATION SECTOR HAS GONE HAND IN HAND WITH A DEEPER FORM OF MARKET INTEGRATION. IN A FIRST STEP, USE ONE OF THE INTEGRATION THEORIES COVERED IN CLASS TO DISCUSS HOW WE CAN THEORETICALLY INTERPRET THIS INTEGRATION DYNAMIC. IN A SECOND STEP, EVALUATE HOW THE EU RULES IN THE TELECOMMUNICATIONS SECTOR HAVE TRANSFORMED THE NATIONAL MARKET IN TERMS OF COMPETITION AND INDUSTRIAL CONCENTRATION, BY MAKING REFERENCE TO A SPECIFIC EU COUNTRY European Business and Politics Final Lukas Frijs-Djurhuus CPR: 130195-2283 STU Count: 22572 Normal pages: 9.9

Introduction More integration is simply indispensable for our economy (Vincenti 2013), the words of former president of the Commission, Juan Manuel Barroso, in an interview on the future of the European economy. It succinctly illustrates the great importance placed on economic integration - a key theme for the EU for many years. Economic integration is generally based on the removal of barriers which inhibit the flow of goods, services, labor, and capital. In the context of the European Union this particularly revolves around the removal of barriers between member states (Johnson and Turner 2016). The EU has come a long way in terms of economic integration since its inception. The Single European Act instilled the necessary conditions for creating a Single European Market, and several previously state monopolized sectors have become an integrated part of the Single Market. This paper will specifically examine the integration mechanism of the liberalization of the EU telecommunication sector, applying a theoretical perspective to uncover the underlying integration process. The paper has a triple aim of: First, examining the liberalization of the telecommunications sector and providing a background for the relevant theoretical framework. Secondly, applying the supranationalist integration theory to the liberalization of the telecommunications sector, and lastly, discussing how EU rules in the telecommunication sector have impacted the national market of Denmark in terms of competition and industrial concentration. The Liberalization of the Telecommunication Sector The liberalization process of the EU telecommunications sector, is something that has been underway for the past 30 years, and is still cause for further integration. The process can be summarized as a process of liberalization, harmonization and application of EU competition rules. During the 1970 s, the European Telecommunication sector was a patchwork of state monopolies (PTTs) (Hulsink 1999, 107). These PTTs were used as political instruments as well as generators of revenue for state purposes. Thus, most European nations had a vested interest in preserving the PTTs. However, the potentially revolutionary impact of the telecommunications sector was gaining widespread attention. It was also becoming increasingly evident, that the deregulated telecommunication sectors in countries like Japan and the US, were allowing their businesses a competitive advantage (Hulsink 1999). Given the fragmented and monopolized state of the European telecommunication sector, innovations came more slowly and at higher prices. (Sandholtz and Stone Sweet 1998). These issues led the European Commission to take a series of 1

actions starting with the RACE program, which was aimed at improving R&D as well as achieving common technical standards throughout Europe (Cordis 2004). The Commission issued its first major policy statement in 1979, which had the objective of creating a European market for telecommunication equipment and services. Several provisions throughout the 80 s culminated with the Green Paper of 1987. The Commission was joined in its efforts by the Roundtable of European Industrialists. The RACE project, the Green Paper of 1987 alongside other Commission initiated incentives, supported by various interest groups, led to the liberalization of all segments of the telecommunication markets (Hulsink 1999). The full liberalization of voice telephony and infrastructures for member states was to be completed by January 1st 1998. Additionally, to harmonize the European market, common rules were established through the Open Network Provision (ONP) framework, which had the purpose of enabling competition through granting new entrants access to networks of the old monopolies. EU competition rules were applied to the telecom market, allowing the Commission enhanced power due to its autonomy in the competition sector (Sandholtz and Stone Sweet 1999). After two years of full liberalization, the rise of the internet had a significant impact on the telecom sector, as it brought together all communications, and meant that networks increasingly carried data. This led to the 1999 review, and in 2002, five new directives were adopted that still serve as the current legal framework for telecommunications today (Citi 2016). Namely; the framework, access, authorization, universal service and privacy directives. Nonetheless, when examining the integration process from a theoretical perspective, this paper will focus on the initial phase of liberalization which led to the abolishment of the state monopolies. Theoretical background Prior to discussing supranationalism, it is important to obtain a cursory understanding of two competing theories, that help nuance supranationalism. The primary theoretical divide, when discussing integration theories, has been the divide between intergovernmentalism and neofunctionalism (Sandholtz and Stone Sweet 1998, 3). Neofunctionalism, is associated with the early decades of EU integration and scholars like Haas and Lindberg. It was intended to be a grand theory explaining the continual expansion of EU competences and the increasing significance of EU institutions. The central neofunctional assertion being, that European economic integration would be self- 2

sustaining, due to the concept of spill-over, in which steps towards integration in one sector trigger economic and political dynamics, leading to further integration in other sectors (Mikkelsen 1991, 7). Neofunctionalism, importantly, does not view states as unitary actors, and emphasizes the role of non-state actors in the integration process (Citi 2016). Opposedly, intergovernmentalism in its classic form, places its focus on state actors and emphasizes the role of national interest in the integration process. The central players in intergovernmental politics are national executives (West 2004). Essentially, where neofunctionalism asserts that states are not fully in control of the integration process, intergovernmentalism views nation states and their respective interests as being the determinants of the integration process. However, since the mid 70 s, neofunctionalism has been largely written off. (Sandholtz and Stone Sweet 1998, 3). For the purpose of this paper, I will discuss the liberalization process of the EU telecommunications sector using supranationalism as the theoretical framework for explaining the integration dynamic, as I believe it to be the most fitting theory. Supranationalism, is at times referred to as the revival of neofunctionalism, and is described in great detail in Sandholtz and Stone Sweet s book European Integration and Supranational governance. The theory essentially combines elements of neofunctionalism and transactionalism, while for the most part distancing itself from intergovernmentalism and controversial aspects of neofunctionalism. The constituent elements of supranationalism, namely, the development of a transnational society, the role of supranational organizations in pursuing integrative agendas, and the focus on European rule-making to resolve international policy externalities, are all derived from neofunctionalism (Sandholtz and Stone Sweet 1998, 6). Importantly, the catalyst behind the development of a transnational society is adopted from Karl Deutsch s transactionalism, which states that increasing the density of social exchanges over a prolonged period of time, drives integration processes by generating social demands for supranational rules and higher levels of organizational capacity (Beetz 2012). Supranationalism primarily distances itself from the neofunctionalist assertion that integration is a process where EU gradually, but comprehensively replaces the nationstates in all of its functions (Sandholtz and Stone Sweet 1998, 4), as it points out that spill-backs can also occur. The following paragraph will illustrate how the liberalization of the EU telecommunication sector lends support to the theory of supranationalism. 3

Telecommunication and supranationalism The purpose of this paragraph is to illustrate how the integration process regarding the liberalization of the telecommunications sector is best explained by the supranationalist theory of integration. First, the key premises of supranationalism will be restated. It is important to note that these premises are all highly interrelated, nonetheless, for the sake of clarity, they will be looked upon separately. The first premise is that the pre-eminent force behind supranationalism and obtaining a transnational society is; that increasing flows of cross-border transactions serves as the driving force behind the integration process. Thereafter, the constituent elements of supranationalism are, that European rulemaking is used to resolve international policy externalities and that supranational organizations are playing a key role in pursuing integrative agendas. To start off, we will examine how increasing transactions served as the catalyst behind the liberalization of the telecommunication sector, leading to a more transnational society. The liberalization process initiated as markets evolved from taking place at a set location, to a digitalized platform. Telecommunication thus became an integral infrastructure in the modern economy, and the increased amount of cross-border economic transactions, created a burgeoning need for international telecommunication facilities (Sandholtz and Stone Sweet 1998). As Europe endured these steady increases in actors needing to communicate across borders, those actors began to oppose the system of state monopolies. As Wayne Sandholtz (1998) puts it, transition from state monopolies to supranational policymaking begins with the societal actors for whom the PTT monopolies were increasingly costly and problematic (Sandholtz and Stone Sweet 1998, 137). Several interest groups, including the aforementioned Roundtable of European Industrialists, lobbied their governments to support the liberalization agenda alongside societal actors like equipment producers and transnational corporations. One of the primary constituents of supranationalism is the usage of European rule-making to resolve international policy externalities. In other words, the use of EU laws and court cases to further the process of integration. The European Court of Justice does not decide its policy domains, however, prior to the liberalization of the telecom sector, there were a string of relevant ECJ cases, which later on were integral to providing precedent for outcomes favoring further liberalization (Sandholtz and Stone Sweet 1998). The high number of court cases relating to telecommunications was far from coincidental, but instead provides further evidence of how the process of liberalization emanates from 4

transactionalism. Actors in need of cross-border telecommunications were seeking remedies in the courts, resulting in many court verdicts on telecommunications to draw precedent from. The Commission took advantage of the Cassis de Dijon case, which provided the underpinning for mutual recognition, and applied it to type approval for equipment, which resulted in PTTs losing their autonomy of product certification (Ungerer, Berben and Scott 1991). Additionally, the Commission made liberal use of article 110, which essentially extends competition rules to PTTs, when member states were deemed to be halting the liberalization process. These actions provided crucial steps towards liberalization and supranational governance. The last important constituent of the supranationalist integration theory, is that supranational organizations are playing a key role in pursuing integrative agendas. Intergovernmentalism would suppose that member states are in control of the integration process, and this is one of the primary reasons why supranationalism is the best fit for interpreting the integration dynamic of the telecommunication sector. The Commission alongside the European Court of Justice played a key role in pushing integration and liberalization forward, making it hard to overlook these pluralistic tendencies, that stand in contrast to the intergovernmentalism approach. Sandholtz (1998) notes that one the primary factors pushing liberalization forward was the Commission s ability to supply focal points for multilateral policy making, and establish alliances with important corporate players (Sandholtz and Stone Sweet 1988, 149). In 1988, the Commission acted autonomously by pushing through legislation faster than member states were prepared to, by teaming up with influential societal actors and relying on the aforementioned ECJ precedents (Sandholtz and Stone Sweet 1988). It unilaterally legislated the abolishment of the state monopolies. And once again, the transactionalist theme is evident, as interest groups played an immense role in pushing through legislation, with the interest group pressure stemming from the increasing amount of telecommunication based cross-border transactions. Furthermore, the RACE program is a testament to the immense role that the Commission played in the integrative process, as no member state was involved with its initiative nor direction. It s important to note that Sandholtz and Stone Sweet (1998) place great emphasis on the fact that no theory of integration is fitting for all integration processes, since integration generally has proceeded unevenly. (Sandholtz and Stone Sweet 1998, 7). Nonetheless, in explaining the liberalization process of the telecommunication sector, I deem 5

supranationalism to be the best fit. Additionally, it is clear, as evidenced, that the increased transactions between nations is the primary force behind the integration process. The increased cross-border transactions related to telecommunication led to interest groups supporting the Commission's integration agenda, as well as establishing precedent through several court cases. The Commission cleverly utilized these factors to push integration further than member states were willing to go, thereby discounting the intergovernmentalist approach which does not place much emphasis on the importance of non-state actors. The impact of liberalization on the Danish Telecommunication sector Having examined the liberalization of the EU telecommunication sector, and applied the theoretical framework of supranationalism to the integration process, this paper will now zoom in on the impact of EU rules on the Danish telecommunication sector. There will be a specific focus on competition and the industrial concentration of the market. Due to the scope of this assignment I will focus on the development within the fixed-line and cellular segments of the market. When assessing the competitiveness of the market, a myriad of factors can be used. I will primarily be focusing on market share, using a Herfindhal- Hirchman Index (HHI) to assess the market/industrial concentration. Additionally, I will briefly touch upon how price levels, innovation and investment in the sector has changed since the liberalization of the telecommunication sector. This analysis will be conducted using a variety of sources, although primarily utilizing a report by researchers at the Danish Institute of Technology, who follow the effects of the liberalization process from its beginning in 1996 up until 2007. Although this report isn t fully up to date, I found it to provide a superior insight into the mechanisms at work. Firstly, I ll give a brief summary of the liberalization process of the telecommunications sector in Denmark. When the Commission was pushing the liberalization agenda forward, during the 90 s, the Danish market was monopolized by the PTT, Tele Danmark. Denmark fully liberalized the domestic telecommunication market by 1996, 2 years prior to the EU deadline (Gyldendal 2009). Upon the liberalization of the telecommunication sector, Denmark privatized Tele Danmark s monopoly, and the company TDC was founded. The liberalization and privatization allowed for globalization, which combined with the EU 6

mandated harmonization through ONP, created the necessary conditions for increased competition, more efficient services and cheaper prices (Gyldendal 2009). The fixed-line and cellular markets The liberalization of the Danish telecom sector can generally be described as a successful endeavor. When aggregating several factors, reports from the World Economic Forum and the Economist Intelligence Unit determine that the Danish telecommunication sector was the world leader in terms of prices and competitiveness at the time of the report (Falch and Henten 2008, 60). Nonetheless, Denmark has segments of the market that are highly competitive, and segments of the market where the level of competition and prices rank averagely compared to other OECD countries. In the following paragraphs, I will assess the fixed-line and cellular segments of the market individually. Starting off with the fixed-line segment of the market, the level of competitiveness is generally determined to be inadequate, and Denmark ranks averagely compared to other OECD countries (OECD 2013). This is due to the dominant starting position of the previously state owned monopoly, TDC, who enjoyed a head-start in regards to accessnetworks. Access-networks are integral elements of the telecommunication sector, however, they require a large amount of capital to build. TDC owned the majority of the access-networks for the fixed-line market, making it difficult to establish competition in this part of the telecommunication market, necessitating service-based competition instead (Falch and Henten 2008). It is important to distinguish between service-and facility- based competition, as it is easier to establish competition within the service-based sector. The disadvantage with this type of competition is that the service-provider is dependent on the provider of the infrastructure, and infrastructure-based competition necessitates that there are multiple operators, which there isn t in the case of the fixedline segment of the market. This resulted in the fixed-line market having the lowest reduction in prices, compared to other segments of the telecommunication market following liberalization (Falch and Henten 2008). For the cellular segment of the market, Denmark ranked better than most OECD countries in terms of prices and competition (OECD 2013). The report explicitly concludes that the introduction of competition in the market as a result of EU rules like ONP, led to a great expansion and development of cellular solutions (Falch and Henten 2008, 63). The 7

primary reason that it was easier to instill competition in the cellular market was that 4 separate operators, with separate access-networks were developed in this area since the market was newer and less developed. It can be determined that the decrease in price in the cellular market has been significantly higher than in the fixed-line market, which can be strongly attributed to increased competition in the market. The picture presents a graphical representation of the cellular market share, and illustrates that although TDC still has the largest market-share, there are several reasonable sized competitors in the cellular market (Erhvervsstyrelsen 2015). 8

Industrial Concentration To determine the market concentration, the report makes use of the Herfindhal-Hirchman Index (HHI), which calculates the level of competition for a given market using the following equation: HHI = Σ(Marketshare) / If a single market has the entire market share, the index will be equal to 1. To determine if there is an adequate level of competition, the HHI should be equal to the sum that would occur if there were 4 or more companies in the market with equal market shares. The HHI scores for various segments of the telecommunication sector, show that it is only the cellular market that can be characterized as having an adequate level of competition, obtaining a score corresponding to 5.3 competitive operators in the market. The fixed-line segment of the market received a score corresponding to only 1.54 competitive operators, once again underlining, that the liberalization of the telecommunication sector has yet to ensure adequate competitiveness in this segment of the market (Falch and Henten 2008, 40). Investment and innovation Concluding on the general effects of the liberalization process, parameters like investment and innovation are looked at, since one of the primary reasons for liberalizing the sector was to boost these. The report states that the liberalization of the sector has had very positive effects in terms of increasing investment in the sector, with OECD reporting that Denmark has the third highest investment per capita in the telecom sector amongst OECD countries (OECD 2013). Additionally, there has been a significant increase in services and applications ever since the liberalization, implying that it has had a positive impact on innovation. This can be attributed to the fact that liberalization has led to increased levels of R&D for manufacturers of equipment (Falch and Henten 2008). 9

Conclusion This paper initially sought to uncover the underlying integration mechanism behind the liberalization of the telecommuncations sector, and concludes that the supranationalist integration theory is the best fit for explaining the process of liberalization within the sector. This conclusion is reached on the basis of the key role increasing transactions within the telecommunication sector played in driving the integration process forward. Additionally, the theory is supported by the Commission s and interest groups role in initiating the integrative agenda, as well as their usage of EU rules and ECJ precedents to further the process of liberalization. In the second part of the paper, the effects of the liberalization of the Danish telecommunication are examined, with a focus on the competition and industrial concentration of the cellular and fixed-line segments of the market. It is concluded that liberalization generally has been a success, as the Danish telecommunication market is amongst the most competitive on a global basis. This is in part due to the high level of competition that exists within the cellular segment of the market. Nonetheless, the liberalization of the sector has not been able to ensure a fully competitive fixed-line segment of the market. It is interesting to note, that only one segment of the Danish telecom market was identified to be fully competitive, despite the Danish telecom sector ranking high on a global scale. This indicates that there is still plenty of work to do in terms of enhancing competitiveness in the sector on a global scale. 10

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