China's Telecommunications Industry: Transformation and Challenges
China's Telecommunications Industry: Transformation and Challenges1
Mingzhi Li and Jin Wang
TRANSFORMATION OF THE REGULATORY REGIME AND MARKET STRUCTURE
DEVELOPMENT OF THE TELECOMMUNICATIONS INDUSTRY: A NATIONAL PERSPECTIVE
CHALLENGES FOR CHINA'S TELECOMMUNICATIONS MARKET
During the past decade, as the largest developing country in the world, China has experienced remarkable transformation and growth in its telecommunications industry. On the one hand, after several rounds of reform, China's telecommunications market has become more and more competitive, which benefits consumers with its lower prices and higher quality of service. On the other hand, the number of telecommunications service subscribers has drastically increased. The total number of fixed-line and mobile telephone subscribers rose from 7 million in 1990 to 200 million in 2002, and the number of Internet users also soared from 0.62 million in 1997 to 79.5 million in 2003.
Despite these spectacular achievements, there are also deficiencies that will impede the further development of China's telecommunications sector. Current telecommunications consumption shows considerable geographical differences. While the eastern part of China is enjoying the growth in advanced telecommunications services, such as mobile telephones and Internet access, many villages in the central and western parts of China are still striving for basic telecommunications services, such as public telephone access. Such a wide digital gap will probably hinder the overall advancement of China's telecommunications industry. The question of how to reduce the disparity of telecommunications consumption has thus become a critical challenge for China.
The mobile telephone sector has been the most profitable in China's telecommunications market. With the rapid advancement of mobile technology and China's opening up
1 We are grateful for financial support from the National Science Foundation of China.
of its market to foreign telecommunications superpowers, it is conceivable that more controversial issues will have to be faced. Among these, the standardization of the mobile telephone business is attracting much attention. The government is striving to foster the Chinese 3G standard TD-SCDMA and is hoping to extract more value from the whole value chain built around this standard. Because of the lack of skills and patented core technology, to realize this ambition is a big challenge.
This chapter aims to add to earlier literature by focusing on the transformation of the regulatory regime and the market structure. While paying attention to the overall development in basic and advanced telecommunications services, which is intimately associated with the macro-reforms in China's telecommunications sector, it will also point out the significant challenges that China's telecommunications industry will confront in the near future.
The Regulatory Regime and Market Structure Before 1999
After the founding of the People's Republic of China (PRC) in 1949, its Ministry of Posts and Telecommunications (MPT) controlled the public telecommunications and post sector, with the State Council at the highest level, thus combining the functions of a public operator with that of a regulator. The Directorate General of Telecommunications (DGT), a department of the MPT, was responsible for the operations of public telecommunications. However, the MPT did not have exclusive power in regulating telecommunications. The State Council (SC) was involved in telecommunications regulations at the highest level, and it intervened to coordinate with the different authorities when necessary (Gao and Lyytinen, 2000).
Before the macro-reforms of 1976, revenue from telecommunications operations was turned over to the central government, and the industry received a set percentage of the budget for development. With the end of the Mao Zedong era in 1976, China's reformers placed economic development at the top of the new regime's agenda. Having realized the importance of telecommunications to development, beginning in the late 1970s, the government listed posts and telecommunications as a preferential construction item and allowed the industry to use funds derived from its operations at national as well as local and collective levels to supplement its development. Moreover, the government also adopted a set of favorable policies toward telecommunications. In June 1979, the SC allowed the MPT to adopt the policy of collecting initial installation fees for telephones. From February 1982, the SC decided that local postal and telecommunications branches could retain 90 percent of their profits, keep 90 percent of their foreign exchange earnings, and be exempted from repaying 90 percent of their state loans, all of which became known as “The Three Reverse 90 percent Policies.” In April 1986, the SC approved a tax refund policy for telecommunications equipment imports (He, 1997). These privileges enabled the MPT to raise enough
funds to develop public telecommunications. It is believed that this regulation system worked well in fostering the development of the telecommunications sector.
However, since the mid-1990s, the public became dissatisfied with the telecommunications sector because of the high prices and low quality of its services. To introduce competition into China's telecommunications market, in 1994, two new operators, China Jitong and China Unicom, were established. Both, acting as rivals, began to compete with the DGT. China Jitong focused on the Internet Phone (IP) service, while China Unicom focused on fixed telephone services (domestic and long distance calls) and mobile telephone services. In April 1995, registered as China Telecom (CT), the DGT was changed from a functional department of the MPT to an enterprise responsible for operating and managing the MPT's fixed and mobile telephone networks. However, this was regarded as a superficial change as CT was still directly under the MPT and had no control over finance, investment, personnel management, and so forth. Because of the special relationship between CT and the MPT, CT still dominated China's telecommunications market and therefore did not generate efficient competition. As a comparison, China Unicom's income was about 1.6 billion yuan in 1998, only a small fraction of that of CT (Li, 1998; and Ministry of Information Industry, 1999).
Deregulation of the Telecommunications Industry, 1999 to 2001
In March 1998, China began a new round of governmental reforms. Within the telecommunications sector, the goal was to completely separate government and enterprise functions, and increase competition. As a result, the Ministry of Information Industry (MII) was established, replacing the MPT, as a neutral regulator of the telecommunications industry, while giving up the functions of enterprise management (Gao and Lyytinen, 2000). Thus, as an independent government branch, the MII has no special relationship with any operator. CT, China Jitong, and China Unicom became pure operating companies.
In 1998, CT was broken up: the mobile and satellite businesses were divested and became two independent corporations—China Mobile Group and China Satellite—while the paging business was given to China Unicom. In 1999, the China Academy of Sciences, the State Administration of Radio, Film and Television, the Ministry of Railways, and the government of Shanghai persuaded the State Council to establish another new operating company, China Netcom. It mainly provides Internet and data services. In 2001, China Railcom was set up, controlled by the Ministry of Railways, and focused its business on fixed-line telephones, the Internet, and data and IP services.
As a result, by the end of 2001, the entire telecommunications industry was made up of seven operating companies: CT, China Unicom, China Mobile, China Netcom, China Jitong, China Railcom, and China Satellite. Table 10.1 gives details of these operators' lines of business.
Developments since 2002
In 2002, China's telecommunications industry experienced another round of reform. CT was divided into two groups: the southern group which kept the name, reputation,
|Table 10.1 Operating companies' main business|
|Operating companies||Main business|
|SOURCE: Compiled from the web sites of the operating companies.|
and intangible assets, covered twenty-one provinces and cities; while the northern group, which covers ten provinces and cities,2 merged with the former China Netcom and Jitong and was renamed the China Net Telecom Group, or China Netcom. After this round of reforms, the market landscape of China's telecommunications industry changed significantly. The market was now made up of six operating companies: CT, China Netcom, China Mobile, China Unicom, China Satellite, and China Railcom. In addition, about 4,000 companies provide value-added and wireless business services. In terms of market share, China Mobile became the biggest operating company in China, followed by CT; China Netcom became the third, and China Unicom was reduced to fourth place. The remaining market was shared by China Satellite and China Railcom (Figure 10.1). However, none of these companies has a market share above 50 percent, a sign that the telecommunications industry in China is quite competitive.
Together with the dynamics of government regulatory policy and changes in market structure, China's telecommunications industry grew rapidly between 1949 and 2002. In 1949, there were only 300,000 telephones for about 550 million people in China, that is, one phone for every 1,800 residents. In the rural areas there were only about 30,000 phones, or one for every 18,000 Chinese (Harwit, 1998).
After 1949, the MPT took up the responsibility of expanding networks in China. And as Figure 10.2 and Table 10.2 show, growth in the industry came relatively quickly in the first years of the new Chinese government, albeit from a low base. In the 1960s, however, with the advent of the Cultural Revolution, overall growth slowed. The number of urban subscribers only increased by 1.95 percent, while the number of rural telephone subscribers even declined by 6 percent. Moreover, the number of rural subscribers began to lag behind urban subscribers by some 50 percent.
Since the late 1970s, owing to the preferential policy granted by the government (see above), the MPT was able to raise enough funds to develop public telecommunications. These policies were quite successful in that the industry enjoyed sustained rapid growth
|Table 10.2 Type of subscribers, 1951–1995|
|Urban subscribers||Rural subscribers||Urban/Rural|
|SOURCE: China Statistical Yearbook (1981 and 1996).|
|Table 10.3 Growth of China's telecommunications industry, 1949–1994|
|Average annual growth|
|SOURCE: China Posts and Telecommunications Annual Report 1995; and Xu and Armstrong (1995).|
|Telephone switching lines||6.0%||23.1%|
|Long distance calls||11.0||26.2|
|Mobile phone subscribers||–||205.0*|
during this period (Table 10.3). Despite this rapid growth, the telecommunications consumption gap between urban and rural China widened, as shown in Table 10.2. In 1980, the ratio between urban and rural subscribers was only 1.7. By contrast, in 1990, this had increased to 3.7, and by 1995 it had risen further to 4.0.
After 1995, CT had replaced the former DGT for operating and managing the MPT's fixed and mobile networks. It initiated the massive universal service project “telephone connection to every administrative village in the rural districts,” with the goal of reducing the telecommunications consumption gap between the rural and urban areas. This program was mainly funded by the telephone installation fee and a cross-subsidy from long-distance calls. CT spent RMB100 billion on new construction, and RMB50 billion on maintenance annually, of which RMB5 billion and RMB3 billion went to universal services (Tang, 2001). With such large inputs, the number of rural subscribers increased rapidly and the gap between urban and rural China began to diminish gradually (Table 10.4).
|Table 10.4 Type of telephone subscribers, 1996–2002 (thousands)|
|Urban subscribers||Rural subscribers||Urban/Rural|
|SOURCE: 2002 Statistics on Telecommunications Development, Ministry of Information Industry.|
Besides basic fixed telephone service subscribers, advanced telecommunications service users, such as mobile telephone subscribers and Internet users, have also enjoyed rapid growth from 1995 to 2002. On the other hand, with the wider use of more convenient communication devices, such as mobile phones, the number of pager subscribers began to decline from 2000 (Figure 10.3).
Regional Disparity of Telecommunications Development in China
China is a vast country in terms of its population and territory. For historical reasons, there exists a huge disparity in its economic development across regions. China's thirty-one provinces, autonomous regions, and cities under the direct guidance of the central government are geographically divided into three regions: the eastern region, the central region, and the western region. In terms of their levels of economic development, the eastern region is the most advanced, the central region is the next, and the western region is the most backward. The eastern region includes ten provinces and cities: Beijing, Shanghai, Tianjin, Liaoning, Jiangsu, Zhejiang, Fujian, Shandong, Guangdong, and Hainan. The nine provinces in the central region are: Hebei, Shanxi, Jilin, Heilongjiang, Anhui, Jiangxi, Henan, Hubei, and Hunan. The western region has twelve provinces and autonomous regions: Inner Mongolia, Guangxi, Chongqing, Sichuan, Guizhou, Yunnan, Tibet, Shanxi, Gansu, Qinghai, Ningxia, and Xinjiang. Table 10.5 shows how big the gap is.
The gross domestic product (GDP) per capita in all three regions has steadily increased in recent years. However, there are still huge gaps among the regions. By the
|Table 10.5 GDP per capita in the three regions (RMB)|
|SOURCE: Compiled from China Statistical Yearbook.|
end of 1999, the GDP per capita in the eastern region was 2.1 times that of the central region, and 2.66 times that of the western region. These gaps have been increasing over time and were 2.15 and 2.78 at the end of 2002.
Highly correlated with this regional disparity is the imbalance in telecommunications services across the three regions. By the end of 2003, the fixed telephone penetration rate in China had reached 21.19 percent, the household telephone rate was 16.26 percent, and the mobile telephone rate was 20.92 percent (Table 10.6). Geographically, the rates for the three types of services for the eastern region were 31.83 percent, 23.53 percent, and 34.02 percent, respectively; for the central region they were 17.40 percent, 14.24 percent and 14.86 percent respectively; while the western region had the lowest rates in all the categories at 16.97 percent, 11.12 percent, and 14.78 percent. More specific measures of ICT diffusion and adoption, especially those pertaining to the “new ICT” of Internet, e- commerce and wireless technologies, further confirm the disparity among the three regions.
With regard to the Internet, for example, the number of subscribers in the eastern region has consistently been more than 50 percent of total Internet users in China, while the number in the western region has been only 15 percent. It was not until the end of 2003 that the proportion for the western region reached 20 percent (Figure 10.4).
Although China's telecommunications industry has made rapid progress in the last few decades, there is still a considerable consumption gap among the different geographical regions. The promotion of a universal service to reduce the digital gap has become a critical issue for China's telecommunications industry policymakers. However, because
|Table 10.6 China's penetration rates for telecommunications services, 2003 ('000 persons)|
|Fixed telephone lines||Households||Mobiles|
|SOURCE: Ministry of Information Industry.|
of deregulation and the introduction of competition, the provision of universal service has become ambiguous. CT, as a monopoly firm, is obliged to provide universal service and cross-subsidies which carriers take advantage of to subsidize non-profitable services. Thus, CT is the primary source of funding for the universal service.
After several rounds of radical reform in China's telecommunications sector, the old universal service schemes are still difficult to maintain. On the one hand, fierce price competition among different carriers has greatly reduced the funding base for the cross-subsidy mechanism of financing. On the other hand, as there are now six carriers in China's telecommunications market, what is becoming increasingly contentious is that the original obligation of the incumbent firm, CT, needs to be redistributed and adjusted in accordance with market conditions.
According to economic theory, in a competitive market environment, the mechanism for financing a universal service should strive to be non-distortionary, inexpensive, and competitively neutral. In other words, it should not distort consumption and investment decisions, it should keep the cost of raising funds low, and it should not benefit one firm at the expense of others (Clarke and Wallsten, 2002). Neutrally competitive mechanisms to support universal service require that firms do not benefit or suffer relative to others in the industry. For example, if the incumbent firm is allowed a monopoly in order to maintain universal service provision, the principle of competitive neutrality would be violated. If new carriers can choose to serve more profitable customers without having to bear the universal service obligation, it is also not neutrally competitive. Under a “competitively neutral mechanism,” the fulfillment of universal service provision can be divided into
two stages: fund-raising, and provision. There are two common methods for financing a universal service. One is through the country's tax system, and the other is through a universal service fund.
Economists typically believe that subsidies should be financed by tax and transfer systems so as to reduce price distortions and social welfare loss. However, most countries have chosen to have a universal service fund (USF) because a general tax system will cost more than the alternative approach, especially in those developing countries with inefficient tax systems. A USF requires all the telecommunications firms to make contributions, and any firm that provides a universal service has the right to a subsidy. In theory, a USF provides a wider tax base and reduces the potential for “cream skimming” whereby a firm can serve the most profitable customers and escape its universal service obligations. Moreover, a USF is more transparent, the cost is much lower, and it is closer to being “competitively neutral,” compared with cross-subsidies. In theory, the fund should be taxed at a certain rate based on the firms’ profits to avoid distortion. However, because of the existence of asymmetric information between the regulator and the firms, most countries collect the fund at a certain rate based on the firms’ revenues.
The allocation of a USF and the provision of services can be realized through the mechanism of auction since the firms will not have the incentive to provide accurate information about their costs. The allocation of operation licenses could also be linked to universal service obligations. For example, in Mexico, Telmex was required as part of its privatization to install payphones in 20,000 rural locations over a five-year period to meet the policy goal of ensuring some telephone access in all villages with at least 500 residents (Wellenius, 2000).
Based on the above analysis, it is recommended that China's telecommunications industry establish a universal fund for providing universal service, and choose the providers of the universal service by means of an auction.
Challenges in the Mobile Telephone Sector
With 200 million mobile telephone subscribers by the end of 2002, China has become one of the largest mobile service markets in the world. As a result, both foreign and domestic telecommunications companies, including carriers and equipment manufacturers, see much potential in this huge booming market. The development of new mobile technology 3G, which is a set of standards known as IMT-2000 set up by the International Telecommunications Union (ITU), is a further improvement on the widely used 2G technology and has provided telecommunications companies with further opportunities. Once the MII permits the application of 3G technologies, a new era of mobile services for operating carriers and equipment manufacturers will begin.
However, there are intense debates about several complex issues involved in 3G technology applications. First, there is the issue of technological standards. There are three alternative 3G technological standards in China at present. CDMA 2000 is suitable for operators with an existing CDMA network. WCDMA is the migration path for GSM operators. TD-SCDMA is China's homegrown 3G technology and is approved by the
ITU but it is an entirely new standard lacking chipsets and other building blocks. While domestic and international vendors have voiced support for this standard, it remains to be seen whether the supply chain can be developed. There are actually two versions of this standard, one for China and one for Europe. TD-SCDMA is the Chinese version.
Among the three alternatives, China's MII prefers TD-SCDMA since it is home-grown. The fact that the Ministry has delayed the issue of 3G licenses several times is, to a large extent, due to the immaturity of TD-SCDMA. However, which technology is suitable for China does not depend on the government but on the responses of the markets and consumers.
The second debate is over the candidates for 3G mobile licenses. While China Mobile and China Unicom dominate the mobile telephone service market currently, CT and China Netcom have no licenses and thus no operations in mobile services (Table 10.7). With the birth of 3G technology, the two carriers, CT and China Unicom, are urgently looking forward to getting 3G mobile licenses, so that they can become comprehensive carriers, compete with China Mobile and China Unicom from the same starting point, and share the profits of this booming mobile service market.
Finally, there is the question of the time schedule for issuing 3G mobile licenses. While some foreign companies, such as Nokia, Motorola, and NEC, and certain carriers, such as CT and China Unicom, suggest that China should adopt 3G technology as soon as possible, some scholars and MII officials are more sanguine and believe that the market demand for 3G is still ambiguous and that the homegrown TD-SCDMA technology is not yet as competitive as the other two technologies.
Since 1949, China's telecommunications industry has undergone several rounds of radical reform, at both the governmental level and the industrial level. The regulatory role of the industry has changed from a posts and telecommunications administration run by the Ministry of Posts and Telecommunications, which acted as both a regulator and an operator, to a neutral regulatory institution, the MII. On the other hand, the telecommunications markets have become more competitive. By the end of 2002, there were six operating companies in China's telecommunications market: CT, China Netcom, China Mobile, China Unicom, China Satellite, and China Railcom, compared with the monopoly before 1955 when the Directorate General of Telecommunications, a department of the MPT, was responsible for the operations of public telecommunications.
With the reforms to the regulatory regime and market structure, China's telecommunications industry grew rapidly, especially during the period between 1978 and 2002. As a result, the number of fixed telephone subscribers, mobile telephone users, and Internet subscribers increased tremendously.
Although China has seen some remarkable achievements in its telecommunications industry, there are also some shortcomings. Current telecommunications consumption exhibits significant geographical differences. This has probably impeded the overall advancement of China's telecommunications industry. In order to reduce the disparity in telecommunications consumption, it is suggested that China further extend its universal service to areas which lack basic telecommunications services. In a competitive environment, it is widely accepted in economic theory that a competitively neutral mechanism should be implemented for universal services, which means that no firms should benefit or suffer relative to others in the industry. Thus, China could establish a universal fund as the financing resource, and choose the providers of the universal service through auctions. Moreover, controversies about the profitable mobile telephone sector, including the choice of standards, the number of licenses for the 3G technology, and the timing of their release, need to be resolved carefully.
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