Cell phone companies in Europe have long been free to set retail prices for their services. What’s more, two or more companies are permitted to provide services. For these reasons, the market is competitive, relative to regular telephones. So, it was shocking to see the European Commission regulate the price of roaming services last year.
International roaming services allow consumers to make and receive calls and text messages in other countries as if they were in their own country.
Up to 2007, cell phone companies were completely free to establish the price for roaming services, which they always did — up to four times above the price of national calls.[1]
This situation was unacceptable for the European Commission. After all, since both types of call roughly involve the same costs, how could the companies justify such different prices? Of course, this could only mean that there was a market failure, making regulation necessary in order to push the price of these services down to the “competitive” level. As a result, the EC set a maximum price for European roaming services.
One year later, the European Commission regards this intervention as a big success: it has certainly been good for European costumers, who now pay less, and no ill side effects are apparent on the cell phone companies. Therefore it comes as no surprise that now the European Commission is also proposing to regulate the prices for data and Short Message Services (SMS).[2]
For economists familiar with Mises’s theory of price control, this is astonishing. How is it possible that price regulation had no side effects in the market? Could this be an exception to — or even disprove — Mises’s theory?
Consequences of Price Regulation
Mises developed the Theory of Price Control in 1929.[3] According to this theory, if government tries to fix the price of a commodity, it will need to keep intervening until central planning is achieved. Otherwise, it will not be able to sustain prices below those the unhampered market would set.
In the case of price ceilings, the goal of the government is to allow “buyers to enjoy the goods at lower prices.” The process evolves through five stages:
Price control: “Sellers are forced to sell their goods at lower prices, so that proceeds fall below costs. Therefore, the sellers will abstain from selling and hold on to their goods in the hope that the government regulation will soon be lifted. But the potential buyers will be unable to buy the desired goods.”
Forced sales: Because the government didn’t want “to deprive buyers of the opportunity to buy goods at all, it tends to supplement the price ceiling with an order to sell all goods at this price as long as the supply lasts.” But, since the price is “below that which the unhampered market would set, the same quantity of goods faces a greater number of potential buyers who are willing to pay the lower official price. Supply and demand no longer coincide; demand exceeds supply, and the market mechanism, which tends to bring supply and demand together through changes in price, no longer functions.”
Rationing: “Of course, government cannot be content with this selection of buyers. It wants everyone to have the goods at lower prices, and would like to avoid situations in which people cannot get any goods for their money. Therefore, it must go beyond the order to sell; it must resort to rationing. The quantity of merchandise coming to the market is no longer left to the discretion of sellers and buyers.”
Regulation of production and distribution: “The intervention mentioned so far concerns only the available supply. When that is exhausted the empty inventories will not be replenished because production no longer covers its costs. If government wants to secure a supply for consumers it must pronounce an obligation to produce.”
Central planning: Of course, this implies that, “If necessary, it must fix the prices of raw materials and semi-manufactured products, and eventually also wage rates, and force businessmen and workers to produce and labor at these prices.”
However, cell phone companies are still selling roaming services with no need of imposing forced sales, in spite of the price control. The price of other services (SMS, Data, even local calls) could also be regulated and this will simply result in better prices for costumers without harmful effects on the companies. Does this disprove Mises’s theory?
Two Possible Explanations
Firstly there could be a simple explanation: the theory of price control only applies when the price control is genuine, that is, the price is different from the one the unhampered market would set. If the regulated maximum is above the unhampered market price, the price control will have no effect at all.
However, the maximum price was set at EUR 0.49 per minute, while the market price was in the range of EUR 1 per minute (see graphic above).[4] In short, the price control is genuine, so this is not the explanation we are seeking.
Secondly, what if this imposition had actually been profitable for the companies? Maybe all European operators were wrong in establishing a too high price for roaming services, and were turning customers away. Rothbard shows that sellers aim to price the goods in such a way that, if the price is lowered, the increase in demand will not compensate for the lost revenue per unit. They do this based on the demand they anticipate, but, of course, they make mistakes.[5]
Perhaps this was the case, and lowering the prices increased the demand enough to compensate the price reduction, and even produced more revenues.
However, cheaper prices have not resulted in any explosive increase in roaming services. In fact, this success would have been very surprising. Kirzner shows that regulators can not simulate the market process.[6] Since regulators have no profit-seeking incentive, they are very unlikely to discover opportunities that market participants have not already discovered.
Cell phone companies in Europe have been providing roaming services for more than ten years, all of them are alert to profitable opportunities, yet somehow all of them missed the chance of making more money off roaming services until the European Commission opened their eyes? That seems highly unlikely.
So, if neither of these two explanations holds water, the question still remains: does this price regulation disprove Mises’s theory?
The Theory of Price Control and the Structure of Production
There are two features in the structure of production of telecommunication services that may help us to understand what is happening.
Variable costs: After the investment is made and the telecom network is in place, there are no significant variable costs for operators. They can deliver as many phone calls as their network can support without incurring more costs.
Economies of scope: Telecom networks may be used to provide a wide range of services. This is also the case of cell networks, which can provide, for example, international roaming services and local services without any adjustment. The same equipment used to provide one service in a given moment can be used to provide another in the next.
Thus, when telecom operators deploy their network, they take into account the expected demand for several services. Then, they can easily switch the use of equipment from one service to another when needed.
A telecom company always profits from providing a service, regardless of its price. It will probably get more profits if it provides the service than if it does not. Besides, the equipment can be easily allocated to the demanded services in each moment.
In brief, telecom undertakings will provide every demanded service while they have available capacity, whatever the price and even if that capacity was not originally intended for that service.
There appears no excess of demand that could make forced sales necessary. Roaming services may be provided with no shortages, even with prices below market level.
However, the harmful effects appear somewhere else, because revenues have been reduced by regulation. Don’t forget that the increase in demand did not compensate the loss in revenues caused by the lower prices.
According to Rothbard, “capitalists at each stage of production have a vital role in maintaining capital through their savings and investment, through heavy savings from gross income.”[7] The investors must save part of their income, so that they can substitute the equipment when it stops being serviceable. The decision on how much to save basically depends on attained revenues.
If telecom revenues are reduced, the same happens to savings for future telecom equipment. So, when the time comes for substituting obsolete equipment, there is less money available. In fact, the lack of savings depletes the telecom capital assets. At first, the depletion slows the growth of the telecom companies, because “their reduced profitability throttles their ability to generate additional capital”. But when the reduced profitability is seen as permanent, “these industries go into actual decline, and their owners withdraw capital to whatever extent they are able in the form of taking dividends.”[8]
Summary
Mises’s theory of price control is also at work in the European regulation of roaming services, even if there are no apparent effects after more than one year in place.
The timing of a price control effects is related to the structure of production of the industry. A price control on commodities like bread quickly leads to shortages, because these commodities are held in relatively small stocks. A telecom network, on the other side, can be seen as a really huge stock of telecom services (enough for 10 or 15 years). So, there may be neither shortages nor need of forced sales — for the moment.
However, if savings do not accumulate, the resulting shortages will not be as easy to solve as they would be in other type of industry. It took a long time to save for telecom networks; if they were depleted, it would take again a long time to provide for their substitution.
Regulating telecoms seems to come without a price, at least from a short-term perspective — like that of most regulators. This is probably the reason why it makes the telecom industry easy prey for them. Nevertheless, economic law is relentless and Mises is still right: due price will be paid sooner or later.
Notes
[1] See “Impact Assessment of Policy Options in Relation to a Commission Proposal for a Regulation of the European Parliament and of the Countil on Roaming on Public Mobile Networks within the Community,” Brussels, Belgium: European Community, 2006. 
[2] See “Texting without borders: ending roaming rip-offs for text messages abroad,” in which the EC gives the impression that it is indeed an operator marketing the services.
[3] Mises, L.v., 1977, “Theory of Price Control,” in Mises, L.v., A Critique of Interventionism, Arlington House, 1977.
[4] Price for calls made to the country of origin while abroad.
[5] Rothbard, M. N., Man, Economy, and State, Auburn, AL: Ludwig von Mises Institute, 1993. See chapter 10.
[6] This is what Kirzner calls “the unsimulated market process”. See Kirzner I.M., 1985, “The Perils of Regulation: A Market Process Approach,” in Ebeling, Richard M., Austrian Economics: A Reader, Champions of Freedom, Ludwig von Mises Lecture Series, Volume Hillsdale, MI: Hillsdale College Press, 1991. pp. 618-654.
[7] Rothbard, M. N., Man, Economy, and State, Auburn, AL: Ludwig von Mises Institute, 1993. See chapter 6, page 399.
[8] Reisman, G., Capitalism, Jameson Books, Ottawa, Illinois, 1990. See Part B, 3.e; “The destruction of the utilities and the other regulated industries,” p. 227.
