metadata: authors: 0: author: Spiller, Pablo T.
1: author: Sampson, Cezley I.
count: Jamaica
docna: 0: docna: Regulation, institutions and commitment :
            the Jamaican telecommunications sector
docty: Policy Research Working Paper
subtopic: Social Policy,Legal Products,Judicial System Reform,Labor Markets,Telecommunications Infrastructure,Common Property Resource Development,International Trade and Trade Rules,Legal Reform,Legislation,Regulatory Regimes,Transport Services
teratopic: Public Sector Development
abstracts: cdata!: The Jamaican telecommunications sector
            today is much more dynamic than it was before and provides
            much better service. There is widespread skepticism about
            the current regulatory framework, which is criticized for
            encouraging a tight telecommunications monopoly, little
            administrative discretion, and continous price adjustments
            to satisfy what many see as a high rate of return
            requirement. But the authors suggest that the regulatory
            framework is a "second-best" alternative, a
            pragmatic response to The Jamaican's institutional
            realities. The authors analyze why the reforms of the late
            1980s took the form they did, and whether they could have
            been better. They find that the changing nature of
            regulatory institutions, ownership arrangements, and sector
            performance in the past 50 years is traceable to intense
            contracting problems between firms or interest groups and
            the government. Attempts to resolves these contracting
            problems have continuously constrained the government's
            (and firms) ability to implement efficient pricing schemes.
            In the abstract, The Jamaican's regulatory structure
            looks inefficient. In the context of The Jamaican's
            political system, politics, judiciary, bureaucracy, and
            interest groups, the regulatory framework developed in the
            late 1980s emerges as a fairly pragmatic, welfare-improving
            set of policies. Perhaps it could have been better, but its
            current design reflects basic commitment problems the
            government has with public utilities.
geo_reg_key: 119228,517206,517191
repnme: repnme: Regulation, institutions and commitment :
            the Jamaican telecommunications sector
display_title: Regulation, institutions and
            commitment : the Jamaican telecommunications sector
listing_relative_url: /research/1993/10/698815/regulation-institutions-commitment-jamaican-telecommunications-sector
topicv3: Personal Property Rights m1326571 1907,Transport m1326661 135,Trade m1326924 698,Telecommunications and Broadband Access
            m1327340 286,Jobs m1503931 2670
publishtoextweb_dt: 2010-07-01T00:00:00Z
historic_topic: Public Sector Development
origu: Finance and Private Sector Development Division
no_of_pages: 86
model_extractions: I POLICY RESEARCH WORKING PAPER 1362

# Summary findings

Jamaica's telecnmmunications sector today is much more dynamic than it was before and provides much better service. There is widespread skepticism about the current regulatory framework, which is criticized for encouraging a tight telecommunications monopoly, little administrative discretion, and continuous price adjustments to satisfy what many see as a high rate of return requirement. But Spiller and Sampson suggest that the regulatory framework is a "second-best" alternative, a pragmatic response to Jamaica's institutional realities.

Spiller and Sampson analyze why the reforms of the late 1980s took the form they did, and whether they could have been better. They find that the changing nature of regulatory institutions, ownership arrangements, and sector performance in the past 50 years is traceable to intense contracting problems between firms or interest groups and the government. Attempts to resolve these contracting problems have continuously constrained the government's (and firms') ability to implement efficient pricing schemes. In the abstract, Jamaica's regulatory strucwre looks inefficient. In the context of Jamaica's political system, politics, judiciary, bureaucracy, and interest groups, the regulatory framework developed in the late 1980s emerges as a fairly pragmatic, welfare-improving set of policies.

Perhaps it could have been better, but its current design renects basic commitment problems Jamaica's government institutions have with public utilities, conclude Spiller and Sampson.

This paper-a product of the Finance and Private Sector Development Division, Policy Research Department-is part of a larger regulatory research cffort in the department. The study was funded by the Bank's Research Support Budget under the research project "Regulation, Institutions, and Economic Efficiency" (RPO 676-94). Copies of this paper are availablc free from the World Bank, 1818 HIStreetNW, Washington, DC 20433. Please contact Bill Moore, roomN9-05S,extension 38526 (78 pages). October 1994.

_The Policy Research Working Paper Series dissemirates the findings of work in progress to encorage the exchange of ideas about development issues. An objective of the series isto get the fndings out quickly, even if the presentations are less than fully polisedL The papes carry the namnas of the authors and should be ud and cited accodingly. The fndings, interpretations, and conclusions are the authors ow and sbould nor be attributed to the World Bank, its Executive Board of Direraors, or any of its member countris_ Produced by the Policy Research Dissemination Center
# REGULATION, INSTITUTIONS AND COMMITMENT: THE JAMAICAN TELECOMMUNICATIONS SECTOR

Pablo T. Spiller and Cezley 1. Sampson WAfiam B. McKinley Professor of Economics and Public Wities. University of Illinois. and Professor of Govemment and Public Affaims. University of Illinois; and Director. Insfitute of Business. University of West Indims. Jamaica Spiller would like to thank the University of Califomia Universitywide Energy Research Group for providing the faciities and the intelledual environment to conduct the research on which this paper is based. We would like to thank the participants at the World Bank Project on 'Regultion. Instiutions and Economic Effiiency." and in paticular. 3rian Levy. wifh whom much of the onginal ideas for this projeK were developed. tor very useful comments. We are also indebted to Professor Edwin Jones. Dr. Damien King and Mr. Audley Haffis, of the Faculty of Social Sciences. Uniwrsity of West Indies. Mona. for their assance in the preparation ot badcground notes for this study. Finally, we would lke to express our appreciation to senior officrs of TOJ. senior staffers at the Jamaican Ministries ot Finance and Public Utilties and Transporm and to previous commissionems of the Jamiacan Public Utilities Commission who provided much of their scwrce time to infmi us and who provided us with access to company's informtion. The resarch for this paper was panilly funded Sy the World Bank Research Committee.
|TABLE OF CONTENTS||
|---|---|
|I. In<br>tro<br>d<br>u<br>c<br>tio<br>n<br>.<br>..............................................................|1|
|11.PoliticalInsbtutions and their Implications for Telecommunications<br>..|4<br>|
|i. The Parties and Their Constituencies .......................................|8|
|ii. The Judiciary and Administrative Discretion .................................|14|
|Ill.<br>A Contractng Analysis of Key Periods and Events in Jamaica's Telecommunications||
|Sector.1880-1985 ........ .............................................|16|
|**i.**Domesbc Telecommunications.<br>.............................|7...........<br>17|
|a. Telecommunicabons Policy under Colonial Rule: 1880-1961 ...............|17|
|b. The Issuing of New Ucenses to JTC and the Creaton of the JPUC:(1962-<br>1966)..............................................|19|
|c. The Takeover of JTC by Continental Telephone Company . ...............|23|
|d. The JPUC and the Quasi-Expropriation of JTC's Assets:1968-1975. ....<br>....|<br>25|
|e. The Takeover of JTC ...........................................|30|
|ii. Intemational Communications ...........................................|32|
|a. Colonial limes.<br>..............................................|32|
|b. Independence and The Creation of JAMINTEL (1971) ...................<br>c. The Boom in the Profitability of Intemational Communications and the|33|
|Beginning of the Policy of Subsidization of the Domestic Network:1979-<br>1 985. ..................................................|37|
|V. The Regulatory and Structural Changes of 1987-1990<br>.<br>.<br>.<br>**i.**The Creabon of Telecommunicabons of Jamaica and the Divestiture of GOJ's|39|
|Holdings . .....................................................|40|
|**ii.**An Assessment of the Regulatory Reforms of 1987..........................|.48|

|VI. Final Comments . .<br>.......................................................|53|
|---|---|
|REFERENCES.<br>...................................................|.........<br>55|
|Figure 1: Total Telephones and Main Unes||

Figure 2: Intemational Circuits and Intemational Calls Figure 3: Monthly Flat Payment Residential: In J$ and US$ Figure 4: Per Minute Intematonal Rates, Kingston to NY City: Full ISO Figure 5: JTC: Real Gross Investment In 1991 Prices

- Figure 6: JAMINTEL: Real Gross Investment

Figure 7: JTC: Real Fixed Assets, Accounting and Economic Figure 8: JAMINTEL: Fixed Assets, Accounfing and Economic; Real 1991 JA Figure 9: JTC: Fixed and Working Capital, Long Term Debt and Equity Figure 10: JAMINTEL Assets, Debt and Equity: Real 1991J$, Depreciation=8% Figure 11: JTC: Retum on FKxed Assets, Real 1991$ (8% Depreciation Rate) Figure 12: JAMINTEL: Retum on Fixed Assets, Net and After Tax; Real 1991 J$ Figure 13: After Tax Retum on Equity, 1991 J$: Combined, JTC, JAMINTEL Figure 14: JTC: Cost of Long Term Debt and Pretax Operating Retum on Fixed Assets Figure 15: Change in Consumer Surplus From Increase in Number of Lines Figure 16: Change in Consumer Surplus from Intemational, Domestic & Unes Figure 17: Change in Total Net Surplus; Consumers, Govemment JAMINTEL & JTC Figure 18: Real Revenue per Lines. C imbined JTCJJAMINTEL Figure 19: JTC: Profits Gross and Nei, 1991 Prices (8% Depreciation Rate) Figure 20: JAMINTEL2s Total Profits in Real 1991 JS; Depreciation=8% Figure 21: Evolution of Demand in Jamaica, Main iines and Held Order Count Figure 22: JPS: Profitabilty, Retum on Equity and Fcxed Assets Figure 23: Value of TOJ Stock and Jamaica Market Index (in US$)
# _Acknowledgments_

_We would like to thank the following individuals for devoting time to illuminate us about JamaicaIs telecommunications. regulations. and political system:_ _Mr. Roy Alexander, Ministry of Public Utilities and Transport; Mr. Charles Bethume, Permanent Secretary, Ministry of Public Utilities and Transport; Mr. Jim Cartner, Senior Vice-President, TOJ; Mr. Alvario Casserly, forrner Secretary, JPUC; Mr. Richard Downer, Price Waterhouse, Jamaica; Mr. Carl Chantrielle, President. TOJ: Mr. James W. Craig, Senior Vice-President, TOJ; Ms. Charmaine Constance. Permanent Secretary, Ministry of Industry, Commerce and Production; Dr. Neville Johnson, Vice-President for Personnel, TOJ; Mr. Trevor 0. Minott. President and CEO, JAMINTEL Mr. Phillip Paulwell, Trade Administrator, Trade Board Limited: Gregg Shirley, Price Waterhouse, Jamaica_
Pop **1**

# I. Introduction.

1. The Jamaican telecommunications sector has been subject to a massive reorganization since the late 1980s in both its structure and regulatory framework. Whereas today a single private company operates subject to a regulatory framework characterized by a license that substantially limits both the discretion of the government and the pricing ability of the company, just five years ago it was composed of a domestc and an intemafional company, both publicly owned, both subject to a regulatory framework characterized by almost total ministerial discretion,

2. Most observers will agree that today's telecommunications sector in Jamaica is a much more dynamic one, providing Jamaicans with a much better service than anytime before. On the other hand, there is widespread skeptcism about the benefits of the current regulatory framework: tight monopoly over all telecommunications (including equipment supply), very little administrative discretion, continuous price adjustments to satisfy, what is seen by many, as a high rate of return requirement This paper attempts to provide an answer to why the reforms of the late 1980s took the form they did, and to whether they could have been done any better. In attempting to answer these questions, there is a need to understand the workings of the political institubons in Jamaica, the nature of the contracting problems that may have given raise to the need for govemment intervention in the sector, ant how the contracting problems are affected by the politics and the political structure and institions of Jamaica.

3. The analysis that we develop below suggests that the intensity of contracting problems between the govemment and interest groups, and between the firm(s) and the govemment explain much of the evolution of the regulatory institutions, ownership arrangements and performance in the Jamaican telecommunications sector over the last fifty years. Furthermore, attempts to resolve contracting problems between the government and the firms and between the govemment and the interest groups, have continuously constrained the ability of the govemment (and of the firms) to implement efficient
Pag 2 pricing schemes. Thus, a major policy implication trom this paper is that while, in the abstract, this regulatory structure looks quite ineffident, once te insttutional characteristics of Jamaica (its political system, its politics and interest groups, the role of the judiciary and of the bureaucracy) are understood, the regulatory framework developed in the late 1980s can be seen as. perhaps, a third best altemative. While it could certainly have been designed better, its current features respond to basic commitment problems that Jamaica's governmental institutions have in their relations to sectors characterized by large sunk investments with a domestic consumption base (i.e, public utilities). In other words, the politics and institutional structure of Jamaica generate an unavoidable tradeoff between providing incentives for private sector development and growth, and implementing the mainstitutional,* theoretical first or even second best regulatory policies.

4. Jamaica is a fascinating case to explore the roles ot institutions because in the 50 years since Jamaicans were granted the right to vote mhere have been several important regulatory instiutional changes accompanied by changes in the performance of the sector. Not only has Jamaica - experienced different regulatory regimes, it also has experienced different ownership arrangements from private ownership, to public and to private again. The variety of regulatory instituons and ownership arrangements, coupled with the extraordinary stability of Jamaica's political system, provides, then, an opportunity to explore, at least qualitatively, some of the main hypotheses of this research project Table 1 provides the key periods and events in the evolution of Jamaican regulatory institutions and ownefship arrangements conceming both the domestic and the intemational telephone companies (JTC - Jamaica Telephone Company, and, since 1971, JAMIINTEL, the Jamaica Intemabonal Telecommunicatiosns sic., respectively).

5. The main hypothesis that we will try to provide evidence about in this paper is that given the nature of Jamaica's politcs and political system, a legislation based regulatory mechanism (e.g., U.S. regulatory style) constitutes an implicit contrac **t** hat is too flexible and incomplete to pmvide the
**Paoe** 3

required safeguards tor investmnent and growth. Instead, regulatory mechanisms based on specif long term contracts between the govemment and the companies may, it properly designed, provide such safeguards. These long term contracts, however, cannot be designed to be fully contngent. As a consequence, they will necessarily contain ex-ante rigidities and inefficiencies.

6. Decentalized constraints on regulatory agencies or ministerial departnents are usually not binding in Jamaica as its Parliamentary system with two strong and competitive parties, assures the party in power full control over legislation. As a consequence, regulatory laws, either sector (e.g. the Electricity Act, the Telephone Law) or agency specific (e.g. the Jamaica Public Utilities Act) will usually not serve as _ex-ante_ constraints on the administration/regulators. Thus. for example, a ruling by the Courts that a partieular administrative decision violates the statute can be overturned by appropriate legisla2ion during the samne administrabon. On the otheSr hand, operabing licenses are contracts between the govemment and the company. While the govemment can change the law, it cannot unilaterally alter the terns of the contract Furthermore, because of the nature of Jamaica's Courts, independent, with long lasting tenure and with a final appeal level at the Privy Council in London, they can be called upon to determine alleged violations of the contract by either party. To be sure, specific long term contracts between the govemment and firms are not the only feasible ways of restraining administrative discretion. Nevertheless, as we will show below, they have been the most important instrument used throughou **t** he last fifty years. Thus, in trying to provide an assessment of whether the current regulatory and ownership regime could have been designed better, an understanding of both the reasons for the prominent use of this particular type of legal form and of its consequences is required.
Pqm 4 7. Both govemments and firms have seen the importance of these regulatory instruments and they have been used during different periods with different results.' A major result of our work is that the nature ot those licenses, given Jamaica's politcal structure and politcs, have been key determinants of the performance of the industry. In particular, we will find that the sector developed relatively well during the periods of time when the licenses constrained the ability of govemment to set rates with political considerations in mind (beiore independence and after 1987). On the other hand, the formalistic but substantively unconstrained regulatory structure defined in the 1966 Public Utility Act, under which the 1966 domestic license was granted, set the stage for the large extent of discrebon taken by the newly created regulatory commission. Such regulatory flexibility increased the contracting costs between the government and the company, triggering the eventual sell-out of the domestic company to the govemment in 1975.

# II. Political Institutions and their ImplIcatfons for Telecommunications.

B. There are three major reasons why legislation-based regulatory schemes do not provide enough commitment power in Jamaica: first, Jamaican political structure (a strong two party parliamentary system) is such that the party in govemment has the ability to unilaterally change laws; second. Jamaican social structure and the political bases of its two main partes imply that the pricing of domestic telecommunications is a highly political issue; and finally, while the judiciary can and does uphold contracts, it has a limited ability to uphuld the original legislative intent against the wishes of the current administration. As a consequence, legislation-based regulations will tend to be unstable, and altemative institutions have to be developed to provide stability and credibility to regulatory arrangements.

' Sharehold.rs agreemrents betwoen the private investors and the government have also been used as regulatory safeguards. Cable & Wireless and the governm oi Jwnaica (GOJ) used shareholders' agreements to regulae their reation in JAMINTEL (in 1971). and again conmering the regulalion of T.lecommunictions of Jamaica (TOJ) in 1987. The second shareholders' agreemnt was eeritually written inbt the licenses givn to TOJ to operafe both ohe domestic and inermational communicaions network
Page 5

||Period|TABLE I<br>KEY EPISODES IN JAMAICA'S TELECOMMUNICAllONS<br>SECTOR<br>Regulatory lnatituton/OwnershipAEvmnt|
|---|---|---|
|*|Prt-1962|_- TecommuruicaDons_<br>_Policy Under Coloinal Rule_<br>-All Island License (domostic operaIons license) granted in 1945 to the Jamaican Telephone<br>Company, with the Telephone & General Trust (T&GT), a British Concern being the majority<br>shwaholder.<br>* License requies:<br>specific minimum returns<br>useatad-Hoc Rate Boards<br>Court enforcement<br>of Licanso<br>* Private ownership of domestic and international<br>companies<br>* Modest but contdnued<br>growth In service|
|*|Independence<br>1962-1967|<br>*_Issuing ot New Licenses to JrC and the Cremdon_<br>_of the JPUC;1962-1966_<br>Requirement<br>of Jamalcanizatlon<br>of ownewhip<br>*_New_License in 1966:<br>specifiesnmaimumrate of raturn<br>rqulation byanew independent and permanent,<br>commission (the Jamaican Pubic Utilies<br>Commission)<br>promotes peacipation by interest groups<br>- requires Jamricanization<br>by 1971<br>_The Takeoer of JTC by Condn_<br>_tnfa_<br>_Telephorn Coanpany 1967_<br>* CTC agrees to:<br>- termsof1966 license<br>- specific expansion and financing plan<br>- extant pricinglevels<br>* Stagnation ofSerice|
|_*_|1968-1975|_*7he JPUC andtheQual-Expropraion of JTCs Assets_<br>-Absence ot judicialreview<br>_Cration of JAMINTEL (1971):_a joint venrure between Cable and Wireless (a Briah<br>govemmert owned company) and GOJ to take over C&W (West Indies) internatonal<br>communicatioans<br>acities (and International<br>communications<br>operating license) in Jamaica.|
|*|1975-1976|-_The Takeover of JrC (i9YS_Transfer of ownership of JTC to the Government<br>-Disbandment<br>of JPUC<br>-Regulation by the Mnisry oD Public Utilities and Transport|
|*|1973-1985|-Introducdton<br>of International<br>Direct Dialing<br>_Boom inte Profitaky ofInterional Communications_<br>_end the Beginning of the Policy of_<br>_Subsidizaon of the DomestcNetwork_<br>Increase in profitability of both the domestic and international<br>companies|
|_*_|1987-1990|_Crafion of Teecommunicrons of Jamaka ond the Diveutibre of_GOJs_Holdings_<br>-Teecommunicakro of Jamaica (TW - a joint venture of GOJ and C&WI to take over all of<br>JTC and JAMINTEL assts and Icenrs<br>-New domestic and interneational<br>telecommunications<br>license grarted to TOJ:<br>- Guawues real returns on equity Inanarrow band equal to current_levels_<br>- Restrict govemmentl discrtion in approving rate increases<br>Introduce binding arbiration<br>- Alowjudicial review<br>- Regulation<br>by Ministry with no participation<br>of interest groups<br>B<br>Boom in irnvstment|

9. Jamaica is a two party Parliamentary system characterized by strong party politics. **The JLP**
Pag 6 (Jamaican Labor Party) and the PNP (People's Natonal Party) have dominated the political scene since the early 1940s, and they have altemated In power every other election. Their hold In power has also translated, through the use of patronage and fund raising, into a hold on their legislators, to the point that Parliamen **t** . oday, is more a dellberative than a policy-making body. The two parties, until the late 1960s/early 1970, were quite similar In their politics, with the middle and upper classes representing the swing voters, while the poor composed both of their core constituencies. As a consequence. until the mid 1970s and again from the mid 1980s, borh pardes have had very similar policies, although they have differed in their rethoric. Because of the parties' hold on their legislators, governments have controlled, to a large extent, the parliamentary agenda. Unless the' issue is constitutional, where parliamentary super-malorities are needed, the govemment of the day can carry its policies through either administrative or parliamentary decisions. Judicial restrain of administrative decisions through statutory (rather than constitutional) Interpretation, then, may not be very effective as the party in govemment couldeasily reverse the Courts interpretation through the introduction of appropriate legislation. Jamaica's Courts, though, are highly professional. Supreme Court judges are appointed with long tenure and are quite independent of politics. The lact that Jamaica is part of the British Commonwealth may have helped in further removing Jamaica's Courts from the politics of the day as the final Court of Appeals resides in London. Furthermore, Jamaica's legal tradition is rooted in common law, with its strong respect for property rights and the enforcement of contracts. The absence of important bicameral divisions, of differences among the executive and the legislature. and the lack of power of the liackbenchers, imply, then, that while Jamaican Courts may be expected to uphold contracts even when the govemment is a party to the agreement they may not be expected to have too much discreton in restraining administrative decisions through statutory interpretation.2

**2** For a similar intrpretaion of judiciul powr in Great Britan, see Satberg (1990 and 1991). For an anaysis of the rods of po instiukiorns indatar.r.ing the _Crt_ of ludicial disaion s-e Galy end SpUtar (1990).
Pe? 7 10. Local telecommunications in Jamaica, as in most developing countries, difer from other public services, like water or mass transport. in that their main customers are middle and upper class households and businesses.' As we will see, though, these are precisely the marginal (or floating) voters. Thus, the availability and pricing of telecommunicatlons becomes a relatively Important political issue. In other words, In a contested political environment as the one in Jamaica, polifical pardes will be sensitive to telephone users' demands. On the othcar hand, the composition ot the demand for intemational communicationi **s** slightly different. In particular, loreign trade business and tourism are more importan **t** han local households. As a consequence, the pricing of intematonal calls should be slightly less politically sensitive. Furthermore, since until recently Jamaica's foreign trade regime discriminated against dynarmic export oniented sectors, the pricing of intematonal telecommunications was not of major concem for businesses.' Thus, policies attempting to keep domestic telephone prices low and expanding the network so as to provide access to the growing middle class, would be key features of both parties' policies. Thus, the Jamaican politics and political structure imply that we should expect relatve stability in telecommunications policy. Changes in government or ideology, then, should not be expected to be key determinants of telecommunications policy.

11. The mniddle class demands for network expansion at low prices require the development of institutional structures that provide incentives to the firms to inve-t in highly specific assets. Given Jamaica's political structure, though, legislation based constraints on administrative discretion may not be credible. Telecommunications politics in Jamaica, however, have traditionally been played in the shadow of the various licenses (and Telephone Acts) goveming the company/govemment relationship. Thus, it is not surprising that major tuming points in Jamaica's telecommunications regulation have 'For example, today more thanfree quanters oft a JTC'5 **CUStOIrfs** -e boated In the Klngston area, and the penetration Isless then 4 telephones per 100 residents. As mentioned above, the main changes in the distribution of the labor force rom the oaly 1940s to the oarly 980s are in the increae of the hghly pi professional tichnical and administrative pesonnel (from 2% to 11% of th labor force), whie farm and casual workers ell from 55% to 38%. Blum colar workers' pmrcipatlon also incresed from 13% to M9%. Stone (1985).

'The T devlopmont of the data erty sedor during the 198Os creatd. however, a highly telcomnmunications senoitive sedr. Estimates of demand for intemabionnl service show some minor increaes in the easticity around 1978/1979.
**rage** a

followed the timing of key license renewals. The emphasis the companies and the different governments have traditionally given to the text of the licenses represents the recognibon that Jamaican governments have had labitude in interpreting laws. Thus, regulation of public utilities through legislation may provide too much discretion to the party in power. On the other hand, a change in a license cannot be done unilaterally by the government as requires the consent of the company. Thus, a violation of a clear license stipulation could be, and has been, seen by the Courts as a breach of contract.

# _l. The Parties end Their Constituencies._

12. Essentially, ail academicians will agree that since 1962 (and to some extent since 1944, the date when Jamaica was granted universal suffrage) Jamaica has had three periods: a period of rapid growth. fueled by import substitution, bauxite exports, and tourism, that ended in 1972. a period of stagnation, socialconflict and attempted socialization through democratic means from 1972 till 1980, and a period of restructuring following the old, pre-1972Z private sector oriented policies, from 1980 till today.

13. These three periods also reflect the electoral politics of Jamaica. Since 1944, Jamaica's politics have been dominated - and affected - by the fierce competition between its two main parties. the Jamaican Labor Party JLP, and the People's National Party PNP. Both parties have been altemating in power every other election, with an electoral cycle, in principle, of five years.<sup>5</sup> Thus, since 1944, the JLP was in power from 1944 to 1955, from 1962 to 1972. and from 1980 to 1988. The PNP has been in power from 1955 tc 1962. from 1972 to 1980 and from 1988 Ill today. Thus, power is highly contested between these two parties, and following an electoral defeat, each has serious expectatons of retuming to power in iess than a decade.

' **The loalty ofthe** elecoral **cycle** seems **to** have been challenged by the call for new elections by the **JLP** In **1983, which** alkwed **it** to continued in power **uni** 1988. The PNP **daired** that the **call** for **new** elections was illegal, as **it was** based **on** the **old vwbe** registry. and hence **it** boycotted the **elecdion** This **gave** the **JLP** a total **contrai ol** the **lower** house **until** the 19B8 **eledios.**
Pap S 14. Most academicians will also agree that until 1972 the differences between the two political parties were mostly of style and personalities than of substance. While the JLP championed the private sector as the leading promoter of growth, and thus has been seen as a "conservative reform party," the PNP also supported the private sector, but saw the govemment's role as more important than the JLP. It also aligned itself with the Democratic Socialist tradition of Great Britain. As a consequence, until 1972 electoral changes did not bring about important political or economic policy changes. This policy stability arose from the fact that the constituency of both parties was (and still is) essentially the same. Both are poor people's parties. The hard core party loyalists are approximately 40 to 50% of the electorate, evenly divided between the two parties (with a slightly higher number for the PNP). This hard core group is overlyrepresented by the very poor black segment of the society. The leadership of both parties camne (and still comes) from the educated Jamaican middle dass.

15. Both parties have engaged in substantial politically based patronage at the local level as a substitute for a welfare state. Local level patronage provided jobs and contracts in local projects. access to local housing, as well as contracts and even overseas jobs. Local level patronage was (and is) organized by the local party bosses, safeguarded by the local party youth gangs, and effected by the local Member of Parliament Because power altemates every eight years or so, so does the distribution of the spoils.s<sup>7</sup> As a consequence, the very poor segments of the society see the continuation in power of their own party as crucial for the maintenance of their weHfare.

16. While the hard core loyalists are the very poor, neither party can win just with their hard core loyal support. They need what are called in Jamaica the *floating voters." These voters, representing the middle and upper classes of the society, are more influenced by the economic performance of the

* There i som evidence. though, that the minority **party** is **also able** to distibuto **some spois. One academic** piece **claims tha** it is up to 40%. but m other writes suggest a much lower participation by the minoriy.

_7_ Sever authors daim that the distribution o1 patronage goods is at the heart of the pos election vioence, where the now mqjority g9gs takes over thair respectiv districts and try to coerce the minority to give up jobs. housing. etc.
Pap 10 country than by either patronage or political rhetoric.8 The floating voters are predominantly urban and middle class. These voters have provided the large swings in votes that the two parties have received (Stone 1981, 1986).

17. For the parties to win, they also need financial support from their trade unions and upper classes contributors. Thus, until 1972 the richest segments of the society could be found supporting and even participating in both parties' govemments.9 The extent of financial support is unknown, though, as it is not reported, but it is believed to be widespread. It is clear, nevertheless, that financial support has not provided the richest segments of the society with control over those parties' policies. The governments. not just until 1972 but until today, have undertook economic policies that have been strongly opposed by their own supporters arnong the richest segments. What financial and political support seems to have provided the upper segments of the society is access and also an equivalent sort of patronageas the poor segments get with their votes. Several scholars<sup>0</sup> claim ftat Government contracts, import rights and licenses have been handed out in an unrepresentative (and uncompetitve) way to the rich supporters of the respective parties. as a form of rich people's patronage. To a large extent until the mid to late 80s, import controls and licenses have provided this segment with a steady source of prolitable opportunities in both import substhituion and distribution activities." The opportunities that the import substition process of the 60s and 70s provided to the members of the richer segments of society implied that senior government jobs moved during the period from the upper class to the middle, educated, and upwardly mobile black groups. These individuals made, until the 4 To somne Cent, the intelligentsla seems to have shaed with the very poor segments a strong interest in political rhtoric.

***** For example, during the PNP government of the early 1970s, Eli Matlon wasa member of cabet while b the s4me time, Mayr Motin **was the** Chainman of **the** Jamaican **Bauxie** Comnission that **negotiated with** the Bauxite compauies the royalLy to be

See. e.g.. Edie (1991).

"hlsexplainstheiriniti opposition to the Seaga liberaliaion program of thn 1980s. which has continued **duriLg** the subsequen Mnley adntisbton.
Pag II mid 1970s, the core of a stable, conservative, senior bureaucracy, characterized by strong seniority system and protessionalism.

18. Thus, until the 1970s. there was a political consensus that can be described as follows: both parties catered to the poor segments through their own different rhetoric and through patronage. They catered to the richer segments through maintaining import substituon policies, as well as through te contnuous expansion of govemment.'2 The middle class also benefitted from the growth of govemment. through their encroachment in the bureaucracy and in the small business - also govemment related/dependent - sector.'<sup>3</sup> The growth in the professional bureaucracy and in the small business sector was accompanied by the growth of professionals in general. While in 1943 only 2% of the employed labor force were professional and technical employees (11,000 in total), by 1980 professionals reached 11% of the employed labor force (or 81,000),'4 making the small business and professional middle class a stronger and more vocal political force.'<sup>5</sup> 19. Not only there was a political consensus. but party politics were also quite similar in both parties. The control of the national party resided with the national leadership. MPs seem to have very litte representativeness. as their contact with their local consttuencies was mostly through the local bosses (and armed party activists). Furtherrnore, the fact that there are very few districts where local voting outcomes substantially differ fron. national outcomes, implies that voters did not see their 12 Govemment employment grew from 4.500 in 1943. to 57.0W0 In 1968 and to 110,000 in 19a80 Sinilarly, pubic expendtures shae of GDP was 13% n 150,.17% In 1962,21% n 1967 and 42%6hI 1977. Simuly. fiscal defit sas shareof GDP w los than 3% unti 1970. It increased throLgh the deaide reaching 20.8% in 1980. faing back to 13.7% by 1S84.

> 3 By 1980thesmall busins s-ea had grown significantly both in terms ofthe numberof enlerprises and empoymnienL By 1980 there _were_ 50000 smll buinesses (with less than 50 empbyees), occupying 31% of the labor foch In contast ther wvo only a thousand lr entrer_is (emplying more than 50 empbyees), empbying 23% of the labor tre. The pay commodit ser. though. employed the largeht number (46% of the labor force), and having the largest number of enterprises r3O0O). The g owth of tie small business sacor is A result of the change in the strutre of Jamaica7s economy. WhUe in 1938 agriculture contibted 36% of GDP. by 1 93 Ns share war only of 7%. On the ther hand manufacturing increased *om 6 to 19%, while govenmem and other services (apart om trnde and commune) ncesd frm 18 to 41 % Stone (1986).

"rhe number of gainfully employed increased during the 1943-1980 period from 505,000 to 737,000.

" See Stoe ( 9868).
**Page 12**

representatives as particularly important for their weffare. Local party bosses performed the distribution of the spoils. As a consequence, the governing party will usually have a strong majority in Parliament, with no MP being able to extract particular rents from the leadership itself. Parliament, then, serves today mostly as a forum for discussion rather than as a place were policy decisions are made. These are made as the result of the interplay of the Prime Minister, the ditferent ministries and their respective bureaucracies. Parliament has played (and still plays) a definitely minor role in Jamaican politics." 20. As Table 1 shows, two major changes in the regulatory structure ot the sector occurred during the decade 1965-1975. This is a decade of large social and political changes in Jamaica. During the mid to late 1960s as the growth rate started to fail, urban unemployment to grow.'<sup>7</sup> and social unrest developed, the consensus between the two main parties started to crumble, as a gradual change started to develop in both the goveming JLP and the PNP in their populist policies. The JLP govemment. therrunder the influence of the 1-mance Minister, Edward Seaga, pursued a process of Jamnaicanization of some of the mnajor sectors of the economy, e.g. the financial sector, but also the telecommunications sector. Jamaicanization, though, did not mean nationalization. Instead, it consisted of pushing towards partial ownership of the companies by Jamaican nationals. Seaga pushed for this process to be undertaken through the stock market. Thus, foreign holding companies were supposed to sell part of their stock in the domestic company in the local stock market with the purpose of achieving 51% of domestic ownership." ' This however. was not the cs during the colonial peiod, evon in the inerim perod between 1ul adult suffage and independence. During that time. poltics were more locaL as the central goernmernt was not much involved in income rediribtAon in a major scale. Thus, locsl independent candidates were abl to achieve substial sLupport This support. diminished, though, as independence approached. Thus, while independent candidates obtained 35% of the vote (and five out of the 32 3ose) in the 1944 elections. they only gained 11% of tho popular vote (and no sass) in the 1965 5ection. The dedined continue. and since the 1959 eections. independen candidates have not gained more than 1% of the total vote.

' From 1950ito 1960 GNP grew byan average of B.1% peryear. From 1961 to 1972 at anaveroge of 5.8%peryearw. rom 1973 to 1980 at -2.3% per year, and from 1981 to 1986 it grew atthe rate of 1.1 5% per yew.

" As we discuss below. the application of this Jamaicanrzation process to the international telecommunications company involed the outnght aeation a a joint venture with C&W. whie for JTC n required lhe expasrion of the capital base of JTC through male in the Jamairan stodc market so as to reduce the foreign company's ownership share to no more than 20% This howevr, was never achieved.
**Page** 13

21. The consensus was finally broken following the 1972 ascension of PNP. While the PNP saw itself, as mentioned, as a Democratic Socialist party, in 1974 PM Michael Manley declared its govemrnment to be a socialist one, aligned with Cuba and the Third World, and started to pursue aggressively a socialist path to Jamaica. This policy was opposed vigorously by the JLP and the upper middle and rich classes. The main ingredients of the domestic part of this new policy was land reform, nationalization of large industries, job creation and new welfare programs. The legal system's defense of property rights, and the independence of the judiciary,'<sup>9</sup> though, turned extremely expensive the land reform and nationalization policies, as they had to be done through outright purchase rather than direct expropriation. The PNP, tried to pass a change in the constitution that would have eliminated property right protection in selected sectors, but it was abandoned facing substantal oppositon from the JLP, as well as disinterest from the public at large.

22, The Mantey govemment lsted until 1980 when the JLP, this time under PM Edward Seaga, regained power. As mentoned above, the new govemment started a liberaflization process, strongly supported and encouraged by both the IMF and the World Bank, that involved privatizabon of previously nationalized companies as well as foreign trade liberalizabon. During the 1980s the opposition, sensing popular disenchantment with its previous policies, came back to its traditional pre72 mode, to the point that when it regained power in 198B, it followed. and to some extent deepened, the policies initiated by the JLP, including the total privatizabon of the telecommunications sector.

# _It. The Judidway and Administrative Discretion._

23. We claimed above that Jamaica's political structure provides substantial discretion to the party in power. We claimed, furthermore, that Jamaican govemments are potentally constrained by the '' Several factors contribule to the independence of the judiciary. First, while the judges _we_ appointed by the govemment of the **day,** the judges of the Supreme **CoLrt** have long lasting tenure **satus. As** a consequence, **they** **_wre_** not **eosily** removed. **Second,** appUl3 to Supreme Court decisions go directly to the Privy Council In London. further isolating final judiciary docisions from **local** poltc.
Page 14 Courts upholding of property rights and of contracts. In this section we provide evidence on the role of the judiciary in constraining administrative decisions.

24. As brietly mentioned abovet, the judiciary played a minor role in the 30 years of independence, except during the 1970s where its adherence to property rights partially contributed to restrain the PNP government from outright expropriaffng land and industrial enterpnes. The judiciary, though, did not completely restrain the govemment in its regulaton of inu private utilities. For example, while the license granted to the Jamaica Omnibus Service spectfied that the decisions of the Public Passenger Transport Board of Control could be appealed to the Court o1 Appeal (the Jamaican Supreme Court), during its contentious relation to the Board the JOS never actually appealed. Also, the regulation by the recently created JPUC of the electricity company, Jamaican Pubic Service Ltd (JPS),?' seems to have been so contentious that during 1970, followung a very long rate hearing, the stock price of the company was atan all time low, at one tenth of (revalued) book value. The JLP govemmen **t** ook the opportunity and nationalized the utility through direct stock-market purchases.

25. The fact that JPS did not obtain relief from the judiciary reflects the basic limitations of the judiciary in restraining administrative decisions by the govemment in a parliamentary system. Since the govemment has majority in Parliament. any judicial interpretation of the act which differs from the govemments can be reversed by Parliament by a re-interpretaton of its previous legislation. This was aggravated by the way Jamaica's regulatory commissions and boards were organized. The members were political appointees, who rotated with the party in power (see Mills (1981)). Thus, for example, upon the PNP coming to power in 1972, the members of the JPUC were replaced by PNP affiliated commissioners. Thus, regulatory agencies in Jamaica are not immune from local politics and in

- According to Swaby (1981). JOS repeatedly thratened the Boawd with a judicia review. but was never carried ouL Swaby raiows conems abou **t** he grounds under which the Court af Appoas could overtum a Bawd's decsion. Sinco the Bard funcioned as a sanjudicla enfty. audicating rs incraes basd an the presented facs collectd by both the company and the Bowd's stba. the ground3 for ovetinmg **a** Board's decicion must be based an 'manest imprpriety in dodeing with the issues. 2' The JPUC w ascerod by an Act of Pariaunont in 1966 Until thenm JPS wa regulated by the Mmistiy.
Pap 15 particular from the political tendencies of the party in power.' The populism of both the JLP and the PNP, then, translated into very activist regulatory agencies, which the judiciary could not be expected to effectively restrain.

26. The Courts, however, seemed to have been able to restrain outright impropriety in dealing with the issues. For example, JTC's 1945 license shpulated that the company's rates should provide a return of 8% over rate capital. Deficit earnings below those levels could be accumulated, and should be counted towards eamings in the next rate review in front of a Rate Board. The license also stpulated that both the company and rate payers had the right to appeal the Rate Board's decisions to the Supreme Court. In 1956 the Rate Board disaUowed JTC's claim to increase rates to compensate for past deficiencies. JTC. represented by a former attomey-general of Great Britain, appealed to the Supreme Court and in December 1956 the Court determined that JTC was entitled to recover those amounts. This was the last time that the Jamaican Supreme Court actually restrained the administation in its relation with the Jamaican public utilities. For example, following a JPUC decision in 1974 to grant only 2/3 of the requested price increase by JTC, the Jamaica Tax and Ratepayers Association, a consumer group that participated in the proceedings filed an appeal with the Court of Appeal to have the rate increase reversed. In that instance, the JTC appealed to the Court as well.= The appeals were not granted.

27. The judiciary could also be expected to constrain the govemment on constilutional decisions, or on specific contracts the govemment entered with private parties. In the case of the regulated utilities, the regulatory framework was based on the enabling law (i.e., the telephone act, the telegraph law, the electricity act. etc). the license provided to the lirm, and following 1966. the PUC Act Only the license The length **of service** of commissioners (JPUCs **length** was **three years).** however, **cannot** be **seen as xogenous. Ir** the 1966 PUC Ad **purxosly** made **the** JPUC commissioners **pditcaily accutablae.** 2 As we **will discuss below,** it **is under** whether JTC appealed to block **the** consumer **group's** appeal, or **wheher** it appealed so es to **obtain** a **larger** price incease.
Page 16 could have been seen as a contract between the government and the firm on which the company could appeal to the judiciary tor a breach of contract by the govemment In the case of the electricity company, neither the act nor the license specified a particular minimum rate of retum. Instead it stipulated that the company was supposed to charge rates so as to obtain a reasonable return.<sup>2 4</sup> In the case of the telephone law, the act stpulated that the licensee should be allowed to obtain a net return of 8% on its rate base. Thus, in principle, the telephone companies (both the intemational and the local) could appeal to the judiciary for administrative decisions which did not aliow the company to recover its stipulated rate of retum. The fact that, as we will see, under the JPUC, the J T C seldom achieved such a rate of retum, and that JTC only appealed to the Courts following an amendment to its license that stipulated a minimum rate of retum, suggests that the Courts effectiveness in restraining legislation- based administrative decisions may be quite different from their effectiveness in upholding license stipulabons. further suggesting the incompleteness of legislation as a contract Ill. A Contracting Analysis of Key Periods and **Events In Jamaica's Telecommunications** Sector. 1 880-1985.

28. The purpose of this section is twofold: first it serves as an 'empirical tesr of our main hypotheses. Thus. in this section we explore, for selected periods and events, to what extent contracting costs between the firm(s) and the govemrnment, and between interest groups and the govemment affected the performance of the sector, and to what extent attempts to resolve those contracting problems may have affected regulatory policies. A second purpose of this section is to provide the background information necessary to be able to analyze the regulatory and structural changes of 1987.

29. There are six major distinct periods in the evolution of Jamaica's telecommunications. The major events of these periods are presented in italics in T able 1. In this section we explore the first five

**2"** Only rte incases required govermenta approvaL
**Page** 17

of these events and periods in the light of the discussion in Sections II and Ill. Unbl the mid 1980s, Jamaica's regulatory tramework and policy evolved differently for the domestic and international segments. Thus. we analyze the main events and regulatory changes for each of the two segments separately.

# I. Domestic Telecommunications.

# _a. Telecommunications Policy_ **_under_** _Colonial Rule:_ **_1880-1961._**

30. Telecommunications's regulatory policy under colonial rule was based on the specific provisions of the different licenses under which the various firmrs operated. The regulatory reforms introduced in the mid-1960s dra3tically changed the regulatory environment and the performance of the sector. Thus. to understand the implications of the regulatory changes of the mid-1960s an analysis of the colonial nstatus-quo<sup>8</sup> is required.

31. Several companies operated telephone systems in Jamaica until the mid 1940s. The Jamaica Telephone Company (JTC) was incorporated in .1892 and took over the small operations of the West Indies Telegraph and Telephone Company. JTC was granted a non-exclusive license to operate throughou **t** he island; initial shareholders of JTC included well-known Jamaican business families. Other companies also received during the 1890s non-exclusive rights to operate small scale telephone systems. Eventually, JTC obtained in 1925 a 40 years exclusive license to provide telephone services in Kingston and St. Andrew. The Jamaican Post Office operated the All Island Telephone System in the remaining parts of the island. JTC's 1925 license provided the govemment with specific takeover conditions. In particular, the Govemment had the right to take over the company at license renewal time at a price to be agreed upon by the company. If there was disagreement, the takeover price should reflect the revalued assets of tie company. The 1925 license included two other important provisions: first, the company (or any twelve ratepayers) could file for rate reviews to be undertaken by a three member ad-hoc Rate Board, named by the Govemor of Jamaica. Rate Board decisions could be
**Page 18**

appealed to the Supreme Court. Second. JTC was allowed to obtain an 8% return on its rate base. Current year earning deficiencies (or excesses) would be entered into a Excess and Deficiency Account' to be kept for future rate variations. As long as the rate of return was not below 7% the company was not entitled to insist upon an increase to make up for the deficiency. The Board was not entited to insist on a reduction unless rates of return exceeded 9%.

32. In 1945, one year after the introduction of universal suffrage, JTC acquired the All Island Telephone System from the Post Office and received an exclusive license to operate telephone services in the whole island. The 1945 license was granted for the remaining part of the 40 year Kingston and St. Andrew license. and reflected the general terms discussed above. As in the 1925 license, Rate Boards were created for each rate review. They had no irstituonal memory, nor permanent staff. The Rate Boards employed ad-hoc consultants, paid by the company but selected by the Rate Board, to review JTC accounts following an application for a rate increase.25 The Rate Boards were supposed to deal expeditiously with rate increases, and at least during the 1950s there were rate increases in 1950, 1952, 1956, 1957, 1958 and 1960. Rate Boards, suffered. then, from a structural informational asymmetry vis-&-vis the company, which, to some extent, may have served the company. In between rate reviews the company was essentially left alone, and the company's development plan was of its own design.0 33. The 1950s saw sustained growth in the number of subscriber . For example, the number of telephones2r increased from 13,437 in 1950 to 41,152 in 1962. Accounting rates of return on rate base 2An interesting alteraion devped owing a 1950 rate vew in whichthe company relused to pay tho bil of the cowt beause it disagreed with the = fts actual work Mr R. Swaby, an accountant. tried to spara. against the conpanys co.plinrts. tatot cost- into Kingston. All Island and Toll charges, Eventually the GOJ had to pay one third of Mr Swaby's biL 2X .1hea _-as_ a **modicum ot** qualdy rguation through an inspecor appoited by the Govemor. The tesk of the inspector was to supennse the cnditions of the plard.

I Number of tlephones are nain lines plus extensins As Figure 1 shows there has been a relaiely stable ratio ot two telsphones per main lint
Pag 19 during the last part of the 1 950s were in the range of 5-7%. While strong disagreements between JTC and the different Rate Boards of the 1950s were not unheard off, license, low real interest rates and inflation, and free capital flows made the 1925 and 1945 domestic licenses relaSively appropriate instruments to support private development.2a 34. To summarize, colonial regulatory institutions were based on contract law rather than on public utility legislation. Furthermore, the strict specifications of the license, provided incentives for the domestic company to invest and develop. The end of the colonial era. though, was also the end of JTCrs licenses, which were due to expire in 1965, and their renegotiabon during the early 1960s is crucial to understand the development of the sector during the 1970s.

**_b._** _The Issuing of_ **_New_** _Ucenses_ **_to JTC_** _and the Creation of_ **_the_** _JPUC4(1962-1966)._

35. The regulatory stability of the colonial period ended with independence and the granting of new licenses to the domestic and intemational operabng companies. The granting of the new licenses serve as a particularly interesting event as it exemplifies the hazards of using licenses as safeguards. As long as licenses have finite term-. end games' will develop, in which both the firm(s) and the govemment will take actions so as to improve their bargaining positions in the license renewal (or granting) process, as well as to safeguard their assets. If renewal is uncertain, and the vajuation of the assets is not sufficiently advantageous, the firm may hesitate to invest in any more specific assets. Similarly, the government may attempt to extract a commitmen **t** o a better investment program through delaying the renewal. Uncertainty about the resolution of the licensing renewal process has, then, predictable performance implications.

' Obsev thal the 8% real raf t return could have been completely inadequate in the 1 970s when interos were in the two digits level Thus. the adequacy of the 1925 lcense is subject to the panicular stable economic onvironment for which it W dosigned.
**Page** 20

36. Independence. the growth of the two national political parties, and the disappearance of the independent politician (all forces centralizing power in the Prime Minister) changed the political calculus at the time when the terms of the main telecommunications licenses were to expire. Cable & Wireless was granted a license relatively easily in 1961 just before the declaration of independence. JTC, however, did not fare as well. Since independence in 1962, JTC (under the control of the Telephone and General Trust Co, -T&GT, a British concern) refused the government request to expand Its services unless a new exclusive all-island license was granted with a specific pricing policy in place. The effects of the company's refusal to invest and expand can be seen in Figure 1. Figure 1 shows that the number of main lines remained stagnant from 1962 to 1967, while the number of telephones increased steadily. Stagnation was also visible at the debt level of the company. Its long term debt remained relatively constant in J$ from 1960 to 1966 (around J$3M). T&GT loans to the company fell from J$1.2M in 1963 to $.8M in 1966. Finally, while in 1969 there were 66,500 telephones in service, customer demand was estimated to be 184.000.2' 37. The company's refusal to invest and expand after 1961 reflects the uncertainties surrounding the renewal of the license 1ollowing the declaration of independence. In 1962, following the first elections under independence, the company made a request for a substantial rate increase to compensate for previous revenue deficiencies (as allowed by the 1945 license and the Supreme Court decision of 1956). The govemment however. requested the rate review to be postponed and decided to start negotiations about license renewal.30 Renewal negotiations started in October 1963, and a Rate Board was established on June 1963. The Rate Board, however, did not allow any important rate increase durng its existence, and the next rate increase came only in 1971 following the creation of the ' **World** Bank ReporL 'Curront Economic Position **and** Prospects **ot** Jamaica.' February 1974. p.<sup>5</sup> Z This figurs. **though, is** substantially **abev, the** number **of** requests for **main** fines. **See** Figure 21.

3 Since **thb** company had **the** tight to **request a rat hearing, the** company agreed to postpone only **if the Goverment** in turm agroed to **severF** conditions a) to **appoint** a Rate Board; b) to **allow** wage increases to **be** recovered; and c) to **recognize the** company's right **lo recover** ening **delfiencien as specified** under **the** 1945 **license.**
**Page 21**

JPUC in 1966, and following the transfer of T&Grs shares to the Continental Telephone Company - CTC.

38. The negotiations over the renewal of JTC's license lasted three years. during which limo the relations between the principa. shareholder (T&GT) and the GOJ became very contentious. A now license was granted in 1965 but was amended in 1966 to accommodate tho formal creaton of the Jamaican Public Utilities Commission (JPUC). A government paper _of_ May 1966 sets out the terms for the renewal. The 1966 license included several new features: a) a PUC style regulatory system; b) a term of 25 years (starting January 1, 1967), renewable for another 10; and most Importantly, that c) the Jamaican public should hold a large proporticn of tlae company's shares, with no individual (including the current owner) could hold more than 20% of the company (T&GT owned 50.2% of the stock). T&GT was given six years to dispose of the 30.2% excess holding. Differing from tho 1945 license, the 1966 license dithot provide for a minimum rate of retum on the rate base, but rather provided for a fair retum.<sup>3</sup> ' The rate base to be determined by the JPUCI.32 39. By the end of the negotiation period, T&GT was looking to divest its interest in JTC, even though it was granted a new license. The long negotiations for the renewal of the license, coupled with the de-facto freez- on pricesn following independence and 'he uncertainty over the outcome of the renewal negotiatons, reduced JTC's incentives to invest and to maintain the outside plant. Thus, by I The Public Utlities Commission Act though, determined that **the** JPUC should set rates **that** will provide the utilites not mre than 2.5% above the redemption yield of Govemmernt long term bonds issued in the UK Thus, the PUC Act did not require a rirnimum rats _at_ retum either. The Telephone AcL though, provided for an 6% return on the rats base. The JPUC Interpreted this provision to mean 'permited' rather than entitled.' See the discussion in the next section.

m This is not a trivial provision during periods of high investments. In those crases whether works in progress **are countod** towards the rate base or not **has** non-trivial revenue implicataons. as it **affects** the rate base and the total amount of depreciation. **Right after** CTC's takeover of JTC. this issue arose. with (predictably) **JTC** claiming that investments **on** works in progress should be **counted** in the year they **re** undeftaken. **while** the JPUC **requiring** those **irvestrment** to be included in the rate base **only** upon complton.

u Adding to the uncetainty felt by JTC about public policy towards telecommunications is the refusal by the newly eleded government In 1962 to include the company in the list of basic industries so as to quality for investment allowances under the Tax Law.
**Pap** 22

1967 the system that experienced continued growth during the 19SOs was in need of major investments, both because of unsatisfied demand as well as because of badly maintained equipment.

40. The renegotiation of JTC's license provides a basic insight on the role of licenses as safeguarding institutons: their finite term implies that the company will face substantial uncertainty about its investments unless either the license clearly specifies how the company's assets would be valued at expiraton time.' or the company is able manipulate the political process appropriately. Since expiration time is the main time for govemment to change the nature of the license, the company faces substantally more uncertainty at expiration than at renewal ime. JTCs 1945 license stipulated that if the government does not want to issue a new .Icemrne -o t.io :;censee, then it has to announce it year ahead that the licensee has to sell to the Governmen i s assets at a fair market value plus 10%. The **t** 1945 license, though, was silent for the case when the Govemment does not force a sale but the company does nOt agree to the new license. The failure to specify the :iquidabon terms for that contingency implies that the Courts may have to be called to arbitrate these terms. Meanwhile, the company would be operating without a license, in a precarious legal environment and - with - overwhelming foreign ownership limited political supporL T&GT seemed to have realized this eventuality by a) stopping its investment plans early in the negotiation process, b) agreeing to the new license even though it did not intend to operate under it, and c) looking for another company interested in operating the domestic network under the new conditions.

41. The new license, which was issued in 1966. made the JPUC the regulator of JTC. The JPUC was granted wide powers and responsibilities, both in terns of service supervision, planning and rate setting. The JPUC was created as a statutory corporaton, its decisions subject to review only by te 3' We have lo differentiste between renewal and expirntion. In a renewr4 the govewment may decide not to renew, and the lime vil usually detil ways to dispose of the company's assm (ther through a sale to anothr company, or through a gwomrmental takeover). Expiration requires a new license to be writtn, and the govemment may grant the now ficnse to another company. The old icerewe thogh, wil usualy stipLiot ways by which the assets have to be disposed at. Ucenses usualy _owed for one renwa period.
Pap 23 Jamaican Supreme Court. It was to hold public hearings in relation to rate increases. to publicize its intended decisions and to subject its decisions to particular formal delays. The PUC Act also attempted to bridge the gap between sector legislaton and licenses, by requiring the PUC to take industry legislabon intc account as 6i relates to minimum rates of return?,5 The nature of JPUC's powers, responsibilities and procedures made bargaining between the company and the govemment more difficult Any deal between the company and the govemment had to get, in principle, the approval of the JPUC, who in tum, would be subject to pressure from interest groups participating in its determination. While the comrmissioners were appointed only for three years, short tern discrepancies between the JPUC and the govemment could easily develop, increasing bargaining costs.

**_ca The_** _Takeover of JTC by Continental Telephone Company._

42. The license renewal process that culminated with the regulatory change of 1966 changed T&GT calculus. -ft not only decided to stop its development plan, but also to leave the island. In this uncertain environmen **t** he Continental Telephone Co. (CTC - a Canadian based holding company, which had been established in 1961, and was undertaking an extremely raoid acquisition program in the U.S., Canada and the Caribbean) expressed. in mid 1967, interest in taking over T&Grs holdings in JTC. The conditions under which CTC agreed to take over T&GT are important as they, in tum. influenced the development of the GOJIJTC relationship.

43. As a condition to the transfer of shares and of the license. Contnental agreed to undertake several financial and developmental obligations. Some of the most important ones were: a) to refinance a 1966 15 year World Bank loan for US$11.5M into a 25 year loan at rates not to exceed .5 above the NY prime rate; b) to lend to JTC USS 5M under similar conditions (the loan was to be redeemed through selling JTC shares to the public - except to CTC); c) to reduce its ownership share Thus, the JPUC should have considered tha 8% minimum rate of return on rate stipulated by the Telephone Act, een though the 966 Icense doe not spocify any minimum rtum
Pap 24 to 20% by January 1971: d) to expedite the completion of JTC's development plan (of JS13M) to within three to three and one halt years. The development plan had very specific quantitative goals in terms oi new service and expansion.

44. Continental involvement in JTC was greeted by the GOJ with enthusiasm. First and foremost, having a large telephone holding company becoming the parent of JTC seemed to the GOJ to relieve JTC of its liquidity constraint and lack of access to capital. Second, CTC's commitment to the investment program and to a particular increase in service generated substantial expectations of improvements in service after several years of stagnant service and increasing demand. Continental, however. seems to have overvalued the quality of JTCs equipment This can be seen from the price it paid for T&GTs shares, as well as from the evolution of its investment plan."a", 4S. As we will see below, CTC's investments did not pay off very well. Furthermore, the conditions under which CTC took over JTC were such that it should not have been expected to be proftable. Thus, CTC's involvement under the conditions of the 1966 license is puzzling. One feasible explanation is that it simply reflects CTC's "growing pains." Since CTC was under a very rapid acquisition plan, this may have simply be another case of mismanagement in acquisitions. On the other hand. it may reflect the differences between the operations of PUC systems in the US and in Jamaica. Since the JPUC was crafted to resemble US style regulatory proceedings, CTC may have expectad to be treated in Jamaica in the same way that its US telephone utilities were treated by the US stare regulators. without recognizing the basic institutional differences between the two countries X Continental paid T&GT in 1967 JS1.1 9 per share, implying that JTC's equity was valued at **JS.11.6** Million. Our computation of JTC's real assets imply that its 1969 equity was JS8.8 Miflion (at 1969 prices), a price premium of at beast 30%. Thus, CTC must have either sswumed thatthe operation of the domestic network was going to be very proftable. or it valued JTC's assets attest S3M _owr_ the real value. Since the debts are usually mtore transparent than the "alum of atsets. CTC may have avevalued JTCsa fixed assets by at loast JS3 M in 1969 prices. Since we value JTC-s fixed assets in 1969 at JS20M (1969 prices). CTC overvuluation of ficed assets must have been at least 15%.

I I mmediately aftet taking over JTC, the company revised upwards its expansion plan to JS25M. In 1969 1 was ufithr increased to J$42.2M. because. it was claimed. the poor quality of the outside plant Also. the maintenance costs of the company in the early 1 970s became a coteontious issue with the JPUC.
**Page 25**

(e.g., Jamaica's lack _of_ legislative checks and balance, the diminished role of the judiciary in restraining administrative discretion). Finally, CTC might have expected to be able to renegotiate, the terms of its participation once it was in. If this is the case, though, then CTC clearly did not understand the workings of the regulatory and political structure in which it was supposed to participate. In any case, CTC's entrance into Jamaica's telephone sector remains a not so easily explainable puzzle.

# _d. The JPUC and the Ouasf-Exproprlatlon of_ **_JTC's Assets:1968-1975._**

46. The period that follows the regulatory change of 1966 is crucial for our understanding of the role of particular insttutions in providing commitment power. What we will see is that given Jamaican politics after independence, a regulatory framework characterized by a) substantal administrative discreton, b) decentralized regulatory processes with interest groups participation, and c) concentrated (foreign) ownership, did not provide sufficient constraints to avoid the quasi-expropriab'on of the company's specific assets.

47In 1968 JTC started a development program (see Figure 1 for number of lines and Figure 5 for investments). At the same tme JTC started to demand rate increases' which received substantial oppositon from the JPUC. JTC also started to change its forecast of inves1ment and revenue needs. The JPUC also questioned the actual extent of investments that JTC was undertaking. Figure 1 shows that there was an increase in main lines in 1969 but that until 1974 main lines increased only slowly, while at the same time, number of telephones increased continuously, even during the stagnation period of the early 1 96Ds. Figure 7, on the other hand, shows that the lack of growth in main lines was accompanied by an increase in fixed assets until 197D. Fuxed assets remained constant until 197Z and started to grow slowly until the nationalization of JTC 1975. The JPUC claimed that JTC was reneging

**Tlhe** last impoant rate increase before CTCs takemoer waz in 1955. In 1960 there was **a** minor aQustaent The first roe increa requested by JTC was mi 1968 lor two paSiculur exchanges. The JPUC rejected the appication outright indicating ht it warted to undeake a major revision of the whole tariff strudure, rather approve increases on an exchange by exchange basiL
Pag 26 on its development plan, and as a consequence no rate increases would be granted.? In the wake of these disagreements with JPUC, JTC halted its investment program in July 1971. at the same time that it formnally applied for a rate increase of 17%. The JPUC granted a rate increase of 15% effective December 1971. Soon after that, in April 1972, JTC applied for a new rate increase of 54%. In August 1972 the commission granted an average price increase of 35% as of September 1972. During these difficultes with the JPUC the price of JTC's shares fell to 28 Jcents by March 1972. well below our book value estmate of J$1.3 for December 1971, and of the J$1.13 paid by CTC.

48. In its August 1972 report, the JPUC stated a policy of making prices contingent on the quality of the service. It furthermore stated that the license reference to the Telephone's Act stpulation of a permnittedo rate of retum is 'not an absolute entitlement. This decision by the JPUC seems to have triggered substantial negotiations between CTC, JTC and the govemment for changing the way JTC was regulated. IrrMarch 1973, and as a consequence of the JPUC's decision not to grant rate increases as desired by the company, the govemment decided to impose a temporary stamp duty tax of 12.5% on intemational and domestic calls and to transfer those funds to JTC as a direct subsidy.4Y As quite an explicit return to that direct subsidy and to the GOJ decision to guarantee loans, JTC issued shares and transferred those to the GOJ, such that GOJ held 10% of JTC outstanding stock.4 ' Following the agreement with the GOJ, JTC started in June 1973 a new development program. At the same btme, the license was amended to provide for a minimum return equivalen **t** o *the high point in the immediately preceding year of the gross redemption yield of the last externa **l** ong term loan bonds JTA claimed tha its investnerts were going into replacing obsolete and badly mantained tacilities, rather than m inweaig nominal capcity. See. The Gleaner. June 9.1971. The JPUC also regulatd JPS, tho olekKicity company. A sinilar approach o not graning rate inaess unti serviee improvemont was achieved was applied for a short period of Uims to JPS. See, The Glnor, August 8. 1971.

"ThePUC **obected** to thotemporary Stamp Tax. In a leaer **t** Minister Bel(12/4/72) tho PUC claimed thatthe Stamp Dutywas against the law. as it was decded without the putkt having the right to objecL At that time. the govermernt also wad to guarante a curtain return to JTC (Comment on the notes of the Managing Diroctor of JTC by Ministy ot Fnance. _December_ 1972).

*' Soon afer tho PNP came to power in l972. the company expressed in a meeting with the then Minister of Public Ulit Eric BelL that it would not objec to equity paitcipation by the {tate (Notes of meeting between Miristetr elL CTC and JTC. Mrch 30, **¶972). The** JPUC **aso** objected to the issue **ot** stocks to the **goverment as.** it contended, **such an bsa** wiil dilute **the ownrship** shlw of **the minoritY shareholem**
**Page** 27

of the Govemment issued in the United l<ngdom.n In April 1974 JTC requested a rate increase of 81%, and the commission granted in July 1974 an average increase of 53%. This was the last rate increase before the takeover of JTC by the govemment in 1975.

49. The introducton, then, in 1966 of a PUC style regulatory system substantially changed the way telecommunications regulation was undertaken. It made the regulatory process more formal and more antagonistic. While previous Rate Boards were ad-hoc and were designed to make expeditious determinations. the JPUC was an independent commission, with a permanent staff, that was charged with overseeing all aspects of the operations of the company. The regulatory challenges facing the JPUC were not simple. While it was given powers very similar to those of the Public Ublity Commissions of the United States, it had a much less experienced and smaller staff. It laced, furthermore, an industry whose accounting procedures, information services, and procurement practices were not transparent. Since before 1967 the company was regulated by a Rate Board without institutional history and with no in-house analytical expertise, its accounting and information systems were designed to facilitate control by the holding company rather than by the regulators. Up until the takeover by the government JTC's board of directors was composed of the who-is-who in Jamaica's business and professional elite.

so. Against this background, the JPUC was supposed to set rates and standards of service. The company's regulatory environment was now totally changed. The company, now, faced a traditonal rate of return system -- yet one with no implicit or explicit juridically protected minimum rates of return. Indeed. despite substantial inflation, no rate increases were granted during the period 1960-1 971.42 During the negobations for the transfer of ownership to JTC, Continental stated that it believed the pricing to be adequate. Soon, though, the company started to claim that because of the inadequate status of the outside plant, the investment needs greatly surpassed their inital expectations, and that as < For eraut btwen 3l69 and 3171 _ptais_ doubled in Jamaica.
Pa 28 a consequence rate increases were needed.'3 The company's claims were received with skepbcism by the JPUC. A series of conflicts involving the definiton of the rate base (whether the investments undertaken were actually proper)," on accounting procedures (e.g., whether depreciation should be computed at beginning of period or at beginning of each month), on what was the cost of capital of the company,4 on what were reasonable costs. and according to Swaby (1981), on procurement practces.4i These issues were all raised with substantial hostlity.

51. Apart from the hostility in the relations between the company and the PUC, a major change from the way Rate Boards made determinations was the participation of third parties in the rate hearings. For example, in the 1972 rate hearing, the Jamaican Tax and Ratepayers Association (JTRA) presented evidence. In the 1974 rate hearing the JTRA was joined by the Jamaican Hotel and Tourist Association in providing evidence against JTCs request. Subsequent to the Commission's decision the JTRA filed an appeal to the Supreme CourLt'<sup>7</sup> 52. Another change was the diminished role given to the Courts in the regulatory proceza. While, as mentoned, the Supreme Court reversed in 1956 a Rate Board decision that did not allow the 5 Tne Gleaner. June 9. 1971.

> 4 The JPUCs main cmpait was that the rat of expansion of the number ot lines was slower than the rate of expansion of the rate base. Essentially,. t seems that the company was replacing tochnically and physically obsolete equipment wkhout ye expanding at the same rate its network.

* Becauso of sorne of these disagreements, the license was amended in early 1974 to sete the way depreataion has to be measured. and further specitying the minlmurn Slowed rate of return.

**a** As mentioned above. Swaby was a consultan **t** ote 1950 and 1953 Rate Boards. His fleeting comment on the non-transprent procurement procedures wer not confirmod by other sources Bt esentially given that JTC now faces a binding rat eo rattm constraintr the maiorily shareholder would have an incentive to organize procurerment through its own subsidiaries so as to transfer profits through overcharged transfer prico. This clans is not very convincing for the JTC case as Continenta's initial hodings were just above 50%. The remaining shaes were in local hands possible among the kcal board members. Furthermore, the locI board members controlled the Boad. For example, the 1971 Board has as Chairman and Deputy-Chairman weU known business persons. As a consequence. for the claim to be valid. Continental and the local hoard members have to devise a system whereby puat of the profits that Continental would accrue from transfer pricing would be syphoned to the board members. No one has claimed such a collusive arrangoment adually was organized in Jamaica Parris (1981) caims that such trnmsfer pricing scheme was organized by Continental for its Trinidad-Tobago irnvestment, a 50-50% govemment-Continenta. loint venture Even hore, though, the **efit** and complexity of the scheme suggest that the govemnmnt appointed board members must have bewn pan to the scheme.

# `7 As metioned above. JTC sko appealed the JPUC dacisiorL
Pae 29 company to recoup its past profits deficiency, following the 1974 review both the JTRA and JTC appealed the Commission's decision to the Supreme Court but it denied both motions. This is the only case when JTC actually tried to act against the PUC through legal channels. The question remains as to why JTC did not attempt to reverse JPUC's decisions in the courts. Two aspects ot the new regulatory environment may have affected the Court's implicit approach to JPUC decisions. First the 1966 license was less forthcoming in providing minimum rates of retum. The license, however, was amended in 1973. and the next year JTC appealed a JPUC decision. Second, while the Rate Boards were ad-hoc commissions, the JPUC was a fully staffed, semi-judicial. organization. Thus, unless the JPUC violated a particular procedural form or clear license stpulation. the Courts would not find it proper to intervene. Furthermore, since the JPUC was directed by political appointees. its decisions could be thought to reflect the will of Parliament.4 53. To summarze. JTC's poor performance and lack of incentives during the first halt of the 1970s can be understood in the light of two basic factors: first, the initial condibons under which it consented to buy T&GTs shares. and second, the passage and implementation of the PUC Act. The former implied that JTC would have to undertake a substantal development program. which to a large extent was supposed to be underwritten by CTC itself. The workings of the JPUC, however, implied that JTC would not want to expose any more funds than already done, and as a consequence it will want to finance the expansion through rate increases, which were, in tum, restrained by the JPUC. Thus, by the mid-1970s JTC's financial situation was precarious, and the market essentially saw its assets as quasi-expropriated already. This, can be seen, to some extent, by the response of the domestic stock market to JTCs issue of new stock to the Jamaican public in 1969 and in 1973 to fulfil its Jarnaicanization obligations. Both issues preceded the PNP's statement of a change of policy towards socialism. Not only did Jamaicans shrewdly choose not to buy the shares that were being offered, but 4" This statement, however. should be taken with great caulion, as the incident conceming the imposition of a 12.5% stamp duty **_30_** sUggesLs.
Page 30 since CTO was required to be the underwriter of both issues, by the end of the process CTC was holding 68% of the outstanding shares, rather than the 50% initially it acquired from T&GT."

# _e._ **_The_** _Takeover of JTC._

54. In 1975 CTC sold its stake in JTC to the government. This episode is a key event in the evoluton of Jamaica's telecommunicatons sector, and, in particular, is most useful to understand the role of regulatory institutions in supporting private investment We will claim that the nationalization of JTC was iess the result of the ideological shift by the Manley govemment of the mid 1970s than of a series of insttutional design failures of the regulatory regime: first, the political changes that occurred surrounding independence seem to have made telecommunications a much more politicized sector, thus complicating the license renewal process. The fact that T&GT stopped investing five years _before_ the expiration of its license shows the uncertainty felt by T&GT conceming the terms under which renewal would begranted. Second, the new regulatory system introduced in 1966 seems to have made the regulatory process even more politicized, substantially disadvantaging the firm. Third. the lack of a coherent conflict resolution process between the JPUC and JTC essentially granted full discretion to the JPUC, dooming JTC to continuous financial difficulties. Finally, it seems that CTCs expectatons about its ability to renegotiate its operating and financial conditions with the GOJ were overly optimistic, exacerbating the financial situation of JTC to a precarious level.

55. By 1975 CTC7s experience in Jamaica was not a very happy one. Figures 11 and 13 show that JTCs real profits were stagnant during the period 1970-1975, barely sufficien **t** o cover the real depreciation of its assets. The Figures show that only 1970 was a profitable year. JTC paid ordinary dMidends only in 1969. Furthermore, as Figure 9 shows, JTC's value of equity during the period 19691975 increased mostly because of the issue of stock to CTC in 1973 (J$8 M in 1973, or J$100 M at

**e** Recail fi in 1973 JTC granted the GOJ a 10% owvnersip shae (4.5 million shares) **a** a counterpart for the govemwrs **dewion** to subsidize the company through revenues rom the smp-duty tax and through the imne ot loan guarant.
**Pep31**

1991 prices),O and with the revaiuation of the J$ that reduced (at least transitorily) the real value of its foreign debt Nevertheless, as Figure 14 shows, the operating return on fixed assets did not exceed the real cost of its long term debt Thus. CTC's ditficulties in attracting capital were not imaginary. The company was not sufficiently prolitable to attract private investors, neither Jamaican or foreign. By 1971 CTC was already asking for direct govemrnment investrnent in JTC. A first step was taken, as mentioned, when the governmen **t** ook a 10% stake in 1973.

56. The government's decision in 1973 to support JTC, though, did not go far enough. First the subsidy originating from the stamp-duty tax was to end in June 1974. Furthermore, the JPUCs attitude towards JTC did not change. Figure 3 shows the evolution of real prices for domestic calls. Through the 197111979 period real prices increased in steps, with nominal price increases, granted by the JPUC until 1976 and by the Ministry of Public Utilities since then, compensating for past domestic inflation. The 1971/1975 does not seem to be too different from the 1975/19. 9 period in the evolution of prices. In 1974, though, the PNP govemment made pubic its change of policy towards a socialist economy, which included govemment ownership of the main enterprises. This change in govemment atfitude provided JTC with an opportunity to negotiate a takeover by the GOJ. In September 1975 CTC agreed to the sale of its holdings in JTC to the govemment 57. The final event on the takeover of JTC was the dismantling of the JPUC in 1976, and the transfer of regulatory responsibilities to the Ministry of Public Utilities and Transport, even though the PUC Act remained in the books. Following the takeover, the financial situaton of JTC did not improve, with JTC showing an economic loss in 1977, after essentially breaking even since 1973 (see Figure 11). The GOJ pricing policy until 1979, though, did not differ substantially from that of the JPUC. Figure 3 shows no break in pricing around late 1975-1976. Furthermore, th.l expansion in the network

- **The** **_issue_** _of_ now **stock to** CTC **did** not **involve** a **new** inflow **of** funds **to the company,** but rather **a** cancellaton of a **shout oem** bond to **CTO.**
**Page** 32

since late 1973 seems to have stopped with the takeover as the increase in the number of main ilnes fell during 1977-1978 as compared to 1974-1976 (see Figure 1). Investment fell also during the 19771979 as compared to 1974-1976 (see Figure 5). As a consequence, JTC's real economic fixed assets lell slightly from 1976 to 1979 (see Figure 7). Finally, while consumer surplus was increasing during the 1973)1976 period, it remained constant, or lell, during the 1977/1980 period (see Figure 17). Thus, the takeover did not produce any short run positive effect, neither consumers benefitted, nor firms' profitability increased. Also, government's revenue from the domestic teiecommunications sector remained constant, rising only in 1980 with JTC's first income tax payment in a decade.

# II. IntematIonal Communications.

## _a. Colonial Times._

58. International communications were started by the laying down of the first submarine cable by the West India ard Panama Telegraph Company in 1870, which reached Holland Bay from Cuba The WIPT eventually became Cable & Wireless (West Indies), and it operated intemational communications until its assets were taken over by the creation of the joint venture of JAMINTEL in 1971. Intematonal communications were not very important until the late 1970s, as revenues from international communications were less than haff those from &:mestic services. See Figure 18. During colonial times C&W operated apparently without a license,.5 under a fixed price system. There is no record of a demand by C&W to increase prices during the late colonial period; indeed, international communications prices were held constant until the late 1970s.

59. The differences between the domestc and the intemational licenses reflect both politics and ownership. On the one hand C&W was an imperial (colonial) operation, whie JTC was a privately held company. Thus, the Jamaica-C&W relation was, at the time, a govemment-to- govemment relation.

" **See.** for **example. Baglehole (1** 970) and Bartygiyng (1979) **for descriptions** of **the early** yeams of Cable **and Wiress interatiomi opeations.**
Pap 33 Furthermore, intematonal communications at the time were of very litte public concern, while the users of telephones were upper and middle class urban residents. Thus, it Is not surprising that ratepayers were given the right to call for a Rate Board review lor JTC while such right was not granted to C&Ws customers.

# **_b._** _Independence and_ **_7he_** _Creatlon of JAMINTEL (1971)._

60. JAMINTEL was created in 1971 as a joint venture between GOJ and C&W, to take over C&W (West Indies) operations in Jamaica and C&W8s 1968 intemational communications license, with GOJ holding 51 % of the shares. The fact that the joint venture was created just three years after C&Ws previous license was amended suggests that the 1968 license was not robus **t** o some external events. Moreover. JAMINTEL itself operated on terms that left it with only modest profits. Investmen **t** , oo, was limited. This episode, then, suggests that exclusive licenses per se do not provide an answer to the problem of commitment, but rather commitment, if at all, comes from the substance of the license agreement, and of the regulatory regime in general.

61. In the early 1960's C&W was operating under a license, granted in 1961. At that time it saw the need to undertake several new investments, in particular, the introduction of an earth station and the development of satellite communications. For that purpose. C&W requested a long term extension of its license.52 In 1968 GOJ extended C&W license for 20 more years, but introduced several new features to the 1961 license. The most important of these was the GOJ's right to terminate the license at will, in which case C&W would be required to seUl all its assets to the govemment at an agreed upon price or at a price set by an arbitrator. If the license was not renewed, then C&W could also be required to sell its assets to the govemment under similar conditions. Furthermore, the 1968 license stipulated that prices were to be set by the Ministry, with no minimum but rather a 'fair rate of return allowed to the company. Less than a year after the granting of the license negotiation **s** tarted Y See Barty-King **(1979.** page 354).
Pap 34 between GOJ and C&W (West Indies) for the lormatlon of a joint venture to take over C&W operatons in Jamaica. In November 1970 a shareholders' agreement between C&W and GOJ was signed, with GOJ taking a 51% and C&W a 49% stake in the venture. The main features of the shareholders' agreement between GOJ and C&W are described In Table 2.

62. There is not much evidence on what precisely led to the govemmen **t** akeover of a majority share of C&Ws interests and the creation of JAMINTEL But we know that at the tme that the 1968 license was granted the JLP's nabonalistic discourse promoting Jamaicanization of the large foreign owned companies was at Its peak. That the JLP wanted to have the option of taking over not just a majority share but the whole enterprise is quite clear from the stipulations of JAMINTELs shareholders' agreement (see Table 2). The reasons for nationalization of the intemational communications operations rather than its Jamaicanization" through private ownership are uncertain, although the failure of JTC's 1969 public issue of $4M mnay have suggested that attempts to MJamaicanize C&W through JLP's preferred instrument (the stock market) would not succeed.

63. The joint venture with GOJ did not tum to be so profitable for C&W. First, while the shareholders' agreement seems to sugges **t** hat C&W fixed assets were valued at approximately US$16M (or approximately J$14M), our permanent inventory model puts the level of JAMINTECs 1972 fixed assets at round USS20M (see Figures 8 and 10). Thus C&W may have given away US$4M, or 25% of its fixed assets.53 Second, the rise in inflation during the 1970s (see Figure 4). the maintenance of a constant nominal price for intemational communications (see Figure 4), and the change in the settlement agreement with JTC that regulates the sharing of intematonal revenues (in JTOs favor - see below), made the terms of the shareholders' agreement quite onerous for C&W. In particular, if we compute the present value of C&Ws investment in JAMINTEL. then, we find that the investnent broke AS **we** wi **l** e biow. JAMINTELs accounting method did not revalue fixed ass. If C&W folbwed prwiously to _pnodure._ then t is poeiibie tht much **difference** implied tihd O&W contibuted more than i was givn acit for.
Page 35 <!-- Start of picture text --> TABLE 2<br>MAIN FEATURES OF THE SHAREHOLDERS' AGREEMENT REGULATING<br>THE CREAllON AND OPERATIONS OF JAMINTEL<br>* JAMINTEL was to take over C&Ws lnternational communicatilons licene which was going to<br>expire In 198B. Thub. the agrement itsedf was vaid only until 19W0.<br>* C&W would contribute buildings, land and equipment for approximately US4M<br>* C&W would provide a loan of US$8 M to JAMINTEL (repayable In 7 yeamr wih three year of<br>grace, linked to the Pound paying 8% ltorest), which will be used (ointly wih the Govrnments<br>contribution) to buy the remaining C&Ws aseto and to provide working capial.<br>* The government's contribution of US$4 M (or J$3.4M) woul be provWod through a loan trom<br>C&W. This lon was supposed to be repaid through the use of up to 3/5 of the govemmenrts<br>recipts trom JAMiNTELs dividends. wihout corge nor interest<br>* Annual dividends were not supposed to exceed 15% of equIty<br>* JAMINTEL was going to be directed by Jamaican personnel.<br>* The govermnent had the option of further acqudring, S book value, the assets of JAMINlEL<br>according to a prespecified formula:<br>up to 60% by 1981<br>up to 75% by 1986<br>up to 100% by 1988.<br><!-- End of picture text --> even only because of the increase in the value of JAMINTEL following the explosion in intemational communications that occurred around 1978/1979.Y Furthermore, JAMINTEL's low profitability, and lbe poor quality of the local network, translated in a very slow path of investments, to the point that their fixed assets fell throughou **t** he period.

64. The change in the sharing of intemational revenues may have been the most opportunistic acton by GOJ in its dealing with C&W, and may have contributed to the quasi-expropriation of C&W assets. Until 1979, the sharing agreement between JTC and JAMINTEL was the same as that between JTC and C&W, whereby C&W retained 70% of all inten:itional revenues while JTC received 30%. By Whibl the GOJ ended repaing its zero inoest debt to C&W only by 1985-1986. rather than _the_ JS7M (of 1971) that It lnt, C&W rcenived. in presen value sens less than JS1 M (of 1971). C&W also sold to JAMINTEL half of its fed ases for a value of J$7 M (of 1971). C&W abo rewivd dividends for a presnt valueo JS1.5 M Iof t971). Finaly in 1987 C&W ctributed lts shares in JAMINTEL to thecration ofTOJ. lt shares woevalued S approximalyJ115 M (of 1987). which o equivalnttoJ$12 Mof1971, whiInprsentvaluebecome3sapprodmtielyJ$3 .Thus ihnpresetvalueCWnreeivedJ$13M oriustabutSwhet it caotribued waording to the accourting valuation, or JS3.3 M (20%) less acrding to our pormanet inventory modeL Al present vau cacbations wer done suming a ra rat ot discount of 8%.
Page 36 1979, though, the government was the majority shareholder in both companies. and thus was able to negotiate a change in the setlement agreement so that JTC's share increased to 40%.m In 1984 JTC's share was increased to 60%, and in April 1987 It was increased to 68%.Y Since the demand for international telecommunications increased rapidly during the 1980s, the change in the sharing agreement allowed the govemment to reduce the portion of those rents going to C&W.

65. To summarize, the creation of JAMINTEL shows that the granting of an exclusive license does not by itself, facilitate private investment. Rather, what is crucial are the implications of the license conceming govemment discreton. In the case at hand, GOJ had total discretion on when to cancel C&W's license. That option most certainly was threatened to be exercised in 1969. triggering C&Ws consent to the creation at JAMINTEL. in such a way that it did not provide C&W with particularly high, ex-post. benefits.

_c. The Boom In the Profitability of international Communications and the Beginning of the Polfcy of Subsidization ot the Domestic Network:19791985._ 66. As Figure 2 shows, international telephone calls started to boom with the introduction of international direct dial from the UK US, and Canada in 1977, and to the US and the UK in late 1978. The growth of intemational communications was only slowed in 1984/1985 following the 1984 price increases. While the growth of intemational communications is also connected to the size of the domestic network. Figure 18 shows that the increase in revenue per line that occurred since the late 1970s is associated mostly with an increase in intemational revenue and number of calls per line.

The Chairman of JAMINTEL's bord until the creation of TOJ was Mr. Barber, a aniseor civ servarit who at the time of the creation of the company was the Financial permanent secretary, and who eventually became the Presidert of the Bank of Jamaica (the Central Bank). To what onti JAMINTELs board represented the interests of the minority shareholders is uncertain. Mjor changes in the reguiatory set-up, though. like changes in the lians5, required. by the 1970 sharehoiders' agreement the consent of C&W. The sharing agreement though, was an operating decision left to the Board. We have no information about C&Ws posidon on this issue.

I As we will sme blobw. though, the iinancial performance of the company, however, started to improve tollowing the 1979 prce increase. as JTC's network incresd and the demand for Internatnal communicalions boomed.
**_Pag._** 37

Together with the increase In international calls, there were two price increases in intemational services -- 50% In 1979/1980 and a further 50% in 1984. These increases reflected the JULP's determination, upon regaining power in 1980, to reverse the socialistic policies of the PNP. The growth in intemational communicatons plus the price increases drastically increased the profitability of intemabonal communications, bringing about a change in the profitability of both JAMINTEL and JTC. The year 1978 is the last one where their retums to fixed assets were essenfially zero (see Figures 11 and 12). Since then, total profits increased rapidly. JAMINTEL's after tax return on fixed assets broke the 10% barrier in 1982. while JTC did so in 1984. See also Figures 19 and 20.

67. The increase in profitability arising from the boom in international communications, then, alowed all parties to be better off: consumers benelitted from an increase in communicatons, the companies benefited from an increase in profits and the government benefitted from an overall decrease in its central deficit. The main beneficaries of these developments, though, tumed out to be the users of the domestic network. Domestic prices have been falling in real terms since 1980, even when taking into account a 1984 price increase of 50%. The real price decreases appear to be the result of two factors. First, as mentioned, the increase in intemational communications, arising from the introduction of internatonal direct dial, provided a windfall to both companies, allowing their performance to improve even with failing real prices. Second. the takeover by the GOJ of JTC implied that there was no more pressure from the companies to pass rate increases when their prices were not compensatory.

68. While in 1978 intemational revenue was just above 20% of total revenue, by 1985 approximately 55% of totat revenues were provided by intemational communications, and by 1991 the share of intemational revenues was close to 80%. Since intematonal services made. in 1985 a direct
**Page 38**

claim on fixed assets of around 20%67 It Is clear that a policy of cross-subsidization of the domestc network by the intemational sector developed around the tum of the decade." The drastc price increase of intemational services in 1979 and the change in the sharing of intemational revenues between the two companies are behind this development 69. By 1985, though, the current system was not sustainable. First the zompanies' after tax rate of return on fixed assets were above 30% and 10% for JAMINTEL and JTC respectively. While the latter was not unusually high, JAMINTE's retums were. Second, the growth in the use of the network that started in the late 1970s brought about an increase in the revealed demand for main lines, to the point that in 19B6 there were as many main lines in held order as in operation. See Figure 21. The potental for maintaining and increasing the cross-subsidy towards the domestic network required either further increases in JTC's share of intemational revenues, or a consolidation. The govemment decided on a consolidation of both companies. Although a consolidation could maintain the cross-subsidy, pressure to reduce Fte combined profitability of the companies, which by 1985 was above 15% - see Figure 13, would naturally develop. This can be seen from the experience of the electricity sector following the increase in JPS' profit level in 1984. As a consequence of the 1984 increase of 50% in real electricity prices, JPS' return on equity exceeded 4% for the first time. This profitability level did not last long, as by 1988 JPS was already making losses as its real price continued to fall. See Figure 22.

' This is the shae of lAMINlELs fixed assets in total fixed mets. Since the size of the domestic network ewarly tas into account the amount of ierndional commnunictions, some emourt of JTC's fixed assesU may be directly reated to the volume of huternatiorl communictions. By 1985, however, JTCVs fixed assets inceased from 1979 to 1985 by less thcn 50% whit intenadIonal communiations increased by 300% in the same period. JTC's domestc revenue increased during the period also by less than 509. " To uhow that around 1964 there **-** cross-subsidization towards the domestic segmern we have to show that a) combned profits were normal b) domesic revenues would not cover the incremental cost of domestic **sannice.** The first **isue** can be **sen** rom thetacthat in 19B4/1985 JTC and JAMINTEL's combined real return on fixod mets wer around 14-16%. Second. the incremental ts of domsIc _servic_ is given by the diference ot total costs minus the costs of operating the network only for international ale. Slince most Intrnaiona call ario from businesses. the size of the network could be substartialy reduced without much ot a reduction in irtern tionl cal Thus, the incremental cst of domestic service should ba at lt hat the arrant costs. Shic by 1 9841 985 domesi revenue was less than half of total revenues, domestic revenue does not cvr its incrmental cost. suggeting t exisence of crosssubsidization towards domestic sorvi.
Pap 39 70. The high level of profitability achieved by the sector, however, allowed the govemment to transfer the companies to the private sector without having to increase real prices. This made privatization politically feasible - in contrab **t** o the power sector where drastic real price increases would have been required to attract private participation (and where real returns on equity marginally in excess of 4% in trhe mid-1980s triggered intervention and real price declines. But even with the increased profitability, private sector participation in telecommunications would not have been forthcoming without a change in the regulatory system that eliminated the ability of the administration to expropriate the sector's specific assets. Once that was achieved. then, the ability of the govemment to use telephone prices for political wealth redistribution became limited.

!'

# V. The Regulatory and Structura,i Changes of 1987-1990.

71. The structural changes of 1987/1990 represent major changes in the way Jamaican telecommunicabons sector was regulated and organized. Not only were the insttutional changes the most important since the introduction of the JPUC in the mid 1960s, the sector subsequently has experienced an unprecedented vitality. The main hypothesis that we want to address empirically is that the performance of the sector responds to a large extent to the resolution of the government/firmn contracting problem through the writing of a regulatory contrac **t** hat was seen as credible and binding. Furthermore, this regulatory contract was designed so as to reduce short run politcal oppositon. In the next section we explore to what extent these regulatory changes could have been improved upon, given the political, contracting and structural consbtaints.

# **_1. The_** _Creaton of Telecommunications of Jamaica_ **_and_** _the Dlvestiture of_ **_GOJ's Holdings._**

72. In 1985, in part for the reasons given in the previous section, but also because of the coming expiration of JAMINTELSs license and of the shareholders' agreement between GOJ and C&W, negotiations began with the intenbon of merging the domestic and intemational operating companies.
Pap 40 In 1987 the two agreed on the creation of Telecommunicabons of Jamaica (TOJ) a joint venture between the GOJ and C&W. The shareholders' agreement had a few basic components: first, the two partners were to contribute to the enterprise their shares in the two operating companies, with the valuation oi each contributon determining their share in TOJ (and with independent shareholders in JTC also receiving shares in TOJ); second, the two companies were to become wholly owned by TOJ; third, a rew regulatory mechanism was devised stpulating the ways by which the govemment was to set JTC and JAMINTEL's prices: fourth, licenses were to be amended to formalize the new regulatory mechanism, and to make TOJ the licensee; finally, a certain divestiture of GOJ's shares in TOJ was also agreed upon.

<!-- Start of picture text --> TABLE 3<br>MAIN COMPONENTS OF THE 1ti TELECOMMUNICATIONS UCENSES<br>a) JTC s ganted a monopoly over all domacto (both local and toll telephone servie, while JAMINTEL<br>is grnted a monopoly over all intematonal commLunications<br>b) Both licenses ae r 25 yeas with a renewal penod ot 25 yers.<br>c) Both companies are reguated on a rate of return basis, with net aRer-tax (and special dvidends) proft<br>having to be not less than 17.5 nor more than 20% of (accounting) shareholders equity, where assas<br>a revalued annually;<br>d) Rate stting is as folws<br>i) a the company want5 to adust its tariffs, it proposes a new tauin to the Minister of Public<br>Utiities and Transport<br>ii) i the Miniser accepts, then that tariff goes in efled:<br>iii) a .e Minis does not accept. and the Mifister's offer is not accepted by the Compmy,<br>there is a relatIvely simple abitration procedure. with the arbitrator having to set rates tha<br>satisfy point c) abovw<br>e) TOJ is not required to obtain permission to perform investments, nor the gwoernmen can disallow<br><!-- End of picture text --> 73. In 1988 the shareholders' agreement was formalized with the grantng of licenses to TOJ. The mnain features of these licenses are summarized in Table 3. These licenses represent a regulatory tuming point They force the govemment to maintain the profitability levels of the companies at their pre-TOJ levels (see Figure 13). thus assuring that their operating retums will be sufficient to cover their cost of capital (see Figure 14). While TOJ will not be able to increase average real prices as its pro-
Page 41 TOJ profitability was close to the upper level of the permissible profit range, in principle it is free to change its tariff structure, so it has an incenbive to increase prices of the inelastic (domestic) segments. For this reason, upon privatizaton an agreement was reached between TOJ and the Government that domestc rates would not be increased.<sup>5</sup> This agreement, that TOJ has so far kept as domestic prices have not been increased since 1984, had three political consequences. First, by providing incentves to the sector to invest. TOJ has increased the rate of expansion of the local network, thus satisfying to a large eMtent the aspirations of the middle class. Second, by focusing the increases in nominal revenues on the intematonal segment, it has not alienated the core supporters of either party concerning telecommunications policy.<sup>6</sup> ' Finally, govemment revenue through taxes has also increased, as its average tax collection from telecommunicabons has doubled in real terms from the period 1981/1985 to 1987/1991.2 74. Three issues require further discussion concerning the creation of TOJ and GOJ's divestiture. First, the regulatory principles on which the 1988 licenses are based: second, the way the divestiture was actually made. and finally, the possible effects that the creation of TOJ may have had on the performance of the companies.

75. Regulaton. The 1988 licenses created a very simple mechanism for price adjustments and for dispute resolution. The govemment has a short period of time to answer TOJ's requests for rate " While there does not seem to exist a digned document an tis respect. insiders mentoned to us the exisence of a gontlbmons agreement to freeze domrstic pricm for, at leaslt five yers. Furthermore, in the TOJ s 1991 Annual Report, the Chairman's Lutw explicXly mentioned thart increased revenues from _network_ expansion and international communifcafons _will_ alow TOJ to maintain ornstant the nominal price of domestic communications.

- TOJ. though, has recognized the fact that the real price of domestic services is too low, creating soo large a demand for the network. As a consequonce. it has tried to increase domestic prices by shifting customers' billing away from flat service fees towards measured calils. We do not know yet the extent of tis proce

n Stone (1992, pp:l 19-120) presents evidence that while initially, most JLP and middle and upper incomo voters upported the sale of GOJ's stock in TOJ to C&W. most PNP and lower income voters opposed iL Since then, though, there has ben an **inmm** in publicsupporttowrdstheGOJdivestmentof TOJshares. Whie iJuly1991 54% supportedthe policy, in March 1990onty36% did so. Most of the shift from negative to positive ocurred among the lower income and PNP voters.

- From JS97M to JS190M hI 1991 prices.
**Pag** 42

<!-- Start of picture text --> TABLE 4<br>DISTRIBUT1ON OF OWNERSHIP IN<br>7ELECOMMUNICAllONS OF JAMAICA<br>on Pereentages)<br>DAWE GOJ CaW PUBLIC PRICE IN USS<br>5119187 82.711 9.402 7.88 0.1811<br>7/23X7 72.111 20.002 7.88 0.1811<br>102187 53.111 39.001 7.88 0.1818<br>9RR188 40.00 39.002 20.99' 0.1564<br>7/13J89 20.00 59.002 20.99 0.2174<br>11C/160 0+ 79.002 20.99 0.2205<br><!-- End of picture text -->

* TOJ empoyees hold 2%.

increase. It TOJ and GOJ disagree, then the issue goes to an arbitrator, who is required to set rates subject to the rates of return specified in the license. Furthermore, GOJ decisions do not have to be subject to public hearings. And TOJ may appeal to Jamaica's Supreme Court for any violaton of the license. The emphasis of these regulatory arrangements on contract rather than on legislation reflects, to some extent the characteristics of Jamaica's politcal institutions. In the absence of a strong judiciary and the consequent observance of property rights, it is uncertain to what extent this contracting approach could have provided the necessary institutional background to promote rapid private sector paruicipation.

76. The license stipulates that rate of return is based on shareholders' equity rather than an rate base. As a consequence, if the rate of return allowed by the license is higher than C&W's opportunity cost of funds, then C&W will have an incentive to increase its partcipation in TOJ, as well as for TOJ to finance its investnents through retained earnings rather than through long-term debt.63 ° Sinse chnges in oquitry quad operating prafits minus dividends, lar"er dividends imply that equity grws less rpidly N as a cosequence tha slowed total profits would increase lass rapidly as welL Thus, by not disibutiig its earnings in the form of dividends, TOSs wodg ca. tul should incres. The exces woridng capital could then be used to financ t systems expansion.
**Page** 43

77. TOJ also has a strong monopoly over telecommunications in the island, including the domestic sate of terninal equipmrent.L" The granting of such strong monopoly illustrates quite clearly the impact of the politics of the times on regulatory institutions insofar as cross-subsidization was used as a way to obtain political capital in support ot the privatization, at the cost, perhaps, of a more dynamic and competitve sector. For the govemmen **t** o maintain, or even deepen, the extent of cross-subsidization towards domestic services, revenues would have to be generated from as many alternative sources as possible. In particular, since internatonal communications is the main provider of subsidies, competibon in the intemational communication **s** ector would damage the ability to cross-subsidize. On the other hand, since the international communications sector has a relatively elastic demand, achieving revenue from all sort of other sources (e.g. surcharges for fax machines) allows the company to reduce the real price of internatonal communications and still achieve its rate of retum. Critics of the licensing arrangement have suggested that it may deter the introduction of new products and technologies. The cost of the cross-subsidy, then, is the maintaining of a strong monopoly situation in a time when new - products are developing rapidly, and where technological convergence is prevalent.<sup>0</sup> 78. Divestiture. A number of the other country cases address the hypothesis that the nature of the privatization may serve as a safeguarding insttution. In particular, they discuss how widespread domestc ownership and multiple providers rather than a single monopoly may serve as institutional safeguards, as they increase political support for maintaining private ownership and for restraining the ' Thfis monopoly position was hld _prevI iy_ byJTC, thui it is not a new eature _of_ the regulatory process. Wile _users_ may atach to the network any equipmen **t** hey want they haveto no the company. Ths requiremont holds also for fax machines, PBXs as wol as for regular tlephon extensions. The company, then, will add a rental chargejsurchage accwrdingly.

° Consider. for wampl. the problem that arose when a company wanted lo provide cellular sevices in Jamaica. TOJ contended at that time that the license provides it wih a monopoly over eJI toloemmunications services. including cellular, and furthermore, that it had alredy perormed several investments kito collular. The governme eventually sided with TOJ and is presenting a bill to Parliament to anend the Telephone Law to includa nan-wire teleommuniations in the monopoly set. The government had at least two reans to side with the company. Frst even though the Tolephone Law talks about wirecommunications. the lice is sibnt about it and the meng of the licns. was that the monopoly was ovr al telecommunicati services. at least those that are so commonly caled. A second reason relats to the cross3-ubsidizati **o** n f the domestic servioe. If cellular turns to be very proitable. then providing TW withthe monopoly overcellular wouldallow itto further reducothe price of intenn communications, reducing, then, the coat of the cross-subsidy. If celular services do not turn to be sufficiently profitable, though, then prices of the remaining sonices would have to be inreased, so as to maidain the minimum rate of return on equity.
Pap 44 government from directly or indirecly expropriating the sector's specific assets. For the most part, though, the creation of TOJ was not performed in that way. Instead, a single monopoly company was created, to which a strong monopoly was granted. and ownership was concentrated in a foreign principal." At the time of the creaton of TOJ, it seems that the intention was for GOJ to retain an important share in TOJ. But C&W saw the advantages of expanding its ownership share, and eventually took over 79% of TOJ stock. See Table 4. Yet some moderate safeguards were built Into the privatizabon. since 13% of the govemment' **s** tockna was sold In a way that facilitated acquisition by workers and domestic households. For example, 2% of the outstanding stock (21.1 million shares) was reserved for employees, while 51,000 residential customers of JTC were granted priority for up to 1750 shares each.9 79. A comparison of the price of TOJ stock in relation to the company's revenues offers an indication of whether the 1987 license arrangements were viewed by investors as credible. Figure 23 shows that until April 1991 TOJ shares were being traded at less than 20 US cents. Assuming that the company achieves every year the lower bound alowed by its license (17.5%), we can compute the rate of discoun **t** hat would generate a price equal to approximately US$.20. Comparing that rate of discount with the actual real rate of interest in Jamaica gives us a measure of how much confidence 0 Apat trorn C&W. the lrgea sharholders e the employees of TOJ (owning 2% of outstanding stock) and seven insdiituonal investor, none with a larger stake than 2%. The lrgest individual shareholder is Joseph Mayor Matalonm the son of TOrs Chairman of TOJs Board, and also a member of TOJ Bowd. who owns .5% of the stock See TOJ 1991 Annual Report After legal cost and excluding dividends receied during a period of two and a half yeas, the GOJ received USS 1SSM. which after discounting (at 12%). represents USS130M. which is our valuation of GOJ-s shares in JTC and JAMINTEL as of March 87. _This._ the GOJ seems to hava received a fair value for its es.

' By the time the prvitizAtion was completed. the govemrnment had sold all of its stock, aside from a few nominal shars enabl it to keep a represenuisve on the Board.

' The empbyee shae scherm implied some restridions on resale. Employees purchasing shares through the 'employe share scheme' could resae frly only those shars that were 'prority shures. Discounted shares could be transferred within two ye, o-ly to 'eligible' employees. while tree share were not transfeable during the frst two years. Unsold 'employee share schem' shares -wo to be retained in a p-d to be sold to 'ligible employees' after the dose of the application list See TOJ prospectus. Almost all shares resentd lor thle mployees were sold, either in the first on the second round. TOJs 1991 Annuai Report 1ist 20.341.946 shares being held by employees thus. appWroimately 750.000 sham that were originally reserned for the empblyw remained to be sold to employeos by March 1991.
Pag 45 investors had in the performance of the license. Assuming that TO.' disburses 4% of its real equity in the form of dividends, then a discount rate of 20% ir4plies a stock price equal to US$.187 In March 198B8. Now, _in_ 1988 the average prime lending rate was 23%, while the rate of devaluation for the year was zero implying a real rate of interest (in US$) of 23% minus the US inflation rate (about 4%). Thus, a real discount rate of 19% for the private sector was quite reasonable for Jamaica in 1988. A real discount rates of 19% would imply a value for TOJ shares as of March 1988 of US$.212, a bit higher than the price of the public sale, but exacty equal to the price paid by C&W In the two latest acquisitions." The similarity between the market valuation of TOJ and an estimate of the value of TOJ's stock on the assumption that the license holds for its complete period, provides support to the hypotheses that the 1987 regulatory regime was seen as credible by investors.

80. Impact on performance. The movement towards the creation of TOJ and the introduction of the 1988 licenses has implied large changes in the way the sector operates. First, Figure 4 shows that since the negotatons for the creation of TOJ were started in 1985, the real price of international calls has ceased to decline, and has remained more or less constant Second, the profitability of the companies has been systematically high (see Figures 11-13), but well within the license-prescribed range. lThis high level of profitability has allowed the companies to increase their level of investment. The increase in the number of main lines has been quite rapid, as has been the increase in the value of the network's fixed assets. See Figures 1 and 5 to 10. As can be seen in Figure 9, furthermore, the increase in profitability has allowed JTC to finance a large part of its investments through long tenn debt.

XThis number is gneraeod as follows: Take K, to be the value (in USS) of TOJ equity per share as of Mardc 1991. The price of a **_share_** in TOJ is given by: P a ZZ65,d/(1 )+14.C(1 .6), **whore** 6 is the discoum rate. K, Is the value of equity as ot peiod t. , K,,'(l+.175)-d, where d, reprosenrt th dividend distribution in period **t,** with dA=K,,04.

**n** Slghy lower raes of discount Imply substaWially higher prices. For example. a rate of discunt ot 15% would Imply a 3188 pran of USS37, almos _100%_ above the public sale price
Page 46 81. Tie increase in the size of the network has implied substantial welfare gains for consumers. We can decomposa 'he change in welfare as the sum in the changes in consumer surplus, govemnnent revenue' and fams' profits. Changes in consumer surplus, for each segment - intemational and domesbc - have two sources: first, changes in prices faced by consumers,73 and second, increases in the network.<sup>4</sup> Figures 15 and 16 show that untl 1987, changes in consumer surplus from network expansion were almost always positive, and of the order of J$50 Million (in 1991 J$) per year. Increases in consumer surplus doubled to J$100M for 1988-1990, and in 1991 reached $350M. Figure 15 also shows that until 1987, changes in consumer surplus from network expansion were more or less evenly divided between domestic and intemational services, but following 1987 the great majority of the gains come from intemational services. Figure 17 presents the annual changes in total net surplus, in its division among consumers, govemment and the firms. Through the 1 970s changes in net total n vrnment's revenu, fram indirec taxs is estimated. Government revenu from incme tax Is providd by the companie' annual reports Govwrnmes Income from its shar of the dividends riLstributed byJAMINTEL appeas as put of the changs in the profitabilky of the compnies.

**'** 'his ogta Is simpiy the Skaz oyfec, and can be computed as -hPO. where aP refiect the ineroe in rea price from year to year. and 0 refes the previous yeaes quantity.

|**'4**BeAUse<br>JanIai<br>an upwad shift inthede<br>of lnes increases<br>tota<br>demand)<br>by the chang<br>per line. We estimate<br>estimated<br>equations.<br>co|cns' accoss<br>tothe toelo<br>mnd curve for the net<br>consumer<br>surplus by th<br>e in the number of lines t<br>d<br>log liner inwrso de<br>rrecting<br>for serial corre<br>|hone network is consrained by the availability of ties, increaseshilinesrepents<br>work. Consequently.<br>holWing<br>constat the quantty of calls anincrease<br>inthenumber<br>e are under the twocurves.This rea can be approxmated<br>(assuming<br>a linear<br>imes theeolsticyof the inverse demandforthe senrice times the enrage revenue<br>mands tor both domesic and internotional<br>services lor the period 197211991.<br>The<br>laion, are s_fllow_<br>|
|---|---|---|
||Log<br>Irnt Pric|Log<br>Domesic Prkc|
|Constant|-10_A2_<br>(4.96)|8.75<br>(43|
|Log ReWi tIl|-.64||
|Output|(24)||
|Log Real Domesi|-|-2.01|
|Output||(.29)|
|Log ines|1.75<br>(.58)|1.43<br>.52)|
|Trend (Post 1980)|-.007|-.008|
||(.02)|(-.01)|

Stndard erors in parerethe We use these estimated oquatons compute the gains frorn changes in the number of lines from domestc and intmational service. Obsme that wo estimate the demand for international services to be mwre elasi than the demnd for domestic srnves. There _w_ two reasos trthis first the growth in demand for intrnational communications by households increased since 19799 Swend. and mor importw0y. Is the way irtemationa and domestie calls - charged Whie international cals - charged by the minute, the pricing system for local eals difets across meas Jamaia with most households paying morthty ft service ees, plus ihteciy toi dcarges Ma consequence, unless substantial toll ails _ae_ made, the measured easticity of the domestic demand woLid be woer than that for intrnational searvie
pag 9 47 surplus were barely positive (seldom exceeding J$100M in 1991 prices). Firms, and the government have small annual gains compared to those of consumers. Note that the consumer welfare measure does not take into account several developments, all of which should provide additional welfare increases. First, the company has been installing fiber optic cables around the island and within all Kingston exchanges. Second, the island has been almost fully converted to digital technology. Third, cellular telephony was introduced in late 1991 (our 1991 measures go up to March 1991).

82. Undoubtedly, then, the post 1987 period has been good for consumers, the firms and the govemment. To what extent this welfare increase could have been repficated without the creation of TOJ and its privabzation is unclear. While Figures 5 and 7 show that there was a drastic increase in investment in the domestic network in fiscal years 1990 and 1991, after the privatization, a live years capital expenditure project of US$600M was announced by the Minister of Public Utilities and Transport in 1988, before **VTre** public issue of shares,7 to be financed, in part, by a loan of the Government of Japan. Eventually, these negotiations ended with the Overseas Economic Corporabon Fund of Japan providing a loan for US$62M to cover equipment bought from Japanese suppliers. Whether the larger program could have been implemented under the pre-1987 regime is unclear. The history of the JTC includes several deveiopment programs that went nowhere, as financing and pricing problems delayed or preempted their implementabon. On the other hand, the 198711988 regulatory change provided the company with a relatively stable regulatory envirunment that could have facilitated the implementabon of such a large expansion program, even without the ownership changes.

83. As for the intemational network, all through the 1970s and 1980s JAMINTEI's rate of investment had been relatively slow, with working capital increasing during the 1980s, to the point that at the end of the decade its working capital exceeded its fixed assets. This experience suggests that neither C&W nor GOJ found it profitable (or could) extend their exposure in the company. As Figures 6

**7lb** Gleanr. Apri **18,** 1988.
**Page 48**

and B show, the pos!. 1t.88 experience has been quite different, with TOJ stardng a rapid process of development of the inter- atlorial network. The implication is that the combination of privatization and regulatory reform provided C&W with incentives and confidence to Invest in Its Jamaican operaton which the company did not have prior to 1987.

# _I. An Assessment of_ **_the_** _Regulatory Reforns of 1987._

84. In this section we analyze the extent by which the regulatory changes of 1987 could have been instrumented better. We discussed above several shortcomings of the regulatory changes of 1988 and of the way the privatization was undertaken. We can classify them in three groups: competition, pricing and ownership policies. The regulatory and structural changes of 19B7 provide for a total lack of competition even in the more dynamic segments of the sector; maintain a policy of crosssubsidization towards the domestic/household segment, and a generally inefficient pricing scheme; the eniasis in the privatization process on direct sales rather than public offerings provide for ownership concentration in a foreign concern with limited domestic ownership. Aul these features have, on the one hand, non-trivial income redistribution aspects. and may, also, impair the evolution of the sector in the future.

B5. It is easy to describe an altemative, more efficient set of regulatory changes. The 1987 regulatory change could have provided TOJ with monopoly over the basic local network, but allowed competition everywhere else; instituted a flexible pricing scheme with small administrative discretion (e.g. price caps); and provided for widespread domestic ownership. This scheme would have, on paper, looked much more efficient given the rapid technological change in value added and long distance communications, would have, in principle, provided TOJ incentives to innovate and to reduce its costs, and would have, also in principle, provided for widespread political support for maintaining the privatization process. In this section we explore whether these three schemes could have been implemented in Jamaica.
**Page** 49

86. Consider, first, the decision to provide TOJ with a total monopoly over all telecommunications, both domestc and Interantional. We discussed already the politcal costs of introducing competition In value added and long distance communicatons (Including International), and thereby undercuttng the possibilities of cross-subsidization. These costs, though, depend on the extent of competitlon that Is allowed. If Internatlonal communications had been left In the monopoly sector, but competition allowed in the provision of value added services and terminal equipment, then the extent of cross-subsidization may not have been impacted so heavily and the costs of reduced revenue could have been smaller. The Jamaican govemment chose an extreme point on the competitlon-monopoly spectrum, 87. While a more narrow monopoly franchise could have been granted, It would have required some more instiutional de;iyn. In particular, a narrow monopoly franchise, may grant the administrabon (ex-post) discreton on the definition of what the local/monopoly segment is. For example. assumrthat the monopoly is just for the local network. In that case, should fiber-optic cables be considered part of the network?" Should large users be allowed to by-pass the network? Should cable TV be considered part of the network7 While, in principle, providing regulators with flexibility on these and related matters could motivate the firm to adopt proper pricing and to innovate, administrative discrebon could also be used by the regulators to expropriate the compants quasi-rents. To counterbalance the extent of administrative discrebon, a conflict resolution process, like arbitration, could, in principle, be developed. Altematively, the license could have defined precisely the boundary between competitive and monopolistic sectors. Here, one opton would have been to define precisely the set of activities that are open for competton, such that what is not explicitly mentioned is granted to TOJ. Thus, terminal equipment, value added services, cellular, cable lV, and even intemational communications, could have been carved out of TOJ monopoly. A second option would define precisely what TOJ has monopoly over and would open for competition whatever is not explicitly mentioned. Although undertaking a more pro-competitive policy would have limited the opportunites for M ihbis Ls not a thoorsimcl question. See the dicussion in footnote 65.
**Pgp** 60

cross-subsidization and thereby had a short run political cost, the fact that the GOJ pursued a total monopoly policy was, to a large extent, a missing opportunity. Observe, however, that reducing the extent of the legal monopoly would have fiscal implications, as private investors would have been willing tn pay less for the company. Thus, while society could have bonefitted 1rom a more rapid technological change and introduction of new products under a more narrow monopoly stipulation, it would have paid up-front with a reduction in the revenues collected from the privatizaton. Given the rapid technological change in this segnent of the industry, such a societal tradeoff seemes worth taking.

88. Consider, now, the total liberalization of intemational or long distance calls. In principle, access pridng to the local network could have been designed so that TOJ's revenues from intematonal operations would still be subsidizing the local network, so as to limit the poflitical cost Since TOJ would retain the monopoly on the local network, access charges would naturally be regulated. To restrain the potential for administrative discretion, though, access charges would have to be included as part of the rate of return system actually implemented. But then, competition would not have driven prices down, substantially limiting the gains from the liberalization of the intemational calls segment.

89. Consider, now, the introducton of altemative pricing schemes. There are several pricing schemes that could be implemented. The one chosen in Jamaica was a rate of return on equity, whereby the company requests rate increases wherever it believes its rate of return is not on the target zone. Disagreements with the GOJ are settled through binding arbitration. While this pricing scheme is behind the current incentives to invest, it also does not provide enough incentives to reduce costs. A more flexible pricing scheme, however, may - given Jamaica's politics and political structure - have increased contracting costs between the govemment and the company. Consider, for example, the introduction in the license of a price-cap system. Price-cap systems operate as automatc adjustments to prces over a base-price fixed ahead of time. Price-cap systems have so far been instituted for a
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limited period of lime since, in the absence of periodic adjustments, they will most probably lead to extremely high or extremely low returns. Price-cap revisions, however, provide substantial administrative discretion, and in the absence of a minimum expected rate of retum. may provide incentives for the regulators to expropriate the firm's quasi-rents. As this paper has shown. Jamaica's political institutions are such that administrative discretion appears to be incompatible with attracting private investment, undercutting the viability of prce-cap regulation in the Jamaican institutional setting.

90. Consider, finally, the way the GOJ disposed of its stake in TOJ. It is clear that at the bme of the public offering, GOJ was interested in achieving widespread stock ownership by domestic residents. For example, the price of J$.88 was consciously chosen by the government so as to assure the total placement of its stock," and, as discussed above, there were also special priority arrangements for household customers of JTC and for TOJ employees. Yet in practice the sale of GOJ's remaining stock to C&W went against widespread ownership. These sales mey have been triggered by two important reasons: first, as mentioned above, JAMINTEL's experience showed that C&W involvement by itself does not assure strong C&W investnents, even when it had almost 50% of the shares. Second. during 1988/1989 there were strong fiscal and foreign exchange pressures that may have convinced the govemmen **t** o sell its shares to a willing and ready buyer. The fact that C&W was willing and ready, though, shows the power of the licensing arrangements. If conflict with the govemment develops, though, the ownership structure of TOJ will not provide it with extra political capital to counter the administration' **s** ide. Thus, it is possible that a few years before license renewal tme. TOJ may iationally forecast poitical problems, and restrain its investment program, triggering perhaps, an early renewal of the 1988 license. On the other hand, a more widespread stock ownership could, in principle, have sewved as a safeguard, and could have made possible a less rigid regulatory scheme than the one spelled out in the 1987 shareholders' agreement Observe, however, that widespread ownership is not assured without restrictions on ownership of shares, as domesbic residents could ' PrIrate conersation wit **Rkhad** Downer, **consulant** to the **GOJ** an the privatiorL
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easily end up selling their shares overseas, fully eliminating the advantages of widespread ownership as a safeguard?7' 91. To summarize, first, because of the ried to restrain administrative discretion, it is not at all clear that a very flexible pricing scheme could have been designed so that it would have produced drastically better cost efficiencies. To a large extent, given the nature of Jamaican politics and political structure, the license provision of a minimum rate of return seems to be crucial for assuring performance, tnus restricting the type of incentive mechanisms that may be able to be used. Furthermore, our discussion above suggests that the range of allowed returns does not seem to be much above C&W`s altematve use of funds, and thus this range may not be excessive. Second, as long as the pelitical will to cross-subsidize domestic communications remains strong, competition in long distance and intemational communications would be constrained. Thie. however, may eventually translate in a large social cost as the segments that cross-subsidize domestic rates are among the most technologically dynamic segments of the sector. Furthermore, realignment of rates prior to the privatization may have substantially damaged public support for the privatization process. Finally, while GOJ could have tried to sell its stake in TOJ to the public rather than to CMW, it is uncertain whether in the long run diffused domestic ownership would have remained, given the openness of Jamaica's capital markets. Thus, the 1987 regulatory change seems to have erred in the preservation of a tight monopoly over all telecommunications segments. While allowing competition in some segments of the market would have required some i'Raiignment of rates with a possible short term political backlash, it could have had long term benefits in the form of a more dynamic sector and lower prices in a quite elastic segment of the market. This, to a large extent, represents the missing opportunity in the whole regulatory change/privatization process.

I For **example.** in **early 1967 Jama_cns** owned 9.1% **of** JTC. Shortly **after** CTCs **acquisition** of T&GT **sham, th** Now York Stock Exhange quMin **of** JTC **shares increased,** and **Jamaicns** !old JTC shares **to the paint thd** by **the end of** 1969 5% **of** the **shaws wer** held by kxc: **residerts.**
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# VI. FAnal Comments.

92. The evolution of Jamaica's telecommunications regulatory and ownership institutions provide a fertile experience to explore some of the main hypotheses as to the relatons between regulations, Institutions and economic performance. We have provided evidence as to the importance of Jamaica's political structure in the development of regulatory institutions and on their performance implications. A major result Is that given the nature of Jamaica's parliamentary system with a strong two party system, with very little independence of Individuals members of parliament, decentralize **d** ecision making based on strong - statutory based - procedural requirements may not provide the necessary regulatory stability to promote private sector investment in sectors characterized by sunk investments and domestc consumpton. Furthermore, very flexible regulatory schemes with strong incentves. a-la UKI may not be feasible either as, given the nature of polifics and ownership of the ublities, political opportunism may be unavoidable. The Jamaican telecommunications sector may have found an intermediate waylhat while restraining administrative discretion, provides strong incentives for investment and restrains prices at their initial, although quite distorted, average levels. This outcome, however, was politically feasible because of the increase in international communications that occurred in the late 1970s and allowed the sector (mostly the intemational firm) to achieve high levels of profitability without having to increase prices. Privatizaton, then, was Teasible and, to a large extent painless.

93. The Jamaican regulatory system is based on a license which stipulates a price setting mechanism. Prices have to be such that the company achieves a particula **r** ate of return on equity. A very specific procedure is spelled out, which triggers arbitration would discrepancies appear. Furthermore. GOJ violabon of the license can be appealed to the Jamaican Supreme Court for breach of contract. The feasibility of this regulatory system is based on the independence of Jamaica's judiciary, its common law tradition and respect for contracts and property rights, including the fact that the final appeal level is with the Privy Council in London. Thus, the Jamaican experience may not be
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easily transferable to other developing counties where the Courts are much less politically independent and professional.

94. The regulatory reform of the late 19BOs, however, could have been done better, albeit at a short run political and fiscal cost. In particular, the maintenance of a strong monopoly over all telecommunications segments was not necessary to suppor **t** he development of the network based on private ownership. It would have, however, reduced the extensive cross-subsidy towards the domestic segment, and reduced, perhaps, public suppor **t** owards the privatization. On the other hand, it could have promoted the development of a whole array of new products and services, and increased the compebtiveness of Jamaica's export oriented sectors. That GOJ did not open up those segments for compebton, attests to the need for more careful design of regulatory institutions that take into account both the politics and political structure of the country and the economic and technological issues in telecommunicaions.