Uberregulation without economics: the World Trade Organization's decision in the U.S.-Mexico arbitration on telecommunications services.

• Author: Sidak, J. Gregory

1. INTRODUCTION II. THE U.S.-MEXICO ARBITRATION DECISION A. The Mexican Regulatory Regime B. The United States' Contentions C. The Panel's Findings 1. Mexico's Commitments under Section 2 of the Reference Paper a. Was Telmex a "Major Supplier"? b. Were Telmex's Interconnection Rates "Cost-Oriented"? 2. Mexico's Commitments under Section 1 of the Reference Paper 3. Mexico's Commitments under Section 5 of the GATS Annex on Telecommunications D. Summary III. WHAT EXPLAINS MEXICO'S INTERNATIONAL SETTLEMENT RATES? A. Non-Traffic Sensitive Costs that Telmex Incurs in Providing Network Access B. Regional Variation in Costs that Telmex Incurs in Providing Network Access C. Would a Competitive Market-Set Price Equal to Long-Run Average Incremental Cost? D. The Cross-Subsidization Policy Chose, by the Mexican Government IV. DO U.S. LONG-DISTANCE CARRIERS PASS REDUCTIONS IN MEXICO'S INTERNATIONAL SETTLEMENT RATE ON TO THEIR U.S. CUSTOMERS? A. Tacit Collusion and the Price of Southbound Long-Distance Services B. In a More Competitive Environment, U.S. Long-Distance Carriers Would Have Reduced Their Price for Southbound Calls Beyond the Decrease in International Settlement Rates V. DID TELMEX HAVE MARKET POWER IN POINT-TO-POINT INTERNATIONAL TELECOMMUNICATIONS SERVICES BETWEEN THE UNITED STATES AND MEXICO? A. Point-to-Point International Telecommunications Services as the Relevant Product Market 1. The Relevant Product and Geographic Market 2. Telmex's Incentive to Eliminate Double-Marginalization on Southbound Calls and the Resulting Incentive to Lower Its Price of Northbound Calls B. Did Telmex Possess Market Power in the Relevant Product and Geographic Markets? 1. Did Telmex Have Market Power in the Market for Northbound Point-to-Point Telecommunications Services? 2. The Demand for Southbound Calls into Mexico Is Price Elastic, which Reduced the Likelihood that Telmex Could Have Exercised Market Power in the Determination of International Settlement Rates 3. The Supply of Northbound International Telecommunications Services by Rival Networks Is Also Price Elastic, Which Implies that Telmex Could Not Have Imposed Excessive Access Charges 4. Telmex Did Not Enjoy Any Significant Advantage with Respect to Cost Structure, Size, or Resources C. Even If the Market Definition Had Been the Termination of Southbound Calls, Telmex Lacked Market Power 1. The Critical Share of Marginal Customers Needed to Render an Exercise of Market Power by Telmex Unprofitable Would Be Small 2. Countervailing Market Power of U.S. Long-Distance Carriers in the Bilateral Negotiation of International Settlement Rates 3. Telmex Offered Termination Access at a Price that Complied with the ITU's Target Rate and Was Substantially Below the Benchmark Settlement Rate That the FCC Established to Protect U.S. Long-Distance Carriers 4. The Absence of International Simple Resale Did Not Give Telmex Market Power in the Termination of Southbound Calls VI. CONCLUSION I. INTRODUCTION

   On April 2, 2004, the World Trade Organization ("WTO") assumed a new role as a highly specialized, global regulator of domestic telecommunications policy. In April 2002, the WTO's Dispute Settlement Body established an arbitration panel in accordance with Article 6 of the Understanding on Rules and Procedures Governing the Settlement of Disputes in response to a complaint filed by the United States against the Republic of Mexico. The United States alleged that Mexico had violated its commitments under Section 5 of the Annex on Telecommunications to the General Agreement on Trade in Services ("CATS") by failing to ensure that Telefonos de Mexico, S.A. de C.V. ("Telmex"), the largest Mexican supplier of basic telecommunications services, (1) provide interconnection to U.S. telecommunications carriers at "cost-oriented" rates, (2) refrain from anticompetitive practices (1), and (3) provide U.S. telecommunications carriers "reasonable and non-discriminatory" access to public telecommunications networks and services as mandated by the GATS Annex on Telecommunications.

   In its April 2004 decision, the WTO arbitration panel found that Mexico had not met its GATS commitments with respect to supply of telecommunications services on a "facilities basis"--that is, services supplied over the service provider's own infrastructure, rather than over leased capacity on someone else's infrastructure. (2) As a result, Mexico became obliged to change its domestic telecommunications regulations or face trade sanctions. The panel report in the U.S.-Mexico decision is the first WTO arbitration to deal solely with trade in services under GATS and the first specifically to address telecommunications services.

   On one level, the decision illustrates the potential for the WTO to compel changes in any area of domestic law that corresponds to one of the topics within GATS. It is conceivable that, having established the precedent of intervening in the domestic regulatory policy of one of its signatory nations, the WTO will one day direct this new form of uberregulation toward a United States regulatory institution that has oversight of domestic firms providing at least one service to foreign customers. On another level, the U.S.-Mexico decision provides an additional example of the U.S. government's recurrent use of trade agreements and institutions to impose specific U.S. regulatory principles on the domestic telecommunications policies of other nations. As the Authors will explain in greater detail below, that exportation of U.S. telecommunications regulation encompasses detailed methodologies used to calculate the costs and permissible prices of regulated carriers. Despite having been exported to other nations, those U.S. policies remain highly controversial within U.S. telecommunications law. (3)

   This Article presents an economic analysis of the United States' complaint against Mexico. Part II summarizes the lengthy decision of the WTO arbitration panel. The panel accepted most of the arguments and reasoning contained in the United States' complaint. Therefore, our criticisms of the U.S. government's complaint in most cases apply with equal force to the WTO decision.

   Part III shows that the U.S. government conflated international settlement rates and domestic interconnection pricing. In both the United States and Mexico, international settlement rates have been set by a different pricing methodology than the one used for domestic interconnection. Contrary to the unstated premise of the U.S. government's complaint, direct comparisons of the two rates are not valid. The complaint of the U.S. government raised economic policy questions that are not within the scope of the WTO agreement. These policy questions are properly addressed by the domestic authorities in Mexico. For example, the recovery of Tenet's total costs through allowed rates is properly within the discretion and expertise of the Mexican telecommunications regulator, the Comision Federal de Telecomunicaciones ("Cofetel").

   At the time that the United States filed its complaint, Mexico's international settlement rates were reasonable and were rationally based on the costs of building and operating the public-switched telecommunications network in Mexico. The U.S. government mischaracterized several of the relevant cost principles. First, the U.S. government's estimate of the costs of terminating a call in Mexico ignored non-traffic-sensitive ("NTS") costs that Telmex cannot recoup through other charges. Second, international settlement rates vary by region to reflect the legitimate differences in costs that Telmex incurs in providing network access. Third, the U.S. government incorrectly relied on long-run average incremental cost ("LRAIC") as the price that a competitive market would establish. Moreover, the U.S. government's complaint did not recognize that the price of northbound long-distance services in Mexico depends primarily on the cross-subsidization policy chosen by the Mexican government. This policy is also within Cofetel's discretion, and the U.S. government did not allege that this cross-subsidization was anticompetitive.

   Part IV demonstrates that, setting aside these cost-justification issues, the U.S. government was advocating a policy that would not necessarily increase the welfare of consumers in the United States. Any complaints regarding the price of southbound long-distance services should have been directed instead to the United States Department of Justice for investigation of tacit collusion, as the market for southbound long-distance calls into Mexico was, at the time that the United States filed its brief before the WTO, highly concentrated by antitrust standards. Although reductions in international settlement rates appear to be correlated with lower international long-distance prices for U.S. consumers, the declines in those prices on calls to Mexico would have been greater had the big three U.S. long-distance carriers--AT&T, WorldCom-MCI, and Sprint--competed more aggressively. Just as competition among U.S. long-distance carriers will naturally reduce southbound long-distance prices, competition among Mexican long-distance carriers has and will continue to put downward pressure on international settlement rates. Indeed, international experience shows that domestic competition in outbound international services brings substantial reductions in international settlement rates.

   Part V shows that the WTO panel failed to recognize that the complaint of the U.S. government collapses if Telmex lacks market power in point-to-point international telecommunications services between the United States and Mexico. It is unlikely that Telmex had such market power in 2002. Point-to-point international telecommunications services--not the termination of long-distance calls onto Telmex's wireline network--constitute the relevant product market. For several reasons, Telmex lacks market power in the relevant product and...