1. Endogenous Financing of Universal Service Laura Ilie, Ramiro Losada

2. Universal Service Obligations (USOs)  A set of services available to all consumers  Rural market exhibits large fixed costs  Regulatory constraints are needed Profitable (urban) area Unprofitable (rural) area

3. Related literature  Riordan (2001) and Laffont and Tirole (2000). Armstrong and Vickers (1993)  Sorana (2000)  Chone, Flochel and Perrot (2002)  Valetti, Hoerning and Barros (2000)  Anton, Vander Wide and Vettas (2002)

4. The model Anton, Vander Wide and Vettas (2002)- benchmark  Two markets, U (urban) and R (rural), linked through the constraint p R ≤ p U and two firms operating in the U market.  Demand functions : D U (p)=a-p in the U market, and D R (p)=b(a-p), b>0  Marginal cost - the same for both firms and both markets; c<a  Fixed costs are F U ≥ 0, in market U and F R >0 in market R. F R sufficiently large.  An entry auction will determine the supplier for the rural market.

5. The game 1. Firms choose their bids (lump-sum subsidies that the firm ask from the government in order to serve market R). The lowest bidder wins, receives a subsidy equal to her bid and becomes a monopolist in the R market 2. Firms choose quantities for the U market. 3. The monopolist in the R market can choose any price p R such that p R ≤ p U. 4. Profits: We solve the game by backward induction.

6.  p U >p Cour.  The equilibrium exogenous (direct) subsidy is: S exo =π ₂ -π ₁ +F R Scope of the article  Direct financing USOs (S paid by gonernment) versus endogenous financing (S paid by firms).  A fund is created and fed through a tax the firms pay.  We show that the way the fund is implemented by the regulatory regime at work goes against the social welfare and we propose a new way of implementing the fund that improves welfare.

7. Current regulation The Directive 2002/22/EC of the European Parliament and of the Council stipulates:  „Compensating undertakings (...) need not result in any distortion in competition, provided that the net cost burden is recovered in a competitively neutral way.„  „(...) the principle of transparency, least market distortion, non-discrimination and proportionality. Least market distortions means that contributions should be recovered in a way that, as far as possible minimises the impact of the financial burden falling on end-users“

8. Possible choices of the regulation regime Two possible choices of the regulation pattern.  “ Non-interverntion regime” The game: Benchmark+ -First: The regulator announces the taxable basis -Last: Budget balances and the tax t is determined  “ Regulated regime” -The regulator – taxable basis -t is determined simultaneously with equilibrium quantities

10. Generic tax in the U market under the regulated regime  Let t be the tax let B i be the taxable basis of firm i ( i=1,2)  Firm 1, the winner solves the following problem:  Firm 2, the loser of the auction, solves : s.t.

11. The three cases studied above can be summarized as follows. 1., i=1, 2, i≠j. 2., i=1, 2, i≠j. 3., i=1, 2, i≠j.

12. ,i=1, 2, i≠j. Proposition The tax the operators pay is a competitively neutral tax for the market if and only if, i=1, 2, i≠j. Corollary The tax the operators pay is a competitively neutral tax as long as the taxable basis does not depend on the price, either on any function of the price.

13. Competitively neutral tax:  S<S exo  S is minimized when the winner does not contribute with anything to the fund.  S min =

14. , i=1, 2, i≠j Proposition If the taxable basis is a concave function with positive cross second derivatives, then the social welfare is higher than under the competitively neutral tax (, i=1, 2, i≠j)  Proportionality principle-tax on total q in U For a convex functional form of the taxable basis, we will consider two functional forms: 1. B(q ₁,q ₂ )=(q ₁ +q ₂ ) α, where α≥2 is any integer number. 2. B(q ₁,q ₂ )=q ₁ α +q ₂ α

15. Conclusions  Two possible choices of the regulation pattern: tax is chosen simultaneously with the equilibrium quantities or at the end of the game. Tax decided at the end of the game: the firms can use it in their favour as a colusion instrument, so the price increases and the social welfare becomes smaller.  The „Regulated regime“ is more restrictive to the firms, but for certain types of taxes the social welfare is higher than in the benchmark case.

17.  The identity of the competitively neutral tax changes with the regulatory regime.  The tax on the total quantity (an equalitarian tax) does not fulfil the proportionality principle, but it is in the family of high welfare.  Policy implications: –Strong regulation increases welfare –Proportionality principle is not desirable