Uberregulation Without Economics: The World Trade Organization’s Decision in the U.S.-Mexico Arbitration on Telecommunications Services

In April 2004, the World Trade Organization (WTO) assumed a new role as a highly specialized, global regulator of domestic telecommunications policy. In response to a complaint filed by the United States, a WTO arbitration panel found that Mexico had violated its commitments under the Annex on Telecommunications to the General Agreement on Trade in Services (GATS) by failing, among other things, to ensure that Telmex, Mexico’s largest supplier of basic telecommunications services, provide interconnection to U.S. telecommunications carriers at international settlement rates that were cost-oriented. The WTO panel deemed long-run average-incremental cost (LRAIC) to be the appropriate cost standard for setting settlement rates. Mexico thus became obliged to change its domestic telecommunications regulations or face trade sanctions.

The decision is the first WTO arbitration to deal solely with trade in services under GATS. This article shows that both the U.S. complaint against Mexico and the WTO decision misunderstood or ignored critical economic facts and principles. Both conflated international settlement rates and domestic interconnection pricing, and both failed to recognize the factors that would justify Mexico’s permitting Telmex to charge a settlement rate exceeding LRAIC. Moreover, the U.S. government failed to understand that U.S. long-distance carriers were not passing reductions in Mexico’s international settlement rate on to their U.S. customers. Finally, both the U.S. government and the WTO incorrectly defined the relevant market and incorrectly evaluated market power.

The relevant economic question should have been whether Telmex had market power in point-to-point international telecommunications services between the United States and Mexico. The WTO decision reveals a startling low level of economic sophistication in its analysis of inescapably economic questions. Given the high level of economic sophistication that is now standard in competition law and sector-specific regulation around the world, the WTO has made a poor start in its implementation of the GATS arbitration process.

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