Competitiveness of New Industries: Institutional Framework and Learning in Information Technology in Japan, the U.S and Germany (Routledge Studies in Global Competition)

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Competitiveness of New Industries

Information and communication technology (ICT) is considered to be one of the ‘drivers of growth’ by the OECD, while others regard it as a new type of general-purpose technology. Countries not able to establish themselves successfully in the ICT-related industries run the risk of losing important growth opportunities. Competitiveness of New Industries examines the extent to which the different institutional frameworks in Japan, the United States and Germany have encouraged and will continue to support the potential of ICTs. This is essentially a question of how rules should be designed in order to reach desired results – a traditional problem in economic policy. It has recently gained new impetus with regard to ICT industries due to the existence of network externalities and the public good character of some ICT subsectors. The volume also discusses the degree to which economic actors are capable of designing ICTs in the institutional framework within which they operate – a discussion that is strongly connected to the long-standing issue of path dependency. Cornelia Storz is Professor for Japanese Economy in the Department of Economics and Business Administration and Centre for Interdisciplinary Centre for East Asian Studies at the Goethe University of Frankfurt, Germany. Andreas Moerke is Head of the Business and Economics Section at the DIJ, the German Institute for Japanese Studies in Tokyo, and Partner at the consultancy iJEB Ltd (Tokyo, Berlin and Hamburg).

Routledge Studies in Global Competition Edited by John Cantwell, University of Reading, UK, and David Mowery, University of California, Berkeley, USA

Volume 1 Japanese Firms in Europe Edited by Frédérique Sachwald Volume 2 Technological Innovation, Multinational Corporations and New International Competitiveness The case of intermediate countries Edited by José Molero Volume 3 Global Competition and the Labour Market Nigel Driffield Volume 4 The Source of Capital Goods Innovation The role of user firms in Japan and Korea Kong-Rae Lee Volume 5 Climates of Global Competition Maria Bengtsson Volume 6 Multinational Enterprises and Technological Spillovers Tommaso Perez Volume 7 Governance of International Strategic Alliances Technology and transaction costs Joanne E. Oxley Volume 8 Strategy in Emerging Markets Telecommunications Establishments in Europe Anders Pehrsson

Volume 9 Going Multinational The Korean experience of direct investment Edited by Frédérique Sachwald Volume 10 Multinational Firms and Impacts on Employment, Trade and Technology New perspectives for a new century Edited by Robert E. Lipsey and Jean-Louis Mucchielli Volume 11 Multinational Firms The global–local dilemma Edited by John H. Dunning and Jean-Louis Mucchielli Volume 12 MIT and the Rise of Entrepreneurial Science Henry Etzkowitz Volume 13 Technological Resources and the Logic of Corporate Diversification Brian Silverman Volume 14 The Economics of Innovation, New Technologies and Structural Change Cristiano Antonelli Volume 15 European Union Direct Investment in China Characteristics, challenges and perspectives Daniel Van Den Bulcke, Haiyan Zhang and Maria do Céu Esteves

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Volume 16 Biotechnology in Comparative Perspective Edited by Gerhard Fuchs

Volume 24 Location and Competition Edited by Steven Brakman and Harry Garretsen

Volume 17 Technological Change and Economic Performance Albert L. Link and Donald S. Siegel

Volume 25 Entrepreneurship and Dynamics in the Knowledge Economy Edited by Charlie Karlsson, Börje Johansson and Roger R. Stough

Volume 18 Multinational Corporations and European Regional Systems of Innovation John Cantwell and Simona Iammarino

Volume 26 Evolution and Design of Institutions Edited by Christian Schubert and Georg von Wangenheim

Volume 19 Knowledge and Innovation in Regional Industry An entrepreneurial coalition Roel Rutten

Volume 27 The Changing Economic Geography of Globalization Reinventing space Edited by Giovanna Vertova

Volume 20 Local Industrial Clusters Existence, emergence and evolution Thomas Brenner

Volume 28 Economics of the Firm Analysis, evolution, history Edited by Michael Dietrich

Volume 21 The Emerging Industrial Structure of the Wider Europe Edited by Francis McGowen, Slavo Radosevic and Nick Von Tunzelmann

Volume 29 Innovation, Technology and Hypercompetition Hans Gottinger

Volume 22 Entrepreneurship A new perspective Thomas Grebel Volume 23 Evaluating Public Research Institutions The US advanced technology program’s intramural research initiative Albert N. Link and John T. Scott

Volume 30 Mergers and Acquisitions in Asia A global perspective Roger Y. W. Tang and Ali M. Metwalli Volume 31 Competitiveness of New Industries Institutional framework and learning in information technology in Japan, the US and Germany Edited by Cornelia Storz and Andreas Moerke

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Competitiveness of New Industries Institutional framework and learning in information technology in Japan, the US and Germany Edited by Cornelia Storz and Andreas Moerke

First published 2007 by Routledge 2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN Simultaneously published in the USA and Canada by Routledge 270 Madison Ave, New York, NY 10016 Routledge is an imprint of the Taylor & Francis Group, an informa business

This edition published in the Taylor & Francis e-Library, 2007. “To purchase your own copy of this or any of Taylor & Francis or Routledge’s collection of thousands of eBooks please go to www.eBookstore.tandf.co.uk.” © 2007 for selection and editorial matter, Cornelia Storz and Andreas Moerke; individual chapters, the contributors. All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging in Publication Data Competitiveness of new industries: institutional framework and learning in information technology in Japan, the U.S., and Germany/edited by Cornelia Storz and Andreas Moerke. p. cm. Includes bibliographical references and index. 1. High technology industries. 2. New business enterprises. 3. Information technology – Economic aspects. 4. Telecommunication – Economic aspects. 5. Electronic commerce. 6. Competition, International. I. Storz, Cornelia. II. Moerke, Andreas. HC79.H53C6565 2006 338.6′048–dc22 2006031342

ISBN 0-203-96360-1 Master e-book ISBN

ISBN10: 0–415–41624–8 (hbk) ISBN10: 0–203–96360–1 (ebk) ISBN13: 978–0–415–41624–5 (hbk) ISBN13: 975–0–203–96360–9 (ebk)

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Contents

List of figures List of tables List of contributors Preface Abbreviations

ix x xii xviii xix

PART I

Introduction 1

Institutions and learning in new industries: an introduction

1 3

CORNELIA STORZ AND ANDREAS MOERKE

PART II

Institutional framework for ICT and options for political governance: Japan, the United States and Germany in comparison

17

Subsection A: Institutional conditions for introducing ICT

18

2

Legacies of the developmental state for Japan’s information and communications industries

19

MARK TILTON AND HYEONJUNG CHOI

3

Institutional framework and competitiveness of the US telecommunications market

41

MICHAEL SCHEFCZYK

4

Information and communication technologies in Germany: is there a remaining role for sector-specific regulations?

57

GÜNTER KNIEPS

Subsection B: The increasing role of self-regulation 5

Private solutions to uncertainty in Japanese electronic commerce CORNELIA STORZ

74 75

viii 6

Contents Institutional conditions for achieving effective implementation of ICT

103

ROB FRIEDEN

7

B2C e-commerce dynamics in Germany: do we need a new regulatory framework?

124

BERNHARD LAGEMAN, MICHAEL ROTHGANG AND MARKUS SCHEUER

PART III

Industrial organization, enterprise structure and ICT: Japan, the United States and Germany in comparison

153

Subsection A: Effects of ICT on industrial organization and on firm structures

154

8

ICT and corporate structure: the diffusion of e-commerce across Japanese companies

155

DENNIS S. TACHIKI

9

The rise and fall of ‘Wintelism’: manufacturing strategies and transnational production networks of US information electronics firms in the Pacific Rim

180

BOY LÜTHJE

10 Open innovation: novel deployment of ICT in new product development

210

RALF REICHWALD, FRANK PILLER, SASCHA SEIFERT AND CHRISTOPH IHL

Subsection B: The social construction of institutions and technology

232

11 Next generation information and communication technologies deployment in Japan

233

MOHAMMED AKHTAR, YOSHIYA TERAMOTO AND CAROLINE BENTON

12 Competitive advantage through co-evolution of technology and organization

256

JANET FULK

13 Shaping organizational technology: ICT as a learning process

270

GEORG SCHREYÖGG, SAMI KHIARI AND LEO SCHMIDT

Index

292

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Figures

2.1 3.1 3.2 3.3 3.4 3.5 3.6 3.7 3.8 4.1 7.1 8.1 10.1 11.1 11.2 11.3 11.4 11.5 13.1 13.2 13.3 13.4 13.5 13.6

International comparison of superiority in information and communications technologies Basic indicators, USA, Japan and Germany, 2003 Mobile indicators, USA, Japan and Germany, 1995 and 2003 Internet indicators, USA, Japan and Germany, 2003 Five phases of US telecommunications regulation Fixed-access competition, US Market share of local exchange carriers, US Market share of long-distance carriers, US High-speed Internet, US Internet periphery versus Internet service provision EU citizens who purchased on the Internet, 2003 Clustering of Internet companies in Tokyo Screenshot of the Adidas virtual customer lab Comparison of KDDI’s 1x, NTT DoCoMo’s FOMA and Vodafone’s W-CDMA subscriptions Cumulative growth of FOMA subscribers 3G licence fees in major countries in 2002 Monthly ARPU trend and total revenue data in major countries Asia’s iron triangle with complementary attributes Temporal modification patterns All adaptive activity differentiated between standard customizing and workbench changes with ABC All adaptive activity differentiated between standard customizing and workbench changes with GERO Level of adaptive activity at ABC on a monthly basis, 1996–98 Level of adaptive activity at GERO on a monthly basis, 1999–2001 Self-organized technology creation as a process

37 42 43 44 46 50 51 52 53 59 129 160 224 243 245 248 249 252 274 280 281 282 283 285

Tables

2.1 2.2 2.3 2.4 2.5 2.6 2.7 4.1 4.2 7.1 7.2 7.3 8.1 8.2 8.3 8.4 8.5 8.6 8.7 8.8 8.9 8.10

OECD composite basket of residential and business telephone charges, August 2002, 2004 OECD Internet access basket at daytime discounted PSTN rates Japan’s software exports and imports, 1995–2000 Percentage of adults who went online at least once in last 30 days (1999–2003) Fixed Internet subscribers/100 population E-readiness rankings, 2005 E-readiness rankings, by category, 2005 The localization of monopolistic bottleneck facilities Local telecommunications networks as monopolistic bottleneck facilities Development of e-commerce in Western Europe and in selected European countries Products most frequently bought via the Internet in Germany, 2003 Selected rules and regulations relevant to e-commerce and central institutions Market size of e-commerce, 1998–2005 Users of e-commerce Organizational characteristics of Bit Valley Internet companies Major newly established dotcom companies (partial list) Leading users of e-commerce, 2000 Online services Online sales How establishments use the Internet to sell products and services Online procurement Impacts of conducting business online

24 25 28 32 33 33 34 62 64 128 130 142 156 158 162 164 165 168 170 172 175 177

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9.1 9.2 9.3 9.4 9.5 11.1 11.2 12.1

Top ten electronics contract manufacturers, 2003 Flextronics International: one contract manufacturing network in Asia, 2003 Global supply chain consolidation, HP/Compaq Typology of outsourced production in the electronics industry EMS/ODM margins: industry average, 1999 to Q1 2004 Market landscape of Japan, August 2003 Mobile shipment in Japan Types of coupling in co-evolving systems

185 190 193 200 200 240 253 263

Contributors

Mohammad Akhtar is Vice President at Motorola and is responsible for telecommunication, infrastructure technology and marketing for Asia Pacific. He is an expert in wireless PCS/Cellular technology and has extensive experience in global wireless markets. He works closely with major global carriers to help them understand future communications requirements. He has a BSc degree in Electrical Engineering from the University of Texas and an MBA from the Kellogg School of Business, Northwestern University. Currently he is a PhD candidate at Waseda University. Caroline Benton is Professor at the University of Wales’s validated MBA programme in Japan. She earned her PhD degree in Management Engineering from the Tokyo Institute of Technology. She has held positions as a Director of a Japanese subsidiary of a European manufacturer and as Chief Consultant of a marketing consulting firm for foreign-affiliated firms in Japan. Hyeonjung Choi is currently Senior Secretary to a member of the Korean National Assembly. He received his PhD in Political Economy from Purdue University with a dissertation on Japanese IT policy and the software industry. His specialties are national ICT strategy, industrial policy and government/business relations. He worked at Korea Air Force Academy as a faculty member and was invited to the Institute of Social Science at Tokyo University. Before accepting his current position of the Legislative Public Officer at the Korean National Assembly, he recently was a Senior Fellow at the IT thinknet (Korean IT consulting institute). Rob Frieden serves as Pioneers Chair and Professor of Telecommunications at Penn State University where he teaches courses in management, law and economics. He also provides legal, management and market forecasting consultancy services. Before accepting an academic appointment, Professor Frieden served as Deputy Director of International Relations for Motorola Satellite Communications, Inc. He has held senior policymaking positions in international telecommunications at the Federal

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xiii

Communications Commission and the National Telecommunications and Information Administration. He holds a BA degree with distinction from the University of Pennsylvania and a JD from the University of Virginia. Janet Fulk is Professor of Communications in the Annenberg School for Communication and Professor of Management and Organization at the Marshall School of Business at the University of Southern California. She holds an MBA and PhD in Administrative Sciences from the Ohio State University. Her research interests include communication and knowledge management, information technology for strategic alliances, and social aspects of knowledge and distributed intelligence. A series of recent projects sponsored by three grants from the National Science Foundation examines how communication and information systems are employed to foster collaboration and knowledge distribution within and between organizations. Christoph Ihl is a Senior Researcher at the Institute for Information, Organization and Management (IOM), TUM Business School, Technische Universität, München. His research focus is the empirical analysis of consumer choice behaviour for technology-intensive products. Sami Khiari works as a Management Consultant at one of the world’s biggest auditing and consulting firms. As a manager for the Financial Services Industry, his work mainly focuses on the improvement of the organizational performance in the Finance & Accounting department. In this context he specializes in organizational analysis and optimization with a strong emphasis on the interplay of technology and processes. As part of his practical and scientific work, he has also conducted case studies on informal and evolving structures on the edge of intra-organizational technologies. Sami Khiari holds a degree of Diplomkaufmann in Business Administration from the Freie Universität, Berlin, where he also received his doctorate degree and where he has co-authored publications with Professor Georg Schreyögg. Günter Knieps is Professor of Economics at the University of Freiburg and Director of the Institute for Transport Networks and Regional Policy, Albert-Ludwigs-Universität Freiburg, Germany. Before that he held a position as Professor of Microeconomics at Groningen, the Netherlands. He has held visiting research positions at Princeton and the University of Pennsylvania, and has contributed numerous publications on network economics, (de)regulation, competition policy, industrial economics and sector studies on network industries. He is a member of the Scientific Advisory Councils of the German Federal Ministry of Economics and Technology, and the German Federal Ministry of Transport, Construction, and Housing. Bernhard Lageman is Chief of the Division ‘Empirical Industrial Organization’ in the RWI-Essen. His research interests lie in the fields

xiv

Contributors

of industrial and institutional economics. Recent research works include the survival of start-ups, the structural change of banking systems, entrepreneurship and enterprise performance, the influence of regulation policies on construction and German craft sectors, firm R&D and innovation, and technology policy. Boy Lüthje is a Research Fellow at the Institute of Social Research (Institut für Sozialforschung) and a Senior Lecturer at the Department of Social Sciences, University of Frankfurt. His research areas are the political economy of production and innovation, the international division of labour, and industrial relations with a focus on the United States and Greater China. Dr Lüthje holds a PhD from the University of Frankfurt where he worked as an Assistant Professor from 1990 to 1996. He has been a Visting Scholar at the University of California, Berkeley in 1996–97; the East–West Center, Honolulu, Hawaii, on several occasions since 2002 and the People’s University of China, Beijing in 2006. He also taught as a Visiting Professor at the University of Kassel, Germany. Andreas Moerke is Partner at the German–Japanese consultance JEB interlogue. He is responsible for market entry strategies to Japan and is consulting with companies in the automobile, supplier, machine tool and software industries. Besides this, Moerke serves as auditor on the board of Landscape Inc., a data solution and marketing company in Tokyo. He has held positions as Head of Business and Economics Section at the German Institute for Japanese Studies (DIJ) and Fellow at the Science Center Berlin doing research on industrial organization, corporate governance, and international management. Moerke holds a PhD in Management and an MA in Japanese Studies. Frank Piller is an Associate Professor of Management (‘Privatdozent’) at TUM Business School, Technische Universität, München, and a Faculty Member of the Smart Customization Group at the Massachusetts Institute of Technology (MIT) in Cambridge, MA. His recent research focuses on value co-creation between businesses and customers/users, and the interface between innovation management, operations management, and marketing. Ralf Reichwald is a Professor of Management at TUM Business School, Technische Universität München, and Head of the Institute for Information, Organization and Management (IOM) also at TUM Business School. His main areas of research are leadership and organization, information and communication, and service management. Michael Rothgang works as a researcher in the RWI-Essen. His work focuses on the application of new technologies on the firm level, the macroeconomic and sector-specific analysis of innovation processes, as well as the effects of technology policy measures. He has published

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xv

research results both on the national and international level and is currently working on several projects in this field. Michael Schefczyk is Professor (SAP Chair of Entrepreneurship and Innovation) at the Technical University of Dresden. He submitted his doctorate in Business Administration at the Rhineland-Palatinate Technical University of Aachen based on an empirical dissertation on key success factors in declining industries. He received the Bifego entrepreneurship research prize in 1999 and the entrepreneurship award from the Heinz-Assmann Foundation. Previous employment includes work in the Communications, Media and Technology practice at Booz Allen Hamilton as Principal of the German Management Team. Professor Schefczyk has contributed nearly 30 German and English language publications on topics of business administration. Markus Scheuer works as a researcher at the RWI-Essen. He is a member of the Council of the international research association on services RESER. Other than services, his research interests focus mainly on the labour market. Leo Schmidt works as a Technology and Business Process Consultant with a multinational consulting firm. His work focuses on designing, implementing and changing technological infrastructures where SAP’s ERP package plays a leading role. He combines his consulting work with involvement in research and publications on technology in organizations on a regular basis. The main contributions from his research in this field support the idea of ongoing processes of interaction between organizations and evolving internal technological settings. He therefore encourages researchers and practitioners alike to accept and manage new roles of technology, allowing it to change shapes and tasks over time as a result of ongoing adaptive activity conducted by the organization. He holds a Degree of Diplomkaufmann in Business Administration from the Freie Universität, Berlin, where he also received his doctorate degree, and where he has co-authored publications with Professor Georg Schreyögg. Georg Schreyögg is Professor of Business Administration, Freie Universität, Berlin. Since 1994 he has held the Chair of Management in the Department of Business at the Freie Universität Berlin where he currently teaches courses in management at undergraduate, graduate and postgraduate levels. Before accepting his current position, Dr Schreyögg was on the faculty of the Fern Universität Hagen, the University of Bamberg and the European School of Management Studies (EAP: Paris–Oxford– Berlin). He received his doctorate degrees from the University of Erlangen-Nürnberg. He is the (co)author of around a hundred articles and seven books on management, job design and strategic management and has conducted research on knowledge management, strategic decision making, organizational change and corporate culture. His research results

xvi

Contributors

have been published in national and international journals; including the Academy of Management Review, Organization Studies, Journal of Business Ethics, Die Betriebswirtschaft, and the Zeitschrift für Betriebswirtschaft. Sascha Seifert is a Consultant in an International Management Advisory Group. Previously, he was a Research Associate at the Institute for Information, Organization and Management (IOM), TUM Business School. His research is in the area of user-driven innovation, with a focus on the identification of lead users. Cornelia Storz is currently Professor of Japanese Economy at the Faculty of Economics and at the Interdisciplinary Centre for Asian Studies at the Johann Wolfgang Goethe University of Frankfurt, Germany. She received her PhD in Economics from the University of Duisburg with a thesis on the Japanese entrepreneur. Since 1993 she has served intermittently as researcher at the Research Institute of Economy, Trade and Industry, METI (RIETI). Further invitations include those from the Kansai University as a Guest Professor, the Institute of Social Science at the Tokyo University and from the Japanese Institute for Labour Policy and Training. She is a council member of the German Asia Pacific Society, a Board of Trustees member at the Jakob-Kaiser-Foundation and Treasurer of the European Association for Japanese Studies. Her research focuses on the comparison of economic systems, genesis and change of institutions, and comparative institutional analysis. Dennis S. Tachiki is currently Professor on the Faculty of Business Administration at Tamagawa University, Tokyo, Japan. He has held teaching and research positions at the University of Minnesota, the University of Michigan, Sophia University, the Sakura Research Institute and Fujitsu Research Institute. He has published widely in newspapers and journals and given lectures around the world on the Japanese economy and society and on Asian regional affairs. The main focus of his current research surrounds the diffusion of information technology in East Asia (World Bank) and human resource management and capacity building (Pacific Economic Cooperation Council). His most recent publications concern the role of multinational corporations in the process of regionalism in East Asia (Cornell University Press) and the diffusion of information technology in Japan (UC Irvine Center for Research on Information Technology and Organization). Yoshiya Teramoto is Professor at the Graduate School of Asia Pacific Studies, Waseda University. His specialities are corporate strategy, organization theory and strategic knowledge management. After some years of business experience in Fujitsu, he has worked for several universities and research institutes, including the Graduate School of Systems Management, the University of Tsukuba, the National Institute

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of Science and Technology Policy (Science and Technology Agency, Japan), and the School of Management at Cranfield University, UK. Mark Tilton is Associate Professor of Political Science at Purdue University and holds a PhD from UC Berkeley. He is the author of Restrained Trade: Cartels in Japan’s Basic Materials Industries (Cornell University Press 1996), ‘Ideas, Institutions and Interests in the Shaping of Telecommunications Reform’ in Linda Weiss (ed.) States in the Global Economy (Cambridge University Press 2003), and editor of Regulation and Regulatory Reform in Japan: Is Japan Really Changing Its Ways? (The Brookings Institution Press 1998). He recently was a George Washington University, Woodrow Wilson Center Asian Policy Studies Faculty Fellow.

Preface

This volume is the outcome of an international conference entitled ‘Information and Communication Technologies in Germany, Japan and the US: Institutional Frameworks, Competitiveness and Learning Processes’, which took place in Tokyo in October 2003. The conference was coordinated by the Centre of Japanese Studies of the Philipps University Marburg, Germany, and the German Institute for Japanese Studies in Tokyo, Japan. Most contributions in this volume were presented at this conference. As the organizers and editors, we would like to express our gratitude to the contributors to both the conference and this volume. All contributions are original contributions and are not yet published in other places. Moreover, we would like to thank in particular the Japan Foundation for its substantial support, which made the conference – and its international approach to the subject – possible, and the TÜV Rheinland Group for its additional and important donation towards the publication of the results of the conference. Thanks also go to the Goethe Institute in Tokyo whose rooms and infrastructure gave us a good and stimulating working atmosphere, and to the German Embassy in Tokyo for financial support and patronage of the conference. The venue and the publication would not have been possible without the help of numerous individuals: therefore, thanks go especially to Keiko Asano, Kristin Koop, Alexander Müller, Patricia Sughrue and Eiko Sugimoto. Last, but not least, we would like to express our thanks to two anonymous referees who gave us important stimuli for the finishing of this volume. The encouragement of Rob Langham and his colleagues at Routledge in taking this project through to publication is also much appreciated. We hope that this volume contributes in some way to increasing understanding of how information and communication technologies in three major economies are influenced by their institutional frameworks and now they, at the same time, influence the specific framework in which they are embedded, leading to often surprisingly heterogeneous solutions. Cornelia Storz and Andreas Moerke April 2005

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Abbreviations

1G 2G 3G 4G ABAP ADSL AHS AI AMPS APEC API ARC ARPU ASP AT&T ATIP B2B B2C B2G BOCs BSI BVA CAP CATV CDM CDMA CEN CEO CLUE CM COM CPNs

first generation second generation third generation fourth generation Advanced Business Application Programming asymmetric DSL American Hospital Supply Artificial Intelligence Advanced Mobile Phone System Asia–Pacific Economic Cooperation application programming interfaces Act Against Restraints on Competition (Germany) average revenue per user active serve pages American Telegraph & Telephone Asian Technology Information Program business-to-business business-to-consumer business-to-government Bell Operating Companies Bundesamt für Sicherheit in der Informationstechnik (Federal Office for Information Security) Bit Valley Association competitive access provider Community Antenna Television Contract Design Manufacturing Code Division Multiple Access Comité Européen de Normalisation chief executive officer Comprehensive Loss Underwriting Exchange Contract Manufacturing Commission of the European Communities cross-national production networks

xx

Abbreviations

CPU CRITO CSLR CTO CUST CVS DIN DSL DTI EC ECOM EDI EEIG EITO EMS ERP ETACS ETRI ETSI EU EWR FCC FOMA GATS GATT GPRS GSM GUI GWB Hanes DSD HDE HP HR HTML IBJ IBP ICT IDC IEC IIE ILEC IMG IMT IOC

central processing unit Center for Research on Information Technology and Organization Center for Social and Legal Research (US) customization-to-order customizing convenience stores Deutsches Institut für Normung digital subscriber line Department of Trade and Industry (UK) electronic commerce Electronic Commerce Promotion Council (Japan) electronic data interchange European Economic Interest Grouping European Information Technology Observatory Electronics Manufacturing Services Enterprise Resource Planning Extended Total Access Communication System Electronics and Telecommunication Research Institute European Technology Standard Institute European Union Early Watch Report Federal Communications Commission (US) freedom of mobile access General Agreement on Trade in Services General Agreement on Tariffs and Trade General Packet Radio System Standard Global System for Mobile Communication Graphical User Interface Gesetz gegen Wettbewerbsbeschränkungen Hanes Direct Store Distribution German Retailers Association Hewlett Packard human resource Hypertext Markup Language Industrial Bank of Japan Internet backbone provider information and communication technology/technologies International Data Corporation International Electronic Commission Institute for Information Economics incumbent local exchange carriers Implementation Management Guide International Mobile Telecommunications International Organization for Standardization

Abbreviations xxi 1111 2 3 4 5111 6 7 8 9 1011 1 2 3111 4 5 6 7 8 9 20111 1 2 3 4 5111 6 7 8 9 30111 1 2 3 4 5 6 7 8 9 40111 1 2 3 44 45111

IP IPA IPR ISDN ISP IT ITU JAB JADMA JCCI JECC JEITA JETRO JFTC JIPDEC JIS JISA JISC JIT JJA JMRA JuSchG LAN LDP MBA METI MIC MITI MM MOA MOTHER MPHPT MPT NAP NCCs NFO NMT NPD NSF NTT OBM ODM

Internet Protocol Information-Processing Promotion Association (Japan) intellectual property rights integrated services digital network Internet service provider information technologies International Telecommunication Union Japanese Accreditation Board of Conformity Assessment Japan Direct Marketing Association Japanese Chamber of Commerce and Industry Japan Electronic Computer Company Japan Electronics and Information Technology Industries Association Japan External Trade Organization Japan Fair Trade Commission Japanese Information Processing Development Center Japanese Industrial Standard Japan Information Technology Service Industry Association Japanese Industrial Standards Committee just-in-time Japan Juku Association Japan Marketing Research Association Jugendschutzgesetz Local Area Network Liberal Democratic Party (Japan) Master of Business Administration Ministry of Economy, Trade and Industry (Japan) Ministry of Internal Affairs and Communications (Japan) Ministry of International Trade and Industry (Japan) materials management memorandum of agreement Market for the High-Growth and Emerging Stocks Ministry of Public Management, Home Affairs, Posts and Telecommunications Ministry of Posts and Telecommunications (Japan) network access point new common carriers National Family Opinion Nordic Mobile Telephony new product development National Science Foundation (US) Nippon Telephone and Telegraph Original Brand-name Manufacturing Original Design Manufacturing

xxii Abbreviations OECD OEM OSS P3P PC PDA PDC PDCA PHS PP PRD QoS R&D RBOCs RBV RegTP RF SAP SD SIC SII SIIA SME SoC SSCR SYST TACS TCA

Organisation for Economic Co-operation and Development Original Equipment Manufacturing Online Shopping Survey Platform for Privacy Preference Project personal computer personal digital assistant Personal Digital Communication plan-do-check-action personal mobile phones production planning Pearl River Delta quality-of-service research and development Regional Bell Operating Companies resource-based view Regulierungsbehörde für Telekommunikation und Post radio frequency Systeme Anwendungen, Produkte in der Datenverarbeitung sales and distributions standard industrial classification Structural Impediments Initiative (Japan) Software & Information Industry Association (US) small and medium-sized enterprise systems-on-a-chip SAP Software Change Registration workbench activities/system changes Total Access Communication System Information Technology and Telecommunications Association TCP transfer control protocol TDMA Time Division Multiple Access TGA German Association for Accreditation TKG Telekommunikationsgesetz TMS Transport Management System TMSC Taiwan Semiconductor TRIPS Agreement on Trade-related Aspects of Intellectual Agreement Property Rights TRON TRON (Real Time Operating-System Nucleus) Project TSE Tokyo Stock Exchange TÜV Technischer Überwach ungsverein UMTS Universal Mobile Telecommunications System UNCTAD United Nations Conference on Trade and Development VOIP Voice over Internet Protocol VPN Virtual private network WARC World Administrative Radio Conference

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WBWT WTO xDSL

Wissenschaftlicher Beirat beim Bundesministerium für Wirtschaft und Technologie World Trade Organization digital subscriber line

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Part I

Introduction

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1

Institutions and learning in new industries An introduction Cornelia Storz and Andreas Moerke

ICT (information and communication technologies) are considered to be one of the new technologies with high growth rates predicted for the future. The OECD (Organisation for Economic Co-operation and Development) assesses the ICT industries as ‘drivers of growth’ (OECD 2001a), while others regard them as a new type of general-purpose technology. The insight that countries that are not able to successfully establish themselves in the ICT-related industries may lose important growth opportunities has led to a high awareness of international organizations, suggesting well-suited ICT policies.1 The leading question of this volume is thus addressed to the ways and the extent to which the different institutional frameworks in Japan, the United States and Germany have encouraged and will continue to support the potential of ICT. It starts from the general question of how different institutional settings influence the competitiveness of ICT, and then moves to discuss the degree to which economic actors are capable of designing ICT in the institutional framework within which they operate. The first part of this question – how rules should be designed in order to reach desired results – is a traditional problem in economic policy. It has recently gained new impetus with regard to ICT industries due to the existence of network externalities and the public good character of some ICT sub-sectors. The second part of the question – how institutions and technologies can be designed – is strongly connected to the long-standing issue of path dependence. The volume is thus connected to the general question of how institutions, organizations and new technologies interact. This volume starts with a discussion of what an appropriate institutional framework for exploiting ICT opportunities should look like. An institutional framework is understood as a set of rules that steer behaviour in a certain direction. This definition includes formal rules, such as governmental rules (also called regulation) or private rules (private constitution) as well as informal rules (e.g. customs, values, attitudes). Economic theory views formal institutions not generated via the market but via a top-down process as generally inappropriate since they tend to reduce the genesis of and the competition between solutions. Moreover, centralized institutions lead to a reduction of freedom and choice. Institutions should thus only be fixed in

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advance when a common interest in a particular institution exists. In other words, the advantages of the common institution must be greater than those found in a comparable situation without the institution. For example, harmonized standards in ICT can reduce the freedom of choice, since products with a lower quality are no longer allowed on the market. On the other hand, this restriction would be appropriate if market failures can be avoided, thus creating a greater economic advantage than a situation without the common standard. In the ICT industry it may be even more necessary to formulate rules ex ante since common interests could be defined as the necessity to overcome network externalities by a common technical infrastructure or to gain credibility by the protection of consumers. In this context, private rules, as a specific form of ex ante formulated institutions, have recently gained attention as an alternative to counteract the problem of the failure of governmental rules. By examining the different economic, political and cultural backgrounds in Japan, the United States and Germany we can better understand not only the reasons for their differences but also the reasons behind different economic policy outcomes. The differences between the Japanese, American and European institutional set-up in ICT are particularly striking. The differences can in part be explained by the fact that government intervention in political processes has a deep-rooted history in Japan. This leads to path dependence in the policy-making process and to some extent reduces the general range of options for market solutions. It may not be astonishing that Japan’s economic outcome in the ICT sector is poor – especially in the area of standardized software, which has induced a broad discussion trying to identify the reasons for this (presumed) weakness (Fransman 1999; Fukutomo 2001; Noguchi 2003). Japanese policy makers and private entrepreneurs seem to be locked into paths that potentially reduce economic welfare. This volume intends to contribute to the understanding of why such lock-ins on the political and entrepreneurial levels take place. In addition it intends to complement previous research focusing on the appropriateness of rules by analysing how different institutional backgrounds influence the implementation of rules. As the informal institutional setting plays a large role in influencing a particular type of implementation, the different informal institutional conditions and their interaction with formal rules are analysed in this volume too. As noted above, the institutional framework steers behaviour in a certain direction. We thus start from the viewpoint that institutions are given, and that they influence the behaviour of economic actors. Indeed, this is a central point in the economic literature. At the same time, however, more research into the genesis of institutions should be conducted. Analyses of how institutions are created lead to a discussion of the mechanisms through which institutional change is achieved. One important presupposition for change is, obviously, a positive attitude towards change. Another important factor is the way economic actors reflect on possible outcomes of institutional

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change. Reforms geared towards changing institutions, doing away with institutions and creating new institutions thus necessitate an institutional setting that is conducive to learning processes. Learning processes are based on comparisons, competition, trial and error, and on the simple insight that a change is more appropriate than holding on to a given institution. Thus, this volume not only contributes to the understanding of why lock-ins take place but also to our understanding of how institutions can be ‘unlocked’, i.e. how institutional change in a more desirable direction can be triggered. The concept of path dependence, which refers to the reasons behind and consequences of lock-ins, is important since it stresses specific historical conditions and acknowledges restrictions for change. Nevertheless, institutions are not simply ‘given’. They are also constructed and altered in order to remain viable. Actors can thus be regarded not so much as ‘mere’ adaptors but as creators – despite the fact that under certain conditions factors such as power or uncertainty may reduce viable options for lock-outs. Institutions themselves, then, can be considered as options, and not simply as restrictions. Such an approach is relatively new in the economic discipline. While it is true that learning theories and constructivist approaches are becoming better known and more integrated, especially in evolutionary and organization theory, institutional economics still tends to overemphasize the impact of institutions and the danger of lock-ins due to a somewhat simplified modelling of the world, still neglecting the creative potential of economic actors. In reference to a new technology such as ICT, however, the fact that entrepreneurial behaviour moves between adaption and creation becomes more evident. At this point a few general remarks about the central ideas of this volume are in order. These include institutions, lock-ins and learning.

Institutions and competitiveness While institutional economics employs an array of approaches to analyse economic problems, all assume that institutions are relevant for growth and development. One point of consensus is that the more transaction costs are reduced, the more transactions take place, and that this leads to a higher level of economic welfare. The quality of institutions thus is said to contribute to the explanation of growth rates and by doing so to a nation’s competitiveness. Competitiveness in relation to firms is understood as the monetary result of operating economically, e.g. market shares, earnings, or other performance indicators. For nations the definition is more difficult. Here, it is understood as a contribution to an increase in welfare, which might be, in the case of ICT, induced by foreign direct investment in the ICTrelated sector or an adequate economic policy. Since not all indicators are equally relevant in the sub-sectors of ICT, the authors of this volume themselves choose the appropriate criteria for each specific case.

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Institutions include formal as well as informal institutions (e.g. attitudes towards entrepreneurship, innovation and/or risk) so the quality of these different institutions needs to be illuminated. For formal institutions, quality centres on credibility, which guarantees that the functions of institutions, such as the reduction of uncertainty, options for specialization and longterm orientation, can be fulfilled. In the case of informal institutions, empirical research has shown that innovative behaviour in a society, secondary virtues or generalized trust are beneficial for economic development (Knack and Keefer 1997). The quality of institutions can be measured by the collection of both objective as well as subjective data. Both forms are exemplified in this volume.2

Institutions and lock-ins Often, institutional change does not take place to the desired extent, even if certain reforms are seen to increase the economic welfare of all actors involved. One important reason behind holding on to inappropriate institutions is path dependence. Positive externalities lock the actors into a situation that may be beneficial in a particular case but may not be in the interest of the common good. This concept of path dependence is inspired by standardization economics, which tries to explain certain technical developments with reference to positive externalities – the fact that the value of a good often depends on the number of users. The more users acquire the good, the more the value of the good increases. On one side, the value of a good thus results not so much out of its technical qualities but rather out of the size of its network; on the other side, path dependence may lead to market failure, lock-in and a rigidity of less optimal standards. The concept of path dependence, developed in the world of standards, soon became the core concept in analyses of institutions in order to explain why a desired institutional change does not take place even if it would lead to an increase of welfare for all participants. It is well known that North (1990) suggested the transfer of the concept out of the world of technology and into the world of institutions with only minor modifications. Since then the discussion has centred on whether and to what degree such a transfer is appropriate. The discussion shall not be reiterated here, but one important result of this move has been that positive externalities important in the world of standards have indeed been found to play an important role in the stabilization of institutions as well. The value of institutions depends on the framework in which they are embedded. Every reform, therefore, not only requires changing particular rules but also implies changing the embedding institutions as well. Other factors that foster path dependence are uncertainties and the distribution of power. The problem of institutional path dependence is especially endemic to homogenous groups within which the implementation of political reforms is even more difficult than in heterogeneous groups (Eisenberg 1999). As a consequence, the

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competitiveness of nations may be hindered because new developments need new institutional conditions that are not being produced due to pre-existing structures. Research has shown that the concept of path dependence is productive in explaining real economic processes. Obviously, there are ‘limits to institutional reforms’ (Eggertson 1998: 335). Nevertheless, there seems to be a tendency, especially in applied research, to overemphasize path dependence to the extent of becoming deterministic (cf. Crouch and Farrell 2004). The discussion about the decline of Japan’s competitiveness is, for example, often led by the idea that established formal and informal institutions that were helpful in the phase of catching up after the Second World War have now turned into competitive disadvantages, since new technologies such as ICT need different institutions. In other words, the institutional complementarity of the existing and the necessary new institutional conditions is not in place. The development of new industries is hindered because the needed structure is not there. The somewhat simplified argument here necessarily results in a pessimistic evaluation of reforms. It also implies that specific Japanese institutions are the reason behind the failure of certain industries. While cautiously incorporating a question mark, Anchordoguy (2000) explains the Japanese failure in the standardized software industry with a ‘failure of institutions’, including the political set of rules in competition policy, underdeveloped markets and industrial organization. The concept of institutions as a restriction can be found in the management literature about technology as well. As in the case of institutions, the emphasis given to structures lies in the focus of interest. Most contributions focus on the problem of how technology changes organizational structures and point out that organizational design needs to adapt to technological needs. Aoki’s argument (1996) – the ‘unintended fit’ of the Japanese economy as the reason for its success – clearly finds its exact replication here in the discourse of management literature. ‘Forces of production’ or ‘technology as an occasion of structuring’ (Noble 1984; Barley 1986) express a certain perspective on technology, namely that technology shapes the organizational design and that the organizational design has to fit technological needs. Without a doubt, institutions and technological conditions influence economic development, but the editors of this volume want to go a step further and stress that institutions and technologies do not simply exist and should not be interpreted primarily as an impact, but that due to creative actors implementing institutions and technologies, change is permanently going on. Technology thus receives a more plasticide character, since it is continuously adapted and created by the members of an organization. Therefore, the authors of this volume stress not so much the impact but the interaction of technologies (such as ICT) and institutions’ respective organizations.3 To summarize, we view the problematic issue as a strong tendency to perceive institutions and technologies as only marginally designable. The

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background for this scepticism towards change stems not only from sobering experiences of holding on to familiar routines in the political and economic realms but it is also influenced by a relatively simple model of the world in which path dependence operates independently of actors. However, path dependence is not past dependence. We can expect actors to attempt to calculate the long-lasting effects of their behaviour, and we can expect that they have an interest in finding better, more effective solutions. In this sense, they are inevitably engaged in learning processes.

Institutions and learning In contrast to the interpretation of path dependence outlined above, the editors of this volume stress that institutional path dependence is different from path dependence of technical standards as we learnt it from the economics of standardization. Institutions and technologies do steer behaviour in certain directions, but this is not simply a process of a ‘passive’, costless or uncreative adaptation. Certainly, it cannot be denied that path dependence in institutional development is also a result of complementarities. Nevertheless, one simple insight seems to carry the most weight: actors reflect on formal and informal institutions with reference to their contribution to the expected outcome. We can assume that actors are ready to change an institution when the return from the change is expected to be larger than the cost of the change. This insight leads to a different approach to change and to the potential of developing new industries. Learning takes place primarily in two forms: as a routine-based and as a more active process of problem solving.4 Learning as a routine-based process means that, in the simplest version, learning follows certain stimuli, such as in Pavlov’s well-known experiments. In a broader sense, instrumental learning, understood as learning according to expected rewards and punishments, belongs to this type as well. A further learning type that becomes important in the case of best-practice learning is model-based learning as developed by Bandura (1976). Model-based learning means that learning takes place by observing other groups and then assessing the degree to which their behaviour is more successful than one’s own. Model-based learning is similar to routine-based learning in that the learning situation and the signals underlying how and in which direction behaviour should be changed are relatively clear. From this perspective, learning takes place in a routine manner. Non-routine situations that are not clearly structured and are characterized by a high degree of uncertainty need a higher degree of individual reflection. It is not sufficient to reflect whether another solution might be more appropriate than one’s own. Rather, individuals have to develop their own logic and their own problem-solving strategies. As cognitive science has shown, actors are indeed able to reflect and change their behaviour to a relatively far-reaching degree. This view presupposes that actors are

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convinced that reforms are necessary and that an intrinsic motivation to learn and an open discourse exist. Learning processes in highly uncertain situations thus can no longer follow a specific logic inherent in the system. Instead, they need much more internal control. The most important strategies to handle uncertain situations in this context are trial and error, restructuring and creativity (i.e. the combination of two elements that are far remote from each other). With this approach to path dependence, the lack of complementarities itself may not be as problematic as it seems to be due to the fact that economic actors themselves are able to create new complementarities and are innovative in searching for new, previously ‘unthought of’ institutional solutions (on the condition that changing costs are reasonable). In this context, Vanberg (1994) and Buchanan (1994) have discussed how informal institutions, which are seen in economics for methodological reasons as stable and thus almost resistant to change, can be integrated in this approach as well. They propose dividing preferences – which are here equated with informal institutions – into theory-related and subject-related components. The theoryled component can be tested and is therefore objective from a scientific point of view, while the subject-related component is only subjectively correct. In order to change learned behaviour it is necessary to individually assess whether and to what degree a given preference has led to a desired aim. If an individual concludes that a certain aim was not reached, then the individual may change its preferences. With this understanding, a change of preferences can also be introduced into economic theory. Individuals thus cannot leave existing paths, but they can develop new paths by learning new preferences and new behaviour. Trial and error, restructuring and creativity are important tools by which one can change one’s behaviour and develop new paths (Holland et al. 1986). To summarize: since rules are learnt, not only do they offer orientation by their stability but they can also in principle be relearnt as well. Indeed, several examples in actual political and economic life demonstrate that institutional development is not as rigid as it is often presumed, and that there is plenty of leeway for action. Selected examples discussed in this volume are the success of i-mode in Japan, specific comparative advantages generated out of specific interpretations of ICT in German SMEs (small and mediumsized enterprises), or the genesis of new ventures in ICT in the United States and in Japan despite their completely different institutional conditions (see Schreyögg, Khiari and Schmidt, Chapter 13; Tachiki, Chapter 8; and Akhtar, Teramoto and Benton, Chapter 11). In order to discuss the competitive potential of ICT against the background of appropriate institutional and technological frameworks, path dependence and learning, the volume is structured as two main sections. Part II focuses on the institutional framework and Part III on the entrepreneurial level. Each section takes the specific backgrounds in the United States, Japan and Germany into account.

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Part II starts from the finding that the institutional framework influences the development of ICT and carefully examines the ways regulation in the political and economic environment takes place in the United States, Japan and Germany. From a dynamic and comparative perspective, we look at the degree to which new rules are seen as necessary and thus influence positively the development of ICT. We find distinct, different and often unexpected patterns between the three systems and, moreover, that selfregulation in all three countries is rapidly beginning to replace governmental regulations. In the first sub-section of Part II, general institutional conditions for introducing ICT are analysed. The leading question is: which set of institutions is appropriate for the development of ICT technologies? As the contributions show, this question has to be answered differently depending on the sub-sector. In contrast to the United States and Germany where the idea of competition policy and a general rule orientation of economic policy is relatively well established despite divergent developments in selected areas, the Japanese case differs since the needs of the ‘developmental state’ have continued up to the present time to lead to comprehensive government intervention. Nevertheless, a more differentiated analysis shows that such tendencies can be found in the United States and in Germany as well. Mark Tilton and Choi Hyeonjung (Chapter 2) discuss the legacies of the developmental state for Japan’s ICT industries. They focus on Japan’s failures and successes in industrial policy for ICT. Japanese policies to promote indigenous technology have limited competition and are focused on funding technologies such as the development of large mainframe computers and a fibre-optic network. While this approach has produced some successes, overall Japan has found itself surpassed by information technology industries in the United States, where policies have emphasized market flexibility and lower prices. Recently, Japan has attempted to catch up by pursuing an ‘e-Japan Priority Policy Program’. While this has produced rapid growth in broadband internet access, regulatory protection of NTT, Japan’s leading telecommunication firm, continues to saddle Japan with expensive basic telecommunication services. The institutional framework and competitiveness of the US telecommunications market is analysed by Michael Schefczyk (Chapter 3). He first briefly puts into perspective the telecommunications markets of the United States, Japan and Germany. He then provides an overview of the development of the regulatory framework in the United States with an emphasis on the Telecommunication Act of 1996. Finally, Schefczyk analyses aggregate statistics to verify broad consequences of regulation on competition in the United States. The highlighted issues include, first of all, the different telecom market characteristics in the three countries in terms of their population density, cellular penetration, digitization and Internet/PC penetration. Second, he finds that the regulatory framework in the United States until 1996 was characterized by a reduction of market entry barriers

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while keeping operators from serving multiple segments and using price cap regulation for incumbent carriers. Third, this framework changed in 1996 to allow operators multiple segments, enforce strong access and interconnection rules, and shift towards intervention-regulation of prices and universal service obligations. Günter Knieps (Chapter 4) discusses with regard to German ICT whether there is still a role for sector specific regulations. The traditionally different roles of government interventions and regulations in the media and in the IT and telecommunication sector may be challenged due to the convergence of all three sectors. On the one hand, convergence may outpace existing sector-specific regimes. On the other hand, sector-specific regulation may even be extended in the future to include markets not yet regulated. The question arises of how to achieve the proper role of government intervention. The focus of this paper is on Internet access and backbone providers. As far as Internet access is concerned, the recent introduction of regulatory unbundling of the European Parliament and the German Regulatory Commission is discussed as problematic due to its lack of justification. However, Internet backbone providers are not subject to sector-specific regulation, which is due to the absence of network specific market power. This results in a competitive market. In the second sub-section of Part II, the state’s decreasing ability to act and the increasing role of self-regulation in the context of ICT is discussed. This sub-section explores the conditions under which private rules may be more appropriate than governmental intervention. It examines the appropriate range of government involvement and the interaction between these two areas. First of all, the contributions draw attention to the fact that the question concerning ‘varieties of capitalism’ has to be considered carefully. In the United States, for example, the country regarded as the ‘model’ for private rules and market solutions, governmental interventions in the ICT sector are playing an increasingly prominent role. Second, most research has so far focused more on the appropriateness of rules and not enough on their implementation. Different social, political and economic contexts influence the implementation of rules, and thus become an important factor in the discussion about the appropriate design of the institutional framework. Cornelia Storz (Chapter 5) asks whether self-regulation is an adequate framework for electronic commerce in Japan. The contribution starts from the point that e-commerce creates new problems of uncertainty, which can lead to low growth rates in e-commerce as the Japanese case shows. Japan views this situation as a politically relevant problem. Although this new form of uncertainty has resulted in several new legal rules for e-commerce, the most adequate solution for this problem is expected to be found in the instrument of self-regulation, i.e. self-binding rules of private associations that define content, enforcement and adjudication. Japan is currently following this approach, as exemplified by both political actors and e-commerce associations. While self-regulation can be a general, adequate

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political solution for reducing uncertainty and building trust, it seems questionable to choose it as a general, adequate institutional framework for Japan. Nevertheless, other innovative, entrepreneurial solutions have stepped in to solve this problem. Robert Frieden (Chapter 6) analyses the institutional framework and competitiveness of the US telecommunications market. Globalization, free trade and the constant pressure to improve productivity and generate growth create incentives to leverage ICT industries domestically and abroad. Regardless of political orientation, national governments have significant functions in ICT development – despite debates concerning the appropriate range of governmental involvement. Even the US government, which traditionally favours entrepreneurialism and private enterprise in ICT, has a lengthy record of incubation and stewardship that helps to develop and exploit competitive advantages. Since ICT is predicted to have a strong global economic impact, its incubation is a matter of great importance to the United States, Japan and Germany alike with regard to competitiveness. These nations cannot simply assume developing nations serve as untapped markets, since technology transfer may expedite development of a low-cost provider. On a macro level, these nations have to consider the impact of monetary, trade, immigration and industrial policy on ICT. On a micro level, they have to formulate nation-specific ICT policies. Bernhard Lageman, Michael Rothgang and Markus Scheuer (Chapter 7) ask whether e-commerce needs an independent e-commerce policy. From a German perspective, they argue that the debate surrounding e-commerce regulation has centred on single economic and public economics issues such as its impacts on taxation or securing property rights, as well as on social issues such as the protection of youth and individual rights. However, in the light of the important changes associated with technological innovation, emerging new markets and the globalization of business processes, the question as to whether there is a need for a new, ordo-political framework and how such an ordo-political framework for e-commerce could be shaped has not been addressed. Part III turns to the development and the use of ICT at the micro level. This approach illuminates the tension between the adaptive and the creative functions of firms. ICT has an impact on the structure and development of institutions and organizations, but the organization of industries and firms also influence the way in which ICT is generated and implemented; both ‘interact’, as described above. Thus, the first sub-section of Part III further examines the effects of ICT on industrial organization and firm structures in Japanese, the US and German contexts. Dennis Tachiki (Chapter 8) discusses whether Japan indeed lags behind in e-commerce, as is often stated. The analytical concern is in the extent to which e-commerce diffuses across industries and within establishments, and the consequent impacts on firm performance. The main data sources for this study are a telephone survey conducted by the International Data

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Corporation in 2002 and primary data from the Fujitsu Research Institute. Overall, the author finds that Japanese groups (keiretsu) play an important role in adopting business-to-business technologies, but that the small and medium-sized enterprises are more active in adopting business-to-consumer technologies. These differences reflect the ability of companies to overcome the barriers and inefficiencies in the existing political economy. The relational context in Japan partially explains the variations in performance of adopting firms. Boy Lüthje (Chapter 9) discusses in the first subsection the American case: how are organizations influenced by ICT? Lüthje examines the profound economic and social changes in the IT industry that are shaping the conditions for electronic contract manufacturing and the Internet as an infrastructure for transnational production networks. The analysis explores three interrelated sets of questions: (1) the patterns of vertical specialization as they relate to new industry structures and changing architectures of IT networks; (2) the shift from traditional, multinational corporations to global network flagships that develop regional production networks with hierarchical layers of participants; and (3) the possible impact of contract manufacturing on international knowledge diffusion and local capability formation. The discussion is based on recent empirical research that compares the development of the contract manufacturing industry in the southern and western United States. Ralf Reichwald, Frank Piller, Sascha Seifert and Christoph Ihl (Chapter 10) focus on change and reorganization in firms, discussing the deployment of ICT in new product development and thus the central question of innovation management, how new knowledge in firms can be created. The contribution follows an institutional approach, e.g. referring to transaction cost theories. It starts from the concept of ‘open innovation’, which is relatively new in the literature and a fascinating concept since it includes a new perspective of the consumer, whose role is interpreted more as a proactive one. Referring especially to lead users, its role changes from a rather passive to a more creative one are analysed. The concrete example that is discussed in this contribution is based on a research project with adidas-Salomon AG. In the second sub-section of Part III, the other side of the coin is examined through analyses of the social construction of institutions and technology. As the contributions outlined above indicate, the development of new entrepreneurial concepts is an indicator of the alertness of entrepreneurs and may lead to lock-outs of inefficient arrangements. This sub-section discusses the conditions under which learning takes place. Subsequently, we look at how ICT gives rise to learning processes in terms of inducing knowledge creation, which in turn can lead to competitive advantages. Mohammad Akhtar, Yoshiya Teramoto and Caroline Benton (Chapter 11) discuss the next generation communication technologies in Japan and its leading economic position. They analyse competing deployments of mobile communications technology by evaluating the benefits that have been

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delivered at the end-user level, operator level, country level and global level. They argue that operators who have successfully captured these benefits not only become formidable players in the Japanese marketplace but are also able to create a win–win relationship for all the stakeholders involved. The empirical part of the analysis examines the development of 3G in Japan, where both W-CDMA and CDMA 1X networks co-exist. Furthermore, the chapter gives insight into the reasons that lie behind the competitiveness of Japan and other Asian countries (mainly Korea and China) in technology development and commercialization. Janet Fulk (Chapter 12) analyses the competitive advantage of US firms by their use of ICT. This chapter reviews theory, research and case examples of the strategic application of communication and information technology to improve productivity and enhance competitiveness of firms headquartered in the United States. When implementation of such technologies is accompanied by changes to corporate strategy, culture and organizational design, these innovations can have a longer period of freedom from imitation by competitors. Trends in such applications often involve partnerships and alliances in which the different firms not only coordinate with each other but also learn from their partners as well. Georg Schreyögg, Sami Khiari and Leo Schmidt (Chapter 13) understand the implementation of ICT as a learning process and technology as a process that is shaped. The importance of technology for designing and managing organizations has long been a standing concern of organizational theory. The traditional approach focuses on the technological impact on organizations and how they inform organizational design to effectively match inherent technological demands. Technology is conceived as an external force that demands adaptation along prescribed patterns. This chapter focuses on these changes and advocates the view that the technological process has become an interactive one whereby organizations increasingly shape technologies. Even more importantly, the relationship between technology and organizational design transforms itself into a learning process. The empirical part of this chapter presents results from recently completed research on the introduction of SAP, one of the most-used customized business software, in a medium-sized enterprise. The volume thus is reasoned in the fact that the advanced OECD countries enter into a new era of knowledge-based industries, to which ICT belong. The question arises, how well Japan, the US and Germany are doing in developing these new technologies. Obviously, Japan and Germany possess strengths in industrial core industries but still have to adjust their policies and strategies in response to the new challenge. In contrast, it is often argued that the US system has been more flexible in its adaption process. One indicator is its strong position in software and most ICT technologies. In this volume, we have chosen an institutional approach to understand weaknesses and strengths. This unifying approach implicates a certain tension – namely, the tension between change, adaptability and

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rigidity – that makes, in our view, the volume with its concrete focus on institutional issues and their respective changes (or non-changes) an exciting one. Moreover, we discuss ICT-related institutional, organizational and technological issues in a comparative view between the US, Japan and Germany. This again gives interesting insights in still different, and often unexpected, patterns of institutional settings, but makes the discussion necessarily less focused. Nonetheless, we hope that the reader will enjoy the volume, and that the implicit tensions will stimulate further discussions.

Notes 1

2 3 4

Compare, for example, Custodio (2004) and its analysis of the e-commerce work programme of the World Trade Organization, Hanna, Guy and Arnold (1995) in a discussion paper for the World Bank and publications of the OECD (2000, 2001) referring to selected issues such as privacy and security. On a critical note we should mention that causality flow from institutions to competitiveness has not gone unquestioned. The causality may also flow the other way around: economic growth induces high-quality institutions. In a pointed way, Crouch and Farrell (2004) did this in an interesting contribution about path dependence. For learning theories, see Brenner (2000) and Edelmann (1996).

Bibliography Ackermann, Rolf (2001) Pfadabhängigkeit, Institutionen und Regelreform, Tübingen: Mohr-Siebeck. Anchordoguy, M. (2000) ‘Japan’s software industry: a failure of institutions’, Research Policy, 29: 391–408. Aoki, Masahiko (1996) ‘Unintended fit’, in Aoki, Masahiko, Kim, Hyung-Ki and Okuno-Fujiwara, Masahiro (eds) The Role of Government in East Asian Economic Development, Oxford: Clarendon Press, pp. 233–53. Aoki, M. and Hayami, Y. (2001) ‘Introduction: communities and markets in economic development’, in Aoki, M. and Y. Hayami (eds) Communities and Markets in Economic Development, Oxford: Oxford University Press, pp. xv–xxiv. Bandura, A. (1976) Lernen am Modell: Ansätze zu einer sozialkognitiven Lerntheorie, Stuttgart: Klett. Barley, S. R. (1986) ‘Technology as an occasion for structuring: evidence from observations of CT scanners and the social order of radiology departments’, Administrative Science Quarterly, 31: 78–108. Brenner, Thomas (2000) ‘Diffusion and waves of innovations: a learning perspective’, in Computation in Economics, Finance and Engineering: economic systems – a proceedings volume from the IFAC symposium, Cambridge, UK, 29 June–1 July 1998, Oxford: Pergamon/Elsevier Science, pp. 87–92. Buchanan, James M. (1994) Ethics and Economic Progress, Norman OK and London: University of Oklahoma. Crouch, Colin and Farrell, Henry (2004) ‘Breaking the path of institutional development? Alternatives to the new determinism’, Rationality and Society, 16(1): 5–43. Custodio, Edsel T. (2004) ‘E-commerce: the work program of the World Trade Organization’, in Drysdale, Peter (ed.) The New Economy in East Asia and

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the Pacific (Pacific Trade and Development Conference Series), London: RoutledgeCurzon, pp. 298–312. Denzau, Arthur T. and North, Douglass C. (1994) ‘Shared mental models: ideologies and institutions’, Kyklos, 47: 3–31. Edelmann, Walter (1996) Lernpsychologie, 5, Vollständig Überarbeitete Auflage, Weinheim: Psychologie Verlags Union. Eggertson, Thráinn (1998) ‘Limits to institutional reforms’, Scandinavian Journal of Economics, 100 (1): 335–57. Eisenberg, A. (1999) Die Lösungen Sozialer Dilemmata und der Wandel Informeller Institutionen, Jena, Max-Planck-Institut zur Erforschung von Wirtschaftssystemen. Fransman, Martin (1999) ‘Where are the Japanese? Japanese information and communications firms in an internet worked world’, Telecommunications Policy 23: 317–33. Fukutomo, Kazuo (2001) IT ka no shinkô to kigyôkan denshi shôtorihiki no kanôsei (Development of IT and the options for business to business e-commerce), Sangyô to Keizai (Nara Sangyô Daigaku), 16(1), June: 1–14. Hanna, Nagy, Guy, Ken and Arnold, Erik (1995) The Diffusion of Information Technology: experience of industrial countries and lessons for developing countries (World Bank Discussion Papers 281). Holland, John H., Holyoak, K. J., Nisbett, R. E. and Thagard, P. R. (1986) Innovation, Processes of Inference, Learning, and Discovery, Cambridge MA: MIT Press. Knack, Stephen and Keefer, Philip (1997) ‘Does social capital have an economic payoff? A cross-country investigation’, Quarterly Journal of Economics, 112 (4): 1251–88. Leipold, Helmut (1997) ‘Der Zusammenhang zwischen gewachsener und gesetzter Ordnung: Einige Lehren aus den postsozialistischen Reformerfahrungen’, in Cassel, D. (ed.) Institutionelle Probleme der Systemtransformation, Berlin: Duncker & Humblot, pp. 43–68. Meyer, John W. and Rowan, Brian (1977) ‘Institutional organizations: formal structure as myth and ceremony’, American Journal of Sociology, 83: 340–63. Noble, D. (1984) Forces of Production: a social history of industrial automation, New York: Knopf. Noguchi, Yukio (2003) ‘Is the IT revolution possible in Japan?’, in Barfield, Claude E., Heiduk, Günter and Welfens, Paul J. J. (eds) Internet, Economic Growth and Globalisation, Berlin, Heidelberg and New York: Springer, pp. 67–83. North, D. C. (1990) Institutions, Institutional Change and Economic Performance, Cambridge: Cambridge University Press. OECD (2000) Transborder Data Flow Contracts in the Wider Framework of Mechanisms for Privacy Protection on Global Networks (Working Party on Information Security and Privacy) (DSTI/ICCP/REG (99)15/FINAL) (www.oecd.org/Long Abstract/0,2546,en_2649_34223_2496189_1_1_1_1,00.html). OECD (2001a) Science, Technology and Industry Outlook. Drivers of Growth: information technology, innovation and entrepreneurship, special edition, Paris: OECD. OECD (2001b) Building Trust in the Online Environment: business to consumer dispute resolution, Joint Conference of the OECD, HCOPIL, ICC (Working Party on Information Security and Privacy) (DSTI/ICCP/REG/CP(2001)2) (www.oecd. org/document/22/0,2340,en_2649_34267_1864982_1_1_1_1,00.html). Vanberg, Viktor (1994) ‘Kulturelle Evolution und die Gestaltung von Regeln’, Walter Eucken Institut, Vorträge und Aufsätze; 144, Tübingen: J. C. B. Mohr (Paul Siebeck).

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Part II

Institutional framework for ICT and options for political governance Japan, the United States and Germany in comparison

Subsection A Institutional conditions for introducing ICT

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Legacies of the developmental state for Japan’s information and communications industries Mark Tilton and Hyeonjung Choi

Introduction The information technology sector tells us much about how Japan’s political institutions shape its economy, and how change and learning takes place. Japanese leaders have observed American success in information technologies and have stated a strong interest in adopting policies that would enable Japan to catch up with the United States. Change and learning have in fact taken place, but in ways that are constrained by established institutions. Beginning in the late nineteenth century, the Japanese state adopted policies to catch up with Western industrial power. These policies evolved and changed over time, but in the period of rapid, post-Second World War growth they emphasized (1) close ties between the bureaucracy and industry and (2) a bias towards helping industries establish private market controls, such as cartels, in order to produce revenues for investment or to maintain jobs. Pro-consumer competition policy has been weak. This does not mean that there is little competition in Japan. However, industrial policy has been based on cooperation between the state and business to coordinate competition and channel resources to targeted industries. Undermining powerful companies by forcing tough, competitive conditions on firms has tended to be viewed with suspicion. The problems of Japan’s industrial policy approach become obvious in the computer and telecommunications sector. Strategies of targeting and managed competition translated into Japan’s late development of widespread access to PCs (personal computers), and this has been one factor that has held the country back in developing access to the Internet. Japan’s cautious approach to subjecting its old telecommunications monopoly, Nippon Telephone and Telegraph (NTT), to competition has meant high telecommunications prices for consumers, which also slowed the spread of Internet use. Recognizing this problem, the Japanese government has again employed a policy of industrial targeting by mandating low prices for digital subscriber line (DSL) interconnection1, while at the same time keeping interconnection rates for standard phone services high.

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The resulting low prices for broadband have fuelled a rapid growth in broadband services. Japan has leapfrogged ahead of the United States (not to mention most of Western Europe) in providing very fast broadband service at low prices to such an extent that by 2005, broadband penetration levels were higher than in the United States (Point-topic.com 2005). In addition to Japan’s success in targeting broadband access, the policy of sheltering the national champion has also not been without its advantages. NTT is in better financial shape than many global telecommunications firms, and NTT’s deep pockets have funded considerable innovation, most notably in mobile services and the creation of a fibre-optic network. Yet even without a tough competition policy, NTT is inevitably faced with new competition due to new technologies that have relaxed the advantages of an incumbent monopoly. Recent changes, such as the development of Voice over Internet Protocol (VOIP), the spread of mobile phones and the lowering of obstacles to building a rival, fixed-line network, as J-Phone is doing, all present direct challenges to NTT. Nevertheless, at this point network regulation still matters, and Japan still lags behind Germany and the United States in pushing a tough competition policy in telecommunications. The United States was successful to a great degree in information technologies due to its powerful competition policy. Japan adopted measures along the lines of its own industrial policy to try to catch up with the technology that was the fruit of American pro-competitive policies. Industrial policy enabled Japan to catch up with and surpass the United States in an area where there was a clear goal – the diffusion of high-speed Internet access. But Japan has not adopted the tough competition policy that enabled the United States to be the early innovator in mass use of the Internet. This chapter examines the effects of a pro-competitive versus a pro-industrial approach to information and communications technology (ICT) industries.

Telecommunications The telecommunications and computer industries are closely connected since the same companies produce hardware for both industries. NTT procurement has long been an important source of sales for computer manufacturers, and both industries are now crucial to the development of the Internet. Let us first take a look at telecommunications. As in most countries, Japan’s telephone company was a state-owned monopoly, and in Japan’s case it was self-regulating. It developed technology through what Martin Fransman (1995: 354–8) calls ‘controlled competition’, in contrast to the vertical or in-house procurement of American Telegraph & Telephone (AT&T) or the pure competition for procurement contracts that British Telecom used. This model of controlled competition was a source of trade friction with the United States, and, beginning in 1981, a series of agreements was signed to open up procurement to foreign firms.

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Telecommunications regulation changed in important ways in response to the 1984 US break up of AT&T. In 1985, Japan privatized NTT, although the Japanese government kept most of the shares in NTT and competitors complained that it was difficult to compete in the areas, such as long distance, that were opened up to them because of NTT’s monopoly in local telephone service. A more significant change came with the split up of NTT in 1999. Local service was split between NTT East and West, mobile phone service was given to NTT DoCoMo, and NTT has ceded market share to a number of competitors although it still dominates most branches of the telecommunications market (Vogel 2000; Seifu Kisei Nado to Kyo¯so¯ Seisaku ni Kansuru Kenkyu¯kai 2002). When NTT was broken up, it was only with the important concession that Japan’s 52-year-old ban on holding companies be lifted. The ban on holding companies had been imposed by the US occupation because of suspicion that the zaibatsu, all held together by holding companies, had been responsible for triggering Japan’s military expansion in Asia (Hadley 1970; Haley 2001). Rapid change in the telecommunications market has been accompanied by controversy and political struggle. The policy-making process is deeply politicized, with NTT exerting significant pressure on regulators. Important liberalization and price drops have occurred, but at crucial times regulators lean in favour of protecting NTT. NTT is a large, powerful firm with over 200,000 employees. The NTT labour union is politically active and a number of Diet members are former NTT employees. Moreover, NTT is effective at mobilizing both the ruling Liberal Democratic Party (LDP) and the Democratic Party to support its efforts against regulations disadvantageous to NTT interests. The regulatory process has, nevertheless, created considerable opportunities for competitors. The challengers to NTT – the new common carriers (NCCs) – have taken a large share of the market in all areas of telecommunications service, with the exception of local service. But their workforces are small. The largest, KDDI, has only 10,000 workers. Their pockets are also shallower and their political clout is correspondingly less than that of NTT. The new common carriers have no significant supporters in the Diet (Tilton 2003b). At the time of privatization in 1985, NTT came under the formal jurisdiction of the Ministry of Posts and Telecommunications (MPT, which became part of the Ministry of Public Management, Home Affairs, Posts and Telecommunications in 2000, and was renamed the Ministry of Internal Affairs and Communications, or MIC, in 2004). The MIC is weak relative to the large firm it regulates. It is unable to match NTT’s expertise, budget or political clout with Diet members. The MIC has supported increased competition in telecommunications, but is sensitive to political pressure from the LDP and occasionally shrinks back from regulatory sallies it had intended. In devising its policy, the MIC consults with the Telecommunications Council, which includes representatives from telecommunications

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firms, consumers and academics. Several important changes have come about through the Council, although the power of NTT and the dominant, conservative mainstream of the LDP act as a brake on pro-competitive reforms (Kawabata 2001). The Ministry of Economy, Trade and Industry (METI, which before 2000 was called MITI, the Ministry of International Trade and Industry) expresses its opinions about telecommunications policy but does not play much of a role in shaping it. It largely confines itself to complaining from the sidelines that there should be more competition in the telecommunications industry and that high telecommunications prices are a drag on the Japanese economy. In contrast to the United States and Germany, Japan’s competition policy authority has had little influence on the development of the telecommunications sector until recently. In the United States, the Department of Justice played a key role in breaking up AT&T, and the courts have regularly intervened to promote competition. Although Germany came late to promoting competition in telecommunications, a variety of competition policy authorities, from the European Commission, the German courts and the Monopoly Commission, have backed the Regulierungsbehörde für Telekommunikation und Post (Regulatory Authority for Telecommunications and Posts, or RegTP, which on 13 July 2005 was folded into the Bundesnetzagentur, or Federal Network Agency) in its efforts to promote competition. But the corresponding antitrust authority in Japan, the Japan Fair Trade Commission (JFTC), has had little to do with telecommunications. In principle, there is a process in place for the JFTC to advise the MIC on telecommunications policy, but the MIC keeps the JFTC’s role quite limited (Tilton 2003a). The JFTC lacks the staff, expertise and, most importantly, political clout to influence telecommunications policy. Foreign pressure (gaiatsu) has played an important role in shaping Japanese telecommunications policy. US pressure has been especially important, and in recent years the European Union (EU) has also made suggestions for changes in telecommunications policy. Currently, however, the United States is less active in trying to influence Japan’s telecommunications policy. In part, this reflects considerable progress that has already been achieved in reforming telecommunications policy as well as the present existence of major telecommunications firms within Japan that can exert some pressure on their own (Tilton 2003c). It undoubtedly also reflects the American emphasis on securing Japan’s cooperation with American foreign policy rather than pushing for further economic reforms in Japan. In all countries, telecommunications is an industry in which states must intervene deeply and persistently in order to create competition. Most states owned telecommunications companies, and those that did not, such as the United States, had nationally regulated monopolies. States have dispensed with the old telephone monopolies, but have found that in order to create competition they must intervene aggressively. The problem is that

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incumbents own a network of wires and switches, and if they are to be challenged in the marketplace, they must be forced by the state to share the network with competitors. At the same time, incumbents must be allowed to make profits from their network, or they will not be able to or have the incentive to continue ongoing investment in the network. Finding this balance between required competition and allowing incumbents to enjoy the profits of their established positions is difficult, and different states have found different solutions. All telecommunications industries have emerged from the status of a monopoly, and all regulatory authorities wrestle with how much competition to introduce. But in Japan there is an affinity between patterns of industrial policy and a tendency to coddle the telecommunications incumbent. Japan’s industrial policy approach to economic development included the following elements: • •

pursuing sectoral goals (such as the promotion of a particular industry or technology) rather than simply promoting economic growth in general; limiting (but not eliminating) competition in order to produce higher prices and more stable markets as well as to provide funds for investment.

Japan’s telecommunications policy still fits this pattern in important ways. Regulators have targeted the development of certain technologies rather than emphasizing low prices for consumers. Prices have tended to be high by international standards, and regulatory bodies have not pushed competition as much as their American counterparts have. The weakness of Japan’s telecommunications regulators in the face of NTT pressure was illustrated by the MIC’s difficulty in regulating interconnection rates in 2003 and 2004. In April 2003, the Telecommunications Council decided to raise interconnection rates, which are the rates charged to NTT competitors to hook up to its network. This rate increase invited protest from competing firms, from the US government and from the EU because Japanese rates were already twice as expensive as European or American rates. The reason the Telecommunications Council raised the rates was because of pressure from NTT-affiliated Diet members (Zaikai 2003). The rate increase produced a 5 per cent increase in NTT’s interconnection fee revenue in 2003, up to 621 billion yen (Jiji Press Ticker Service 2004). Telecommunications policymaking took a surprising twist in July 2003 when five telecommunications carriers sued the MIC for raising interconnection rates (Japan Times 2003). Observers suggested it was unlikely the suit would succeed, but it was a striking way for the new competitors to voice their objections to Japan’s conservative, anti-competitive policies. The generally gloomy prognoses of the litigation highlight a contrast between Japan’s telecommunications regulatory process and that of the United

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States or Germany. In the two latter countries, the courts have played an important role. A year later, in July 2004, the Telecommunications Council tacitly responded to the suit by floating a proposal to gradually reduce interconnection fees over five years. NTT East and West put out a statement the next month that was interpreted as ‘an indication of the vehemence of NTT’s reaction’ to that proposal. NTT called for the outright scrapping of the requirement that it should share the fixed phone network with companies (Jiji Tsûshin Kigyo¯ Nyûsu, 2004). METI has expressed the concern that the high telecommunications prices resulting from limiting competition stunt the growth of downstream uses of telecommunications technology, such as the use of the Internet. Weak regulation has kept prices in Japan higher than in the United States and Germany. OECD data for 2002 and 2004 show Japanese telecommunications prices were considerably higher than in both Germany and the United States, although the decline in the dollar’s value relative to the euro from 2002 to 2004 meant that American prices fell relative to Germany’s (see Table 2.1). High telecommunications prices have meant that dial-up Internet access in Japan has been expensive. Forty hours of Internet usage in 2000 cost $78 in Japan, $49 in Germany and $23 in the United States. Twenty hours cost $59 in Japan, $33 in Germany and $22 in the United States. By September 2002, these figures had dropped, although Japan’s rates were still higher than those in the United States and in Germany (see Table 2.2). The fact that Japanese telecommunications regulation was slower than that in the US or even Germany to push down telephone prices meant that Japanese consumers lacked the cheap phone rates that enabled Americans to experiment with widespread use of the Internet. While broadband was becoming more important in Japan by 2004, the initial move to the Internet had been slowed by high telephone prices.

Table 2.1 OECD composite basket of residential and business telephone charges, August 2002, 2004 Residential (US$)

Business (US$)

Ratio of residential charges to German residential charges

Ratio of business charges to German business charges

2002

2004

2002

2004

2002

2004

2002

2004

722 589 638

1,736 1,128 1,149

1,772 1,384 1,157

1.46 1.00 1.18

1.23 1.00 1.08

1.54 1.00 1.02

1.28 1.00 0.83

Japan 703 Germany 482 United States 567

Source: OECD 2003: 179, 181; OECD 2005: 185, 187. Note: Includes mobile and international calls, excludes VAT.

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Table 2.2 OECD Internet access basket at daytime discounted PSTN rates (US$)

Japan Germany US

2000, 40 hours

2000, 20 hours

2002, 40 hours

2002, 20 hours

78 49 23

59 33 22

54 23 23

34 14 21

Source: OECD 2000a, 2000b, 2003: 170, 172. Note: the public switched telephone network (PSTN) ties together the world’s circuit-switched telephone networks.

The computer industry The computer industry in Japan differs from the telecommunications industry in that it has been under the jurisdiction of METI and thus close to the heart of full-fledged industrial policy. Nevertheless, as mentioned above, it has also been closely tied to the NTT procurement system. In the early 1960s, METI defined computers as a strategic industry. It protected the industry, selected players in it, and provided large subsidies, tax benefits and ‘Buy-Japanese’ policies as well. The computer industry had some of the ideal characteristics for industrial targeting. It was envisioned to produce high quality and high value-added machines, to require few natural raw materials and little energy, to use skilled labour power, and to have expanding domestic and international markets. METI obtained IBM patents and distributed them to select domestic companies with track records – Fujitsu, Hitachi, NEC, Toshiba, Mitsubishi Electric, Oki and Matsushita. All these firms, apart from Matsushita which withdrew in 1964, have remained the major Japanese computer companies and have been strategically protected and subsidized by the government. METI regulated the number of firms in each market segment to allow each firm to achieve economies of scale. After selecting the players, the government needed to create a market environment in which the computer companies would be willing to invest heavily to develop and manufacture sophisticated computers and Japanese users would be willing to purchase them. METI and the computer companies created the Japan Electronic Computer Company (JECC) in the early 1960s, which purchased and then rented out large numbers of Japanese-produced computers (Anchordoguy 1989: 59). In addition to stimulating the demand for and supply of the domestic computer, the JECC played various key roles in developing the industry. By giving the computer makers up-front cash, the JECC made it possible for them to invest heavily in improving their computers. The JECC also acted as a central agent for price and production coordination. In consultation with METI and the computer makers, the JECC set computer rental prices to prevent domestic price competition. In addition, although in general market demand and production costs were the primary determinants of the computers, the JECC used its

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discretion at times to pressure the computer makers to produce certain types of machines or to develop more advanced computers before market demand and production costs warranted such a strategy. For example, as the domestic computer makers became competitive in small computers, the JECC shifted its support from the rental of small computers to mediumscale and large-scale ones, and encouraged the makers to increase their efforts to develop and produce larger and more sophisticated computers. The computer industry was supported by subsidies, low-interest loans and loan guarantees, which gave the industry access to capital for research and development (R&D) and production.2 NTT played an important role in providing invisible financial support for the ‘NTT Family’ firms to create a computer industry. Financial support by NTT, which was just partly privatized in 1985, provided an additional means of putting public investment into the computer sector. Japan’s developmentalist strategy paid off in the late 1970s. Not only did Japan become a top exporter of semiconductors, but in 1979 Fujitsu became the first maker to beat IBM in any domestic market. Also, Japan became a mainframe computer exporter (Shimoda 1984: 178). But the advent of a new information technology environment in the 1990s proved that METI’s ‘vision’ for the computer industry and its development strategy was ultimately misguided. While Japan succeeded in catching up with existing technologies, it now faced an IT revolution based on personal computers, software-centred computer business and PC networks. METI failed to foresee the new computing world that was about to dawn in the early 1990s. The 5th-Generation Computer Project (1982–91), which was planned and implemented at a time when Japan had begun to have confidence in its computer industry, was an exemplary case. It was an ambitious attempt to develop a ‘thinking’ computer, the so-called Artificial Intelligence (AI) computer, which would infer new knowledge from its database, compute through its self-developed program and produce its own output without any input. It turned out that the massively funded national project had rather vague goals that were not realized.

Challenges to Japan’s PC and software industries In the United States, where the PC revolution originated, IBM deliberately adopted an ‘open-but-owned’ architecture strategy in order to attract thirdparty support in complementary products – components, expansion boards, peripherals and software. It published critical technical specifications that allowed outside independent vendors to develop peripheral devices and application software. Moreover, Microsoft’s operating system software controls the ‘application programming interfaces’ (APIs), which determine which software is compatible with which platform with the same ‘openbut-owned’ strategy. The open-but-owned strategy of the two major US computer firms not only included continued R&D but also drew on

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outsourced peripherals and applications based on their architectures. Thus, with their core technologies in microprocessors and operating system software, Intel and Microsoft could increase the network externalities of their products, and their own profits as well (Egan 1996; Gevel 1997). The major Japanese mainframe computer makers also produced PCs based on spin-off technology from mainframe computers. They developed their own models of PCs based on ‘closed-and-owned’ architectures as they had done for their mainframe computers, which are incompatible with one another. By the early 1990s, NEC created a comfortable lead of more than 50 per cent with its PC-98 models in the domestic PC market. NEC’s ‘closedand-owned’ standards strategy enabled it to keep prices high and earn fat profit margins from locked-in Japanese users. However, NEC suffered from a problem endemic to successful pioneers, which West and Dedrick (2000) call ‘incumbent inertia’, because it failed to continue to develop advanced technology for users and network externalities. In other words, it failed to stimulate a network of software built on NEC’s own technology. Another serious problem was that, since funding was so dependent on government and keiretsu-based sources, there was no technological or financial basis for independent PC makers – such as Compaq and Dell of the United States – to enter the market. METI and the major computer companies never allowed their cooperatively developed computer engineering technologies to spill over to outsiders. Furthermore, it was difficult for outsiders to get financial support from the government or keiretsu-centred banks to start up their businesses. For software developers in Japan, it was harder to obtain funding from private investors because they were not producing tangible goods. Limited competition in the Japanese market has meant that the prices of PCs have been high and thus the PC penetration rate has been low even up to recent years. Japan’s weaknesses were exposed in 1992 when Compaq began selling PCs equipped with globalized Wintel architecture and with the availability of a larger software library at about half the level of prevailing Japanese prices. When Compaq began shipping cut-price computers to Japan, it captured only 4 per cent of the market, but computer prices in Japan fell abruptly by one-third (Edwards 1999: 5–7).3 Microsoft’s PC software, DOS/V (introduced in 1990 by IBM Japan) and Windows (1992), forced Japanese PC makers to abandon their ‘closed-and-owned’ architectures. This was a revolutionary development as DOS/V took a ‘software’ approach to displaying Japanese kanji, in contrast to Japanese PCs’ use of a ROMbased ‘hardware’ approach. Moreover, Windows (version 3.1) introduced the user-friendly Graphical User Interface (GUI) to the Japanese and the world market, which vastly simplified PC use. Once Wintel arrived on the scene, Japanese PC makers’ high prices cost them market shares. NEC’s market share slipped from over 70 per cent during the 1980s to 43 per cent in 1994 and again to 32 per cent in 1997. Moreover, Japan’s software makers have been overwhelmingly outpaced

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Table 2.3 Japan’s software exports and imports, 1995–2000 1995

1996

1997

1998

1999

2000

Exports 3,931 To the US 813 (Japan’s share of (20.7%) total world exports to the US)

5,679 1,394 (24.5%)

2,812 913 (32.5%)

8,752 1,251 (14.3%)

9,292 3,255 (35.0%)

8,981 3,934 (43.8%)

Imports 392,576 From the US 351,348 (US share of total (89.5%) imports into Japan)

393,540 344,978 (87.7%)

474,913 391,302 (82.4%)

595,165 544,051 (91.4%)

720,104 659,142 (91.5%)

918,860 821,653 (89.4%)

Source: JISA (Japan Information Technology Service Industry Association) 2001.

by American software makers, as seen in the trade imbalance between the two countries in this sector. From 1995 to 2000 Japan exported only 1 per cent of the value of software it imported, and some 90 per cent of its imports were from the US (see Table 2.3).

Industrial policy approach to the challenges METI did not pay much attention to software engineering when it established the Japanese computer industry. The first R&D project for the computer industry in 1962, the FONTAC Project, did not include software development but consigned it to an American software company. In 1966, in order to promote software development for the Super High-Performance Computer Project (1966–71), METI established the Japan Software Co., reluctantly joined by NEC, Fujitsu, Hitachi and the Industrial Bank of Japan (IBJ). As soon as the project ended in 1972, the company went bankrupt. METI next tried a different approach with the Software Module Project (1973–75), which concentrated 40 independent software vendors into five groups to develop various application programs. However, without any central body coordinating the participants, each of the five groups developed its own programs based on totally different standards so that the software programs developed by the participants could not communicate with others. Also, because the software programs did not address users’ demands, they were ignored in the marketplace. Inspired by the JECC’s success, the METI designed another national policy institution to play a similar role in the software business. The Information-Processing Promotion Association (IPA) was established in 1970 with a large government budget to promote the efforts of independent software vendors to develop standardized packaged software. The IPA rented out the software packages developed by the domestic software companies

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at low rental fees, just as the JECC did for hardware, and issued loan guarantees to the software companies that needed venture capital. However, despite the fact that the IPA paid independent software vendors more than 10 billion yen to develop some 70 software programs from 1970 to 1978, very few of these programs were ever rented or sold on the open market (Kompyutopia 1978: 72). In the mid-1980s, METI recognized Japan’s dependence on IBM’s architecture for operating mainframe computers and tried to reduce it through another national project, the Software Industrialized Generator and Maintenance Aids Project (the Sigma Project, 1985–89). The programme was funded by the government as well as by 164 private firms, including foreign computer makers such as IBM, Hewlett Packard and AT&T. The Sigma Project also tried to reduce redundant software development due to incompatible hardware and to increase the supply of software engineers. Today, however, there is nothing much to show for the Sigma Project: there are no longer any Sigma Workstations or Sigma operating systems in existence, and software developers are still in short supply (Fujiwara 1995). While METI gave priority to the development of mainframe computers to catch up with IBM, it did not learn valuable lessons to be applied in the subsequent PC era. It did not recognize the global trend in the computer industry – the ‘open-but-owned’ strategy and the importance of network externalities from the standpoint of standardization. As a result, Japan developed a PC industry without standardized architecture for either hardware or software. It was Japan’s private sector that noticed the significance of standardization. Initiated in 1984 by Sakamura Ken, a professor at the University of Tokyo, in collaboration with all the leading Japanese computer firms without direct government intervention, the TRON (Real Time OperatingSystem Nucleus) Project aimed at developing its own hardware and software independent of Western standards and even used processing based on Japanese language commands. Despite the much boasted goal of producing a hi no maru (‘rising sun’) computer, the TRON Project failed. Because TRON PCs were incompatible with the architecture of both IBM-compatible PCs and NEC’s PC-98s, they could run none of the software for these platforms, which had become standard in the Japanese market. Although METI and the Ministry of Education favoured the TRON PCs, the Japanesedesigned PC failed to become a standard for educational purposes and never caught on in the commercial marketplace (Callon 1995). No matter how superior the TRON PC was in technological terms, it could not succeed because it did not consider network externalities. None of the government’s attempts to develop Japan’s own architecture and to reduce its dependence on the American-made standard succeeded. Due to the repeated failures of national projects and an economic slump in the 1990s, METI and Japanese computer firms practically gave up on trying to compete with the Wintel architecture and instead decided to use it themselves.

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Outcome: weak PC penetration The outcome of Japan’s industrial policy approach to computers is that Japan has been slow to expand PC penetration and thus slow to give consumers and businesses a platform for access to the Internet. In 2000, only about 28 per cent of Japanese households had at least one PC, about half the level of the United States. Most Japanese businesses had PCs that year but only 20 per cent had one for each employee (Reuters 2000). In mid-2000, one report stated, ‘In Japan, PC prices are still not considered cheap, and wired infrastructure is expensive to install’ (Scuka 2000). By 2001, over 40 per cent of Japanese households were estimated to have at least one PC, but this was still lower than the PC penetration rate of South Korea, Australia and Singapore at 64–68 per cent and Taiwan, Hong Kong and New Zealand at 58–59 per cent (Nielsen-NetRatings Co. 2001).

Targeting broadband In July 2000, the Japanese cabinet attempted to get around NTT’s lack of initiative in promoting Internet access and MPT ineffectiveness by establishing an IT Strategy Headquarters in order to promote comprehensive measures for the creation of an internationally competitive ‘IT nation’ (IT Strategy Headquarters 2001a: Preface). The government also established an IT Strategy Council, which put forth a ‘Basic IT Strategy’. On 6 January 2001, a new law came into force, the Basic Law on the Formation of an Advanced Information and Telecommunications Network Society (The IT Basic Law) (Advanced Information and Telecommunication Society Promotion Headquarters 2001). In certain respects, the e-Japan Strategy is reminiscent of traditional industrial policy. For one thing, the policy is clearly oriented towards industrial catch-up: as for penetration rate of the Internet, which other nations identify as the core of IT policies, Japan is still at a low level among major industrialized nations. . . . [T]he swift action of a nation in creating an environment necessary for realizing an advanced information and telecommunications network society determines the nation’s world competitive leadership in the 21st century. As nations in the Americas, Europe and Asia are intensively promoting efforts to create such environments, the delay in the world arena for socioeconomic structural changes at a high speed will result in irrecoverable competitiveness gap [sic] in the future. (IT Strategy Headquarters 2001b: Sec. I) The report echoes the concern of the Meiji period (1868–1912) with catching up with the West and, in fact, refers to that earlier time: ‘Just as a nation’s

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response to the Industrial Revolution later determined its economic prosperity, the same will hold true with the IT revolution’ (IT Strategy Headquarters 2001b: Sec. I). The report states that the key problem is the high prices created by NTT’s monopoly, and puts forth the goal of providing high-speed Internet access. The new policies were quickly put into practice by the MIC. Japan’s stodgy regulatory policy had allowed little room for competitors to break into the market and promote Internet access. And NTT itself was doing little to promote broadband. It had decided early on a strategy for expanding Internet access by focussing on ISDN (integrated services digital network) and on creating a fibre-optic network. These technologies ended up being obsolete, and NTT had also been standing in the way of other companies introducing DSL. Based on this new initiative from the Cabinet, policy changed quickly. On 31 August 2000, the Telecommunication Council recommended introducing local loop unbundling for copper cables. New carriers were able to connect their networks to NTT East and West networks and to put their equipment in NTT buildings (collocation) as of December 2000. Several new carriers, as well as NTT East and West, immediately began offering DSL services (Ministry of Public Management, Home Affairs, Posts and Telecommunications 2001). In March 2000, regulators forced NTT to allow access to local lines (local loop unbundling). NTT East and West tried to prevent competitors from entering the market by opening only eleven offices for collocation. It also limited equipment space and the number of lines provided for unbundlers, and it dragged its feet in processing applications. In July 2000, the MPT forced NTT to open all its offices to collocation, but by December 2000 Japan still had fewer than 10,000 DSL subscribers (Point-topic.com 2003). Then, in December 2000, the MIC forced NTT to unbundle its lines to enable competitors to use them to provide DSL service. The charge for using the lines was dropped from 800 yen to 187 yen per month, which stimulated new entrants to provide DSL service, notably Yahoo Japan (Pointtopic.com 2003). The selection of DSL service as strategic and the regulatory decision to force NTT to cut charges for this service is in the tradition of earlier industrial policy. The policy was similar to previous policies in that it led to differential pricing. Since broadband Internet access was identified as the key problem, regulators required NTT to sharply cut its interconnection charges to encourage DSL access, making it possible for Yahoo to enter the broadband market and sell broadband access at some of the world’s lowest prices. Not long afterwards, interconnection rates for fixed line phone services not identified as strategically important were actually raised, even though they were already twice or more the rates of other advanced countries. In this way, Japan managed to catapult itself to the front ranks of the major industrialized countries in broadband, while at the same time keeping

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NTT revenues up (OECD 2004: 4). The United States and the EU complained that Japan’s high interconnection rates were unjustified because NTT was inefficient and its costs needlessly high. High interconnection charges kept phone rates high, kept NTT employees on the payroll and funded an unusual national project of fibre-optic network. Some American critics have argued that the United States has been wrong to press Japan to make NTT unbundle access to its network (Rohlfs and Sidak 2002). And indeed, in 2003, the United States Federal Communications Commission (FCC) voted to phase out the low prices for unbundled access to the local loop that had been required. The purpose was to encourage local providers to invest in infrastructure, especially fibre to the home, much as the MIC had been requiring. The ruling is that the incumbents will be allowed to close off access to their fibre networks, although they must continue to discount access to their copper wire networks. Surveys by Ipsos-Reid found that Japan was slow to develop widespread use of the Internet. In 1999 twice as many Americans and Canadians used the Internet as Japanese, Britons or Germans. By 2005 the Japanese, as well as Europeans, had closed most of the gap although Internet use continued to be most widespread in the US (see Tables 2.4 and 2.5). While Japanese industrial policy succeeded in creating widespread access to broadband, the industrial policy approach has left Japan behind Germany and the US with respect to broader successes in information technologies. The 2005 Economist Intelligence Report sums up Japan’s weakness. The report evaluates all of the advanced industrialized nations and many developing countries on their capacity to promote information and communications technology services. The US ranks second among the

Table 2.4 Percentage of adults who went online at least once in last 30 days (1999–2003); percentage of population who are Internet users, July 2005

US Canada South Korea UK Japan Germany France Urban Mexico Urban China Urban Brazil Urban India Urban Russia

1999

2000

2002

2003

2005

59 56 31 33 33 29 22 27 12 21 21 5

59 56 45 35 33 29 30 33 21 22 10 6

72 62 53 50 47 43 37 37 30 24 19 8

68 71 70 64 65 60 43 37 41 21 19 10

69 64 63 60 61 57 42 14 8 12 4 16

Source: Ipsos-Reid, 2002, 2004. Note: Data for 2005 are for the entire populations of Mexico, China, Brazil, India and Russia.

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Table 2.5 Fixed Internet subscribers/100 population

Canada Japan US Germany

Dial-up 2003

Broadband 2003

Total 2003

Broadband, Aug. 2005

2 8 16 24 22

33 14 10 9 6

34 22 26 33 28

73.0 42.7 38.6 29.9 14.8

Source: OECD 2005: 126; European Travel Commission 2005.

65 nations, after Denmark, with a score of 8.73 (See Table 2.6). Germany ranks twelfth, with a score of 8.03, tied with Canada, and behind the UK and Nordic countries, but ahead of France and Italy. Japan ranks twentyfirst, with a score of 7.42. Japan lags behind all the north-western European countries and the wealthy East Asian economies (with the exception of Taiwan). The scores for individual categories of readiness generally show the same rank order, with the US ahead of Germany, which in turn is ahead of Japan (see Table 2.7). This rank ordering reflects Japan’s earlier stubbornness on insisting on a mercantilist, go-it-alone policy in developing computers, which put Japan behind Western countries in the development of computers, software and broad computer skills among the population. As witnessed in Japan’s continued high telecommunications prices, Japan lags behind the US and Germany in adopting policies that emphasize competition and consumer benefit.

Table 2.6 E-readiness rankings, 2005 Rank

Country

Score

Rank

Country

Score

1 2 3 4 5 6 (tie) 6 (tie) 8 9 10 11 12 (tie) 12 (tie) 14

Denmark US Sweden Switzerland UK Hong Kong Finland Netherlands Norway Australia Singapore Canada Germany Austria

8.74 8.73 8.64 8.62 8.54 8.32 8.32 8.28 8.27 8.22 8.18 8.03 8.03 8.01

15 16 17 18 19 20 21 22 23 24 25 26 27 28

Ireland New Zealand Belgium South Korea France Israel Japan Taiwan Spain Italy Portugal Estonia Slovenia Greece

7.98 7.82 7.71 7.66 7.61 7.45 7.42 7.13 7.08 6.95 6.90 6.32 6.22 6.19

Source: Economist Intelligence Unit 2005: 6–7.

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Table 2.7 E-readiness rankings, by category, 2005 Category weight Connectivity Business environment Consumer and business adoption Legal and policy environment Social and cultural environment Supporting e-services Overall score Overall rank among 65 countries surveyed

0.25 0.20 0.20 0.15 0.15 0.05 1.00

US 7.65 8.57 9.80 8.41 9.20 10.00 8.73 2

Germany Japan 6.40 8.23 9.10 8.09 8.60 9.25 8.03 12

6.90 7.34 8.00 7.27 7.60 8.00 7.42 21

Source: Economist Intelligence Unit 2005: 5, 22–3.

The political reasons for weak pro-competitive regulation In comparing Japan to the United States and Germany, the most striking difference is Japan’s lack of organizations that routinely help the telecommunications regulator promote competition. The courts play no role and the JFTC intervenes very little. NTT and its labour union have been much more effective at keeping regulators at bay than either AT&T or Deutsche Telekom. Why? Are things likely to change? It is often said that the reason procompetitive policy in Japan does not go forward is because of the opposition of powerful interest groups. We certainly can see this effect in the case of Japanese telecommunications. But German and American reformers also faced determined opposition from incumbent firms and unions. In the case of the United States, this was overcome due to a new consensus that developed among economists in the 1970s against regulation (Derthick and Quirk 1985). What made it possible was the fact that antitrust law was well established and the court, agreeing with the economists’ new consensus, was able to intervene and order the break up of AT&T in 1982. The political explanation for why the court was able to do this goes back to the populist antitrust movement that led to the 1890 Sherman Act (Freyer 1992). In no other country did a grass-roots political movement lead to the creation of a national antitrust policy. The political thinking in the United States that served as the foundation of the antitrust movement was the opposition to the concentration of power from the time of the revolution against the British Crown. The antitrust movement was based on political opposition to the concentration of power, rather than on ideas about the efficiency of competitive markets. In the case of American telecommunications regulation, existing ideas and institutions provide a repertoire from which contemporary political actors can draw inspiration and political support for new policies. The same populism that drove the antitrust movement also supported a regulatory

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movement that created regulated prices and monopolies in the 1920s for a wide range of public utilities, such as telecommunications, electric power and transportation. The antitrust legal doctrines that developed from the populist antitrust movement then gave economists and politicians sources to take the opposite approach to breaking up AT&T’s monopoly in the 1970s and 1980s. Thus, US telecommunications policy is path dependent, as can be seen in the different paths taken by US policy compared to that of Japan and Germany, although the same path has led to different outcomes at different times. Germany was slow to break up its telecommunications monopoly. In that country there were two sources of change. The first was learning from abroad, as the thinking and experience of the United States and the United Kingdom changed minds in Germany about telecommunications regulation. This, however, did not directly lead to change. The second source of change was the drive from within the EU to create a unified market. This drive itself did not quickly result in tough, pro-competitive regulatory policy, nor was it by any means solely responsible for the change. But the framework of the EU created an arena within which European nations could negotiate the ‘mutual disarmament’ of their national telecommunications monopolies. Each state could agree to break up its monopoly, knowing that while they would open their own national markets to competition they would gain access to other national markets (Thatcher 2002). EU regulatory institutions gave assurance that market access would be real. Looking back further, the roots of the EU, similar to the American antitrust movement, come from non-economic political motives – an anti-nationalist drive to prevent war from reoccurring. While it is true that the push to integrate the European economy in the 1980s and 1990s had strong economic motivation, the political framework within which it was possible was created for noneconomic reasons. In industries with large economies of scale, of which network-based industries such as telecommunications are good examples, two powerful forces can block pro-competitive regulatory reform: (1) the political power of established firms with market power, such as AT&T, Deutsche Telekom or NTT and (2) nationalism, which supports defending national champions against foreign competitors. Against these anti-competitive forces, ideas favouring competition for the sake of efficiency are in themselves not very powerful. In the case of the United States and Germany, as well as the EU more generally, liberal economic ideas alone do not explain the choice to move to pro-competitive regulation. Instead, non-economic ideas about political power provide the deep roots of institutions that promote competition: in the United States the populist roots of antitrust and in Germany (and Europe more broadly) the anti-nationalist, anti-war roots of the EU. In Japan there is no comparable history of powerful, non-economic motives for creating competition policy. While some economists and some political leaders espouse liberal economic ideas, there are no powerful political

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movements or enforcement organizations to make these a reality. Antitrust in Japan was imposed from outside and has been met with suspicion (Tilton 1996). When, during the 1989–91 Structural Impediments Initiative (SII), the United States put pressure on Japan to adopt a stronger antitrust policy, there was powerful opposition to change, principally from the main Japanese big business organization, the Keidanren (Schoppa 1997). Nevertheless, the Japanese Diet did increase penalties to a modest extent under the Antimonopoly Law at that time and approved a gradual increase in the staff and budget at the JFTC. In 2003, the JFTC floated a new proposal to strengthen the Antimonopoly Law, but again was met with stiff opposition from NTT, the MIC, METI and especially from the Keidanren and the construction industry. The principal forces favouring the reform are the JFTC itself and Prime Minister Koizumi. Remarkably, some rank-and-file LDP members, especially junior members, also supported the revisions and opposed both the Keidanren and the construction industry (Nihon Keizai Shimbun 2004). In October 2004, the LDP agreed to increase penalty levels and to carry out further reforms of the Antimonopoly Law at a later time, although the increased penalties were not actually enacted. In April 2005 the Diet did pass a bill to increase penalties under the Antimonopoly Law, and perhaps the JFTC may begin to act more aggressively in the area of telecommunications and communications technology. In the past, the JFTC was constrained by LDP threats to take away JFTC funding and powers if it aggressively enforced the Antimonopoly Law (Beeman 2002). Yet tougher penalties combined with enthusiastic support from a large block of LDP diet members could translate into a significant change in Japanese competition policy. Again, learning and change have happened in Japan, but they have been constrained and shaped by established ideas and institutions. Radical liberal ideas about challenging national champions with competition are not easily introduced anywhere. In the United States and in Germany they required the support of non-economic political campaigns. This new, nearly successful initiative by the JFTC represents a political change in Japan, but this political change is weak and gradual compared to the tremendous increase in antitrust enforcement in Europe. The major challenge confronting Japan is how to raise the prestige, resources and political power of the JFTC to a level sufficient for it to intervene effectively in the ICT sector.

The Future of e-Japan The result of Japan’s use of high prices for telecommunications is that NTT has had a reliable source of funding for developing mobile telephony, and Japan is widely regarded as a leader in this technology, as can be seen in Figure 2.1. But high telecommunications prices held back Japan’s early development of Internet technologies, and industrial policy has not produced much success in computers or computer software.

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37

Figure 2.1 International comparison of superiority in information and communications technologies Source: MIC 2003:10. Note: The figure shows the results of a survey of researchers in Japan and other countries as to which country or region was superior in each of the above information and communications technologies.

Japan still lags behind in many IT sectors, especially software, Internetand content-related businesses. In the early 1960s, Japan’s industrial policy for developing the computer industry began with regulating players and selecting the keiretsu-based, large electronics companies to be players in the industry. Because of successful results in the mainframe hardware sector, institutional inertia has held back further development of the computer industry and the national effort to become an IT superpower in the PC era. Japan’s developmentalist policies, while good at catching up, are holding it back in new fields. While Japan’s deft, differential pricing for access to NTT’s network has made rapid expansion of Internet access possible while simultaneously keeping NTT employees on the payroll, Japan may be missing out on other opportunities due to high telecommunications prices. Much of the success of Japan’s economy is based on the quickness of Japanese firms to learn from other countries. Japanese firms in electronics and other fields were able to ‘reverse engineer’ new technologies created abroad, make successful incremental improvements and produce goods efficiently. Marie Anchordoguy (2001) argues that Japan’s economy has slumped because it is no longer possible to maintain high growth rates based merely on incremental improvements on new technologies from abroad. On the other hand, Kozo Yamamura (2003) argues that as information technology passes its period of rapid innovation, Japan’s (and Germany’s) ability to learn radically new technologies from other countries and then improve on them will stand them in good stead. The jury is still out as to whether this will work for Japan in the computer and telecommunications sector.

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Notes 1 2 3

A digital subscriber line connects a subscriber to the Internet over copper telephone wires without interfering with voice telephone calls. Calculations are based on Japan Electronic Company Ltd (various dates) and appendixes in Anchordoguy 1989. Even a modest volume of foreign goods sold into the Japanese market can do a lot to encourage price competition. When Daiei, a supermarket retailer, decided in 1994 to import Dutch beer, domestic beer prices also dropped by one-third. The liberalization of petrol imports in 1996 reduced prices by a quarter.

Bibliography Advanced Information and Telecommunication Society Promotion Headquarters (2001) Basic Law on the Formation of an Advanced Information and Telecommunications Network Society, The Japanese Law no.144 of 2000, accessed at www. kantei.go.jp/foreign/policy/it/index_e.html. Anchordoguy, M. (1989) Computers Inc.: Japan’s challenge to IBM, Cambridge MA: Council on East Asian Studies, distributed by Harvard University Press. Anchordoguy, M. (2001) Whatever Happened to the Japanese Miracle?, Japan Policy Research Institute Working Paper 80: 1–6. Beeman, M. L. (2002) Public Policy and Economic Competition in Japan: change and continuity in antimonopoly policy, 1973–1995, Japanese studies series, The Nissan Institute/Routledge, London and New York: Routledge. Callon, S. (1995) Divided Sun: MITI and the breakdown of Japanese high-tech industrial policy, 1975–1993, Stanford CA: Stanford University Press. Derthick, M. and Quirk, P. J. (1985) The Politics of Deregulation, Washington DC: The Brookings Institution. Economist Intelligence Unit (2005) The 2005 E-readiness Rankings, White Paper, Economist Intelligence Unit, accessed at http://graphics.eiu.com/files/ad_pdfs/ 2005Ereadiness_Ranking_WP.pdf on 12 October 2005, pp. 6–7. Edwards, B. (1999) ‘Brace yourselves’, The Economist 353 (8147), November 27: 5–7. Egan, Edmund A. (1996) The Era of Microsoft? Technological Innovation, Network Externalities, and the Seattle Factor in the US Software Industry, BRIE Working Paper 87, Berkeley CA: Berkeley Roundtable on the International Economy. European Travel Commission (2005) New Media Review, accessed at www.etcnewmedia.com/review/default.asp?SectionID=10&OverviewID=8 on 8 October 2005. Fransman, M. (1995) Japan’s Computer and Communications Industry: the evolution of industrial giants and global competitiveness, Oxford and New York: Oxford University Press. Freyer, T. (1992) Regulating Big Business: antitrust in Great Britain and America, 1880–1990, Cambridge: Cambridge University Press. Fujiwara, H. (1995) Kono Gyo¯kai no Okite! (The Way the [Computer] Industry Really Works!), Tokyo: Gijutsu Hyo¯ronsha Co. Gevel, A. J. W. van de (1997) Wintelism and Production Networks in the Electronics Industry, Research Memorandum 750, Tilburg, Netherlands: Economics and Business Administration, Tilburg University. Hadley, E. M. (1970) Antitrust in Japan, Princeton NJ: Princeton University Press.

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Haley, J. O. (2001) Antitrust in Germany and Japan: the first fifty years, 1947–1998, Asian law series, vol. 16, Seattle WA: University of Washington Press. Ipsos-Reid (2002) Internet Use Continues to Climb in Most Markets, 10 December, accessed at http://stat.nca.or.kr/news/files/ipsos-raid2.pdf on 20 October 2003. Ipsos-Reid (2004) Ipsos News Center Report, accessed at www.etcnewmedia.com/ review/default.asp?SectionID=10 on 8 October 2005. IT Strategy Headquarters (2001a) ‘e-Japan Strategy’, available at www.kantei. go.jp/foreign/policy/it/index_e.html. IT Strategy Headquarters (2001b) ‘e-Japan Priority Policy Program’, available at www.kantei.go.jp/foreign/policy/it/index_e.html. Japan Electronic Computer Company (various issues) JECC Kompyûta No¯to (Computer Notes), Tokyo: Japan Electronic Computer Company. Japan Times (2003) ‘Telecoms to sue government over NTT’s fee hike’, Japan Times, 11 July. Jiji Press Ticker Service (2004) ‘NTT group’s interconnection fee revenue rises in FY “03”’, Jiji Press Ticker Service, 30 July. Jiji Tsûshin Kigyo¯ Nyûsu (2004) ‘Shindenden e no kashidashi gimu teppai o, kotei denwa no shinai tsûshin mo¯ NTT Higashi Nishi ikensho’ (NTT East and West call for scrapping mandatory leasing of NTT’s lines for local fixed service to new common carriers), Jiji Tsûshin Kigyo¯ Nyûsu, 27 August. JISA (Japan Information Technology Service Industry Association) (2001) Report on Software Export & Import Statistics: FY2000 Result, 2001, Tokyo: Japan Information Technology Service Industry Association. Kawabata, E. (2001) ‘Sanction power, jurisdiction, and economic policy-making: explaining contemporary telecommunications policy in Japan’, Governance 14 (4): 399–427. MIC (Ministry of Internal Affairs and Communications) (2003) Information and Communication in Japan, White Paper, Tokyo: Ministry of Internal Affairs and Communications, p. 10. Ministry of Public Management, Home Affairs, Posts and Telecommunications (2001) Recent Regulatory and Policy Development in Japan, presented to the APEC Telecommunications and Information Working Group. Tokyo: Ministry of Public Management. Nielsen-NetRatings Co. (2001) Quarterly Global Internet Trends Report (Q2 2001), August, accessed at www.nielsen-netratings.com on 24 March 2002. Nihon Keizai Shimbun (2004) ‘Skirmish over amending AMA rekindles’, Nihon Keizai Shimbun, 11 April: 5. Nikkei BP Asia (2002) ‘Nikkei Market Access’, Nikkei Electronic Asia, 8 April, accessed at http://neasia.nikkeibp.com. OECD (Organisation of Economic Co-operation and Development) (2000a) Internet Access Price Comparison 20 hour basket, accessed at www.oecd.org/dsti/sti/it/ cm/stats/isp-40hrs.htm on 17 October 2000. OECD (2000b) Internet Access Price Comparison 2000: 40 hour basket, accessed at www.oecd.org/dsti/sti/it/cm/stats/isp-40hrs.htm on 17 October. OECD (2003) Communications Outlook, Paris: OECD. OECD (2004) Benchmarking Broadband Prices in the OECD, Directorate for Science, Technology and Industry, Committee for Information, Computer and Communications Policy, Working Party on Telecommunication and Information Services Policies, Paris: OECD.

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OECD (2005) Communications Outlook, Paris: OECD. Point-topic.com (2003) ‘Japan: broadband overview’, 8 April, accessed at www.pointtopic.com. Point-topic.com (2005) ‘World DSL lines close in on 100m in 2004’, 10 March, accessed at www.point-topic.com/content/dslanalysis/Q404DSLana050310.htm. Reuters (2000) ‘Internet fever spurs PC sales in Japan’, 9 February, accessed at http://today.reuters.com/news. Rohlfs, J. H. and Sidak, J. G. (2002) ‘Exporting telecommunications regulation: the US–Japan negotiations on interconnection pricing’, Harvard International Law Journal, 43 (2): 317–60. Schoppa, L. J. (1997) Bargaining with Japan: what American pressure can and cannot do, New York: Columbia University Press. Scuka, D. (2000) ‘Unwired: Japan has the future in its pocket’, J@pan, Inc., accessed at www/japaninc.net on 25 June 2002. Seifu Kisei Nado to Kyo¯so¯ Seisaku ni Kansuru Kenkyûkai (2002) Denkitsûshin Bunya no Seido Kaikaku Oyobi Kyo¯so¯ Seisaku no Arikata (Competition Policy and Systemic Reform in the Field of Telecommunications), Tokyo: Seifu Kisei Nado to Kyo¯so¯ Seisaku ni Kansuru Kenkyûkai (Study Group on Government Regulations and Competition Policy). Shimoda, H. (1984) IBM to no 10-Nen Senso¯ (The Ten-Year War against IBM), Kyoto: PHP Kenkyûjo. Thatcher, M. (2002) ‘The relationship between national and European regulation of telecommunications’, in Jordana, Jacint (ed.) Governing Telecommunications and the New Information Society in Europe, Cheltenham and Northampton MA: Edward Elgar, pp. 66–85. Tilton, M. (1996) Restrained Trade: cartels in Japan’s basic materials industries, Ithaca NY: Cornell University Press. Tilton, M. (2003a) Interview with JFTC official, July. Tilton, M. (2003b) Interview with official at new common carrier firm, July. Tilton, M. (2003c) Interview with US State Department official in Tokyo, July. Vogel, S. K. (2000) Creating Competition in Japan’s Telecommunications Market, Japan Information Access Project. Working Paper. Washington DC: Japan Information Access Project. West, J. and Dedrick, J. (2000) ‘Innovation and control in standards architectures: the rise and falls of Japan’s PC-98’, Information Systems Research, 11 (2): 197–216. Yamamura, K. (2003) ‘Germany and Japan in a New Phase of Capitalism: confronting the past and the future’, in Yamamura, K. and Streeck, W. (eds) The End of Diversity? Prospects for German and Japanese Capitalism, Cornell Studies in Political Economy, Ithaca NY: Cornell University Press. Zaikai (2003) ‘KDDI nado shin denden go sha ga “NTT no setsuzoku ryo¯ o sagero” to so¯musho o teisho¯’ (KDDI and four other new common carriers sue MPHPT to get it to lower NTT’s interconnection rates), Zaikai, August: 66–70.

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Institutional framework and competitiveness of the US telecommunications market Michael Schefczyk

Introduction While information and communications technology (ICT) has been characterized as having the potential to foster economic development, it has also been portrayed as having the ability to advance political freedom and democracy, human rights, a more acceptable distribution of wealth and social mobility.1 In order to better address the parameters of an institutional framework on the nation level that can support and encourage ICT development, the purpose of this paper is to: • • •

briefly put the US, Japanese and German telecommunications markets in perspective; provide an overview of the development of the regulatory framework in the United States with an emphasis on the Telecommunications Act of 1996; and analyse aggregate statistics to verify broad consequences of regulation on competition in the United States.

Thus, in the next three sections I address the three purposes listed above in a stepwise fashion, and in the final section I summarize a few conclusions that may be drawn from the analysis.

The telecommunications markets in the United States, Japan and Germany in perspective The telecommunications markets in the United States, Japan and Germany are characterized by quite different circumstances. One important factor is population size and density as a proxy for number of customers and customer density, which ideally should also reflect business customers. Operating in a large and densely populated country is advantageous for network operators as well as equipment manufacturers and content providers, as fixed costs (e.g. regulation, standardization, branding and corporate management) can be better distributed across a larger number of customers. Density, in

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particular, can contribute to the economics of an access network, as larger switches and shorter lines, including shorter long-distance lines, can be employed. Figure 3.1 compares the United States, Japan and Germany with respect to such basic indicators. We see that the US market is two to three times larger than the telecommunications markets in Japan and Germany respectively. On the other hand, the population density in the United States is less than a tenth of the density in Japan and less than a seventh of the density prevailing in Germany. Thus, metropolitan areas provide a better basis for comparison when it comes to telecommunications market issues across countries. Across these three markets, the number of telephone subscriptions per 100 inhabitants ranges between 115 and 145, indicating that many residents hold multiple lines (e.g. ISDN in Germany). These figures are by far above the global average of 40 lines per 100 inhabitants. The picture for mobile telecommunications in these three countries is very similar, as Figure 3.2 indicates. Differences in market size are to some degree compensated by the number of subscribers per 100 inhabitants, which is lower in the larger US market at 54 than in Japan and Germany (68 and 79 respectively), cumulating in 158, 86 and 65 million subscribers respectively. The smaller markets experienced a later but also a substantially steeper period of growth. Between 1998 and 2003, average annual growth 338 292

231

127 83 31

USA

Japan

Germany

116

119

144

Population (millions)

Population Density (Inhabitants per km?)

Telephone Subscribers per 100 Inhabitants (World average: 40)

Figure 3.1 Basic indicators, USA, Japan and Germany, 2003 Source: ITU ‘Basic Indicators’.

Institutional framework and competitiveness, US 1111 2 3 4 5111 6 7 8 9 1011 1 2 3111 4 5 6 7 8 9 20111 1 2 3 4 5111 6 7 8 9 30111 1 2 3 4 5 6 7 8 9 40111 1 2 3 44 45111

43

158

+18 % p.a. 86 +13 % p.a.

69

65

47

+36 % p.a. 14

1995

USA

2003

1995 Japan 2003

1995 Germany 2003

68

79

54

Cellular Cellular Mobile Mobile Subscribers Subscribers (millions) (millions) 1995

2003

Cellular Mobile Subscribers per 100 Inhabitants (World average: 22)

Figure 3.2 Mobile indicators, USA, Japan and Germany, 1995 and 2003 Source: ITU ‘Cellular Subscribers’.

rates ranged from 13 per cent in Japan to 18 per cent in the United States up to 36 per cent in Germany. Subscriber density indicates, however, that future growth potential remains the highest in the United States.2 The relatively slow development of the telecommunications market in the United States can mostly be attributed to the late introduction of digital cellular telephony and to the larger number of regional network operators, which limited the use of cellular telephones and maximized less customerfriendly roaming charges.3 The situation in Internet and personal computer penetration shown in Figure 3.3 differs significantly from fixed and mobile telephony. At 66 PCs per 100 inhabitants, the United States is far ahead of Japan and Germany, both at around 40 PCs per 100 inhabitants. Internet connections vary less, but the United States still leads with 55 Internet users per 100 inhabitants over 45 to 50 in Japan and Germany.4 In each market, only 10 to 15 per cent of residential Internet users employ a broadband connection instead of dial-up access up to ISDN speed. In terms of broadband Internet technology, access based on cable TV leads in the United States with a share of 57 per cent of all connections, while the telephone network based digital subscriber line is the leading technology in Japan (72 per cent) and the dominating technology in Germany (96 per cent). Slower development

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Michael Schefczyk 66 55 47

45

43 38

7

6

4

USA

Japan

Germany

Cable (57 %)

DSL (72 %)

DSL (96 %)

Internet Users per 100 Inhabitants Narrowband Broadband PCs per 100 Inhabitants

Leading Broadband Technology

Figure 3.3 Internet indicators, USA, Japan and Germany, 2003 Source: ITU ‘Internet Indicators’, FCC.

in Germany is usually attributed to Deutsche Telekom’s grip on both (local) telephony and cable TV, at least until some of the cable TV infrastructure was divested in the late 1990s, as well as on its dominance in the wholesale broadband Internet access market.

Regulatory framework in the United States The development of telecommunications regulation in the United States can be divided into five phases, as illustrated in Figure 3.4.5 The first phase, between 1877 and 1956, was characterized by a shift from an initially unregulated situation towards regulation and then a movement back in the opposite direction to partial liberalization and deregulation. The award of the Bell patent on voice telephony in 1877 marked the beginning of this phase. Prior to the Bell patent, telegraphy established by Western Union was in a quasi-monopolistic situation. Voice telephony, promoted by a system originating with Bell Operating Companies (BOCs), became a competitor to telegraphy and particularly to Western Union, which itself was seeking to enter the telephone market. Substitution was managed via a settlement between Western Union and the Bell System. Subsequently, American Telegraph & Telephone (AT&T) was founded as a long-distance carrier

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in 1889 to connect regional BOCs. Its monopolistic structures were far reaching. For example, proprietary telephone equipment developed by Western Electric, a predecessor to Bell Labs and acquired from Western Union, grew to dominate the entire telephony market, including local telephony and customer premise equipment. Competition in local telephony had increased after the expiration of Bell’s patents in 1893–94. Shortly thereafter, however, beginning approximately in 1907, competition in local telephone markets was reduced due to the growing importance of longdistance connections provided by AT&T. As a consequence, many competitors, except for less attractive rural carriers, were absorbed by the Bell System. Excesses during the Great Depression led to regulation of the telephone industry from 1929 onwards. Public utilities commissions served as regulators of the telephony industry on a state level parallel to regulating energy and water providers. The US Department of Justice first aimed to reduce the power of AT&T via a lawsuit in 1949. Seven years later the litigation was settled based on the agreement that AT&T would not enter into the computer market but would merely continue to develop and manufacture telephone equipment. The second phase from 1956 to 1971 and designated as ‘toward managed competition’ led to the first step-wise deregulation of some of the segments of the telecommunications market. First, customer premise equipment was deregulated in two steps in 1956 and 1968 based on conformity to published standards. In the meantime, microwave operators were licensed from 1959 onwards, which initiated some competition in long-distance and regional transport. The second phase created the ground for further deregulation in the following phase. First, the data transmission market was gradually deregulated between 1971 and 1980, beginning with corporate networks and eventually allowing multiple competitors to provide public network access. Second, between 1971 and 1977, long-distance carriers were licensed to compete with AT&T on a call-by-call basis when customers dialled a prefix number, which eventually led to the founding of firms such as MCI and US Sprint. Pre-selection was introduced later in this process, and until the early 1990s, even large corporate customers were able to reach longdistance carriers only via regional BOCs. The third phase, between 1971 and 1982, can be characterized as ‘managed competition’, as some competition did exist in the long-distance market while the telephony market at large remained dominated by AT&T across all segments. Parallel to long-distance telephony, satellite telecommunications operators were licensed in 1971, inducing international consortia of publicsector operators, in particular, to pool their satellite operations. In 1973, value-added services were deregulated to allow, for example, third-party directory providers to begin operations. Resale and infrastructure sharing was legalized in 1976 to enable firms to buy larger volumes of telecommunications services in order to resell them in smaller volumes without becoming a network operator. Finally, AT&T long-distance and seven Regional Bell

• Data transmission market deregulated 1971 – 1980

• Long distance carriers licensed 1971 – 1977

• AT&T founded as a long distance carrier 1889

• Great Depression and regulation via public utilities commissions 1929

Figure 3.4 Five phases of US telecommunications regulation

Major deregulation in five areas

1996-…

• Separation of AT&T long distance and Regional Bell Operating Companies 1982

• Liberalization of telephony vs. cable TV separation 1992

• Competitive Access Providers licensed 1991

• Price cap regulation 1989

• Value-added services deregulated 1973 • Resale and infrastructure sharing legalized 1976

• Open network architecture liberalization 1986

1982 – 1996 Toward Local Competition

• Satellite telecommunications licensed 1971

1971 – 1982 Managed Competition

Bitte in dieser Abbildung wie folgt korrigieren:

Source:***

• Microwave operators licensed 1959

• Customer premise equipment monopoly deregulated 1956, 1968

1956 –1971 Toward ManagedCompetition

• System of Bell Operating Companies established against Western Union (Telegraphy)

• Bell Patent 1877

1877 – 1956 Before Liberalization

BC

TEL

CATV

EQV

Telephony Equipment Cable TV Broadcasting Internet

WWW

– – – – –

• Major deregulation in five areas:

1996 – … Post 1996 Telecommunications Act

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Operating Companies (RBOCs) were separated in a settlement in 1982 (the ‘modified final judgement’). This was the result of an antitrust lawsuit by the United States versus AT&T filed in 1974. The RBOCs were confined to local and regional telephone service within their territory. This landmark event ended the phase of managed competition. The fourth phase, between 1982 and 1996, can be called ‘toward local competition’. Local competition was enabled via the creation of the RBOCs as noted above. As a second step, open network architectures were liberalized in 1986 to lay the ground for interconnection among competing local carriers. While the previous ‘management’ of competition had been based on setting a maximum return that licensed operators were allowed to achieve, price cap regulation was introduced in 1989 to link the price of various bundles of telecommunications services to a predefined development of prices in order to enforce efficiency gains. Since RBOCs took a gatekeeper position between end customers and long-distance carriers, competitive access providers (CAPs) were licensed from 1991 onwards to provide links to long-distance carriers for business customers and in such a way were able to bypass traditional RBOCs. Competitive access was important and successful because the actual cost of providing access to a long-distance carrier was approximately 0.2 cents per minute, while regulated access charges averaged at about 2 cents per minute for both the origination and the termination of a call. In 1992, the requirement to keep telephony and cable TV separate was also relaxed, enabling telephone and cable TV network operators to branch out into each other’s respective market. The fifth phase began with the Telecommunications Act of 1996. The Telecommunications Act advanced deregulation in five areas – telephony, equipment, cable TV, broadcasting and the Internet – and led to the key rules described below.6 The Telecommunications Act of 1996 aimed to reduce barriers to entry and increase competition. To achieve these goals, the Act relied on non-discriminatory access via handing over traffic among interconnected networks and via access to unbundled parts of telecommunications networks on a long-term, incremental cost basis. In many ways, the Telecommunications Act aims to abolish cross-subsidies among different products and different types of customers. Nevertheless, ‘universal service’ obligations were imposed at least upon larger carriers to ensure broad availability of basic services.7 To meet universal service obligation, a transparent and competitively neutral system of cross-subsidization was created via universal service funds. Rules on telephone service Based on the Telecommunications Act of 1996, RBOCs were finally allowed to offer long-distance service outside their own region and – after meeting certain requirements – also within their own region. The requirements focus on permitting local competition and abstaining from

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cross-subsidizing different services in order to provide a level playing field for competitors in the region. Furthermore, access and interconnection became mandatory for all local carriers far beyond the standards of the open network architecture liberalization enacted ten years before. Requirements were created to negotiate agreements for interconnection, resale, number portability, dialling parity, access to rights-of-way and reciprocal compensation. In addition, the incumbent local carrier is required to provide non-discriminatory, unbundled access as well as resale at ‘wholesale’ rates to competitors, and disclose certain information. Exceptions are allowed for small and rural carriers because the US government perceived a need to shield such carriers from competition. Universal service obligations are maintained to guarantee availability of standard services at set prices in rural and high-cost areas. Within the universal service regime, reduced prices for low-income subscribers, schools, libraries and rural health-care providers, as well as infrastructure sharing among certain carriers are required. Eligible carriers fulfilling universal service obligations are compensated via a universal service fund. This fund effectively cross-subsidizes customers benefiting from universal service by drawing on mainstream customers. Rules on telecommunications equipment RBOCs were allowed to manufacture telephone equipment once they met the prerequisite of providing out-of-region, long-distance service provision, i.e. once they enabled an effective framework for competition. Crosssubsidization with telephone operations is prohibited and monitored by the Federal Communications Commission (FCC). As a measure of preventing cross-subsidization and breaking other non-discrimination safeguards, equipment manufacturing needed to be performed in ‘separate affiliates’ for three years. Furthermore, technical information and standards for customer premise had to be opened to all competitors as well as the research and development community. Bell Core, the traditional developer of AT&T telecommunications equipment, was prohibited from manufacturing equipment. Similar ‘separate affiliate’ requirements were introduced to enforce restrictions against joint marketing of local telephone and electronic publishing services. Rules on cable TV Rules capping cable TV rates were removed in a stepwise process. In 1996, price caps were removed for small cable operators in the case of effective competition by a telephone company that had entered the cable TV market. By 1999, remaining price caps were further reduced to the ‘basic tier’ of cable programming.

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In addition to competition across market segments traditionally kept separate, the possibility of cross-ownership of telephone and cable TV network operation was also further liberalized. A telephone company may now own more than 10 per cent of the shares of a cable TV company – or vice versa – under the following circumstances: • •

in cable TV markets of up to 35,000 inhabitants if the cable TV company serves less than 10 per cent of the households in the telephone company’s overall service area; and in cable TV markets of more than 35,000 inhabitants but one that is not among the top 25 markets nationwide served by multiple cable TV companies. The latter are subject to further restrictions.

The aim of this regulation is to prevent a telephone operator from acquiring a cable TV operator predominantly for the purpose of reducing competition. To compete directly with cable TV operators, telephone operators were permitted to run ‘open video systems’ where at least two-thirds of the content is provided by unaffiliated programmers. This is to guarantee that no single owner can control the entire value chain from programming down to distribution, which includes both cable TV and telephony. Furthermore, cable TV set top boxes were unbundled from cable TV operations, both in terms of technology used as well as in terms of retail availability. This rule was created to reduce switching costs for consumers and thus to increase competition. Rules on radio and TV broadcasting As far as the media was concerned, concentration limits were relaxed but not eliminated. Basically, any one company may own TV stations that reach up to 35 per cent of the national TV audience. This figure is up from a limit of 25 per cent prior to the Telecommunications Act. TV broadcast networks were allowed to own cable TV systems, but no network is allowed to acquire another network. Broadcasters were also allowed to temporarily use new spectrum for advanced TV services (such as High Definition TV) on the condition that these frequencies are either purchased or returned once the transition to digital TV broadcasting is completed. All nationwide limits on radio station ownership were repealed, and local limitations on radio station concentration were amended. Rules on Internet, online computer services and miscellaneous regulations Rules on Internet and online services in the United States focus on the prevention of use deemed to be inappropriate. In particular, unlawful use

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Michael Schefczyk

of a computer or any other telecommunications device to transmit obscene material with the intention to annoy, abuse, threaten or harass another person or to transmit indecent material to a minor is prohibited. Such regulation is directed against the user or the sender of the information, and not against the network operator unless the operator knowingly or intentionally permits a facility under its control to be used for prohibited purposes. RBOCs (except for Ameritech) were prohibited from entering the alarm monitoring business until 2001, as this was felt to create an uneven playing field. As public pay telephones are frequently used for long-distance calls, calling card access to long-distance carriers provided no compensation to operators of pay telephones. Thus FCC was required to develop a plan to compensate pay telephone owners for long-distance calls placed. Regulation of direct broadcast satellite services was concentrated at the FCC. Furthermore, the FCC was authorized to relax tariff and rate regulation on competitive carriers who have little market power.

Development of competition in the United States When we consider the fact that telecommunications network access is still fixed, we find a remarkable level of competition after the passage of the Telecommunications Act. Competition was largely enabled by the effective regulation of access to unbundled network elements. Figure 3.5 illustrates the development between 1999 and 2002. The overall share of fixed-access lines provided by competitors (i.e. not by incumbent operators such as RBOCs or traditional rural or small % of lines offered by Alternative carriers

13.2

10.3 9.8

7.7

7.5

5.0 4.3 2.8

2.1

26 % Competitor’s own infrastructure • declining due to inefficiencies if infrastructure already exits

2.2

2.5

1.8

55 % Offers based on unbundled access • increasing due to efficient regulatory regime • relatively attractive for competitor as well as incumbent

19 % Resale • declining due to lack of control by competitive carrier

1999

2000

2001

2002

41 %

45 %

48 %

58 %

Residential and small business customers

Figure 3.5 Fixed-access competition, US Source: FCC ‘Trends in Telephone Services’.

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operators), grew from 4 per cent in 1999 to 13 per cent by the end of 2002. While approximately 19 per cent of such access is provided by resale, the overall percentage of lines attributable to resellers remained relatively low at 2 to 3 per cent. This is largely due to the fact that competing carriers lack control over the lines they are reselling. Some 26 per cent of competitive access is provided based on the competitors’ own infrastructure. While this segment grew, it did not grow proportionately, since inefficiencies generally result from the fact that already existing infrastructure is no longer being used. The largest segment and also the segment experiencing the strongest growth rates is the one that offers services based on unbundled access, such as the leasing of existing access lines from incumbent carriers. Since its regulatory regime is quite efficient and since it is relatively attractive for the competitor as well as for the incumbent, 55 per cent of the competition takes place in this manner. The competitor retains relatively strong control over customer relationships while at the same time minimizing investments. The incumbent can at least partly avoid idle infrastructure and can – depending on the price level permissible under the regulatory regime – collect relatively attractive revenues via infrastructure leasing contracts with competitors. The situation in local telephony is shown in Figure 3.6. The local exchange market has been declining since 1988 due to price cap regulation, which puts pressure on achieving efficiency gains and causing them to at least partly be passed on to customers. Traditional ‘rate of return’ regulations in monopolistic times enabled carriers to maintain inefficiencies and overheads since, to the extent these were accepted by regulators, they would tend to harm customers but not shareholders. One of the major consequences of the 1996 Telecommunications Act was to increase competitive pressure on RBOCs, and even more so on other Revenues in billion US$ 16 14 12

Competitive Local Exchange Carriers 1984 0% 1996 0% 2001 33 %

10 8

Other incumbent carriers 1984 27 % 1996 29 % 2001 8%

6 4 2

1984

1986

1988

1990

1992

1994

1996

1998

2000 2001

Figure 3.6 Market share of local exchange carriers, US Source: FCC ‘Trends in Telephone Service’.

Regional Bell Operating Companies 1984 73 % 1996 71 % 2001 59 %

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incumbent carriers, such as rural and small operators. These other carriers have been necessary in order to ensure telecommunications access to otherwise underserved areas but they have nevertheless been frequently less customer friendly because they have been able to demand high prices. While the Telecommunications Act of 1996 included a few measures to shield these carriers from full competition (e.g. via exceptions on interconnection, resale and number portability requirements), innovative competitors frequently took advantage of opportunities to enter even these rural market segments. By 2001, new, competitive local exchange carriers had secured one-third of the local exchange market. Initially focusing on the business customer market similar to the strategy employed by the archetypal competitive access providers, they began to turn towards smaller customers over time. As the percentage figures at the bottom of Figure 3.5 show, the fraction of lines supplied by these new carriers to residential and small business customers grew from 41 per cent in 1999 to 58 per cent in 2002. Moreover, research has demonstrated that reasonably low interconnection prices offered by incumbent local exchange carriers (ILEC) are usually beneficial for both the competitor and the incumbent. In particular, relatively low interconnection prices contributed to an increase in fibre-optic and digital network deployment.8 The picture differs substantially in the long-distance telephony market, as shown in Figure 3.7. While AT&T’s market share declined from 90 per cent in 1984, two years after the break-up of AT&T and the RBOCs, to 37 per cent in 2001, AT&T revenues from long-distance services remained constant for the most part. Traditional competitors such as MCI and US Sprint increased their sales and market share until they reached a peak in 1999, thereafter experiencing a slight decline along with AT&T. The winners Revenues in billion US$ 100 Other Carriers 1984 3% 1996 17 % 2001 30 %

80

US Sprint 1984 3% 1996 10 % 2001 9%

60

40

MCI 1984 1996 2001

4% 25 % 24 %

AT&T 1984 1996 2001

90 % 48 % 37 %

20

1984

1986

1988

1990

1992

1994

1996

1998

Figure 3.7 Market share of long-distance carriers, US Source: FCC ‘Trends in Telephone Service’.

2000 2001

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in the long-distance market from 1996 onwards were other carriers. Their collective share grew to 30 per cent, and while they also experienced decline, their decline in market share came in 2001, i.e. slightly later than that of AT&T, MCI and US Sprint. Due to the Telecommunications Act, the composition of the ‘other carriers’ segment shifted from a large number of smaller providers towards: (1) a group of infrastructure-based new competitors focusing in the business customer market, e.g. Qwest, Level 3 and Williams; (2) RBOCs offering long-distance services to customers in their own region as well as elsewhere; and (3) a large number of generally smaller resellers. Overall, deregulation has produced remarkable results since 1996, as up to one-third of the mainstream telephony service market is occupied by providers that were not active in the respective segment in 1996. This can be taken as an indication that choices have increased from a customer’s perspective, and that quality and prices will have improved accordingly. The fact that in 2001 only slightly more than 10 per cent of fixed access lines were operated by major competitors while competitive local exchange carriers collected 33 per cent of the revenue further indicates that competition for the best customers must have been particularly strong. The situation in high-speed Internet access is shown in Figure 3.8. The number of high-speed lines grew tremendously from 1.4 million in 1999 to 11.4 million in 2002. Lines with >200 kbit/s in at least one direction are classified as high-speed, while >200 kbit/s in both directions classifies a line as advanced. Unlike the situation in many other countries, the largest proportion of high-speed Internet access lines is implemented via cable TV networks. Cable TV-based Internet access offers a strong technical basis (73 per cent of lines are advanced), but is limited to residential and small business customers. Approximately 4.5 million lines were implemented along Lines (millions)

Advanced2)

11.4 Cable

73 %

100 %

DSL

43 %

85 %

Other3)

90 %

24 %

7.1 6.5

3.6 2.0

3.9

1.8

2.0

1.4 1.0 0.4 1999

1.5

2000

2001

2002

1) > 200 kbit/s in at least one direction 2) > 200 kbit/s in both directions

Figure 3.8 High-speed Internet, US Source: FCC ‘Trends in Telephone Service’.

3) traditional wireline (60 %), fiber (27 %), satellite/fixed wireless (13 %)

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Michael Schefczyk

the telephone network via the digital subscriber line (DSL) technology. The number of advanced lines are fewer but business customers do receive useful capabilities. Other technologies were used for two million high-speed lines, including traditional wireline leased lines, leased fibre lines, and satellite and fixed wireless access.9 Most of these lines qualify as advanced and the majority are implemented for business customers, which also reflects the higher costs associated with these technologies. In addition to increasing competition, then, we may say that deregulation after 1996 also fostered some innovation, albeit in a different direction from that taken in Japan and Germany, where high-speed residential Internet access tends to be based on the DSL technology.

Findings and conclusions The facts considered in this chapter support four conclusions. First, the US, Japanese and German telecommunications markets may be distinguished by: • • •

population density, with the US density a seventh and a tenth of Germany’s and Japan’s population density respectively; cellular penetration and digitization levels, with the United States at 30 per cent lower in penetration and 10 per cent lower in digitization; and Internet and PC penetration, with the United States 20 to 50 per cent higher in Internet and PC penetration than in Germany or Japan.

Second, until 1996, the regulatory framework in the US was characterized by a focus on: • • •

reducing barriers to market entry; keeping operators from serving multiple segments simultaneously, e.g. local and long-distance telephone; and using price cap regulation for incumbent carriers following traditional cost and rate-of-return-based regulation.

Third, in 1996 the regulatory framework in the United States was restructured to: • • •

allow operators to serve multiple segments simultaneously, e.g. local and long-distance telephony, customer premise equipment, cable TV and content; enforce strong access and interconnection rules; and move towards intervention regulation of prices and universal service obligations.

Fourth, results in terms of competition, price/productivity improvement and performance/quality have been strong:

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• • •

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in long-distance and local telephony; in high-speed Internet access; and in mobile telephony, but less obviously so.

Beyond conclusions based on descriptive statistics, a couple of key economic arguments should be discussed briefly. One of the most interesting debates surrounds the reappearance of cost-based regulation for unbundled access and interconnection after the cost and rate-of-return-based regulation of end customer prices was abolished in favour of price cap regulation. Cost and rate-of-return-based regulation was seen to lead to high investment and operating expenditures and thus ultimately to high end customer prices. According to some observers, however, the new regulation based on longrun, incremental costs for services provided among competing network operators is seen to cement high cost and price levels, while others maintain that it provides free options to competitors and leads to underinvestment.10 I note, however, that the analysis provided here takes a mid- to longterm perspective with a focus on telecommunications. From this viewpoint, innovation and deregulation are likely to appear in a more positive light than from a viewpoint that focuses on a broader perspective of ICT infrastructure in general or from the more common perspective circulating at the moment that focuses on short-term comparisons across nations.11 One approach from where fruitful research contributions can be is comparative sector-specific analyses that focus more on selected segments of customers across countries. However, this type of approach requires more detailed data than those currently provided by the FCC and similar national entities.

Notes 1 See Sein and Harindranath (2004: 19–20) for a more detailed conceptual framework. 2 See Banerjee and Ros (2004: 128–31) for the situation in different types of countries. Low and middle income countries are not covered here. The United States, Japan and Germany fall in a cluster with high telephone and cellular density but relatively low growth rates in fixed and mobile telephony. Growth rates are found to be higher in lower income countries. 3 For an analysis of the impact of the European GSM standard on the development of mobile telecommunications, see Mina (2003: 444–50). 4 See Chapter 2 by Tilton and Choi, and Chapter 5 by Storz in this volume. See also Davis (2003: 296–8) for an analysis of computer and Internet penetration and its association to websites, electronic purchases and electronic sales in Canada. 5 For a more detailed analysis, see Sarkar (2001: 39–114) and Huurdeman (2003: 85–600). For an overview of the regulatory framework in Germany, see Knieps (2003: 383–97). 6 See for example Pitz (1999: 45–80), Laffont and Tirole (2000: 18–29) and Economides (2003: 196–204). 7 See Schement and Forbes (2003: 234–47) for details on universal service.

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8 For a statistical analysis on the relationship between prices on the one hand and fibre-optic and digital network development on the other, see Chang et al. (2003: 679–88). 9 For a comparison of broadband access technologies with an emphasis on powerline see Tongia (2004: 569–76). 10 See Hausman (2001: 64) for one position. 11 See Chapter 6 by Frieden in this volume.

References Banerjee, A. and Ros, A. J. (2004) ‘Patterns in global fixed and mobile telecommunications development: a cluster analysis’, Telecommunications Policy, 28: 107–32. Chang, H., Koski, H. and Majumdar, S. K. (2003) ‘Regulation and investment behaviour in the telecommunications sector: policies and patterns in US and Europe’, Telecommunications Policy, 27: 677–99. Davis, T. (2003) ‘E-commerce measures and analysis’, Statistical Journal of the United Nations, 20: 289–301. Economides, N. (2003) ‘US Telecommunications Today’, in Brown, C. and Topi, H. (eds) I.S. Management Handbook, Boca Raton: Auerbach, pp. 191–212. Hausman, J. A. (2001) ‘Regulation by TSLRIC: economic effects on investment and innovation’, in Sidak, J. G., Engel, C. and Knieps, G. (eds) Competition and Regulation in Telecommunications: examining Germany and America. Boston MA: Kluwer, pp. 51–67. Huurdeman, A. A. (2003) The Worldwide History of Telecommunications, Hoboken: Wiley. Knieps, G. (2003) ‘Sector-specific regulation of German telecommunications’, in Madden, G. (ed.) World Telecommunications Markets: the international handbook of telecommunications economics, volume III, Cheltenham: Elgar, pp. 383–99. Laffont, J.-J. and Tirole, J. (2000) Competition in Telecommunications, Cambridge MA: MIT. Mina, A. (2003) ‘The creation of the European market for mobile telephony: overview of an instituted process’, International Review of Sociology, 13: 435–54. Pitz, D. (1999) Wettbewerb auf dem US-amerikanischen Telekommunikationsmarkt: Anbieterstrategien und Regulierungsphilosophie nach dem Telecommunications Act, Göttingen: Vandenhoeck & Ruprecht. Sarkar, R. S. (2001) Akteure, Interessen und Technologien in der Telekommunikation: USA und Deutschland im Vergleich, Frankfurt am Main: Campus. Schement, J. R. and Forbes, S. C. (2003) ‘Universal service in the information age’, in Madden, G. (ed.) Emerging Telecommunications Networks: the international handbook of telecommunications economics, volume II, Cheltenham: Elgar, 234–49. Sein, M. K. and Harindranath, G. (2004) ‘Conceptualizing the ICT artefact: toward understanding the role of ICT in national development’, Information Society, 20: 15–24. Tongia, R. (2004) ‘Can broadband over powerline carrier (PLC) compete? A technoeconomic analysis’, Telecommunications Policy, 28: 559–78.

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Information and communication technologies in Germany Is there a remaining role for sector-specific regulations? Günter Knieps

Introduction The role of government interventions and regulations has different traditions in the media, information technologies (IT) and telecommunications sectors. The media industry, for example, has traditionally been viewed as a bearer of social, cultural and ethical values within society. As such, the media has historically been subjected to federal regulation to some extent, e.g. public broadcasting. Federal intervention in private communication in most western, industrialized countries, on the other hand, has been largely absent, as it has generally been in the computer and IT industry as well. In Europe, the computer and IT industry has been allowed to develop in an unregulated manner for the most part under the general competition law. Moreover, despite the fact that the telecommunications sector is fully liberalized in Germany – as well as in all other European countries – it is still characterized by a complex set of sector-specific regulations today. These various degrees of government intervention may be challenged in the future, however, due to the convergence of the telecommunications, media and IT sectors.1 The increasing convergence of these three sectors gives rise to two different scenarios: (1) convergence may outpace existing sector-specific regimes; and (2) sector-specific regulation may be expanded to cover presently unregulated markets, such as mobile telephones and Internet services. Convergence raises the question as to how to achieve the proper balance of government intervention within a comprehensive, institutional framework that will allow markets as much freedom as possible. The same question can also be applied to a related topic. Recent developments towards deregulation and subsequent vertical disintegration of telecommunication networks have illuminated a number of problems associated with network access and network interconnection. In this context, the question revolves around the extent to which interconnection and access problems can be solved voluntarily by private market contracts between the parties involved, or whether government intervention, such as

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harmonization and integration policies set forth by the European Union (EU), becomes necessary. The basic idea behind a disaggregated approach to network regulation put forth in this chapter is to identify those parts of networks where market power remains and may be abused in the interconnection process. This chapter outlines the increasing vertical and horizontal interconnection problems within information and communication technologies (ICT) networks and the corresponding role of government intervention in this sector in a conceptual way. Several authors have raised questions along these lines with regard to the Internet. Mestmäcker (2001), for example, asks whether content will still be subject to regulation in the future considering the enormous scope of content production and distribution in the converging markets. Fisher (2000) and others wonder whether there is still a serious applications barrier to entry in the microprocessor market, given the enormous potential for middleware threats due to innovations on the browser market (see also Economides 2000; Sidak 2001). Kesan and Shah (2001) make an attempt to identify the potential and the limits to selfregulation in the organization of access to Internet Protocol (IP) number assignments and domain name systems (see also Hillebrand and Büllingen 2001), while Müller and Rannenberg (1999) question the safety of the Internet, and the enforcement of property rights within its domain has been considered, for example, by Engel (1999). These highly relevant and pertinent questions, however, will not be addressed here. Instead, the focus of this chapter is on those elements of the Internet periphery and Internet service provision heavily based on telecommunications, in particular Internet access and Internet backbone. Access to the Internet requires a connection between the Internet user and the interface to the Internet service provider (ISP). In the past, the local loops of the established telecommunications carriers have been considered as areas with network-specific market power and thus have been subject to sector-specific regulation. Gradual phasing out of this sector-specific regulation is now under debate due to increasing access alternatives. By contrast, transit and peering arrangements among Internet backbone providers (IBPs) are not subject to sector-specific regulation. The agreements that cover interconnection between IBPs are characterized by private negotiations and fall under non-disclosure rules. According to the economic theory of regulation, there is no need for sector-specific regulation due to the absence of network-specific market power. The input market of communications bandwidth is competitive, and each IBP can develop its own logistic concept to optimize its own backbone and set of transit and peering arrangements. This chapter is organized as follows. The first section deals with the role of telecommunications for the Internet, differentiating between local network access and long-distance network capacity. The next section discusses the new regulatory arrangements for communications services within Europe,

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with a particular emphasis on Germany. In order to analyse the future role of sector-specific regulation from a normative point of view, the following section introduces the network economic concept of a disaggregated regulatory approach. Subsequent sections then turn to the phasing-out potential for sector-specific regulation due to increasing competition within the local loop and to considering the role of ‘technology-neutral’ regulation – a term that implies that in an environment of competing network infrastructures, sector-specific regulation should not be expanded but rather removed completely. The final section explains the role of competition in the markets for backbone interconnections (interconnectivity).

The role of telecommunications for the Internet The main elements of Internet service provision are an inherent part of the Internet and would not exist without the Internet. However, Internet service provision also requires several complementary elements, designated here as the Internet periphery, which are viable on their own, even in the absence of the Internet (see Figure 4.1). ISPs offer their customers a wide spectrum of different services by combining both peripheral and main elements (Elixmann and Metzler 2001: 14–17). O’Donnell (2000: 17–21) has classified these services as fundamental networking and inter-networking, application services and customer relations.

Terminal Equipment

Content

ty

Internet Service Provision

B In ack te b rc on on e ne ct iv i

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Local Network Access

Long Distance Network-Capacity

Figure 4.1 Internet periphery versus Internet service provision Source: Knieps 2003: 219.

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Terminal equipment (e.g. PCs and cellular phones) can be used either with or without access to the Internet, although obviously the use of the Internet is not possible without any terminal equipment. Content (including broadband applications) may be provided via the Internet (e.g. video on demand, customized music and video libraries), but it is also available through other distribution channels, such as cinemas, traditional video libraries and traditional broadcasting. Internet service provision would be possible without any sort of content provision. For example, ISPs could specialize in interactive services such as e-mail. In order to provide Internet services, capacity of long-distance telecommunications networks (bandwidth) is required. Today, for the most part, investments in long-distance telecommunications infrastructure are strongly motivated by Internet demand, despite the fact that telecommunication transmission capacity has many different purposes.

New regulatory arrangements for communication services The basic goal of the 1999 Review of the European Commission (European Commission 1998) was to consider the extent to which phasing out sectorspecific market power regulation should take place. The key objectives stated at the beginning of the review process were: (1) to maximize the application of the general European competition law; (2) to minimize sectorspecific regulation; and (3) to rigorously phase out unnecessary regulation (European Commission 1998: 3). On 12 July 2000, the European Commission presented its ‘1999 Review Package’, which included five proposals for Directives of the European Parliament and the Council, and one proposal for a Regulation. Since then, the following directives have been enacted: an ONP Framework Directive,2 an Access and Interconnection Directive,3 a Licensing Directive,4 a Universal Service Directive5 and a Personal Data/Protection of Privacy Directive.6 In addition, the proposal for the regulation of unbundled access to the local loop was passed by the European Parliament and the Council, and enacted in January 2001.7 This regulation marks a first for the EU, as the legal instrument of a regulation has never been used before in telecommunications policy. In contrast to a Directive, which requires national legislative enactment measures, a Regulation is the most powerful legislative tool made available by the EC Treaty. It is binding in its entirety and directly applicable in all Member States, meaning that it automatically becomes law in all Member States as soon as it is enacted.8 According to this regulation, the incumbent operator with significant market power is obliged to provide full, unbundled access, as well as shared access, to the copper local loop under transparent, fair and non-discriminatory conditions. The implementation of price regulation is left to the national

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regulatory authorities. As long as the level of competition for local access is insufficient to prevent excessive pricing, national regulatory authorities are required to ensure that the principle of cost orientation is applied. Both the Framework Directive and the Access Directive provide no clearcut definition of future sector-specific regulation. The Framework Directive provides a new interpretation of the criterion ‘considerable market power’, moving in the direction of establishing the criterion of dominance in a given market as a prerequisite for sector-specific market power regulation. It gives the Commission discretionary power to identify a variety of markets for which the introduction of sector-specific regulatory measures should at least be considered. The Access Directive already indicates that sector-specific regulation may be extended to competitive markets (e.g. mobile telephony) as well as newly developing innovative markets (e.g. the Internet). This would be a definite step backwards from the Access Notice of August 1998, which extended the role of competition policy by emphasizing the importance of ensuring non-discriminatory access to essential facilities. In Germany, the telecommunications law of 25 July 1996 has allowed global market entry since January 1998.9 The EU review process spurred on a review of the national communications law in Germany, which was finally revised in June 2004.10 The question thus arises as to whether additional sector-specific regulations now in place will be removed, or whether there is still a role for sector-specific regulations.

The disaggregated regulatory approach Criteria such as relative market share, financial strength and access to input and service markets can only serve as a starting point for evaluating the existence of market power. ‘Criteria for conjecturing a dominant position’ (‘Vermutungskriterien’) on the basis of market shares, for example, can lead to economically unjustified criteria for government intervention in network industries. From a competition economics point of view, the use of ex ante, sector-specific regulatory intervention constitutes massive interference with the market process and thus always requires a particularly well-founded justification based on modern network economics.11 Obviously, the development of an ex ante regulatory criterion creates a need for a more clear-cut definition of market power. Stigler’s concept of entry barriers, which focuses on long-term cost asymmetries between incumbent and potential entrants is essential here to identify a proper regulatory basis: A barrier to entry may be defined as a cost of producing (at some or every rate of output) which must be borne by a firm which seeks to enter an industry but is not borne by firms already in the industry. (Stigler 1968: 67)

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The sector-specific characteristics of network structures (economies of bundling) do not constitute a sufficient basis on which to conclude that market power does actually exist. It is necessary to differentiate between those areas in which active and potential competition can work and other areas, so-called monopolistic bottleneck areas, where a natural monopoly situation (due to economies of bundling) in combination with irreversible costs exists. It can be demonstrated that the regulation of network-specific market power is only justified in monopolistic bottleneck areas. In all other cases, the existence of active and potential competition will lead to efficient market results as in the other sectors of an economy. The pressure of potential competition can be sufficient to discipline the behaviour of the active supplier, even in those cases where the supplier is the owner of a natural monopoly. Such networks are called ‘contestable’ (see, for example, Baumol et al. 1982). An essential condition for the functioning of potential competition in order to discipline a natural monopoly already providing network services is that the incumbent firm does not have asymmetric cost advantages compared to potential entrants. If sunk costs are relevant, consumers who would intrinsically be willing to switch immediately to less costly firms are unable to do so. Sunk costs are no longer relevant for the incumbent monopoly, whereas the potential entrant is confronted with the decision of whether to build network infrastructure and thus spend the irreversible costs or not. Thus, the incumbent firm has lower decision relevant costs than potential entrants, and this creates an outlet for strategic behaviour on the part of the incumbent firm to the extent that monopoly profits (or inefficient production) will not necessarily result in market entry (see Knieps and Vogelsang 1982). It follows, then, that sector-specific, ex ante regulatory intervention in order to discipline market power can only be justified in monopolistic bottleneck areas, i.e. where a natural monopoly in combination with irreversible costs is present (see Knieps 1997a; 1997b). This basic concept of disaggregated identification of network-specific market power is illustrated in Table 4.1. Table 4.1 The localization of monopolistic bottleneck facilities Network area

With sunk costs

Without sunk costs

Natural monopoly (bundling advantages)

(1) Monopolistic bottlenecks

(2) Potential competition (contestable networks)

No natural monopoly (bundling advantages exhausted)

(3) Competition among active providers

(4) Competition among active providers

Source: Knieps 2000: 96.

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The network economic concept of monopolistic bottlenecks suggests a connection with the essential facilities doctrine resulting from US antitrust law, which is now also being used increasingly in European competition law (see Knieps 2000: 104).12 In accordance with this doctrine, a facility can only be regarded as essential if the following two conditions are fulfilled: (1) entry into the complementary market is not actually possible without access to this facility; and (2) providers on the complementary market cannot, using reasonable effort, duplicate the facility. There are no substitutes either (see Areeda and Hovenkamp 1988).13 The application of the essential facilities doctrine means that a traditional instrument of competition law can be used as a regulatory instrument. A facility is regarded as essential when it fulfils the criteria for classification as a monopolistic bottleneck facility in the context of the disaggregated regulatory approach. The starting point for this approach is to differentiate between those network areas in which active and/or potential competition is possible, and those network areas in which stable, network-specific market power can be localized. The disaggregated regulatory approach involves applying the essential facilities doctrine in a dynamic way. This means that it should be applied not only on a case-by-case basis, but also to a category of cases, namely to monopolistic bottleneck facilities. Moreover, non-discriminatory conditions of access to the essential facilities must also be set out in more detail. The aim is to design the conditions of access so as not to hinder infrastructure competition but rather to create an incentive for research and development as well as innovations and investments at the facility level. This is the only way to establish a balanced relationship between services and infrastructure competition.

Localization of monopolistic bottlenecks within telecommunications networks Competitive long-distance networks Although some markets for long-distance telecommunications services may be characterized by economies of scale as well as bundling advantages, there is nevertheless competition. Inefficient suppliers are replaced by less expensive ones because there is free market entry. Even when the incumbent’s market share is high, inefficient production or services not geared to market requirements will soon lead to a considerable loss in market share, as customers are not tied to a specific supplier and can react without delay to price cuts on the market. There is thus no regulatory need for disciplining the market power of alternative network providers. Since overall free entry has become possible, the performance of the German long-distance telecommunications market has markedly improved. Germany exhibits a large number of service providers who have increased their scope

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of services, and the country has seen the entry of several network carriers, which has notably lowered prices for all services (Stumpf and SchwarzSchilling 1999; Gabelmann and Gross 2003: 113; Knieps 2006: 205). The market for long-distance transmission capacity is also very competitive (Laffont and Tirole 2000: 98). A large number of newcomers have built transnational network infrastructure as input for Internet backbone capacity (Elixmann 2000: 7), which represents another possibility for leasing transmission capacity from several alternative network infrastructure providers. Moreover, a larger number of carriers possess their own fibreoptic networks (Immenga et al. 2001: 14, Table 1). Presently, the telecommunications transport capacity is readily available from a variety of providers (Kende 2000: 25). The remaining regulatory problem in the local loop It has been traditionally assumed that local networks constitute monopolistic bottlenecks for which neither active nor potential substitutes are available (see Table 4.2). The EU regulation on unbundled access to the local loop proceeded from this assumption and concluded that there is still a need to regulate an incumbent operator’s local access network. To the extent that local networks constitute monopolistic bottlenecks, ex ante regulation appears justified. Non-discriminatory access to essential facilities has to be guaranteed (see Knieps 1997a: 328). Since unregulated tariffs would enable owners of monopolistic bottlenecks to generate excessive profits, the instrument of price-cap regulation should be introduced (see Beesley and Littlechild 1989). Its major purpose is to regulate the level of prices, and it takes into account the inflation rate (consumer price index) minus a percentage for expected productivity increase. It is important to restrict such price-cap regulation to those areas of telecommunications networks where market power due to monopolistic bottlenecks is a regulatory problem. In all other subparts of telecommunications networks, price setting should be left to competitive market forces. Table 4.2 Local telecommunications networks as monopolistic bottleneck facilities

Terminal equipment Telecommunications services (including voice telephone services) Satellite/mobile networks Long-distance, cable-based networks Local cable-based networks Source: Knieps 2000: 99.

Natural monopoly (economies of bundling)

Irreversible costs

–

–

X X – X

– – X X

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Concentrating on regulating the local loop does indeed constitute the one remaining task of tailored, sector-specific market power regulation. Nondiscriminatory access to this bottleneck facility must be guaranteed for all competitors. The EU regulation on unbundled access to the local loop contains an obligation for full unbundling as well as line sharing. In order to guarantee competition in long-distance telecommunications markets, global access to local networks already seems to be sufficient (Engel and Knieps 1998). In any case, one variant of non-discriminatory access to the local loop should be considered sufficient to overcome the monopolistic bottleneck problem. Increasing competition within the local loop in Germany Local network competition started with business customers in urban centres where the preferred access technology was optical fibre (Distelkamp 1999: 94). However, after licences for point-to-multipoint microwave systems were granted by the state, the wireless local loop has also been gaining in importance in Germany (Regulation Office for Post and Telecommunication 1999: 24). Platform competition, where alternative ISPs have complete control of all aspects of their networks and their corresponding services, has effectively claimed a stake in the market. Consequently, ever since the comprehensive opening of the telecommunications market, the pressure of innovation has increased in local networks as well. The competition has led to considerable variety in technological platforms, e.g. optical fibre, wireless networks, Community Antenna Television (CATV) networks and satellite technology, as well as to an increase in product variety. In addition, because of these rapid developments, the local loop facilities in larger cities and agglomerations in Germany are increasingly losing their status as monopolistic bottlenecks. Although it is not possible at this point to predict exactly how long it will take for the monopolistic bottlenecks in the local loop to disappear completely, it is clear that the building of access networks parallel to monopolistic bottlenecks, which was until only recently considered a futuristic dream, is now in full swing. The development of alternative access networks indicates that the potential for phasing out sectorspecific regulation in telecommunications should be fully exhausted, particularly by not extending the essential facilities doctrine to facilities that have yet to be created, as this would tend to inhibit the necessary investments in new technologies in the first place.

Broadband versus narrowband access to the Internet: is there still a role for sector-specific regulation? Access to the Internet requires a connection between the Internet user and the interface to the Internet, which in turn requires access to a local telecommunications network. In addition, a (long-distance) link between the originating (local) network and the ISP is required.14

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Several access technologies exist: copper, fibre optics, two-way cable TV infrastructure (CATV network), power line communication and radio in the loop. One may also differentiate between narrowband and broadband Internet access. Narrowband Internet access takes place on two-paired, copper cables via analogue modem and ISDN (integrated services digital network). Broadband Internet access can be provided either by upgrading two-paired copper cables by means of xDSL (digital subscriber line) technologies (the most popular is ADSL (asymmetric DSL) technology), CATV-based broadband Internet access, as well as broadband wireless technology (e.g. Universal Mobile Telecommunications System (UMTS)). Convergence and platform independence, however, does not mean that these broadband access technologies have the same cost characteristics. They also have different access quality attributes (e.g. mobility, reliability, startup speed, etc.). There are particularly strong quality differences between low-speed access (narrowband) and high-speed access (broadband). For example, the transmission of 100 text pages takes 120 seconds via modem, 25 seconds via ISDN and 0.4 seconds via ADSL. Five colour photos take 22 minutes via modem, five minutes via ISDN and four to five seconds via ADSL. A 30-minute video takes 38.8 hours via modem, 8.7 hours via ISDN and 8 minutes via ADSL (Fesenmeier 2001: 17). The difference in speed already indicates that narrowband Internet access does not provide an economically sensible way to consume data-intensive Internet services such as streaming video and interactive entertainment. On the other hand, dial-up access is sufficient for managing an e-mail account and surfing the Internet for a few hours a week. To the extent that the local loops of the established carriers are still monopolistic bottlenecks, there is still a need for sector-specific regulations, such as price caps, accounting separation and discriminatory-free entry. Alternative providers of broadband access (e.g. CATV networks) are not yet able to discipline the market power of the established local loop provider. Line-sharing obligations, however, which are geared towards stimulating broadband access, are superfluous from the perspective of this low-speed access market. Line-sharing regulation does also not appear to be justified from the perspective of broadband Internet access. From the dynamic perspective of convergence, the division of the Internet into one large narrowband section on the one hand and a rather marginal broadband section on the other is artificial. In order to develop innovation potential for data-intensive Internet services, broadband access is indispensable. Whereas the local loop of copper pairs via xDSL can provide one broadband access possibility, there are also a number of economically feasible access alternatives. Mobile Internet access based on GPRS (General Packet Radio System Standard), as well as UMTS in particular, demonstrates the large innovation potential and evolution of

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mobile technologies for the Internet (see, for example, Büllingen and Wörter 2000; Büllingen and Stamm 2001). Looking ahead, the Europe 2005 Action Plan promotes a multi-platform approach to broadband development driven by strong competition between networks and services. In the meantime, the focus of the EU Commission has shifted towards considering the importance of technology-neutral regulation, which is designed to avoid favouring one technology over another. Technology-neutral regulation is considered to allow provision of new services to lead to competition between different network-access methods (facility based competition). The Commission concluded: ‘When there is effective facilities-based competition, the new framework will require ex-ante regulatory obligations to be lifted’ (Commission of the European Communities 2003: 6). Effective, facilities-based competition should include high-speed access. From the perspective of high-speed broadband access, the local loops of the established telecommunication carriers will thus lose the characteristics of a monopolistic bottleneck. Alternative, broadband-access technologies (such as cable modems, UMTS and mobile access) create economically sensible alternatives to xDSL. Due to the increasing role of product differentiation based on the different network characteristics of these access technologies, the long-run convergence towards a single, globally dominating access technology seems unrealistic. As a consequence, sector-specific regulation of broadband access – especially line-sharing obligations – seems superfluous. The aim of technology-neutral regulation is also stated in the revised German telecommunications law of 2004 (§ 1 TKG). It suggests that in an environment of competing network infrastructures, ex ante regulation should not be extended but removed entirely. Moreover, the traditional regulation of narrowband access should not be continued for historical reasons, but rather abolished as soon as narrowband access loses its bottleneck characteristics. Only then will the adequate incentives for investments in new network infrastructures be provided and an unbiased infrastructure and service competition be guaranteed.

Backbone interconnection: is there still a role for sector-specific regulation? Competitive markets for communications bandwidth Access to the IP-based backbone network is impossible without access to telecommunications transport capacity, which can be delivered by a variety of means, such as high-speed, fibre-optic networks, coaxial cables and satellite. The performance-price ratio for cutting-edge, optical communications technology has been improving rapidly. New transmission technologies work

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most effectively over new fibre strands that have enhanced optical properties, and developments in optical technology have unquestionably made massive increases in bandwidth possible. Consequently, the growth of bandwidth for Internet traffic use has been dramatic since 1995. Nevertheless, expectations of a bandwidth revolution similar to Moore’s Law on the performanceprice ratio for computers have not yet been fulfilled. Costs and benefits of additional investment into bandwidth have to be counterbalanced, also by exploiting the benefits of substitution among bandwidth, storage and CPU (central processing unit) cycles (Galbi 2000). Communications bandwidth is readily available today from a variety of providers. IBPs own or lease communications bandwidth that is connected by routers which the backbones use to deliver traffic to and from their customers. The underlying network logistics is the TCP/IP protocol. Whereas the IP (Internet Protocol) is responsible for shifting the data packets from router to router, the TCP (transfer control protocol) is responsible for the reliability of transmission, including error correction. Internet backbone providers (IBPs) are also responsible for the quality of service and network management, including the capacity control of the backbone network. An additional dimension of Internet backbone services is the organization of interconnections with other IBPs by means of peering and transit arrangements. Unregulated interconnections: transit and peering Each IBP forms its own network that enables all end users and content providers connected to it to communicate with each other. End users, however, often want to be able to communicate with a wide variety of end users and content providers, regardless of the IBPs involved. In order to provide end users with such universal connections, IBPs must interconnect with one another to exchange traffic destined for each other’s end users. It is this interconnection that makes the Internet the ‘network of networks’. Peering and transit arrangements can be differentiated. Peering partners exchange traffic on a settlement-free basis (bill and keep type), that is, each peer terminates the traffic originating with other peers without charge. In contrast, in transit arrangements one IBP pays another IBP to deliver traffic between its customers and the customers of other IBPs (see Kende 2000: 5). Peering used to take place in the United States at public peering points, so-called NAPs (network access points),15 where different backbones could exchange traffic. Due to increased congestion at the NAPs, IBPs turned to bilateral peering arrangements (private peering). As each bilateral peering arrangement only allows backbones to exchange traffic destined for each other’s customers, backbones need a significant number of peering arrangements in order to gain access to the full Internet. Many IBPs have adopted a hybrid approach to interconnection, peering with a number of

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backbones and paying for transit from one or more IBPs in order to have access to the backbone of the transit supplier as well as the peering partners of the transit supplier. Transit and peering arrangements among IBPs are not subject to sectorspecific regulation, neither by the Federal Communications Commission (FCC) nor by the regulatory agencies in Europe. The agreements that cover interconnection between IBPs are characterized by private negotiations and are subject to non-disclosure rules. The input market of communications bandwidth is competitive and each IBP can develop its own logistic concept to optimize its own backbone and set of transit and peering arrangements.16 In this context, there is indeed no role for exante regulation due to the absence of network-specific market power.

Summary In order to analyse the remaining role for sector-specific regulation the focus of this chapter has been on those elements of the Internet periphery and Internet service provision that are strongly based on telecommunications, in particular Internet access and Internet backbone. The first section dealt with the role of telecommunications for the Internet, differentiating between local network access and long-distance network capacity. In the next section the new regulatory arrangements for communications services within Europe, with particular emphasis on Germany, were explained. In order to analyse the future role of sector-specific regulation from a normative point of view, in the following section the network economic concept of a disaggregated regulatory approach was provided. In subsequent sections the phasing-out potentials for sector-specific regulation due to increasing competition within the local loop was dealt with and the role of technologyneutral regulation was considered, which implied that in an environment of competing network infrastructures sector-specific regulation should not be extended, but removed. The final section explained the role of competition in the markets for backbone interconnection.

Notes 1 For the important role of markets and committee solutions in order to deal with network externalities, see Blankart and Knieps (1993, 1995) and Holler et al. (1997). 2 Directive 2002/21/EC of the European Parliament and of the Council of 7 March 2002 on a common regulatory framework for electronic communications networks and services (Framework Directive), Official Journal of the European Communities L108/33, 24 April 2002. 3 Directive 2002/19/EC of the European Parliament and of the Council on access to, and interconnection of, electronic communications networks and associated facilities (Access Directive), Official Journal of the European Communities L108/7, 24 April 2002.

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4 Directive 2002/20/EC of the European Parliament and of the Council of 7 March 2002 on the authorization of electronic communications networks and services (Authorization Directive), Official Journal of the European Communities L108/21, 24 April 2002. 5 Directive 2002/22/EC of the European Parliament and of the Council of 7 March 2002 on universal service and users’ rights relating to electronic communications networks and services (Universal Service Directive), Official Journal of the European Communities L108/51, 24 April 2002. 6 Directive 2002/58/EC of the European Parliament and of the Council of 12 July 2002 concerning the processing of personal data and the protection of privacy in the electronic communications sector (Directive on privacy and electronic communications), Official Journal of the European Communities L201/37, 31 July 2002. 7 Regulation (EC) No 2887/2000 of the European Parliament and of the Council of 18 December 2000 on unbundled access to the local loop, Official Journal of the European Communities L336/4, 30 December 2000. 8 This does not rule out the fact that Directives may have direct effect in member states, provided that the provisions of the Directive are sufficiently precise and unconditional. 9 Telekommunikationsgesetz (TKG) vom 25 Juli 1996 (BGBl. I S.1120). 10 Telekommunikationsgesetz (TKG) vom 22 Juni 2004 (BGBl. I S. 1190). 11 The traditional methods and approaches in general competition law, both with respect to merger control and the control of abusive practices, are fundamentally different from those of sector-specific, regulatory economics. Any mingling of these two different approaches is misleading. The chapter examines the question of a sector-specific need for regulation and thus does not comment on merger cases. Market shares and turnover are easily measurable and are therefore usually taken up as criteria in competition law. However, they must not in any way be confused with a sound economic analysis of the effectiveness of active and potential competition. When examining a merger case, the competition authorities use a large number of criteria to which they attach, by their own discretion, a varying degree of significance on a case-by-case basis. For the general control of abusive practices, as well, competition law envisions a correction of market processes on a case-by-case basis. 12 This means that access to ports, airports or railway networks can neither be refused nor granted under conditions that penalize competitors without factual justification. 13 The fact that use of this facility is essential for competition on the complementary market is also occasionally expressed as a third criterion, as it reduces prices or increases the volumes offered. This third criterion, however, only describes the effects of access. 14 Oftel (2001: 41) differentiates between ‘wholesale call origination’ and ‘wholesale Internet call termination market’. 15 In 1993, the US National Science Foundation (NSF) designed a system of geographically dispersed NAPs (Kende 2000: 5). 16 General competition law also applies to transit and peering arrangements. However, antitrust proceedings are geared towards dealing with concrete conflicts case by case and not towards designing a new, exante regulatory policy.

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References Areeda, P. and Hovenkamp, H. (1988), ‘“Essential facility” doctrine? Applications’, in Areeda, P. and Hovenkamp, H. Antitrust Law, 202.3 (Suppl. 1988), pp. 675–701. Baumol, W. J., Panzar, J. C. and Willig, R. D. (1982) Contestable Markets and the Theory of Industry Structure, San Diego CA: Harcourt Brace Jovanovich. Beesley, M. E. and Littlechild, S. C. (1989) ‘The regulation of privatized monopolies in the United Kingdom’, Rand Journal of Economics, 20: 454–72. Blankart, Ch. B. and Knieps, G. (1993) ‘State and standards’, Public Choice, 77: 39–52. Blankart, Ch. B. and Knieps, G. (1995) ‘Market-oriented open network provision’, Information Economics and Policy, 7: 283–96. Büllingen, F. and Stamm, P. (2001) Mobiles Internet – Konvergenz von Mobilfunk und Multimedia, Discussion Paper no. 222, Bad Honnef: Wissenschaftliches Institut für Kommunikationsdienste (WIK). Büllingen, F. and Wörter, M. (2000) Entwicklungsperspektiven, Unternehmensstrategien und Anwendungsfelder im Mobile Commerce, Discussion Paper no. 208, Bad Honnef: Wissenschaftliches Institut für Kommunikationsdienste (WIK). Commission of the European Communities (2003) Communication from the Commission to the Council, the European Parliament, the Economic and Social Committee and the Committee of the Regions, Electronic Communications: the road to the knowledge economy, Brussels: COM, 11 February, COM(2003) 65 final. Distelkamp, M. (1999) Möglichkeiten des Wettbewerbs im Orts- und Anschlußbereich des Telekommunikationsnetzes, Discussion Paper no. 196, Bad Honnef: Wissenschaftliches Institut für Kommunikationsdienste (WIK). Economides, N. (2000) The Microsoft Antitrust Case, Working Paper no. 2000–09, New York: Stern School of Business, New York University. Elixmann, D. (2000) ‘Wettbewerbsintensität auf dem Markt für Übertragungskapazität’, WIK Newsletter no. 41 (December): 6–9, Wissenschaftliches Institut für Kommunikationsdienste (WIK), Bad Honnef. Elixmann, D. and Metzler, A. (2001) Marktstruktur und Wettbewerb auf dem Markt für Internet-Zugangsdienste, Discussion Paper no. 221, Bad Honnef: Wissenschaftliches Institut für Kommunikationsdienste (WIK). Engel, C. (1999) Das Internet und der Nationalstaat; Gemeinschaftsgüter: Recht, Politik und Ökonomie, preprints of the Max-Planck – project group ‘Recht der Gemeinschaftgüter’, Bonn. Engel, C. and Knieps, G. (1998) Die Vorschriften des Telekommunikationsgesetzes über den Zugang zu wesentlichen Leistungen: Eine juristisch-ökonomische Untersuchung, Baden-Baden: Nomos. European Commission (1998) The 1999 Review of the Telecommunications Regulatory Framework, ONP COM 98–42, September, Brussels: Directorate General XIII ONP Committee. Fesenmeier K.-H. (2001) ‘Plötzlich wollen alle ADSL’, Badische Zeitung, 14 July: 17. Fisher, F. M. (2000) ‘The IBM and Microsoft cases: what’s the difference?’, American Economic Review, Papers & Proceedings, 90: 180–3. Gabelmann, A. and Gross, W. (2003) ‘Telekommunikation: Wettbewerb in einem dynamischen Markt’, in Knieps, G. and Brunekreeft, G. (eds) Zwischen Regulierung und Wettbewerb – Netzsektoren in Deutschland, 2nd edition, Heidelberg: Physica.

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Galbi, D. A. (2000) Growth in the ‘New Economy’: US bandwidth use and pricing across the 1990s, FCC Working Paper, 9 July, Washington DC: FCC. Hillebrand, A. and Büllingen, F. (2001) Internet-Governance – Politiken und Folgen der institutionellen Neuordnung der Domainverwaltung durch ICANN, Discussion Paper no. 218, Bad Honnef: Wissenschaftliches Institut für Kommunikationsdienste (WIK). Holler, M. J., Knieps, G. and Niskanen E. (1997) ‘Standardization in transportation markets: a European perspective’, EURAS Yearbook of Standardization, 1: 371–90. Immenga, U., Kirchner, C., Knieps, G. and Kruse, J. (2001) Telekommunikation im Wettbewerb: Eine ordnungspolitische Konzeption nach drei Jahren Marktöffnung, Munich: C. H. Beck. Kende, M. (2000) The Digital Handshake: connecting internet backbones, Federal Communications Commission, OPP Working Paper no. 32, Washington DC: FCC. Kesan, J. P. and Shah, R. C. (2001) Fool Us Once Shame On You – Fool Us Twice Shame On Us: what we can learn from the privatizations of the internet backbone network and the domain name system, Law and Economics Working Paper no. 00–18, Urbana Champaign IL: University of Illinois College of Law. Knieps, G. (1997a) ‘Phasing out sector-specific regulation in competitive telecommunications, Kyklos, 50: 325–39. Knieps, G. (1997b) ‘The concept of open network provision in large technical systems’, EURAS Yearbook of Standardization, 1: 357–69. Knieps, G. (2000) ‘Interconnection and network access’, Fordham International Law Journal, 23: 90–115. Knieps, G. (2003) ‘Competition in telecommunications and internet services: a dynamic perspective’, in Barfield, C. E., Heiduk, G. and Welfens, P. J. J. (eds) Internet, Economic Growth and Globalization: perspectives on the new economy in Europe, Japan and the US, Berlin: Springer, 217–27. Knieps, G. (2006) ‘Privatisation of network industries in Germany: a disaggregated approach’, in Köthenbürger, M., Sinn, W.-H., Whalley, J. (eds) Privatization Experiences in the European Union, Cambridge MA; London: MIT Press, pp. 199–224. Knieps, G. and Vogelsang, I. (1982) ‘The sustainability concept under alternative behavioural assumptions’, Bell Journal of Economics, 13: 234–41. Laffont, J.-J. and Tirole, J. (2000) Competition in Telecommunications, Cambridge MA: MIT Press. Mestmäcker, E.-J. (2001)’ Unternehmenskonzentrationen und Urheberrechte in der alten und “neuen” Musikwirtschaft’, Zeitschrift für Urheber- und Medienrecht (ZUM), 3: 185–94. Müller, G. and Rannenberg, K. (1999) Multilateral Security in CommunicationsTechnology, Infrastructure, Economy, Munich: Addison-Wesley-Longman. O’Donnell, S. (2000) ‘Broadband architectures, ISP business plans, and open access’, paper presented at the 28th Annual Telecommunications Policy Research Conference, 23–25 September, Alexandria VA. Oftel (2001) ‘Oftel’s 2000/01 effective competition review of dial-up Internet access’, issued by the Director General of Telecommunications, London. Regulation Office for Post and Telecommunication (Regulierungsbehörde für Telekommunikation und Post) (1999) Jahresbericht, Bonn. Sidak, J.G. (2001) ‘An antitrust rule for software integration’, Yale Journal on Regulation, 18: 1–83.

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Stigler, G. J. (1968) ‘Barriers to entry, economies of scale, and firm size’, in Stigler, G. J. The Organization of Industry, reprint, 67–70, Chicago: University of Chicago Press. Stumpf, U. and Schwarz-Schilling, C. (1999) Wettbewerb auf Telekommunikationsmärkten, Discussion Paper no. 197, Bad Honnef: Wissenschaftliches Institut für Kommunikationsdienste (WIK).

Subsection B The increasing role of self-regulation

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Private solutions to uncertainty in Japanese electronic commerce1 Cornelia Storz

Introduction Electronic commerce is a central element in the OECD’s vision of the tremendous potential that our networked world now holds.

(OECD 2001) There is no doubt that the development of electronic commerce has become an important political issue. Its political and economic potential is seen to reside in major gains in efficiency, in the creation of new markets and in the worldwide integration of trade. Several guidelines and recommendations made by the OECD (Organisation for Economic Co-operation and Development) and its member states suggest the creation of best practice institutions to reduce many of the uncertainties that accompany electronic commerce, such as concerns about the fairness of exchange and the protection of privacy (OECD 1999).2 Institutions – defined here as a sum of rules that govern human behaviour and are secured by a credible sanctioning mechanism – aim at facilitating interaction by reducing uncertainty. They can be generated by the government (public policies) or by private actors (private regulation).3 Especially in the United States and in Japan, private regulation has been given the priority in fostering the development of electronic commerce. Japan, for example, has only just recently amended laws directed at electronic commerce after having relied on the creation of private rules, such as minimum quality standards aimed at the protection of consumer privacy, for many years.4 Nevertheless, the interesting point is that despite comprehensive and high-quality private regulations, electronic commerce in Japan today is still far less developed. Research in the field of information economics has shown that the probability of markets to fail is high without protective institutions. The design of appropriate institutions to prevent market failure has thus become a major theoretical focus. While it is indeed important to consider what kind of institution induces what kind of behaviour, a mere focus on the design of institutions overlooks the fact that institutions by themselves – whether privately or publicly designed – do not ‘automatically’ reduce

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uncertainty. In order for institutions to function well, they need to be regarded as legitimate by those who are encountering them. In other words, informal institutions become important. Since informal institutions vary across countries, formal, more structural institutions perceived in one country as legitimate and trustworthy may be perceived in another country as untrustworthy precisely due to the different values, norms and attitudes in which they are embedded. It thus becomes necessary to take a closer look at informal institutions and the ways in which they influence the acceptance of formal institutions. This reasoning becomes clearer when we examine the concept of path dependency. In economic theory, path dependency describes a process by which events of the past have long-lasting effects on events that follow, and actors can only influence this process to a certain degree. The development of electronic commerce, for example, is said to be constrained in societies such as in Japan where the normative framework of personal trust predominates. Newly created institutions set up to raise the credibility and legitimacy of electronic commerce need a more general type of normative framework, namely institutional trust. Path dependency further implies that it is extremely difficult to reform institutions due to the complementarities between formal and informal institutions. According to this approach, then, certain kinds of informal institutions may hinder the acceptance of new formal institutions, even in the long run. Electronic commerce in Japan and in other Asian countries is thus ‘locked in’ a specific path of development that renders these countries unable to take advantage of its potential.5 While I acknowledge the existence of and the implications associated with specific informal institutions such as trust, I want to go a step further by arguing that there is much more leeway for change in a society than institutional economics has often identified. I develop an alternative framework by incorporating an emphasis on the learning capacity of individuals and their ability to generate creative solutions to economic problems based on a case study of Japanese electronic commerce. The chapter is thus organized as follows: this paper starts with the general question of which institutions are appropriate to stimulate electronic commerce. Based on these reflections, the next section provides a description of the institutional solutions that have been implemented in Japan. The following section presents the argument that an important precondition for these appropriate institutions is that they are generally accepted and regarded as being trustworthy, and that this type of legitimacy necessitates a special form of trust, namely institutional trust. In a society in which personal trust predominates, even perfectly well-designed institutions will not be perceived as trustworthy and therefore will not be able to channel behaviour into the desired direction. Without widespread institutional trust, even best practice institutions would not lead to an increase in electronic commerce in Japan. However, I argue in the next two sections

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that paths can be channelled into new directions by entrepreneurial alertness. Creative solutions are discussed that have been generated to solve the specific problems inherent in Japanese electronic commerce. In the final section I summarize my results, discuss the future perspectives for electronic commerce in Japan, and offer a few general considerations on a revised concept of path dependency.

Consumer uncertainty and institutional solutions Electronically traded goods as experience and credence goods: the problem of new uncertainties Electronic commerce takes place in electronic markets in which personal communication is replaced by electronic communication. Electronic commerce can therefore be described as a virtual room in which actors realize exchange. In the 1990s, the new and open HTML standard (Hypertext Markup Language) ushered in the starting point for worldwide business-toconsumer commerce (electronic commerce between business and consumers) by opening the electronic marketplace to all participants in contrast to the previous infrastructure based on proprietary standards.6 With the new standard, the use of the Internet became possible even for those with relatively little knowledge of information and communication technology. However, by replacing real with virtual rooms, electronic commerce leads to new uncertainties that are not present in conventional, stationary trade. Consumer uncertainty results out of a lack of information, which cannot be supplied even at high costs due to information asymmetries. Information asymmetries describe the fact that economic actors possess information to varying degrees and with varying quality. The problems associated with consumer uncertainty are nothing new in economic history and are generally solved by institutions providing information to consumers.7 In the wellknown example of the used car market as ‘lemon’ markets, Akerlof (1970) demonstrated that without uncertainty-reducing institutions, information problems can lead to less than optimal market outcomes and, in extreme cases, to market failure (see also Beales 1998). The wide range of institutions working to counteract market failure can be divided into public policies and private regulations. Such institutions place restrictions on both consumer and business choices. For example, lower-quality goods at lower prices are not allowed on the market. Such restrictions are appropriate, however, if the advantages resulting from them are on average superior to a situation without them. Institutions are, in this view, a response to the demand for better information about products and services and encourage the development of new markets.8 The information problem has a lot to do with differences in the characteristics of goods. Inspection goods are products that consumers can evaluate before their purchase at no major cost. Experience goods, on the

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other hand, can only be assessed after they have been bought and used. Consumer assessment of credence good quality is even more difficult since the product cannot be evaluated even after the purchase. A physician’s treatment is the classic example of a credence good. Assessing product quality is also difficult when product quality is expanded to mean not only the quality of the actual product itself but also the quality of the production and distribution processes that go into it, such as how well the consumer’s personal data are protected or how secure the transaction conditions for its purchase, return and payment are. When we define product quality in broad terms such as these, we find that the new uncertainties and information problems associated with business-to-consumer commerce are quite daunting: the quality of all goods traded in business-to-consumer commerce can only be assessed after the purchase, and sometimes, as with payment or data security, not at all, so that electronic commerce goods belong mostly to the class of experience or credence goods. At the same time, established signals such as the location of stores, the conduct of sales assistants, nonverbal communication in the ‘real world’ and the hands-on experience of inspection goods – all of which reduce uncertainty – no longer have any meaning in virtual trade. The reduction of consumer uncertainty, especially on the Internet, is thus crucial for the success of business-to-consumer commerce. In order to stimulate electronic commerce, the first and necessary step is to develop appropriate institutions to combat consumer uncertainty. A wide range of literature has discussed the positive and normative aspects of these rules, to which the following section will now turn. Public policies and private regulation In institutional economic theory there is a general consensus that government regulation should not interfere with exchange and should be provided in a way that leaves sufficient leeway for private actors to solve the problems that arise in the private market. The expression ‘sufficient leeway’ indicates that there are different ideas about the extent to which private regulation should take place, as the different modes of regulation in Japan, in the United States and in Germany demonstrate (see Knieps, Chapter 4; Lageman, Rothgang and Scheuer, Chapter 7). Over the past few decades and partly due to the new characteristics of computer technologies, most countries have preferred to rely on private regulation in business-to-consumer commerce for three reasons. First of all, private regulation is believed to be more efficient since the costs for governments are lower if formulation, decision making and sanctioning lie in the hands of private actors. According to transaction cost theory, even if control in the form of accreditation agencies is incumbent on the state, most of the costs stemming from the prior phases of the political process are not applicable (Campbell 1998–99). One problem with this viewpoint is that the extent to which transaction costs can be reduced varies depending

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on the structural characteristics in a given society (e.g. distribution of information or the degree of consumer organization). Nevertheless, according to this argument, private solutions may be superior to public policies. A second argument for favouring private regulation over public policy centres on the market’s specialized knowledge. It is assumed that those actors involved with the day-to-day, actual market processes know better where major problems in the marketplace lie as well as the major difficulties associated with implementing solutions to those problems. In contrast to governmental regulation – an approach that presumes that the state as a central institution can correctly recognize market deficits and choose suitable instruments – private regulation avoids the pitfalls of centrally created knowledge since the creation of rules devolves on a variety of individual actors. More knowledge is created among decentralized, acting individuals and among them better rules (Michael 1995). Finally, economists influenced by insights from social psychology argue that the motivation to adhere to a rule is greater when it is privately agreed upon than when it is dictated by the government. Motivation to comply with a private contract is intrinsic to the contractual process itself (Frey 1997). The problem of information asymmetries can be solved by private actors by signalling or screening.9 The discussion will be restricted to signalling. The establishment of signals requires private regulations such as standards determined by independent parties as a basis for quality assessment. This takes place in private standardization committees on national, regional and international levels, such as in the German DIN (Deutsches Institut für Normung), the Japanese JISC (Japanese Industrial Standards Committee), the European CEN (Comité Européen de Normalisation), the ISO (International Organization for Standardization), or the IEC (International Electronic Commission). They all set minimum quality standards that regulate, for example, the use of private data and transaction conditions.10 In those cases in which such standards do not exist or in which they are considered to be insufficient, they may be supplemented by standards set by industrial associations or private companies. Firms introduce such labels and certificates in order to signal credibility. But the introduction of a signal is not equivalent to compliance with the signal.11 In order to ensure compliance with private regulation, then, it is crucial that credible sanctions accompany it. Such sanctioning normally takes place through monitoring systems that control an economic actor’s conformity to a standard. Private certification agencies formally accredited by a government agency, such as the German Association for Accreditation (TGA) or the Japanese Accreditation Board of Conformity Assessment (JAB), usually perform this function. Most OECD countries have such a certification and accreditation system for electronic commerce.12 Assuming that a minimum standard of quality and a working monitoring system are in place, private regulation can play a reliable and, in some cases, an even better informational role for consumers than mandatory,

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governmental rules. For this reason I will focus in the following on private regulation in Japanese electronic commerce and compare it to the United States.

Private regulation in Japanese business-to-consumer commerce13 The Japanese government has stressed the importance of private regulation in ensuring reliable transaction processes, data protection and consumer privacy. Private regulation has been encouraged by several guidelines put in place by Japanese central ministries. Nevertheless, in some cases the need for governmental regulation has been stressed. After a brief discussion of government policies regarding electronic commerce in Japan, I will turn to the area of private regulation. In the course of the growth of the Internet and its accompanying problems of privacy protection (CSLR (Center for Social and Legal Research) 2000b: 17–19), there ensued a growing demand in Japan to amend laws and to formulate new ones to apply to the Internet. In addition to consumer associations, even the leading business federation Keidanren called for governmental regulation of electronic commerce (Keidanren 1999). Most Japanese laws applicable to electronic commerce rely on general, non-specialized laws. This is somewhat unique in comparison to other countries. One of the most important laws is the Specific Commercial Transaction Act enacted in 1976 and amended in 2000. It requires direct marketers to inform consumers about important transaction issues such as their merchandise return policy, or to provide consumers with the name of a contact person (Doi 2001: 5–9; Mitsubishi Research Institute 2002). Other important new laws enacted are the Consumer Contract Act, the Privacy Bill and the Digital Signature Law: •

•

•

The Consumer Contract Act of 2001 is designed to protect consumers from unfair business practices due to insufficient information by allowing them to nullify contracts under certain conditions, e.g. if the supplier fails to disclose disadvantageous material facts (Doi 2001: 6). The so-called Privacy Bill of 2001, which concerns the protection of data and consumer privacy, aims to protect consumers by ensuring that their data is not misused and that it is handled appropriately. Violators may be subjected to punishment of up to six months in jail or to a fine of up to 300,000 yen – about $2,750 (Horibe 2000). The Digital Signature Law of 2000 grants electronic signatures the same legal status as handwritten signatures (Mitsubishi Research Institute 2002; see also Horie 2002).14

Not only the relatively late amendment and formulation of laws but also the early formulation of guidelines for private regulations make it obvious that the Japanese government was reluctant to enact strict regulations.

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Already in 1989, the Japanese Ministry of Economy, Trade and Industry (METI) encouraged the private sector to take the initiative in formulating appropriate private rules for fostering Internet transactions. Over the following years, ministries and agencies developed guidelines for their particular constituencies.15 Private regulation of electronic commerce is promoted in international foreign trade relations as well, as the US–Japanese Joint Statement on Electronic Commerce announced in 1998 by the President of the United States and the Prime Minister of Japan demonstrates. This statement pinpoints privacy issues in particular as a very important area for the development of business-to-consumer commerce and suggests that governments should encourage private regulation through guidelines or model contracts (OECD 1999: 33).16 Guidelines play an important role in Japanese economic policy and are often implemented by business associations. The METI guidelines of 199717 were based on the earlier version of 1989 and derived from recommendations geared towards protecting personal data laid out by the OECD in 1980. The revised form of 1997 specifically addressed issues raised in the European Union Personal Data and Privacy Directive of 1995. Thus, the METI guidelines of 1997 are ultimately based on so-called ‘fair information principles’ very similar to those formulated by the OECD or the EU. They regulate data collection and usage, the rights of data subjects, the duties of data controllers and requirements in formulating standards for data security. The METI guidelines also explicitly call for industry guidelines and put pressure on Japanese associations to support their member companies in implementing privacy policies. Shortly after the revision of the guidelines in 1997, METI published a Personal Data Protection Handbook, which served as a model for standards such as the Japanese Industrial Standard JIS Q 15001 by virtue of its detailed explanation of guidelines and its incorporation of case studies (OECD 1999: 34; CSLR 2000a: 3, 19–20; Mitsubishi Research Institute 2002). This JIS standard provides minimum privacy requirements and applies to both online and offline activities. A certified company is required to prove that it carries out appropriate measures for consumer protection by ensuring that it adheres to the following technical and organizational procedures: • • • •

Consumers’ consent is required before a company acquires personal information. Consumers must be provided with appropriate information, such as how their personal data will be used. Consumers must be informed that the company is required to supply them with certain information. Organizational strategies, such as appointing an in-house data protection manager or implementing education and training programmes for employees, have to be undertaken.18

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In order to encourage further the development of private standards, the Japanese Information Processing Development Center (JIPDEC), a nonprofit organization founded in 1967 with the support of the METI to promote the use of information processing in Japan,19 developed a privacy mark programme in 1998. To do so it relied heavily on the newly created JIS Q 15001 standard, which thus served as a basis for measuring the quality of transaction terms. Such privacy mark programmes constitute a core element of the development of business-to-consumer commerce in the United States as well. Certification with the privacy mark of JIPDEC follows the general pattern of certification and accreditation systems: JIPDEC is approved by METI and works as the certifying and auditing organization for the privacy mark awarded to single firms and associations. Associations approved to carry out certifications themselves include the Japan Information Technology Service Industry Association (JISA), the Japan Marketing Research Association (JMRA) and the Japan Juku Association (cram schools) (JJA). The concrete activities of granting the mark, auditing and monitoring are carried out by the Privacy Mark System Committee within JIPDEC. The auditing fee is around 80,000 yen (about $730), while the mark use fee comes to about 50,000 yen ($460). The mark is awarded for a two-year period and can be renewed. JIPDEC may sanction certified enterprises for non-compliance. The severest sanction is the withdrawal of the mark, and this has been carried out in one case. In addition, there is a consulting centre for consumers within JIPDEC, which processes complaints regarding the illegal processing of personal data. According to the assessment of experts, the requirements and the certification system are similar to the US privacy seals programme developed by the two leading American certification organizations – BBBOnLine and TRUSTe.20 The signing of a mutual recognition agreement between JIPDEC and BBBOnline is a further indicator that the quality level of the American and the Japanese certification systems should be comparable (Matsumoto 1998; CSLR 2000a: 30, 32 and 2000b: 33; Privacymark 2003a, 2000b, 2000d). The number of companies certified with the JIPDEC privacy mark is 136, still low as of 2002 (Nagato 2003: 61), yet the promotion of the privacy mark has been successful in the sense that businesses and consumers are now more sensitive to privacy and security issues. This is evidenced by the fact that those associations active in electronic commerce, such as the Japan Chain Store Association, the Japan Direct Marketing Association, the Japan Department Stores Association, the Cyber Business Association and the Japan Federation of Consumer Credit Companies, have all adopted guidelines to protect personal data (for a list of organizations see the CSLR 2000a: 36). Another indicator is that 58 per cent of the single member companies of the private Electronic Commerce Promotion Council (ECOM) have established rules on personal data protection. The rest either have formulation under review (21 per cent) or their creation depends on the business division (15 per cent).21

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The privacy mark described above reduces uncertainty when it comes to a firm’s privacy policy. However, another important issue is the reduction of uncertainty within the whole transaction process itself. With this aim in mind, ECOM was founded in 1996. Like JIPDEC, it is an approved association as well, but the majority of its members and staff belong to the private sector.22 One work group in ECOM established in cooperation with consumer associations launched the ‘Consumer Transaction Guideline’ in 1998 in order to reduce uncertainties in business-to-consumer commerce. According to this guideline, Internet suppliers are required to disclose information about their trading conditions and to clearly display the firm’s privacy policy on their homepage. The collection of personal click-stream data without informing the consumer is forbidden. Moreover, firms are obliged to fully disclose their transaction terms, introduce a system for cancellations of orders and return and implement measures for quickly settling disputes (CSLR 2000a: 31 and 2000b: 31–32; Plate 2000: 66). This guideline has been taken up by several members of ECOM, which then grants them a trust mark. The most important member association is the Japan Direct Marketing Association (JADMA), which adapted the ECOM guideline in its ‘Guidelines for Electronic Direct Marketing’ in 1999 and which grants the so-called ‘Online Trust Mark’ in cooperation with the Japanese Chamber of Commerce and Industry (JCCI). The Mark has been awarded to about 640 businesses, which constitute about half of the JADMA membership as of 2003 (ECOM 2001a; Mitsubishi Research Institute 2002; ECOM 2003). Moreover, ECOM has also started an international cooperation with leading American institutions (BBBOnline 2000). An ‘Online Trust Alliance’ between JADMA, JCCI, BBBOnLine and the Korea Institute for Electronic Commerce has been established, and European trustmark organizations such as the Association of European Chambers of Commerce and Industry and the Federation of European Direct Marketing have announced their commitment to the Alliance (ECOM 2001b). As a first result, an Asia Trustmark Alliance was established in 2003, also designed as a mutual recognition system. In summary, the rules reducing uncertainties in business-to-consumer commerce in Japan seem to be relatively comprehensive. The quality of the Japanese system is recognized by bilateral US–Japanese alliances and mutual recognition agreements. The JIS Q 15001 standard constitutes a minimum quality standard for privacy concerns that echoes the requirements for the protection of privacy set out by the OECD. Thus, the quality of certification should be as high as it is in the United States, where private regulation has also been enforced as the dominant strategy to reduce uncertainty in electronic commerce. Nevertheless, an astonishing difference between the volume of businessto-consumer commerce in Japan and that of the United States still persists. Even if the existing statistics are difficult to compare, they show at least an interesting trend. In Japan, the volume of business-to-consumer commerce

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lies at about $10.5 billion. In contrast, the volume of business-to-consumer commerce in North America is $135.3 billion – more than tenfold that of the Japanese.23 Japan is not even under the top ten OECD members with the highest share of online-shopping by Internet users (NFO 2003: 234, 310).24 The share of electronic commerce in retailing is about 1 per cent in Japan while it is about 1.9 per cent in the United States. In addition, business-toconsumer commerce growth rates in Japan are slow. Business-to-consumer commerce grew by 0.1 per cent in 1999 and 0.25 per cent in 2000, whereas the growth rates in the United States were 0.69 and 1.37 per cent respectively (METI 2001). The low volume and low growth rates for Japan are especially surprising when two additional facts are taken into account: Internet compatible mobiles such as i-mode are highly successful in Japan, so that mobile commerce could potentially stimulate more electronic commerce than the amount currently taking place in the United States. Moreover, Japanese consumers report the same advantages to business-to-consumer commerce as do their American consumer counterparts. From a customer’s point of view, the economic advantage of electronic commerce lies in its lower transaction costs. In mobile, highly industrialized, time-pressed and increasingly price-sensitive societies, we would expect enormous incentives to purchase via the Internet. But trade via the Internet in Japan has fallen far short of expectations. Even if one takes underestimated factors that favour traditional commerce into account, such as the Japanese retail system with long shopping hours, the numbers are perplexing. Institutional conditions, such as old-fashioned payment systems or high access costs for the Web, also appear to be insufficient as explanations in and of themselves.25 A more convincing explanation seems to be the role of trust. The problem of producing trust in electronic commerce is generally a widespread problem, as experimental economics has shown (Bolton et al. 2003). However, it gains special importance in countries with informal institutions that do not seem to fit with the necessity of electronic commerce. In the following section I discuss why trust and exactly what kind of trust is a sufficient precondition for business-to-consumer commerce and how the Japanese form of trust should be understood in this context.

Trust as a precondition for institutional solutions Trust and path dependency As briefly described above, reducing information asymmetries through private regulation encourages the development of trust. Since regulations are always incomplete – be it the type of sanctioning system or the rules themselves – a certain level of uncertainty always exists. It is in this sense that trust becomes important, since only the pre-existence of a certain level of trust makes the institutions work. If established economic rules are not

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perceived to be trustworthy, they will not contribute to the aim of increasing the number of economic transactions. Trust is defined here as a special type of an informal institution that allows actor A to reasonably expect that actor B will comply to the arrangement agreed upon between A and B, even in a situation of uncertainty. Trust reduces complexity and risk and enables individuals to build up mutual expectations about the future. Individual expectations and perceived obligations thus constitute important elements of trust. As a consequence, trust becomes a functional substitute for control and monitoring, especially in those cases where the costs of searching for information are extremely high. Furthermore, trust also needs to be distinguished from similar terms that express expectations such as confidence or hope. Confidence designates a more passive mode of behaviour in the sense that an actor relies on a system functioning well, while hope is associated with chance or fortune. In contrast to both confidence and hope, trust implies an intention or motivation to carry out a concrete activity, in this case a transaction via the Internet (see Khalil 1994; Yamagishi and Yamagishi 1994). Arrow (1974) once stated that trust is an efficient lubricant in economic exchange processes. Nevertheless, extensive research on trust has only just begun. A well-known research project carried out by Knack and Keefer (1997) presents empirical evidence that different degrees of trust and civic norms – the two core elements of social capital – have an effect on a nation’s competitiveness, thereby supporting earlier, more exploratory research that focused on the interconnections between culture and economic growth (Casson 1993; Khalil 1994). On the micro level, Lane and Bachmann (1996: 365) come to the conclusion that ‘the new goals [such as high quality, versatility and innovativeness of products] cannot be achieved by isolated firms but only through the development of close and integrated relationships between manufacturing firms and their suppliers’, and that ‘trust plays an important role in the constitution of supplier relations’. Other findings confirm the important economic role of trust in functional areas such as marketing partnerships (Aulakh et al. 1996). In other words, trust is becoming more and more recognized as an important economic resource and increasingly relevant to economic analysis.26 In fact, trust becomes a factor of production, which explains its close association with the term ‘social capital’. Not only does it increase efficiency and make better coordination of economic exchange possible but, even more importantly, it becomes a precondition for exchange. Without trust, exchange would be impossible in many instances due to the characteristics associated with experience and credence goods noted above. In electronic commerce, trust gains even more importance. The tremendous importance of trust and the problems of specific cultural dispositions become obvious if the term trust is differentiated further according to its objects and its genesis. The first differentiation deals with the object of trust, which corresponds to the distinction between personal

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and institutionally based (or institutional) trust (Giddens 1990; Loose and Sydow 1994). This differentiation is so important that social psychologists do not even call personal trust ‘trust’ but rather ‘assurance’ or ‘commitment’ (Yamagishi and Yamagishi 1994). Institutional trust provides a ‘springboard in the attempt to break psychological inertia that has been mobilized to maintain committed relations’ (Yamagishi and Yamagishi 1994: 129), whereas personal trust is described as a commitment that becomes a liability rather than an asset as opportunity costs increase (Yamagishi 1988). The second important differentiation refers to the different ways in which trust is generated. Zucker’s work (1986) on the genesis of trust examines the role of trust in economic development in the United States from 1840 to 1920. She starts from the premise that there are three different types of trust: (1) process based; (2) characteristic based; and (3) institutionally based. Process-based trust develops out of the concrete experience of long-term and stable transactions by which expectations towards further transactions arise. Characteristic-based trust centres on the characteristics of the trustees, e.g. his or her family background or ethnicity. With characteristicbased trust, the concrete transaction experience is not necessary. Finally, institutionally based trust abstracts from the concrete transaction situation and from the concrete transaction partner. This form of trust is tied to institutional structures in a society, e.g. standards, certificates or labels. Zucker’s central point is that the replacement of process-based and characteristicbased trust – both of which were destroyed by exogenous instabilities in the nineteenth century – by institutionally based trust was critical for the successful industrialization of the United States. Putting these differentiations together, we may say that trust tied to a person can be generated by longterm transaction experiences or by his or her personal characteristics, while the trust tied to a system is generated by rules. Since institutional trust is independent of spontaneous individual preferences, it has also been termed ‘generalized trust’. Most works referring implicitly to Zucker’s concept assume that (only) institutional trust is the source of successful economic development. According to Khalil (1994: 340), for example, capitalist society needs institutional trust as ‘economic exchange becomes less intermingled with kinship and more based on formal contractual relationships [so that] the monitoring conducted by the kin members and the threat of ostracism almost vanish’. The same stance towards institutional trust can be found in the influential study by Knack and Kneefer (1997). They contrast high-trust environments (cultures with institutional trust) to low-trust environments (cultures that rely on personal trust), and describe the latter as environments in which transactions take place more among close friends and relatives than among strangers. They argue that high-trust cultures carry one of the major preconditions for economic success (see especially Knack and Kneefer 1997: 1256). Their conclusion that dense, horizontal networks do not reinforce trust fits into this line of argumentation (Knack and Kneefer

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1997: 1284). Another common theory that draws on modernization literature is that personal trust loses its importance in advanced societies due to ever expanding anonymous markets. In the words of Tönnies, Gesellschaft gains in importance at the expense of Gemeinschaft (cited in Khalil 1994: 341). A lack of institutional trust induces economic stagnation and underdeveloped markets. Especially in the era of information and communication technologies, a lack of institutional trust may thus become a competitive disadvantage. Phrased more bluntly, in economic theory there is a favourable form of trust and a less favourable form of trust for economic development.27 In order to understand more clearly the implications of this research, a short recourse to institutional economics and its concept of path dependency is necessary. The concept is employed as a core concept in understanding institutional change, particularly in understanding why desirable reforms do not take place. The problem of institutional change becomes especially relevant when institutional arrangements are identified as harmful to economic development. Due to their embeddedness in societal structures and their complementarity to other rules, institutional change is difficult and slower than often deemed necessary. The adherence to established institutions and the resulting hesitancy towards reforms may be rational from an individual’s point of view, but as a collective process it may result in institutional lock-in. One of the first who accentuated the difficulty of institutional change is North (1993), who acknowledges at most the possibility of marginal reforms on the fringe.28 North concludes that for all economies that are not heirs to market-oriented belief systems, the transformation into a market economy is expected to be difficult: It takes much longer to evolve norms of behaviour than it does to create formal rules and for those economies without a heritage of such norms the reconstruction process is necessarily going to be long and the outcome very uncertain. (North 1993: 21) Other authors follow this argument, such as Eggertsson (1998) in his paper on ‘Limits to institutional reforms’. In a publication related to Japan and other Asian nations, Aoki and Hayami (2001) see formal and informal institutions as complementary to the degree that community norms such as personal trust become a prerequisite for economic exchange, but that such community norms can induce dysfunctions as well, since community trade tends to be small in volume and competition in the group becomes club-like and restricted. In other words, certain informal institutions can lead to institutional lock-in and hinder the development of markets. Their drive to analyse ‘what types of community relationships promote or deter market development’ (Aoki and Hayami 2001: xix) resembles very much the idea prominent in institutional economics discussed above – to differentiate between favourable and less favourable institutions. Finally, one can find, particularly in the

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German literature, strong scepticism towards change, which might partly stem from the negative experiences of the transformation processes in Eastern Europe.29 According to Eisenberg (1999), for example, the more homogenous the group is, the slower institutional change may occur. If one classifies Japan as a relatively homogenous culture,30 institutional change in its society is deemed to be extremely difficult. Earlier research on Japan, such as works concerning public policy or standardization policy, tends to support institutional path dependency theory (Pascha 2001; Storz 2003, 2005b). The negative experiences in developing and transformation countries have helped to sustain the path dependency tradition in institutional literature as a relatively deterministic concept. Groups without favourable informal institutions are restricted in their options to create better institutions. With the rise of new information and communication technologies making markets even more anonymous, institutional trust becomes an even more critical resource for a nation’s competitiveness and the lack of complementary informal institutions even more problematic.31 The lack of institutional trust in Japan and electronic commerce Institutional trust in a society is a precondition for the success of electronic commerce since societies in which it is not widespread will not readily accept a new market with newly established rules. Even market rules that have been successful in other countries need not be successful in the case of their transfer to another society if this important precondition is not given. Since informal institutions are fairly stable, we expect electronic markets to remain underdeveloped in the long run as well. Comparative empirical research has shown that there are indeed stark differences in the amount of institutional trust in Japan and the United States (Markus and Kitayama 1991; Yamagishi 1998). American respondents are more trusting in other people in general. They consider reputation to be more important than their Japanese counterparts. In contrast, the amount of institutional trust in Japan is low, while the amount of personal trust is high. Japanese respondents see more utility in dealing with others directly – a phenomenon that Befu (1989) has explained with the fact that interpersonal relationships are long-term oriented so that instrumental and personal aspects become more mixed. These insights correlate with Hofstede’s hypothesis that Japanese actors also tend to avoid uncertainties in the sense that they are more prone to risk aversion (see for its reception Kanbayashi 1999). These results may be somewhat astonishing since Japan has often been designated as a high-trust culture (see, for example, Casson 1993: 431), but this characterization is grounded in an insufficient differentiation of different forms of trust. Japan is a society in which there is a high level of personal trust and less institutional trust.

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If these empirical results, on the one hand, and the thesis of incremental change discussed above, on the other hand, are correct, then it is not surprising that the Japanese electronic markets are underdeveloped. Public policies and private regulation are almost without effect since they require widespread institutional trust not found in Japan. The low success rates of business-to-consumer commerce in Japan can, in this view, be explained by the preference for personal trust. And personal trust cannot be transformed by appropriate rules into institutional trust in a mechanical way. Japanese actors simply will not put their trust into them. Yamagishi’s conclusions (1988) might even be correct in emphasizing that sanctions are needed more in Japan than they are in the United States in order to enforce commitment to rules. Indeed, the argument that the predominance of personal trust hinders the development of anonymous market transactions such as business-toconsumer commerce was grasped by leading Japanese think tanks in order to explain the slow growth of electronic commerce (Kitamura et al. 2000; Tagawa 2001).32

Learning processes and path dependency Entrepreneurial alertness and learning The previous sections have discussed how institutions may reduce uncertainty and that institutional trust is a necessary precondition for institutions to function well. This argument is based on the assumption that there are two different kinds of trust – institutional and personal. If one follows the argument that these two different forms of trust exist and if the concept of path dependency is correct, then institutional change is obviously restricted. Generating trust by introducing institutions, as suggested by Zucker (1986), becomes almost a tautology. At this point I would like to suggest a different approach. I depart from the view that informal institutions favouring market development, i.e. institutional trust, and those that favour communities, i.e. personal trust, are two different, alternative ways of organizing economic activities, and that economic development necessarily entails moving from personal to institutional trust. I see the common problem of many of the institutional approaches as residing in this viewpoint: that informal institutions are seen as given and that they perpetuate certain preferences that then lead to specific behavioural restrictions as well as specific rules for decision making. In this understanding, informal institutions are treated as exogenous determinants of individual behaviour. Nevertheless, a number of authors are increasingly acknowledging that this approach contains a number of deficiencies.33 In conjunction with neuro-biological theories and learning psychology it may perhaps be more useful to view informal institutions as internalized rules. Such internalization takes place by learning. The learning process is subjected both to exogenous control, such as sanctions

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or incentives, and endogenous control, which is initiated by the individual and carried out systematically. If internalization takes place by learning it seems questionable that rules persist practically unchanged after they are internalized, and such learning processes can challenge previously learnt rules. In order to understand the conditions under which and the ways in which re-learning takes place, it is helpful to follow the suggestion made by Vanberg and Buchanan (1994). They break informal rules down into their theory and interest components. The theory component is comprised of a validated finding, and the interest component entails a subjective evaluation. Since the theory component can be reflected upon in relation to its contribution to an expected outcome, there is an incentive for the individual to determine when and under which conditions established informal institutions are helpful in order to achieve this outcome. We can expect that individuals analyse the long-term outcomes of informal institutions with respect to their efficiency, i.e. whether and to what degree these institutions contribute to a long-term goal. A change in informal institutions can be expected if their effectiveness is perceived to be improved by the change over time.34 Since learning takes place in paths, re-learning also does not normally take place in radical bursts. It is more often the case that one learns in unspectacular, incremental steps in everyday life. Informal institutions, such as personal or institutional trust, can evolve in a slow, almost imperceptible process of change. In such a way, informal institutions undergo processes of change and may become locked out of given paths. But even if one is more sceptical about learning processes and tends to interpret informal institutions as stable, there is still another way of interpreting the existence of paths. If one understands paths as plasticine and considers the range of varieties in existing paths, then one may say that the existence of a path itself is less important. More important is the entrepreneur’s ability to find creative answers to (supposed) path restrictions. Such an approach renders the determinism that shines through in at least applied economic research questionable (Garud and Karnoe 2001; Storz 2005a, b). The role I attach to learning capacity and to entrepreneurial creativity does not deny that learning takes place on the basis of accumulated storages of experiences, and that certain informal institutions may restrict economic development if incentives for learning are not present. Nevertheless, the thesis of institutional rigidity loses some of its strength when we consider that internalized rules can be modified or even rejected through creativity and learning. The issue is then not so much the fact that certain informal institutions hinder a certain type of development as it is more the underlying learning processes in a society and the fact that they might be hindered. The availability of information and its credibility, public discourse about the ‘truth’ of rules and the subjective conviction that new rules would be

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more desirable are central elements for successful reforms. The precondition for change, therefore, are not favourable institutions but rather the creation of an institutional framework that enables learning processes and that accommodates well-functioning feedback processes. Within this approach, options for reforms and change emerge. New solutions in Japanese electronic commerce Electronic commerce is a fairly recent form of individual economic transactions, so that it may be too early for an assessment of learning processes; even general statistics on business-to-consumer commerce began to be collected only a few years ago. Nevertheless, the following section will attempt to interpret the recent developments on the Japanese business-toconsumer market within the conceptual framework developed above. As mentioned earlier, the volume of business-to-consumer commerce in Japan is low. However, one turning point appears to be in the making by way of connecting the ‘old’ to the ‘new’ market. A unique form of business-toconsumer commerce has developed in Japan by which convenience stores have been converted into ‘windows of electronic commerce’ (Matsumoto 2000: 100). Japanese convenience stores, originally an invention from the United States, are small supermarkets with long business hours (90 per cent of them are open 24 hours a day) and a large number of small outlets at convenient, consumer-dense intersections. Since their introduction in the 1970s, they have become the most successful form of retailing in Japan, boasting more than 30,000 in number. In Japan’s urban areas, at least one, and usually two or three, are within walking distance. The largest companies are 7-Eleven, Lawson and Family Mart. Together they comprise more than 50 per cent of all outlets. Over the past few years they have developed two very dynamic electronic commerce strategies: (1) their own portals in electronic commerce and (2) service for other virtual shops. 1

In 2000, several convenience stores began to go online. 7dream.com, founded by 7-Eleven and seven partners including NEC, Sony, Mitsui and Nomura Research Institute, is one of the largest virtual stores in Japan and offers about 100,000 items. It also offers services in the areas of travel, digital photo printout, books and mobile phones. Another start-up of the 7-Eleven group entered into the meal delivery market (7meal.services). Lawson offers retail electronic commerce as well, also in cooperation with partners who are top leaders in their industry, such as Mitsubishi and Toyo Information System. Consumers can use easyto-select items in terminals installed in Lawson shops and pay at the shop. Smaller products are picked up at the shops while bulkier items are delivered to the customer’s home (Whipple 2000; Joffe 2001).

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Cornelia Storz A second strategy is to offer a delivery and payment service to other virtual stores. Since their distribution network, their IT-based logistics and their demanding payment system are the best in Japanese retailing, convenience stores possess a competitive advantage in the logistical distribution of goods. Today, about 75 per cent of Internet shoppers reportedly pick up their purchases from stationary retailing (Ebusinessforum 2001). The idea of combining virtual stores with stationary retailing is so successful that even companies with high-priced items and no financial investments in convenience stores, e.g. Toyota, plan to incorporate business-to-consumer commerce via convenience stores. One plan is to sell more than half of the automobiles originally to be sold by Toyota’s own homepage Gazoo through convenience stores (Ebusinessforum 2001: 27).

Within the theoretical framework presented here, the second strategy is particularly interesting. Its uniqueness is grounded in the cooperation between business-to-consumer commerce and conventional retailing. One way to interpret this strategy would be to say that this is simply another case of strict path dependency. Business-to-consumer commerce organizers found a way to generate these new business models by relying on consumers’ personal relationships with well-known retailers, thereby circumventing restrictions associated with certain informal institutions. The trustworthiness of business-to-consumer commerce is strengthened as a high percentage of convenience stores are successors to traditional neighbourhood stores, and often the franchises are operated by the former. One could argue that personal trust has come to electronic commerce through the backdoor.35 The problem with this interpretation is that it continues to employ a static approach to economic development. Other approaches allow more room for creative potential and stress the importance of personal trust as a precondition from which institutional trust may derive. According to organization theory, for example, the sales staff in convenience stores can be interpreted as actors with special organization roles known as ‘boundary spanning roles’ (Loose and Sydow 1994). Even if they fulfil more the function of an institution than a person, they can help through their reliable behaviour to build trust into the system. Trust is thereby stabilized since consumers can fall back on established norms and schemes in which previous trustworthy relationships have not changed. As consumers conduct businessto-consumer commerce via stationary retailing, they learn the advantages of electronic commerce while positive feedback loops concerning the quality of products prove to them that a change in their behaviour may be in their interest. Such a dynamic perspective allows the possibility that institutional trust may result out of personal trust and may be built up incrementally to the benefit of new market opportunities. Personal and institutional trust are in this perspective neither contradictory nor merely complementary but dynamic and interactive.36 Even if a lack of institutional trust somewhat

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restricted the development of electronic commerce in Japan in the beginning, the above-average growth rates of mobile commerce in business-to-consumer commerce may be an indicator that institutional trust is growing.37 Another indicator of the potential of this new retailing strategy lies in the fact that it has been successfully exported to other Asian countries which exhibit to some degree similar informal institutions. But even if one takes informal institutions as given, the case of Internetbased retailing provides a good example of the way in which presumed restrictions may trigger entrepreneurial creativity, which in turn can overcome the presumed restrictions. The case of Internet retailing via convenience stores thus closely resembles the development of the Japanese enterprise groups, which was a strategic response to formal institutional restrictions of underdeveloped markets of labour, capital and knowledge in the 1950s and 1960s. Here again, because of presumed restrictions, this new strategy could be generated and expanded upon. The coupling of business-to-customer commerce to convenience stores is not only interesting as a case of clever entrepreneurial alertness. It also strongly reminds us that economic development is always open. The fact that paths exist is not a problem per se if an adequate solution to the economic problem at hand can be found. It is too early to evaluate whether the solution of coupling business-to-customer commerce to stationary trade is indeed an adequate one, but it has clearly opened up new and innovative business possibilities.

Conclusion This chapter started with the assertion that electronic commerce – here the business-to-customer commerce form – is characterized by new consumer uncertainties that result from new information asymmetries. According to information economics, uncertainties can hinder the development of markets. Institutional answers to uncertainty are generally supplied by public policies and private regulation. Since private regulation may be more flexible and superior with regard to knowledge creation, it has gained much attention in recent years. In order to solve the problem of uncertainty, Japan has chosen to rely on private regulation, as has the United States. Mutual recognition agreements between American and Japanese certification organizations indicate that Japan’s mode of regulation should have the same quality as the mode in the United States. But, despite an elaborate and comprehensive institutional infrastructure, Japanese electronic markets are still underdeveloped compared to the United States. Why is this the case? I find one important explanatory factor in the different kinds of trust that exist in each of the two countries. Empirical research has shown that institutional trust is weak in Japan (as well as in other Asian countries), while personal trust is widespread. Since private regulation requires institutional trust in the sense that consumers must be able to assume that certified parties will comply with the rules and that defection is sanctioned,

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and because of the extent to which personal trust dominates in Japan, it is not surprising that private regulation did not lead to the expected results in Japan. Nevertheless, uncertainty and information asymmetries have been tackled in Japan in a different way. Japan as well as other Asian countries rely on personal solutions by incorporating anonymous Internet shopping into stationary retailing. Western countries have tended to accept the more anonymous shopping on the Internet without much ado. One could stop at this point and remain sceptical about the future development of electronic commerce in Japan. Such scepticism would be underscored by a certain stream in institutional economics in which restrictions to institutional change are stressed. But the conceptual framework presented here departs from this view since informal institutions are learnt and relearnt: the sales staff in convenience stores fulfil special organizational functions in boundary-spanning roles, thereby contributing to the build-up of institutional trust – specifically but not only in electronic commerce – through their trustworthy behaviour. Although it is too early to state that these business models are functional equivalents of the type of electronic commerce we find in the United States, Japanese convenience stores have clearly developed into focal points of business-to-consumer commerce. They function as distribution and payment centres, and have even exported the model into south-east Asian markets. The above-average increase of mobile commerce may be an indicator that the needed institutional trust is slowly beginning to develop. Moreover, entrepreneurs have an incentive to develop their own, creative solutions. Indeed, as I showed for Japan, innovative business models have been created exactly by drawing on pre-existent informal institutions. In directing attention to the option of unlocking, I do not deny that learning takes place in paths and that institutional lock-ins are possible. Pathdependency is a given fact. I merely emphasize that we should not underestimate an actor’s capacity to learn, nor should we disregard the leeway of options within paths. The selection of a certain analytical perspective tends to portray certain institutional developments in a more favourable light or – as the case may be with business-to-consumer commerce – in a more unfavourable light than reality might suggest. This contribution is meant as a possible starting point to discuss further other possible modes of economic development.

Notes 1 This contribution was supported by an invitation to conduct research at the Kansai University from September to October 2003, and I would like to thank the University for its generous hospitality, especially Professors Mitsuru Tanaka and Hirohiko Yasuki. During this research stay I was able to conduct several interviews with staff in institutions active in self-regulation, and the results have been incorporated into this chapter. Special thanks go to Kazuhiko Wakaizumi and Shogo Asanuma from ECOM and to Hideo Shindo from METI.

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2 The validity of electronic signatures, a new problem caused by the disintegration of identity and authenticity, will not be touched upon here. Special laws regarding electronic signatures and private certification systems have been formulated in almost all OECD countries. 3 Private regulation is defined here as a set of rules formulated by the private sector, also called market solutions or private constitution. Some scholars prefer the term ‘self-regulation’. ‘Self’ refers to the fact that the rules are formulated by the actors themselves. ‘Regulation’ refers to the activity of the subjects, namely the formulation of suitable rules, their enforcement, and the control over their enforcement. 4 The appropriateness of private rules depends very much on the respective sector. In the case of broadband penetration, for example, private rules lead to very low penetration, which may be explained by the fact that federal regulation is often necessary in order to guarantee a common standard (see the contributions by Frieden; Knieps; Lageman, Rothgang and Scheuer; Schefcyzk in this volume). 5 For South Korea and Singapore, see Tagawa 2001. 6 Electronic commerce includes every type of electronic commerce that is conducted between different actors, independent of the medium (e.g. it includes mobile commerce as well). It can be carried out between firms and consumers, between firms and other firms, and between public institutions and firms and/or consumers. Since the economic problems arising with each of these types differ, this chapter focuses only on electronic commerce conducted between firms and consumers, or business-to-consumer commerce. 7 The systematic analysis of information problems started in the 1960s with the idea that both sides of the market do not have perfect information. Stigler (1961), who can be seen as the founder of the economics of information, discusses the consequences of information problems and demonstrates that information asymmetries may be in the interest of sellers. The theories of adverse selection and signalling (Akerlof 1970; Spence 1974) are formulated in this neoclassic tradition. 8 Since institutions restrict individual behaviour, a common interest in the solution of a problem is necessary before the institution can work. Only when a common interest can be established, in the sense that ‘it can be assumed that all individuals might agree to it’ (Kerber and Vanberg 2001: 67), may limits on individual freedoms be legitimized. 9 Screening is the process by which the uninformed consumer searches for information about products and services, while signalling refers to the information about product or service quality by the supplying actor. 10 Brand names can also be interpreted as signals. It can be argued that sanctioning here occurs internally since economic actors tend to stick to one particular brand on the basis of its reputation. 11 The dilution of rules is usually subsumed under the term ‘defection’. 12 Other problems associated with collectively formulated standards are the creation of less demanding rules and the restriction of competition. While neither can be further discussed here, both are highly relevant for the problem of technology clubs. For a general theory of clubs, see Buchanan 1965 and Olson 1971. For information on technology clubs, see Gilroy 1992 and Kuno 1998. 13 B2C stands for business-to-consumer commerce. 14 The problem of electronic signatures will not be discussed here, but the Japanese government relies on private regulation in this area as well. Private certification authorities provide so-called public key infrastructures, which require the government to recognize the formal equivalence of electronic and handwritten signatures (Keidanren 1999; Nikkei Communications 2000). A list of federal laws and corresponding administrative guides relating to online trade can be found in Horibe 2000. 15 For an overview, see CSLR 2000a: 3–6, 21–3 and 2000b: 21–3.

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16 Further international cooperation takes place in the APEC (Asia–Pacific Economic Cooperation), where an Electronic Commerce Task Force has been established (CSLR 2000b: 27–8). 17 The full name is ‘Guidelines Concerning the Protection of Computer Processed Personal Information in the Private Sector’. 18 In Japanese management literature, JIS Q 15001 is often seen as an entity within the international standards ISO 9001 (quality management standard) and ISO 14001 (environmental management standard), since together they outline a firm’s social responsibility. As in the case of ISO 9001 and ISO 14001, the single requirements of JIS Q 15001 are embedded in a strategy called PDCA (plan-docheck-action), which aims to permanently improve the company’s policy. Both internal and external audits are prescribed (see Horie 2002; Nagato 2003: 55, 136). For further details on this standard see CSLR 2000a: 30 and 2000b: 25–6 and Nagato 2003: 25, 138. 19 There are several different English translations for the JIPDEC certification system, including the System of Granting Privacy Marks, the Privacy Mark Award System, or the Privacy Seal Granting Program. JIPDEC receives tax abatements as an incorporated foundation (zaidan hôjin). This status requires annual approval by the corresponding ministry (Privacymark 2003a, 2003b, 2003c, 2003d; for Japanese associations see Schaede 2000). 20 The licensing fees at BBBOnline are graduated depending on the size of the enterprise. Total company sales of one million or less pay $50, one to five million pay $250 and more than five million pay $500 per year. 21 Information relayed through interviews. 22 Nevertheless, ECOM is also relatively closely associated with the METI since about 30 per cent of its staff is sent by JIPDEC to ECOM on a temporary basis. 23 In Europe, the volume is about $82 billion. The absolute volume for electronic commerce for 2003 lies at $674.6 billion in the United States, $170 billion in Germany, and $87.4 billion in Japan (NFO 2003: 235, 237, 241). Statistics present different absolute levels of business-to-consumer and business-to-commerce, but the trend is the same in all statistics: North America leads followed by Europe, while the volume of Japanese electronic commerce is much lower. 24 The United States is again in first place, South Korea in second and Germany in third. 25 Most of the procured goods in Japan are paid by bank drafts or postal giro. This form of payment is often cited as a barrier to electronic commerce. But the volume of electronic commerce in Germany, a country in which it is equally not very common to pay by credit card, is much higher than in Japan. Access costs for the Internet in Japan are indeed relatively high – an issue that has been discussed as Japan’s ‘backwardness in IT’ at length (Nihon okureta IT kakumei). It was hoped that this could be overcome by the so-called ‘e-Japan Strategy of 2001’. Nevertheless, the share of mobile commerce, which could be an important pillar of business-to-consumer commerce since its access costs are cheap, was – at 7.2 per cent of the overall business-to-consumer volume in 2000 – still low (METI 2001; MPHTP (Ministry of Public Management, Home Affairs, Posts and Telecommunications) 2003). 26 On this point, see for further details Mayer et al. 1995; Uslaner 1999; Alesina and La Ferrara 2002. 27 For further analysis, see Hardin 1998 and Rousseau et al. 1998. 28 For further case studies of transformation countries, see Sztompka 1995; for trust building in medieval Italy, see Putnam 1993. 29 Leipold (1997: 64) states that because of the necessity of reform policy to set even further into deeper social layers, there are no prospects for quick reform successes in Russia (see also Panther 1998). One central reason for this assumption lies in the reception of a certain strand of social psychology that stresses that

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certain moral rules are learnt primarily in youth and are then more or less fixed (Nunner-Winkler 1992; Lind 1993). This statement does not negate important foreign cultural influences in Japan. In institutional economics the concept of path dependency is not necessarily static, and many scholars examine ways in which institutional change can be triggered. Nevertheless, most of the research tends to address the problems of path dependency and the impact of institutions on human behaviour while neglecting the questions of institutional lock-out and the genesis of new institutions. The case of credit cards is another example in point. One qualifying remark here is necessary. The history of private regulation enacted to reduce information asymmetries is quite young in Japan. Private regulation was often closed to corporatist structures both in the domestic as well as in the export market. In the domestic market agreements in the banking sector, within the steel industry in export markets and in the household appliances industry have all become wellknown examples. See Schaede 2000 for a general overview. For critical voices towards self-regulation, see Fujita 1999 and Nihon Keizai Seisaku Gakkai 2001. Institutional economics focuses more on the effect of institutions and less on their genesis. Eggertsson (1993) and Gäfgen (1983: 25) have already voiced this criticism. Both state that there is a growing consensus that a theory of institutional change requires a theory of the formation of value systems. If one adds this concept of effectiveness to the analytic framework, the change of preferences can be integrated into the economic model of behaviour as well. The volume of TV shopping is about tenfold that of business-to-consumer commerce, and TV shopping has shown growth rates of about 4.7 per cent (Plate 2000: 64; Nikkei Weekly 2003a). The case of TV shopping is interesting, since important personal interaction still exists, albeit at a physical distance (e.g. by personal presentation of goods even by company presidents). The idea of combining electronic commerce with personal relationships is not new and has been applied successfully in other areas as well: about one-third of catalogue shopping payments takes place in neighbourhood shops. The utilization of personal trust in order to create institutional trust has been observed in other industries as well, for example, in the insurance sector where access to the customer takes place via insurance brokers (see Loose and Sydow 1994: 183–4). The increasing sums of purchase in business-to-consumer commerce can also be interpreted as learning curves. People who have been using shopping sites for less than six months spend about 6,900 yen in Japan, whereas the sum for people with experience in this area for more than five years is much higher at 18,600 yen (Nikkei Weekly 2003b).

Bibliography Akerlof, G. A. (1970) ‘The market for “lemons”: quality uncertainty and the market mechanism’, The Quarterly Journal of Economics, 84 (3): 488–500. Alesina, A. and La Ferrara, E. (2002) ‘Who trusts others?’, Journal of Public Economics, 85: 207–34. Aoki, M. and Hayami, Y. (2001) ‘Introduction: communities and markets in economic development’, in Aoki, M. and Hayami, Y. (eds) Communities and Markets in Economic Development, Oxford: Oxford University Press, pp. xv–xxiv. Arrow, K. J. (1974) The Limits of Organisation, New York: Norton. Aulakh, P. S., Kotabe, M. and Sahay, A. (1996) ‘Trust and performance in crossborder marketing partnerships: a behavioral approach’, Journal of International Business Studies, special issue: 1005–32.

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BBBOnline (2000) New Online Privacy Protection Tool to Transcend Borders: BBBOnline and privacy seal program (JIPDEC) announces plans for joint online privacy seal, accessed from http://www.bbbonline.org./about/press/2000/051800.asp on 5 May 2003. Beales III, J. H. (1998) ‘Licensing and certification systems’, in Newman, P. (ed.) The New Palgrave Dictionary of Economics and the Law, vol. II, London: Macmillan pp. 578–81. Befu, H. (1989) ‘A theory of social exchange as applied to Japan’, in Sugimoto, Y. and Mouer, R. E. (eds) Constructs for Understanding Japan, London: Kegan Paul International, pp. 39–66. Bolton, G. E., Katok, E. and Ockenfels, A. (2003) Bridging the Trust Gab in Electronic Markets, accessed http://ockenfels.uni-koeln.de/pubs.php?w=all on 20 August 2004. Buchanan, J. M. (1965) ‘An economic theory of clubs’, Economica, 32: 1–14. Campbell, A. J. (1998–1999) ‘Self-regulation and the media’, Federal Communications Law Journal, 51 (3): 711–71. Casson, M. (1993) ‘Cultural determinants of economic performance’, Journal of Comparative Economics, 17: 418–42. CSLR (Center for Social and Legal Research) (2000a) Guide to Privacy and Data Protection Program in Japan, Washington DC: CSLR. CSLR (2000b) Guide to E-Commerce and Privacy Developments in Japan, Washington DC: CSLR. Doi, E. (2001) Recent Developments on Internet Related Laws and Regulations in Japan, accessed at www.nzls.org.nz/conference/pdfpercent20files/DoiF12.pdf on 19 September 2003. Ebusinessforum (2001) Seven-Eleven Japan: blending e-commerce with traditional retailing, 24 May, accessed at www.ebusinessforum.com/index.asp?layout=rich_ story&doc_id=3544&categoryid=&channelid=&search=Sevenpercent2DEleven+ Japan on 1 April 2004. ECOM (Electronic Commerce Promotion Council) (2001a) Electronic Commerce: onrain mâku seido ni tsuite (Electronic Commerce: about the online mark system), accessed at www.ecom.jp/onlinemark/index.html on 15 April 2003. ECOM (2001b) ECOM Newsletter No. 16, 12 October, accessed at www.ecom.or.jp/ ecom_e/latest/newsletter_no16.htm on 15 April 2003. ECOM (2003) ECOM Newsletter No. 31, 29 January, accessed at www.ecom.or.jp/ ecom_e/latest/newsletter_no31.htm on 15 April 2003. Eggertsson, T. (1993) ‘Mental models and social values: North’s institutions and credible commitment’, Journal of Institutional and Theoretical Economics (JITE), 149 (1): 24–8. Eggertsson, T. (1998) ‘Limits to institutional reforms’, Scandinavian Journal of Economics, 100 (1): 335–57. Eisenberg, A. (1999) Die Lösungen sozialer Dilemmata und der Wandel informeller Institutionen, Discussion Paper no. 04–99, Jena: Max-Planck-Institut zur Erforschung von Wirtschaftssystemen. Frey, B. S. (1997) Markt und Motivation. Wie ökonomische Anreize die (Arbeits) Moral verdrängen, Munich: Vahlen. Fujita, S. (1999) ‘ISO kankyô kokusai kikaku ninshô shutoku kigyo ni taisuru ankêto chôsa hôkoku. Kikyô no kankyô taisaku to kankyô risuku manejimento’ (A Survey of Companies Certified under the International Environmental ISO Standard. Corporate Management of Environment and Risk), Hokengaku Zasshi, 567: 94–115.

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Gäfgen, G. (1983) ‘Institutioneller Wandel und ökonomische Erklärung’, in Boettcher, E., Herder-Dorneich, P. and Schenk, K.-E. (eds) Jahrbuch für Neue Politische Ökonomie, vol. 2, Tübingen: J. C. B. Mohr (Paul Siebeck), pp. 19–49. Garud, Raghu and Peter Karnoe (2001) Path Dependence and Creation, London: Lawrence Erlbaum Associates. Giddens, A. (1990) The Consequences of Modernity, Oxford: Polity Press. Gilroy, B. M. (1992) International Production, Technology Clubs and Governments, Discussion Paper No. 65, Department of Economics, University of St Gallen: St Gallen. Hardin, R. (1998) ‘Trust’, in Newman, P. (ed.) The New Palgrave Dictionary of Economics and the Law, vol. III, London: Macmillan, pp. 623–8. Horibe, M. (2000) ‘Denshi-shô torihiki to puraibashii’ (E-Commerce business and Privacy), Jurisuto, 1183 (8): 77–85. Horibe, M. (2002) ‘E-komaasu ni okeru hoshô to kansa no gainen wakugumi’ (Security in E-commerce and the framework of a concept for inspections), Hitotsubashi Ronso, 128 (4): 470–85. Joffe, H. (2001) ‘Japanese business models for electronic commerce – laying the foundation of a ubiquitous networking infrastructure with mobile phones and convenience stores’, Vierteljahresheft zur Wirtschaftsforschung, 70 (4/2001): 546–70. Kanbayashi, N. (1999) ‘Jôhô gijutsu shisutemu no sekkei to bunka kôzô’ (The design of the system of information technology and the construction of culture), Kokumin Keizai Zasshi, 177 (5): 39–51. Keidanren (1999) Denshi Torihiki no Suishin ni Kansuru Teigen. III. Kakuron (Suggestions for the promotion of E-Commerce. III. The arguments), accessed at www.keidanren.or.jp/japanese/policy/pol240/part3.html on 15 April 2003. Kerber, W. and Vanberg, V. (2001) ‘Constitutional aspects of party autonomy and its limits – the perspective of constitutional economics’, in Grundmann, S., Kerber, W. and Weatherill, S. (eds) Party Autonomy and the Role of Information in the Internal Market, Berlin/New York: Walter de Gruyter, pp. 49–79. Khalil, E. L. (1994) ‘Trust’, in Hodgson, G. M., Samuels, W. J. and Tool, M. R. (eds) The Elgar Companion to Institutional and Evolutionary Economics. L-Z, Aldershot: Edward Elgar, 339–45. Kitamura, Y., Ôtani, A. and Kawamoto, T. (2000) Denshi-shô Torihiki no Genjô to Kadai: atarashî chûkai-gyô no shussan to shinrai keisei (The present condition and the tasks of e-commerce business: birth of new intermediation-industries and the development of trust), Discussion Paper No. 2000-J-13, IMES (Institute for Monetary and Economic Studies, Bank of Japan), Tokyo. Knack, S. and Keefer, P. (1997) ‘Does social capital have an economic payoff? A cross-country investigation’, The Quarterly Journal of Economics, November: 1251–88. Kuno, A. (1998) ‘Kokusai hyôjun no keizai bunseki’ (Economic analysis of international standards), SRIC Report, 3: 49–64. Lane, C. and Bachmann, R. (1996) ‘The social construction of trust: supplier relations in Britain and Germany’, Organization Studies, 17 (3): 365–95. Leipold, H. (1997) ‘Der Zusammenhang zwischen gewachsener und gesetzter Ordnung: einige Lehren aus den postsozialistischen Reformerfahrungen’, in Cassel, D. (ed.) Institutionelle Probleme der Systemtransformation, Berlin: Duncker & Humblot, pp. 43–68.

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Lind, G. (1993) Moral und Bildung. Zur Kritik von Kohlbergs Theorie der moralischkognitiven Entwicklung, Heidelberg: Asanger. Loose, A. and Sydow, J. (1994) ‘Vertrauen und Ökonomie in Netzwerkbeziehungen – strukturationstheoretische Betrachtungen’, in Sydow, J. and Windeler, A. (eds) Management interorganisationaler Beziehungen. Vertrauen, Kontrolle und Informationstechnik, Opladen: Westdeutscher Verlag, pp. 161–93. Markus, H. R. and Kitayama, S. (1991) ‘Culture and the self: implications for cognition, emotion and motivation’, Psychological Review, 98 (2): 224–53. Matsumoto, To. (2000) ‘Konbini daikin shûnô – ukewatashi sâbisu’ (‘Convenience stores’ service: cash pay and handing over of goods’), Nikkei NetBusiness, January: 98–103. Matsumoto, Ts. (1998) The Development and Future Challenges of Self-Regulation in Japan, with Special Regard to Electronic Commerce, accessed at www.law. kyushu-u.ac.jp/luke/ecommerce.html on 19 September 2003. Mayer, R. C., Davis, J. H. and Schoorman, F. D. (1995) ‘An integrative model of organizational trust’, Academy of Management Review, 20: 709–34. Michael, D. C. (1995) ‘Federal agency use of audited self-regulation as a regulatory technique’, Administrative Law Review, 47 (2): 171–253. METI (Ministry of Economy, Trade and Industry) (2001) Heisei Jûni-Nendo Denshishô torihiki ni Kansuru Ichiba Kibo, Jittai Chôsa ni tsuite, accessed at www. meti.go.jp/kohosys/press/0001317/0/0201ecom1–1-html on 5 September 2003. MPHPT (Ministry of Public Management, Home Affairs, Posts and Telecommunications) (2003): Jôhô Tsûshin Hakushô (White paper on Information and Communications), accessed at www.johotsusintokei.soumu.go.jp/whitepaper/ja/ h15/pdf/index.html on 06 April 2004 (short English version available at www. johotsusintokei.soumu.go.jp/whitepaper/eng/WP2003/2003-index.html.) Mitsubishi Research Institute (2002) ‘Japan’, in JETRO (ed.) Report on ‘Asia-Pacific B2C E-Commerce Legal Framework’, January: 299–330, accessed at www.jetro.go. jp/ec/e/stat/surveys/b2c/index.html on 20 April 2004. Nagato, N. (2003) Yoku Wakaru Puraibashii Mâku (Understanding privacy mark), Tokyo: Nihon Jitsugyô. NFO (2003) Monitoring Informationswirtschaft. 6. Faktenbericht 2003, accessed at www.nfoeurope.com/ib/Newsitem.cfm?lan=en&ObjectId=E2A82F11-E282–4202BBA422E19776630C on 6 April 2004. Nihon Keizai Seisaku Gakkai (Japan Economic Policy Association) (2001) ‘Nijûisseiki no Nihon no saisei to seido tenkan – kankyô seisaku’ (Reforms and institutional change in Japan in the 21st century – Environmental Policy), Nihon Keizai Seisaku Gakkai Nenpô (The Annual of Japan Economic Policy Association), 49: 21–6. Nikkei Communications (2000) ‘Denshi-shô torihiki wo sasaeru PKI no dônyû-hô’ (The methods of introducing an e-commerce supporting PKI), Nikkei Communications, 19 June 2000: 202–7. Nikkei Weekly (2003a) ‘Consumers take to TV, online shopping’, The Nikkei Weekly, 10 November: 20. Nikkei Weekly (2003b) ‘A world of content at their fingertips’, The Nikkei Weekly, 15 December: 22. North, D. C. (1993) ‘Institutions and credible commitment’, Journal of Institutional and Theoretical Economics (JITE), 149 (1): 11–23. Nunner-Winkler, G. (1992) ‘Zur moralischen Sozialisation’, Kölner Zeitschrift für Soziologie und Sozialpsychologie, 44: 252–72.

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Olson, M. (1971) Logic of Collective Action: Public Goods and the Theory of Groups, Cambridge MA: Harvard University Press. OECD (Organisation for Economic Co-operation and Development) (1999) Inventory of Instruments and Mechanisms Contributing to the Implementation and Enforcement of the OECD Privacy Guidelines on Global Networks, accessed at www.oecd.org/ dataoecd/12/54/2092454.pdf on 14 April 2004. OECD (2001) Electronic Commerce, accessed at www.oecd.org/document/29/ 0,2340,en_2649_201185_2346205_1_1_1_1,00.html on 6 April 2004. Panther, S. (1998) ‘Historisches Erbe und Transformation’, in Wegner, G. and Wieland, J. (eds) Formelle und Informelle Institutionen: Genese, Interaktion und Wandel, Marburg: Metropolis, pp. 211–52. Pascha, W. (2001) ‘Ordnungspolitik in Japan? – Zur möglichen Rolle von Regelbindung und unabhängigen Agenturen’, in Bosse, F. and Köllner, P. (eds) Reformen in Japan, Hamburg: Institut für Asienkunde, 337, pp.167–192. Plate, P. A. (2000) ‘Elektronischer Handel in Japan’, Japan Aktuell. Wirtschaft, Politik, Gesellschaft, 1/00 (February): 61–71. Privacymark (2003a) Nintei Jigyô-Sha no Kojin Jôhô ni Kakaru Jiko nado ni tsuite (Certification companies and violation of private data use), accessed at www. privacymark.jp/pr/20021210.html on 11 September 2003. Privacymark (2003b) Diagram of accreditation and certification processes in ecommerce, accessed at www.privacymark.jp/pr/19980325a.gif on 18 September 2003. Privacymark (2003c) Yôgo-Shû (Glossary), accessed at http://privacymark.jp/misc/ glossary.html on 18 September 2003. Privacymark (2003d) Puraibashî Mâku Fuyo Nintei Shitei Kikan (Certification institutes für privacy), accessed at www.privacymark.jp/list/dlist on 18 September 2003. Putnam, R.D. (1993) Making Democracy Work: civic traditions in modern Italy, Princeton NJ: Princeton University Press. Rousseau, D. M., Sitkin, S. B., Burt, R. S. and Camerer, C. (1998) ‘Not so different after all: a cross-discipline view of trust’, Academy of Management Review 23 (3): 393–404. Schaede, U. (2000) Cooperative Capitalism: self-regulation, trade association, and the antimonopoly law in Japan, Oxford: Oxford University Press. Spence, A. M. (1974) Market Signalling: information transfer in hiring and related screening processes, Cambridge MA: Harvard University Press. Stigler, G. J. (1961) ‘The economics of information’, Journal of Political Economy, 64 (3): 213–25. Storz, C. (2003) ‘Globalisierung, Technik, Normen – Warum weichen japanische Unternehmen von internationalen Normen ab?’, in Deutsches Institut für Japanstudien (ed.) Japanstudien 15, Munich: iudicium, 219–46. Storz, C. (2005a) ‘Private Regulierung aus institutionenökonomischer Sicht. Das Beispiel Japan’, in Pascha, W. and Storz, C. (eds) Wirkung und Wandel von Institutionen: Das Beispiel Ostasien, Stuttgart: Lucius & Lucius, pp. 199–228. Storz, C. (2005b) ‘Standardization and the convergence of production systems’, in Pascha, W. (ed.) Systemic Change in the Japanese and German Economies: convergence and differentiation as a dual challenge, London: Routledge, pp. 203–30. Sztompka, P. (1995) ‘Vertrauen: Die fehlende Ressource in der postkommunistischen Gesellschaft’, Kölner Zeitschrift für Soziologie und Sozialpsychologie, special issue 35 (Politische Institutionen im Wandel): 254–76.

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Tagawa, Y. (2001) ‘E-komaasu hatten no kongen-teki mondai wo kangaeru: Ichiba ni okeru shinrai’ (The critical issue for e-commerce: trust in the market), InfoCom Review, 25: 4–16. Uslaner, E. M. (1999) ‘Trust but verify: social capital and moral behaviour’, Social Science Information, 38 (March): 29–56. Quoted version accessed at www.bsos. umd.edu/gvpt/uslaner/verify.pdf on 5 April 2004. Vanberg, V. and Buchanan, J. N. (1994) ‘Interests and theories in constitutional choice’, in Vanberg, V. (ed.) Rules and Choice in Economics, London: Routledge, pp. 167–77. Whipple, C. T. (2000) Japan Rushes to Catch Up on the Internet, accessed at www.iht.com./articles/3720.html on 31 March 2004. Yamagishi, T. (1988) ‘The Provision of a sanctioning system in the United States and Japan’, Social Psychology Quarterly, 51 (3): 265–71. Yamagishi, T. (1998) Shinrai no Kôzô: kokoro to shakai no shinka gêmu (The structure of trust: the evolutionary games of mind and society), Tokyo: Tokyo Daigaku. Yamagishi, T. and Yamagishi, M. (1994) ‘Trust and commitment in the United States and Japan’, Motivation and Emotion, 18 (2): 129–66. Zucker, L. G. (1986) ‘Production of trust: institutional sources of economic structure, 1840–1920’, Research in Organizational Behaviour, 8: 53–111.

Glossary Certification Agency Certifying and Auditing Organisation for the Privacy Mark Consulting Centre for Consumers Incorporated Foundation In-house Data Protection Manager Japan Accreditation Board of Conformity Assessment Japan’s ‘Backwardness in IT’ Japan Information Processing Development Center Mutual Recognition Agreement Privacy Mark System Committee Specific Commercial Transaction Act

Puraibashî Mâku Fuyo Shiteikikan Puraibashî Mâku Fuyo Kikan Shôhisha Sôdan Madoguchi Zaidan Hôjin Kojin Jôhô Hogo Kanri Sekininsha Nihon Tekigôsei Nintei Kyôkai Nihon Okureta IT Kakumei Nihon Jôhô Shori Kaihatsu Kyôkai Sôgô Shônin Puraibashî Mâku Seido Iinkai Tokuteishô Torihikihô

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Institutional conditions for achieving effective implementation of ICT Rob Frieden

Introduction Information and communications technologies (ICT) can effectively stimulate a nation’s economy and the welfare of its citizens (OECD (Organisation for Economic Co-operation and Development) 2002).1 Efficient information age infrastructures enhance productivity (Grace et al. 2004) by providing intelligent networks that can efficiently handle converging voice, data and electronic commerce applications (Hukill et al. 2000). These infrastructures provide a comparative advantage in ‘knowledge-based’ (OECD 1995: 3)2 industries, which include such diverse fields as data processing, banking, insurance, management and technical consulting, travel planning, customer relations management, business logistics and others. With an increasingly global economy enhanced by fewer trade barriers and the quest by companies to find new growth opportunities, substantial incentives exist for public and private players to leverage comparatively greater competency in information and communication markets domestically and abroad (Zhen-Wei Qiang et al. 2003).3 Curiously, the track record for ICT implementation achieved by individual companies and nations does not always correlate with other indicators of success in trade, development and quality of life. The United States, for example, has excelled in a number of information industries, including public sector leadership in developing the Internet and private sector success in electronic commerce, and other ICT markets such as computers, software and integrated circuits (Leiner et al. n.d.). Nevertheless, observers across the political and social spectrum have roundly criticized the state of broadband network development (Grant and Latour 2003)4 in the United States (Ferguson 2002; Morgan 2002).5 Comparatively poor deployment of broadband network access juxtaposes with far greater success achieved by other nations, including ones with no comparatively greater prior success in ICT development and with fewer financial resources than the United States (Hopkins 2004). The International Telecommunication Union (ITU) reported that as of 1 January 2006, the five top nations for broadband network market penetration

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were Iceland, Korea, the Netherlands, Denmark and Hong Kong. (ITU 2006). The ITU ranked the United States sixteenth in broadband penetration. The OECD reported that at year end 2004 the top market penetration for member nations occurred in Korea, the Netherlands, Denmark, Iceland and Canada, with the United States ranked twelfth (OECD 2005). One might infer that comparatively poor, new, telecommunications infrastructure development (FCC (Federal Communication Commission) 2004)6 in the United States and in other developed economies would adversely affect overall ICT development and global marketplace success. Indeed, some stakeholders seeking more aggressive governmental support and regulatory relief claim that the United States has forgone billions of dollars in lost business revenues and productivity gains (Pociask n.d.).7 These assertions make sense as national and private investments in ICT have a multiplier effect that accrues individual and societal benefits well in excess of the amount invested (New Zealand Trade and Enterprise n.d.; Digital Opportunity Initiative 2001).8 Aside from the obvious geographical and demographic advantages accruing to small nations with large urban populations, broadband telecommunications network development has become a national priority for many nations. Governments in many developed and developing nations have organized a cohesive and comprehensive strategy for stimulating capital investment in ICT infrastructure, and for expediting the deployment of ICT services in ways US public and private sector stakeholders have not embraced. Such efforts have accrued ample benefits, including lower broadband access, higher broadband market penetration and enhanced opportunities to use the Internet for individual and corporate benefits. For example, the ITU reports that in 2002, Japanese consumers paid $0.09 per 100 kilobits per second of broadband access compared to $3.53 in the United States (ITU 2003a). This wide disparity exists in part because Japanese broadband service providers have made the investment necessary to accommodate robust demand and to achieve economies of scale. This chapter will identify the institutional conditions in legislative, regulatory and business forums that help achieve success in developing faster, better, smarter, cheaper and more convenient broadband services. The chapter will concentrate on strategies that have worked well in Canada, Japan and Korea, as well as the institutional constraints that have handicapped broadband development in the United States. The chapter uses broadband development as a proxy for considering how institutions can achieve greater efficiency and effectiveness in ICT development, despite their vastly different geographical, political and economic conditions.

The importance of ICT incubation Both developed and developing nations recognize that ICT provides an effective opportunity to improve national living standards through enhance-

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ment of productivity and accrual of other efficiency gains (Hanna 1994; Zhen-Wei Qiang et al. 2003).9 Few would dispute that telecommunications and information processing technologies serve as powerful agents for economic and social development by improving access to information, enhancing trade in commodities and services, reducing costs and improving efficiency: ICT can help enhance the working of markets and reduce transaction and coordination costs within and across organizations. This is of particular relevance to developing countries where transaction costs are very high because of logistical problems. ICT applications can enable improvements in productivity and quality in a number of sectors . . . such as agriculture, manufacturing, infrastructure, public administration, and services such as finance, trade, distribution, marketing, education and health. (Sein and Harindranath 2004, p. 18) Nations must continually improve ICT innovation, incubation and exploitation because an increasingly integrated global economy can quickly erode a nation’s comparative advantages, particularly ones prone to volatility resulting from technological innovation. For example, ICT provides developing nations with greater opportunities to accelerate their rise along a technology development learning curve through technology transfer and foreign direct investment. While ICT first might generate threats to employment in developed nations through outsourcing, it might subsequently jeopardize wealth generation in knowledge industries as emerging nations establish their own research and product development prowess. When developing nations wean themselves of dependency on developed nations’ patents and innovations, the upside revenue generating opportunities become more contestable among all nations. China, for example, has quickly evolved from providing cheap labour for component assembly, e.g. cellular radiotelephones, to a nation that can challenge developed nations on the intellectual property and standards that next generation equipment will use. In the span of a few years, Chinese companies have increased the amount of value they contribute to a product and, in turn, the financial returns accruing for such an effort. Chinese mobile telephone manufacturers initially assembled handsets for sale within the country. Soon these companies provided world-class quality assurance in addition to cheap labour, so that their assembled handsets rivalled anything offered in the global marketplace. Not content with low-margin assembly work, some manufacturers have collaborated with the Chinese government, technology parks and universities to develop the intellectual property needed for next generation mobile telephones. Over a short period of time, Chinese companies have migrated from ICT original equipment

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manufacturers for other companies, to ICT royalty paying ventures marketing their own equipment, to ICT innovators possible soon to seek royalty payments from other manufacturers (Yan n.d.).10 ICT development presents both challenges and opportunities to all nations. Developing nations no longer face the inevitability of having to organize their economies primarily for the benefit of developed countries that provide the market demand for cheaply produced products. Developed nations, for their part, can no longer consider technology transfer as largely a one-sided transaction that expands market penetration without risk of lost markets in the future.

ICT incubation by government Regardless of political and economic philosophy, national governments have significant positive roles in successful ICT development. Strategies have included an expansive governmental role in several areas, including: • • • • • • • •

developing a vision and strategy; promoting digital literacy, i.e. the ability to use digital technologies to pursue information, communications and entertainment interests; investing in infrastructure, aggregating demand and serving as an anchor tenant; fostering facilities-based competition of telecommunications and information processing infrastructures; creating incentives for private investment and disincentives for litigation and other delay tactics; offering electronic government services, including healthcare, education, access to information job training and licensing; promoting universal service through subsidies and grants; and revising and reforming governmental safeguards to promote a high level of trust, security, privacy and consumer protection in ICT services, including electronic commerce.

Nations pursuing successful ICT development strategies do not appear to quibble about whether government should meddle in areas that the private sector possibly could manage exclusively. However, one person’s view of government stewardship might come across to another as ‘industrial policy’, centralized management by the public sector and pre-emption of private initiatives. Successful ICT incubation appears to require government involvement, albeit with a light hand that stimulates and rewards investment, reduces unneeded regulatory scrutiny, and promotes global marketplace attractiveness without ‘tilting the competitive playing field’ in favour of one technology or company and without foreclosing market-driven industries.

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ICT incubation in the United States Curiously, even as the United States severely lags in broadband market penetration, this nation has achieved global supremacy in other ICT markets in part through the successful partnership of the public and private sectors. The United States model for ICT development favours entrepreneurism and private enterprise coupled with direct and indirect financial support by government primarily through early stage incubation. The Internet, for example, originated as a collaboration of government agencies and universities under the auspices of the Defense Advanced Research Projects Agency, a branch of the United States Defense Department. The Internet later evolved under loose management and financial support from the National Science Foundation with the Department of Commerce administering domain name registration. While the US government later eliminated direct financial underwriting when it privatized the Internet backbone, few would argue that early underwriting and anchor tenancy exemplified effective and successful government incubation of ICT. In the United States, governmental financial underwriting of Internet development had a short time span due to an institutional predisposition against government management of commercial markets and the perception by entrepreneurs that high monetary rewards justified risk-taking. In stark contrast to the absence of broadband incubation, the US government got involved early, but calibrated a timely exit strategy when a critical mass of private resources had developed. The government was able to make a quick exit because venture capital could readily replace taxpayer financed investment, research and development. Additionally, a well-developed marketplace for lawyers, accountants, consultants and entrepreneurs made it possible for private risk taking. A favourable tax climate ensured that ample rewards provided incentives for entrepreneurship. High technology hotbeds, such as Silicon Valley, California, demonstrate a largely private orientation to ICT development in the United States. In an assessment of what makes Silicon Valley a high technology development success, the authors of The Silicon Valley Edge (Lee et al. 2000) suggest ten factors: 1

2

3

favourable rules of the game – laws, regulations and conventions for securities, research and development, taxes, accounting, corporate governance, bankruptcy, immigration and development designed to support entrepreneurship and risk taking; knowledge intensity – the region has achieved a critical mass of ideas for new products, services, markets and business models. Silicon Valley serves as a magnet for entrepreneurs, educators, venture capitalists and people with vision; a high quality and mobile workforce – talented, educated and motivated people seek to make a home and a fortune in the region;

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a results-oriented meritocracy – talent and ability accrue rewards in Silicon Valley without regard to race, ethnicity and age; 5 a climate that rewards risk-taking and tolerates failure – the region supports a high risk/high reward calculus, but also makes it possible for entrepreneurs who have experienced failure to regroup and try again; 6 an open business environment – the region supports robust competition but also knowledge sharing. This win/win environment results from the frequent formal and informal interactions among people with similar interests and objectives. Networking and relationships matter as much as technological innovations; 7 universities and research institutes that interact with industry – major universities such as Stanford foster exchanges among academics and entrepreneurs; 8 collaborations among business, government and non-profit organizations – the region houses universities, trade associations, labour councils, service organizations and companies, all of which collaborate and network with an eye on a successful future; 9 a high quality of life – despite traffic congestion, soaring housing prices, a relentless work pace and recent power outages, Silicon Valley offers proximity to open spaces and urban amenities; 10 a specialized business infrastructure – the region provides access to specialists needed for economic development, including consultants, lawyers, venture capitalists and executive recruiters. ICT incubation in the United States has achieved great success, in part thanks to governmental involvement. One should not discount the effect of early government financial involvement coupled with ongoing financial benefits accrued through favourable tax treatment and other financial incentives, e.g. tax holidays, revenue repatriation, infrastructure improvements and favourable immigration policies.

ICT development failures in the United States The fact that the United States lags significantly in broadband infrastructure development provides a stark contrast to the success story outlined above. Several legislative and regulatory initiatives have failed to achieve the intended results, or have backfired. While the United States may lead in technology incubation at technology parks and in regions such as Silicon Valley, the nation substantially lags in the increasingly essential, first and last kilometre access to broadband services and the Internet. This failure juxtaposes with this nation’s leadership in development of the Internet and Internet-mediated services, including electronic commerce. The failure of the United States to develop best-in-class broadband infrastructure results in part from lack of investment in new ICT technology by incumbent ventures such as telephone and cable television companies.

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Most market entrants in telecommunications markets concentrated on serving long-haul transmission markets while opting to rely on incumbents to provide first and last kilometre access at promotional prices as required by law. The Telecommunications Act of 1996 (Frieden 1997; United States of America, 1996) provided a legislative quid pro quo for incumbent Bell Operating Companies: the authority to provide long-distance toll telephone services in exchange for providing local exchange access based not on historical technology deployment costs, but on forward-looking best practices and new technology costs, i.e. theoretical costs of installing the infrastructure needed to provide access to local exchange facilities using the latest and cheapest technology (Frieden 2003a). While the incumbent Bell Companies welcomed the opportunity to generate new, long-distance telephone service profits, they objected as ‘confiscatory’ the duty to offer access to the local exchange network at rates well below what they considered cost and what they would demand in commercial negotiations (Baumol and Merrill 1998; Spulber and Yoo 2003). The Telecommunications Act of 1996 did not stimulate the development of viable, local, exchange service competition and the upgrading of local networks to provide broadband, high-speed data services (Dibadj 2003). The Bell Operating Companies refused to make the necessary investments based on the view that they should not have to continue subsidizing competition, particularly in the light of the fact that many new competitors did not appear inclined ever to migrate from reselling Bell network capacity to building and operating their own local facilities. Moreover, both incumbents and newcomers suffered heavy financial losses as a result of a severe reversal in the markets for anything relating to the Internet. The bursting of the dotcom bubble shifted investor sentiment from irrational exuberance to extraordinary pessimism. Investment bankers quickly moved from supporting acquisition of market share to requiring evidence of near-term profitability, thereby making capital investment contingent on largely unachievable short-term results. In addition, the proliferation of operating standards, particularly in wireless services, had fragmented telecommunications equipment markets making it difficult for any one company or technology to reach a critical mass. Consensus on operating standards can occur as a result of government stewardship, market forces or stakeholder collaboration. In the United States none of the three options has occurred, thereby causing a slow down in the commercial rollout of some ICT technologies and adoption by consumers. The combination of market downturn, legislation failure and lack of consensus on operating standards has removed much of the incentive for risk taking and investment, even as the need for network upgrades proved essential for the evolution of high-speed broadband ICT services. Stakeholders appeared more intent on competing in the courtroom than in the marketplace. The incumbent Bell Operating Companies made infrastructure investment contingent on securing massive, regulatory liberalization that,

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if implemented, might result in the establishment of a shared monopoly among telephone and cable television companies without significant government oversight. Broadband network development in the United States already has begun to accelerate as the overall economy improves and as the Bell Operating Companies succeed in securing regulatory relief, including forbearance from having to comply with requirements specified in the Telecommunications Act of 1996. However, the potential for much faster and earlier rollout of new ICT technologies existed in the United States without government legislators and regulators capitulating to threats of stalled investment by dismantling still essential regulatory safeguards.

Best practices in ICT development Nations as diverse as Canada, Japan and Korea can provide insights on how to achieve maximum success in ICT development and what roles governments can effectively pursue. These and other nations offer insights on how government-led integration of technology incubation and development can generate favourable results. While these governments readily encourage private enterprises and direct foreign investment in technology ventures, they do not shy away from pursuing an active and vital role. In vivid contrast to the most effective strategy pursued by the United States, namely government incubation followed by a quick departure and reliance on marketplace forces, best-practices ICT development in many nations demonstrates the benefits of long-term involvement by honest, technologically sophisticated government officials. Public officials may better understand the macro-level, societal stakes involved and work conscientiously to establish a transparent, efficient, flexible and positive business environment for the long run. In many nations, for example, governments sponsor science and technology parks where the government or a government-appointed manager integrates all the necessary elements for ‘the production and commercialization of advanced technologies by forging synergies among research centres, educational institutions and technology-based companies’ (Petree et al. 1999). Governments can achieve this synergy primarily through investments, preferential policies and focused leadership under the auspices of an economic development board that underwrites programmes designed to finance research and development projects and to promote commercialization of applied research. Put another way, nations have expedited ICT development by mastering the ability to foster an efficient and favourable business environment without abdicating ongoing oversight responsibilities. This environment results in part from the ability of technology parks and other development vehicles to foster:

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cooperation in both pure and applied research and development with scientific research institutes and laboratories; ease of access to venture capital; the availability of professional, technical, administrative and legal assistance; state-of-the-art information and telecommunications services; and a fair and transparent business infrastructure.

Indigenous comparative advantages Before considering the types of public and private actions that can expedite ICT development, one should appreciate that a significant set of indigenous factors contribute to or deter progress, regardless of what affirmative steps are taken. A number of localized characteristics favour ICT development independent of concerted actions. For example, geography and demographics can make ICT development tasks easier or harder as a function of nation size, population density, per capita income, percentage of high-rise housing and size of households. Nations and administrative regions such as Korea, Singapore (Aizu 2002; Wong 2003)11 and Hong Kong (ITU 2003b) should have an easier ICT development task simply because telecommunications carriers have fewer lines to install and greater population density served by these lines. Geographically small nations with little rugged terrain and high incomes can achieve ubiquitous digital network access on a timely and efficient basis, perhaps even without having to create a sizeable fund for subsidizing services to rural and low-income residents. Similarly, with a population skewed to youthful, urban apartment dwellers, telecommunications carriers can more readily introduce new broadband services and achieve comparatively higher penetration rates than carriers in other nations would achieve. A nation such as Korea enjoys a larger percentage of technology ‘early adopters’ – people who are keen on accessing services that provide faster, better, smarter, cheaper and more convenient solutions to existing requirements coupled with a willingness to use technologies to serve new wants, needs and desires. Well-educated Korean youth with sufficient discretionary funds supported ICT development, first by frequenting personal computer gaming rooms, known as PC bangs, and later by embracing new markets, including streaming music, Internet and wireless messaging and online photography. Furthermore, one cannot underestimate the impact of attitudes towards ICT and the extent to which entrepreneurs will take risks to provide services offering clearly better consumer benefits. A culture favouring education, speedy resolution of problems and risk-taking favours ICT development, simply because consumers will more readily embrace technologies that provide tangible improvements. The push of new technologies meets an equally aggressive demand pull.

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Acquired comparative advantages Indigenous comparative advantages cannot reliably propel a nation into ICT development supremacy, nor do the identified factors fully explain why some nations excel while others falter. Acquired comparative advantages result from concerted efforts by the public and private sector to achieve ICT development with an eye towards fostering improvements in the quality of life, individual wealth and national economic development (OECD 2003). The best advantages result when governments effectively calibrate the scope of intervention (1) to the degree of market stimulation required, and (2) to the extent to which ICT development would not occur but for government subsidization, demand aggregation and sponsored pilot projects.

Government vision, strategy and stewardship The acquisition of comparative advantages in ICT development appears impossible without some degree of ongoing government involvement. No matter how attractive ‘blue sky’ technologies appear on the horizon, governments may need to jump-start new technology adoption and thereby accelerate the accrual of a critical mass needed to achieve scale economies and the ability to offer services at rates a mass market will support. Before private enterprises can operate largely free of government involvement and/or support, a technology incubation phase typically must occur, as was the case for Internet development in the United States. Governments willing to undertake an active role need to reach closure on a vision of what constitutes ICT development success and what steps they should take in order to achieve those outcomes.

Canadian government efforts The Canadian government also launched a series of early ICT development initiatives articulated in the 1990s (Industry Canada 1994; Government of Canada 1996; Connecting Canadians website n.d.). The Ministry of Industry articulated a strategy to make Canada the most connected country in the world.12 It set out to achieve ICT development primarily through the promotion of online access, developing ICT-intensive, ‘smart communities’, creating incentives for the development of indigenous content for transmission via the Internet, expediting electronic commerce and delivering electronic government services (ITU 2003c). In 2001, a National Broadband Taskforce specified a strategy for achieving ubiquitous access to broadband networks and services by 2005 (Government of Canada 2004). Specifically, the Task Force established several access priorities, including the view that all communities, including small businesses and residential users, should have Internet access at throughput speeds in excess of 1.5 megabits per second, rural access rates should not exceed urban rates, and the local broadband infrastructure should extend to schools, public libraries and other public access points.

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The Task Force identified two funding vehicles for achieving these goals: 1 2

a top-down, infrastructure government support model that creates broadband network and service investment incentives; and a bottom-up, ‘community aggregator model’, where government-funded pilot programs and the delivery of electronic government services helps stimulate the generation of sufficient demand to use existing network capacity and stimulate the construction of new facilities.

Korean government efforts The Korean government articulated an action plan in 1997 entitled Cyber Korea 21 (Government of Korea 1999, 2002). The Ministry of Information and Communications articulated a vision of a ‘knowledge-based economy’ where every citizen would have access to a personal computer, the government would expedite development of an information infrastructure and all stakeholders in ICT would work together (ITU 2003d) to increase productivity, employment and exports (Dahlman and Andersson 2001; Government of Korea 2003). The Korean government recognized that the scale and ambitiousness of such a vision would require several types of initiatives and financial inducements (Lee n.d.), including: • • •

• • • •

efforts by regulatory authorities to encourage infrastructure investment by incumbents and market entrants (OECD 2004); regulatory parity among operators with an eye towards promoting facilities-based competition, but also market entry by operators who might need to access some facilities of the incumbent; direct financial underwriting as well as offering loans and loan guarantees, favourable tax treatment, and other types of financial support for the construction of new, high-capacity backbone digital broadband networks; financial support for research, development and technology demonstration projects; subsidies for purchase of personal computers by low-income citizens; the promotion of digital literacy, including the ability to use information technologies for interacting with government and for acquiring information, communications and entertainment services (Han 2003); the support of electronic government, education, e-commerce (Lee et al. 2003), healthcare and other types of ICT-mediated services.13

Japanese government efforts Japan developed a high-level, national, information ‘e-Japan’ strategy in 2001 with ambitious goals addressing infrastructure, human resources, e-commerce, e-government and network security (see Prime Minister of Japan

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and his Cabinet 2001 for the e-Japan strategy).14 Perhaps smarting from less robust development than nearby Korea, Japan expedited the development of the world’s most advanced telecommunications and information networks, blending private and public sector initiatives (ITU 2003e; Ishii 2003). The e-Japan strategy triggered the development of 220 separate projects in its first year, as well as achieving the goal of linking 30 million households to high-speed Internet access options (Takada 2003; Taniwaka 2003, 2004; Yamada 2004). Today, Japanese residential consumers have the highest throughput speeds and the lowest per megabit cost.

Regulatory initiatives Perhaps the key regulatory initiative pursued by nations such as Canada, Korea and Japan lies in effectively changing the regulatory climate without triggering the kind of costly and protracted litigation that has thwarted progress in the United States. Nations can use regulatory change to promote facilities-based and resale competition through incremental deregulation of the sector, liberalization of rules affecting incumbent carriers and mandating cost-based and compulsory access to the incumbent carrier’s switches and transmission capacity at fair and compensatory rates. Progressive tax policies, including investment tax credit, further stimulate incentives to invest in ICT infrastructure. National regulatory authorities have to find a way to create incentives for incumbents and newcomers alike to invest in infrastructure needed to provide high-speed broadband data services. Only with sustainable facilitiesbased competition with a multiplicity of operators in each of the technologies will broadband services thrive. Incumbent wireline telephone companies initially will provide broadband services using existing copper and later using fibre-optic facilities. Additionally, competition will come from wireless operators and cable television ventures. Whether robust competition will evolve depends primarily on decisions by incumbent carriers. Both telephone and cable companies will need to consider broadband service market share as essential to ongoing commercial viability in the light of declining margins in, and the maturation of existing services. Faced with such competitive necessity, it follows that an incumbent would have to diversify services and pursue new profit centres, including value-added network, wireless and broadband services (Frieden 2003a). The need to respond to declining revenues in core business lines and new deregulatory opportunities has begun to stimulate interest in expediting delivery of broadband services by US carriers. However, years earlier, carriers in Canada, Japan and Korea made such investments as a result of governmental encouragement, the real or perceived competitive necessity and internal market forecasts. Meanwhile, in the United States, incumbent telephone companies complained about the unfairness of having to unbundle their networks and offer access to individual elements at below market

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rates. Cable television ventures succeeded in thwarting efforts to force them to provide open access to any Internet service provider (ISP) in lieu of dedicated access to a corporate ISP affiliate or joint venture partner. Carriers in best-practice nations accept regulatory mandates and emphasize capitalizing on new market opportunities. Carriers in the United States resorted to litigation and delay with an eye towards conserving capital until such time as the demand for broadband services became unassailable. Such stalling tactics resulted from conditions of heightened fear, uncertainty and doubt resulting from an economic downturn largely triggered by the decline in confidence that the Internet and demand for Internet services would trigger perpetual growth. Carriers more willing to embrace change and to accept the onset of a ‘new world order’ predominated by data services (Kiser and Collins 2003; Frieden 2003b) appear better equipped to capitalize on new market opportunities. Carriers keen on conserving capital and reducing risk exposure appear less able to migrate from a business plan predominated by voice services, despite the fact that this once core market has deteriorated and will continue to decline as consumers migrate to wireless and Internetbased services.

Supply-side stimulation: underwriting research, funding pilot programmes and community champions Nations offering best practices in supply-side stimulation recognize the importance of triggering an expedited migration from narrowband to broadband services and promoting widespread availability of new services at attractive prices (United Kingdom Department of Trade and Industry and Brunel University 2002).15 While preferring private carriers to make the transition to broadband on the basis of competitive necessity and declining margins in basic voice telephony markets, governments at the local, provincial and federal level volunteered to provide financial support under conditions of market failure, i.e. the unwillingness of private firms to make the investment based on the view that they lacked certainty as to whether or not they could accrue a sustainable and adequate profit. Such self-help programmes brought broadband digital services to hinterland locations north of the Arctic Circle in Canada, primarily through the assessment of business plans created by community groups, also known as ‘community champions’, and the grant of up to 50 per cent of the costs to develop a broadband network. Ironically, the use of metered pricing for narrowband services made it financially more attractive to migrate to unmetered, always on (‘all you can eat’) broadband services. Unlike in the United States, telecommunications consumers in many nations have to pay per minute rates for access to voice telephone and Internet services. With the onset of broadband services charged on a flat-rated, monthly basis, even moderate World Wide Web surfers could substitute unlimited access for metered service at only a slightly higher cost.

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Demand-side stimulation: promoting digital literacy, aggregating demand and delivering e-government services Best practices also include efforts by national governments to stimulate and aggregate demand primarily by offering citizens better ways to acquire government, education and health services. While youthful video gamers needed no inducement to appreciate the benefits of high-speed online access, others grew to appreciate the time-saving and productivity enhancements available from broadband services. For example, high-speed data networks make it possible for remote communities to secure medical consultations between local nurses and doctors based at urban teaching hospitals, as well as quick transmission of X-ray images. E-learning possibilities include highspeed access to databases, multi-media learning tools and video conferencing with teachers in a virtual classroom environment.

New challenges to developed nations Developed nations such as Germany and the United States increasingly have to rely on ICT markets to accrue competitive advantages that generate wealth and sustain current high standards of living. These nations can no longer simply assume that developing nations will serve as largely untapped markets or as low-cost assemblers and manufacturers of goods using intellectual property created in developed nations. For developed nations, ICT development generates new risks and insecurity, not only in the light of employment losses due to outsourcing, but also because ICT incubation in developing nations helps them become innovators as well as low-cost assemblers. Developing nations such as China have already established themselves as least-cost manufacturers by using the intellectual property created elsewhere. ICT incubation for some developing nations provides the opportunity to become more than technology licensees and copiers. For developed nations to maintain their comparative advantage in ICT, they must continually prime the pump through research and entrepreneurship. As never before, ICT incubation provides upside opportunities for all nations.

Conclusions ICT development, including investment in a robust broadband infrastructure, requires extensive coordination and cooperation among private and public sector players. Successful ICT development typically occurs if, and only if, both types of participants stick to roles proven to maximize benefits. For government, the empirically proven optimal role involves neither a laissezfaire abdication of responsibility nor intrusive, heavy-handed, commandand-control regulation that predominated when private or government monopolies largely controlled how the public received telecommunications

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services. Governments can enhance ICT development by articulating from the top a broad vision of what telecommunications and information processing services can do for a nation and its citizens, while at the same time leaving to community champions the flexibility to propose specific, ‘bottom-up’ projects that aggregate the supply of services needed to support the build-up of needed infrastructure. For the private sector, the proven role does not involve extensive litigation and delayed investment, nor does it constitute the leveraging of ICT investment in exchange for even greater deregulatory relief. The private sector needs to make the necessary investments in ICT incubation, but government can create incentives for such investment by underwriting and guaranteeing loans, providing favourable tax treatment and financially supporting a portion of the necessary research, development and technology demonstration projects. Governments do not serve as a catalyst simply by throwing money at the ‘problem’ of insufficient ICT development. Wasted investment in ICT development can occur if government relies on one category of private sector participant, e.g. incumbent local exchange telephone companies, to administer the major programmes designed to promote universal access to basic telecommunication services. The incumbent develops a reliance on and expectation for this funding source. It thus has little incentive to achieve a universal service goal, as opposed to justifying an ongoing source of subsidies for preferred beneficiaries, which includes the carrier itself. Developing a recurring subsidy and funding mechanism, as opposed to relying primarily on ad hoc project funding, typically justifies the need for an extensive bureaucracy similarly keen on pursuing an ongoing mission or expanding broad development goals. Ironically, the universal service funding mechanism in the United States, which promotes subsidized access to often unmetered basic telephony, has created disincentives for consumers to migrate to available, yet unsubsidized, broadband services. Nations achieving comparatively greater success in ICT development demonstrate the value in having a specific mission, achievable goals and policies designed to achieve success. The governments of Canada, Japan and Korea articulated a vision of what ICT could do for both public and private sector beneficiaries. At the macro-level, these nations designed laws that created incentives for risk taking and innovation, and penalized litigation and strategies which delayed making the necessary investment in capitalintensive projects. At the micro-level, these nations linked public funding with private initiatives that aggregated demand, generated matching funds and justified the installation of ICT, even in comparatively unattractive locales. The United States has largely failed to match its comparative advantage in private ICT incubation, such as Silicon Valley, with similar, world-class governmental incubation, despite having achieved success in developing and then privatizing the Internet. The lack of success in recent governmental incubation efforts, e.g. in broadband market penetration, stems largely from

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the failure to appreciate the need to blend and integrate both private sector entrepreneurialism and public sector stewardship. Such stewardship involves active governmental involvement, as cheerleader, referee, loan guarantor, grant funder and anchor tenant in a sector that many in the United States believe warrants little, if any, government involvement. Nations exhibiting best practices in ICT development clearly show the benefit in a combination of public and private initiatives.

Notes 1 ‘The capacity of countries and firms to develop and manage knowledge assets has become a major determinant of economic growth and competitiveness. . . [I]nvestment in and exploitation of knowledge remains a key driver of innovation, economic performance and social well being. Over the last decade, investments in knowledge – as measured by expenditures on research and development (R&D), higher education, and information and communication technologies (ICTs) – grew more rapidly than gross fixed capital formation’ (OECD 2002). 2 ‘Knowledge is now recognized as the driver of productivity and economic growth, leading to a new focus on the role of information, technology and learning in economic performance. The term “knowledge-based economy” stems from this fuller recognition of the place of knowledge and technology in modern . . . economies’ (OECD 1995: 3). 3 See also World Summit on the Information Society n.d.; ICT for Development website n.d.; ITU n.d. 4 ICT development covers many diverse segments of a national economy. Accordingly, broadband development, by itself, may not serve as a complete measure of national success or failure in ICT development. On the other hand, one cannot overemphasize the importance of broadband network access for a variety of ICT services, including high speed Internet access and an increasing percentage of Internet-delivered services, such as Voiceover Internet Protocol and telephone services. ‘Currently VOIP [Voiceover Internet Protocol] accounts for less than 3% of global voice phone calls, according to an AT&T estimate. But a number of trends are working in its favor, say industry executives: the boom in demand; the evolution of the technology, which permits companies to offer services beyond the reach of conventional phones; and the spread of broadband connections, which make VOIP much easier to use’ (Grant and Latour 2003). 5 ‘The pace of deployment and technological progress in broadband, or high-speed, services remains seriously inadequate, a problem that results from the monopolistic structure, entrenched management, and political power of incumbent local exchange carriers (ILECs) such as BellSouth and Verizon and the cable television industry. It is worsened by major deficiencies in the policy and regulatory systems covering these industries. Failure to improve broadband performance could reduce U.S. productivity growth by 1 percent per year or more, as well as weaken public safety, military preparedness, and energy security’ (Ferguson 2002). ‘[Bill] Gates said US broadband would lag behind European and Far Eastern countries by “five to six years”. He slammed US telecom providers and cable networks for recently increasing prices’ (Morgan 2002). 6 Current broadband infrastructure enhancements primarily involve upgrading existing telephone and cable television networks. Digital subscriber line (DSL) service from local exchange carriers involves an upgrade to local loop, copper wires. They offer more bandwidth capable of providing both legacy voice

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telephone service and Internet access. Cable modem service from cable television companies involves the partitioning of an existing broadband wire into separate video delivery and Internet access links. Unlike most nations, cable modem access had predominated in the United States. Cable modems provide 75.3 per cent of all broadband services in the United States, while DSL serves 14.9 per cent as of December 2003. ‘Waiting for computer screens to fill has resulted in $25 billion a year in lost e-commerce and countless billions of dollars in lost time for consumers’ (Pociask n.d.). ‘ICT is an integral component of every sector in the New Zealand economy – working behind the scenes as an “enabler” – and is also a major sector in its own right. . . . The information and communications technology sector: makes a significant contribution to export growth; can have a multiplier effect across other sectors; can transform business and operational processes; lifts productivity; improves health and education outcomes; has the potential to add exceptional value to New Zealand’s traditional industries’ (New Zealand Trade and Enterprise n.d.). ‘Well-targeted ICT interventions in five key interrelated areas can play a crucial role in igniting and sustaining this development dynamic by creating the necessary conditions to achieve critical mass and to reach the thresholds required for significant multiplier effects and increasing returns to scale’ (Digital Opportunity Initiative 2001). ‘Information technology dramatically increases the amount and timeliness of information available to economic agents – and the productivity of processes to organize, process, communicate, store, and retrieve information . . . [thereby impacting] countries, as producers and users of this technology’ (Hanna 1994: 1). In a joint venture with Siemens, the China Academy of Telecommunications Technology has developed the TD-SCDMA mobile radio standard for third generation mobile radiotelephones. This is the first telecommunications standard proposed by the Chinese industry and accepted as one of several standards by international forums. Izumi Aizu compared successful deployment in Korea versus mixed results in Singapore. For background on Canada’s broadband initiatives, see www.broadband.gc.ca/ pub/media/index.html. For extensive research and reports on ICT issues in Korea and elsewhere, see Korea Information website n.d. and Korea Information Strategy Development Institute website n.d. See Prime Minister of Japan and his Cabinet n.d. ‘We will strive to establish an environment where the private sector, based on market forces, can exert its full potential and make Japan the world’s most advanced IT nation within five years by: (1) building an ultra high-speed Internet network and providing constant Internet access at the earliest date possible, (2) establishing rules on electronic commerce, (3) realizing an electronic government and (4) nurturing high-quality human resources for the new era’ (Prime Minister of Japan and his Cabinet 2001). Stewardship by the Korean government offers several vehicles for expediting broadband deployment and use. See United Kingdom Department of Trade and Industry and Brunel University 2002.

References Aizu, I. (2002) A Comparative Study of Broadband in Asia: deployment and policy, accessed at www.anr.org/web/html/index_e.htm on 14 November 2004.

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Baumol, W. and Merrill, T. (1998) ‘Deregulatory takings, breach of the regulatory contract and the Telecommunications Act of 1996’, New York University Law Review, 72 (5): 1037–67 (1998). Connecting Canadians website (n.d.), accessed at http://cap.ic.gc.ca/english/5000.shtml on 9 November 2004. Dahlman, C. and Andersson, T. (2001) Korea and the Knowledge-Based Economy: making the transition, accessed at http://oecdpublications.gfi-nb.com/cgi-bin/ OECDBookShop.storefront/EN/product/922000061P1 on 18 November 2004. Dibadj, R. (2003) ‘Competitive debacle in local telephony: is the 1996 Telecommunications Act to blame?’, Washington University Law Quarterly, 81 (1): 1–46. Digital Opportunity Initiative (2001) Creating a Development Dynamic: final report of the digital opportunity initiative (Section 4), accessed at www.opt-init.org/ framework/pages/title.html on 8 September 2005. FCC (Federal Communications Commission) (2004) Availability of Advanced Telecommunications Capability in the United States: fourth report to congress. (FCC 04–208), Washington, DC: FCC, 9 September, accessed at http://hraunfoss. fcc.gov/edocs_public/attachmatch/FCC-04–208A1.pdf on 18 November 2004. Ferguson, C. H. (2002) The U.S. Broadband Problem, accessed at www.brookings. edu/comm/policybriefs/pb105.htm on 1 October 2002. Frieden, R. (1997) ‘The Telecommunications Act of 1996: predicting the winners and losers’, Hastings Communications & Entertainment Law Journal, 20 (1): 11–57. Frieden, R. (2003a) ‘Fear and loathing in information and telecommunications industries: reasons for and solutions to the current financial meltdown and regulatory quagmire’, The International Journal on Media Management, 5 (1): 25–38. Frieden, R. (2003b) ‘Adjusting the horizontal and vertical in telecommunications regulation: a comparison of the traditional and a new layered approach’, Federal Communications Law Journal, 55 (2): 207–50. Government of Canada (1996) Building the Information Society: moving Canada into the 21st century, accessed at www.ifla.org/documents/infopol/canada/ihac9601.pdf on 18 November 2004. Government of Canada (2004) The New National Dream: networking the nation for broadband access, Report of the National Broadband Taskforce, accessed at http://broadband.ic.gc.ca/pub/program/NBTF/table_content.html on 18 November 2004. Government of Korea (1999) Cyber Korea 21, accessed at the Ministry of Information and Communication website www.innovazione.gov.it/ita/intervento/banda_larga/ corea_cyber.htm on 8 September 2005. Government of Korea (2002) E-KOREA VISION 2006, accessed at the Ministry of Information and Communication website www.mic.go.kr/index.jsp on 8 September 2005. Government of Korea (2003) Information and Communication White Paper 2003, accessed at the Ministry of Information and Communication website www.mic.go.kr/ index.jsp. on 8 September 2005. Grace, J., Kenney, C., and Zhen-Wei Qiang, C. (2004) Information and Communications Technologies and Broad-based Development: a partial review of the evidence, World Bank Working Paper No.12, accessed at www-wds.worldbank.org/servlet/ WDS_IBank_Servlet?pcont=details&eid=000090341_20040302090454 on 8 September 2005.

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Grant, P. and Latour, A. (2003) ‘Battered telecoms face new challenge: internet calling’, The Wall Street Journal, 9 October: 1. Han, G. (2003) ‘Broadband adoption in the United States and Korea: business driven rational model versus culture sensitive policy model’, Trends in Communication, 11 (1): 3–25. Hanna, N. (1994) Exploiting Information Technology for Development: a case study for India, World Bank Discussion Paper, No. WDP 264: 1, accessed at www1. worldbank.org/wbiep/decentralization/saslib/hanna.htm on 8 September 2005. Hopkins, J. (2004) ‘Other nations zip by the USA in high-speed net race’, USA Today Online Edition, 18 January, accessed at www.usatoday.com/tech/techinvestor/ 2004–01–19-broadband_x.htm. Hukill, M., Ono, R. and Vallath, C. (2000) Electronic Communication Convergence: Policy Challenges in Asia London, Thousand Oaks CA: Sage. ICT for Development (n.d.) Website accessed at http://topics.developmentgateway.org/ ict on 8 September 2005. Industry Canada (1994) Spectrum, Information Technologies and Telecommunications Sector – the Canadian information highway – building Canada’s information and communications infrastructure, accessed at www.ifla.org/documents/infopol/ canada/cihac001.txt on 18 November 2004. Ishii, K. (2003) ‘Diffusion, policy and use of broadband in Japan’, Trends in Communication 11 (1): 45–61. ITU (International Telecommunication Union) (2003a) Birth of Broadband Executive Summary (Sec. 8), September, accessed at www.itu.int/osg/spu/publications/sales/ birthofbroadband/exec_summary.html on 8 September 2005. ITU (2003b) Broadband as a Commodity: Hong Kong, China internet case study, workshop on promoting broadband, May, accessed at www.itu.int/ITU-D/ict/cs/ hongkong/material/CS_HKG.pdf on 8 September 2005. ITU (2003c) Promoting Broadband: the case of Canada, workshop on promoting broadband, 9 April, accessed at www.itu.int/osg/spu/ni/promotebroadband/ casestudies/canada.pdf on 8 September 2005. ITU (2003d) Promoting Broadband: the case of Korea, March, workshop on promoting broadband, accessed at www.itu.int/ITU-D/ict/cs/korea/ on 8 September 2005. ITU (2003e) Promoting Broadband: the case of Japan, 7 April, workshop on promoting broadband, accessed at www.itu.int/osg/spu/ni/promotebroadband/casestudies/japan. pdf on 8 September 2005. ITU (2006) Top 15 Broadband Economies, 1 January, accessed at www.itu.int/ osg/spu/newslog/ITU+Broadband+Statistics+For+1+January+2006.aspx. ITU (n.d) World Summit on the Information Society website (n.d.) accessed at International Telecommunication Union web page www.itu.int/wsis/ on 8 September 2005. Kiser, C. R. and Collins, A. F. (2003) ‘Regulation on the horizon: are regulators poised to address the status of IP telephony?’, CommLaw Conspectus, 11: 19–44. Korea Information Strategy Development Institute website (n.d.), accessed at www.kisdi.re.kr/ on 8 September 2005. Korea information website (n.d.), accessed at Ministry of Information and Communications website www.mic.go.kr/index.jsp on 8 September 2005. Lee, C. M., Miller, W. F., Hancock, M. G. and Rowen, H. S. (2000) ‘The Silicon Valley habitat’, in Lee, C. M., William F. Miller, Marguerite Gong Hancock and

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Henry S. Rowen (eds) The Silicon Valley Edge: a habitat for innovation and entrepreneurship, Stanford CA: Stanford University Press, pp. 1–15. Lee, H., O’Keefe, R. M. and Yun, K. (2003) ‘The growth of broadband and electronic commerce in South Korea: contributing factors’, The Information Society, 19: 81–93. Lee, J. H. (n.d.) Korea Information Strategy InstituteVision of E-Korea and Policy Agenda, accessed at www.kisdi.re.kr/img/eng/pdf/oecd_kisdi_ppt.pdf on 8 September 2005. Leiner, B. M., Cerf, V. G., Clark, D. D., Kahn, R. E., Kleinrock, L. et al. (n.d.) A Brief History of the Internet, accessed at www.isoc.org/internet/history/brief. shtml#wolff on 8 September 2005. Morgan, G. (2002) Gates Warns US Lags Behind in Broadband, 4 February, accessed at Vnunet website www.vnunet.com/vnunet/news/2117463/gates-warns-lagsbehind-broadband on 8 September 2005. New Zealand Trade and Enterprise (n.d.) ICT: growing our high-tech advantage, accessed at www.nzte.govt.nz/section/11757.aspx on 8 September 2005. OECD (Organisation for Economic Co-operation and Development) (1995) The Knowledge-Based Economy (OCDE/GD(96)102), accessed at www.oecd.org/ dataoecd/51/8/1913021.pdf on 8 September 2005. OECD (2002) Towards a Knowledge-Based Economy – recent trends and policy directions from the OECD, Directorate for Science Technology and Industry background paper for the OECD-IPS workshop on promoting knowledge-based economies in Asia, accessed at www.oecd.org/dataoecd/32/15/2510502.pdf on 8 September 2005. OECD (2003) Broadband Driving Growth: policy responses (DSTI/ICCP(2003)13), 9 October, accessed at www.oecd.org/dataoecd/18/3/16234106.pdf on 8 September 2005. OECD (2004) ICT Diffusion to Business: peer review, country report: Korea (DSTI/ICCP/IE(2003)9), working party on the information economy, 7 May, accessed at www.oecd.org/dataoecd/8/6/31787529.pdf on 8 September 2005. OECD (2005) Broadband subscribers per 100 inhabitants, by technology, December 2004, accessed at www.oecd.org/dataoecd/40/16/34919335.xls on 8 September 2005. Petree, R., Petkov, R. and Spiro, E. (1999) Technology Parks – concept and organization, Columbia International Affairs Online Working Paper, accessed at Columbia International Affairs Online website www.ciaonet.org/wps/per01/ on 8 September 2005. Pociask, S. (n.d.) Putting Broadband on High Speed – new public policies to encourage rapid deployment, accessed at www.epinet.org/studies/broadband_pociask.pdf on 8 September 2005. Prime Minister of Japan and his Cabinet (2001) E-Japan Strategy, accessed at www.kantei.go.jp/foreign/it/network/0122full_e.html on 8 September 2005. Prime Minister of Japan and his Cabinet (n.d.) Information Technology, accessed at http://www.kantei.go.jp/foreign/it_e.html on 8 September 2005. Sein, M. K. and Harindranath, G. (2004) ‘Conceptualizing the ICT artifact: toward understanding the role of ICT in national development’, The Information Society, 20 (1): 15–24. Spulber, D. F. and Yoo, C. S. (2003) ‘Access to networks: economic and constitutional connections’, Cornell Law Review, 88 (4): 814–54. Takada, Y. (2003) Promoting Broadband: the case of Japan, Powerpoint presentation at workshop on promoting broadband, Geneva, Switzerland, 9 April, accessed

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at www.itu.int/osg/spu/ni/promotebroadband/presentations/06-Takada.pdf on 8 September 2005. Taniwaka, Y. (2003) ‘Emerging broadband market and the relevant policy agenda in Japan’, Journal of Interactive Advertising, 4 (1), accessed at www.jiad.org/vol4/ no1/taniwaki/ on 8 September 2005. Taniwaka, Y. (2004) Outline of the Japanese Broadband Market, The Alliance for Public Technology: 2004 Broadband Forum, 5 March, accessed at www.apt.org/ confer/yasu-taniwaki-presentation.ppt on 8 September 2005. United Kingdom Department of Trade and Industry and Brunel University (2002) Investigating Broadband Deployment in South Korea – broadband mission to South Korea, accessed at www.broadbanduk.org/reports/SKorea_report.pdf on 8 September 2005. United States of America (1996) Telecommunications Act of 1996, Pub. L. No. 104–104, 110 Stat. 56 (codified in scattered sections of 47 USC), accessed at www.fcc.gov/telecom.html. Wong, P. K. (2003) ‘Global and national factors affecting e-commerce diffusion in Singapore’, The Information Society, 19: 190–213. World Summit on the Information Society (n.d) World Summit on the Information Society and the Role of ICT in Achieving the Millennium Development Goals, accessed at The World Bank, InfoDev, Development Gateway website http:// topics.developmentgateway.org/ict/sdm/previewDocument.do~activeDocumentId=8 15843 on 8 September 2005. Yamada, M. (2004) Broadband Development and Security Policies in Japan, 10 January, accessed at the Communications and Information Network Association of Japan website www.ciaj.or.jp/content/topics/Yamada.pdf on 8 September 2005. Yan, X. (n.d.) The Economic Context of 3G Development in China, accessed at TD-SCDMA Forum website www.tdscdma-forum.org/en/pdfword/2004614124 00489465.pdf on 8 September 2005. Zhen-Wei Qiang, C., Pitt, A. and Ayers, S. (2003) The Contribution of Information Communication Technologies to Growth, accessed at http://info.worldbank.org/ict/ WSIS/docs/comp_ICTGrowth.pdf on 8 September 2005.

7

B2C e-commerce dynamics in Germany Do we need a new regulatory framework?1 Bernhard Lageman, Michael Rothgang and Markus Scheuer

Why does consumer oriented e-commerce develop ‘so slowly’? Is there a simple answer to a simple question? Since the burst of the new economy bubble it became clear that the highflying expectations that had accompanied the growth of the Internet economy during the 1990s would not be fulfilled. This holds true for the United States, where e-commerce (electronic commerce) began and where it reached its highest growth rates. But it also holds true, perhaps even more so, for most other developed market economies such as Germany, where e-commerce developed with a time lag of about five to eight years compared to the United States. The immature Internet dreams of the 1990s notwithstanding, the growing importance of the new electronic chains of distribution should not be underestimated. ICT (information and communications technology) equipment and processes are an indisputable element of business life today. It remains difficult, if not impossible, to judge at present the future effects of ICT on the economy and society (Carr 2004: 149). From a long-term point of view, the Internet and the electronic firm networks expanding within it are still very young mediums. Against the background of the novelty of these electronic communication channels, the expansion of electronic transactions, which could be observed within a fairly short period of time, is remarkable. Nevertheless, the diffusion of new technologies often takes a long time. This general assertion applies to all major inventions in the industrial era, so why should it be different in the case of e-commerce? In this sense, then, the question of whether e-commerce has been developing at too slow a pace since its initiation is ill posed. For one thing, we lack a suitable benchmark for the right pace of its diffusion. The evolution of e-commerce depends on many factors, such as relevant technology and hardware, software applications, number and quality of Internet firms and e-commerce business models on the supply side, and consumers’ technical equipment, preferences and behaviour on the demand side. Regulation, as well, plays an important role in the development of

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markets. Placed within this context the question arises as to whether or not existing institutional conditions are responsible for the seemingly low number of business transactions in cyberspace. Recent literature has provided ample evidence that the regulatory framework is crucial in determining the output of market activities. Many authors discuss the effects of regulation and the necessity of regulation in general (Delong and Fromkin 1997, 1999; Klodt 2001), the protection of intellectual property rights (Quah 2000), the role of standards (Varian 2001) and the functioning of the market mechanism within the Internet (Donges and Mai 2001). Other contributions have raised the question as to whether or not and to what extent an e-commerce policy is necessary (Rothgang and Scheuer 2001) and have investigated experiences gained with e-commerce governance (Christiansen 2003). If e-commerce governance and regulation were a serious problem impeding the evolution of e-commerce, then the setters of rules and regulations on different levels should do everything possible to establish a more suitable institutional setting with which to create a more favourable environment for the Internet economy (Zerdick et al. 1999: 257). Of course, that does not mean that the state itself should define the rules for e-commerce. Co-operative arrangements between firms would be an interesting alternative. Thus, before calling for the state to deregulate or re-regulate e-commerce we should examine the actual development of e-commerce both nationally and internationally in order to determine where the barriers to the further development of e-commerce are. In the next two sections we look at the development of e-commerce in Germany and then focus on the development of business-toconsumer (B2C) e-commerce. In the subsequent section we discuss existent regulations for e-commerce in Germany, including the rules defined by the European Union and international organizations, and ask whether Germany is in need of changes in its institutional setting for e-commerce. We summarize the results of our investigation in the final section.

Business-to-consumer e-commerce in Germany Definitions of B2C There is no generally agreed definition of electronic commerce. The term is used very differently in various settings depending on whether one is talking about different kinds of activities (e.g. trade and/or services), different data transmission channels (e.g. the Internet, firm intranets, extranets and other networks) and/or the different types of technical media involved (e.g. computers, phones and television sets). Furthermore, there is no consensus concerning which parts of a complex purchase or sales transaction extending from the electronic order to after-sales services must be carried out by electronic transmission to be counted as ‘e-commerce’ (Preissl 2003: 1). Most observers will agree that the use of the Internet as a source

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of information for comparing offers does not justify its classification as ecommerce. But what about the form of payment chosen? Is electronic payment (e.g. by credit card) a prerequisite for classifying a transaction as e-commerce? The sale of goods on the Internet normally includes the physical transmission of the sold articles by post services. In this case, the electronic dimension is restricted to certain parts of the transaction. Circumstances are different when tickets or music files are sold, articles are published, or weather forecasts are supplied through the Internet. The delimitation of e-commerce is important, particularly if we want to assess the volume and development of e-commerce. Following the definition used by the US Census Bureau, e-commerce is ‘any transaction completed over a computer-mediated network that involves the transfer of ownership or rights to use goods or services’ (Mesenbourg 2000: 3; Atrostic et al. 2000: 2). According to this definition, electronic payment is not a precondition for a transaction to be classified as e-commerce. Payment may be carried out in conventional ways, yet the transaction may still be defined as e-commerce. Electronic transactions between enterprises are defined as business-tobusiness (B2B) e-commerce. The electronic sale of goods and services by firms to consumers, on which we concentrate in this article, is denoted as B2C. We use term ‘e-commerce’ interchangeably with ‘Internet commerce’, because the Internet is the dominating medium in electronic sales to consumers and will remain so in the near future. However, e-commerce may also be based on different communication channels such as electronic data interchange (EDI) networks that are not connected with the Internet.2 Phone order transactions in which no computer is involved are also usually not included in e-commerce. The buying and selling processes classified as e-commerce are completed as soon as agreement is reached between seller and buyer upon the transfer of ownership or rights to use goods or services. The evolution of B2C and overall e-commerce sales E-commerce as the act of purchasing goods and services performed by a customer via the Internet is still a field of the economy where reliable statistical data are scarce (UNCTAD (United Nations Conference on Trade and Development) 2003: 16–17). Most relevant statistics to date are produced by consulting firms and private research organizations specialized in information technologies and e-commerce, such as Forrester Research and Jupiter Research in the United States or Bitkom in Germany. Statistical offices have just begun to pay attention to e-commerce. In most cases they do not collect data on e-commerce in any systematic way, but some offices such as the Federal Statistical Office of Germany have carried out pilot surveys (Schnorr-Becker 2004). In 2000, the US Census Bureau initiated a programme that aims to fill this data gap. It now collects and publishes relatively detailed data on e-commerce in the United States.

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The discrepancies between the e-commerce statistics produced by the US Census Bureau on the one hand and those produced by market research companies on the other indicate the difficulties associated with collecting the ‘correct’ data. Forrester Research estimated the US online retail e-commerce sales at $110.7 billion in 2002. The corresponding value for online retail spending published by Jupiter Research for 2002 was $41.2 billion. The latter value was not far from the figure for e-commerce sales in retail trade published by the Census Bureau, which was $44.3 billion (US Census Bureau 2004: 664–5, 790). One partial explanation for the difference is that the retail e-commerce projection by Forrester Research included service sales such as travel arrangements and event tickets. The Census Bureau estimated the value of services sold by electronic transmission channels in 2002 to be $41.5 billion. Total B2C would then add up to $82.7 billion, thus more closely approximating the Forrester Research estimate. For a long time, public discussion on e-commerce concentrated on B2C. The perspective that millions of consumers would order their purchases via the Internet proved to be a very fascinating idea. However, B2B electronic transactions over the Internet already surpassed B2C in the early development stage. All relevant data sources agree that in all developed market economies only 10 to 15 per cent of all e-commerce sales can be attributed to B2C, whereas B2B accounts for 85 to 90 per cent. This relation is not expected to change in the near future (TNS Infratest/IIE (Institute for Information Economics) 2004: 220–3). Table 7.1 shows the European Information Technology Observatory (EITO)3 estimates of the present volume and development trends of ecommerce in selected European countries. Western European e-commerce, which added up to € 172 billion in 2000, was still on a relatively modest level. The increases over the last few years have been very impressive in all countries compared to sectoral growth records, even those of new branches. These data should also be interpreted with care. They are based on rather rough estimates and the forecasts for 2008 may be too optimistic. Nevertheless, these data clearly show that the Internet economy and e-business are thriving. Internet commerce in Germany has developed remarkably well compared to the larger member states of the European Union. That appears to be the case both for B2B and B2C. Total e-commerce sales per capita reached € 2,460 in 2004 in Germany, €2,030 in the United Kingdom, and only € 1,650 in France, €1,290 in Italy and €950 in Spain. The German position in e-commerce is especially strong in the field of B2B transactions. The sales in Germany (€ 180.3 billion) approximated to the sum of B2B sales in France, Italy and Spain (€184.3 billion). The Scandinavian countries, which are not included in Table 7.1, are clearly ahead of the Central and Southern European countries in e-commerce. Thus, Germany assumes a relatively stable, middle position in the development of e-commerce in Western Europe.

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Table 7.1 Development of e-commerce in Western Europe and in selected European countries 2001 (€ bn)

2002 (€ bn)

2003 (€ bn)

2004 (€ bn)

2008 (€ bn)p

Average growth 2001–08 %

Total Internet commerce France 21.1 Germany 44.9 Italy 17.3 Spain 6.9 United Kingdom 38.3 Western Europe 171.6

38.7 87.8 32.3 14.2 58.5 308.9

65.9 138.1 52.1 24.9 84.9 476.7

97.7 202.6 73.9 38.3 120.3 680.0

331.9 670.0 239.9 127.2 399.8 2,217.2

48.2 47.1 45.6 51.6 39.8 44.1

Business-to-business France 18.6 Germany 39.7 Italy 15.4 Spain 5.7 United Kingdom 32.4 Western Europe 149.1

34.1 78.3 28.9 12.3 48.8 270.3

57.8 122.7 46.2 22.0 68.0 413.6

85.7 180.3 65.3 33.3 97.7 591.7

272.9 580.6 199.4 111.0 329.9 1,866.1

46.8 46.7 44.1 52.9 39.3 43.5

Business-to-consumer France 2.5 Germany 5.3 Italy 1.8 Spain 1.2 United Kingdom 5.9 Western Europe 22.5

4.6 9.5 3.4 1.8 9.7 38.6

8.0 15.4 5.9 2.9 16.8 63.1

11.9 22.3 8.6 4.0 22.6 88.3

59.0 89.4 39.6 16.2 69.8 351.1

57.1 49.7 55.5 45.0 42.3 48.1

Source: EITO 2002: 28–9; EITO 2003: 26, 28; EITO 2004: 21; EITO 2005: 21–2. Note: p Projected volume.

Business-to-consumer e-commerce in Germany: dimension, dynamics and structure The volume of German B2C transactions in 2004 was estimated by EITO to be €22.3 billion (Table 7.1). This figure includes electronic retail trade and services. A more conservative source, the Association of Retail Traders, estimated the volume of B2C sales (retail trade and services) to be €13 billion for the same year (HDE 2004: 15). Data published in September 2004 from the GfK[pc332] WebScope study4 (GfK 2004) show that in the first half-year of 2004 €5.3 billion were spent on goods purchased through the Internet. This would equal a total turnover of online sales of about €11 billion in 2004. The Federal German Statistical Office (Statistisches Bundesamt) estimated the B2C turnover of goods in Germany to be about €6 billion in the year 2002 as a minimum level (Petrauschke and Kaumanns 2003). However, the Association of German Direct Marketers (Bundesverband des Deutschen Versandhandels e.V. 2005) published an estimation of the volume of turnover in e-commerce in Germany (excluding digital

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services and travel bookings) of only €4.9 billion. This would mean that in comparison to the year 2000, e-commerce turnover would have more than quintupled, and compared to 2003 would have increased by 36 per cent. The statistical evidence on e-commerce is, to say the least, not very clear. It is reasonable to assume that both consumer goods and services in B2C make up about 50 per cent of the total volume of sales. Estimated retail trade sales in Germany amounted to about €470 billion in 2004. Thus, according to EITO figures, the percentage of e-retailing with respect to total retail trade sales would have been 2.4 per cent. This figure seems to be rather surprising. In 2002, the US Census Bureau estimated that e-retailing in the United States made up 1.4 per cent of total retail trade sales ($44.3 billion to $3,230.1 billion; US Census Bureau 2004: 665). Even if we considered that this percentage increased in the United States to about 1.9 per cent in 2004 (estimation in US Census Bureau 2005: 1), the share of e-commerce in Germany would still be higher. This seems highly implausible. Most available qualitative information on e-commerce in Germany and in the United States, indicates that B2C not only developed earlier in the United States but that it also has been accepted to a higher degree by American consumers. Perhaps EITO figures overestimate B2C in Germany and thus also in other European countries. In that case, the number given by the Association of German Direct Marketers (€4.9 billion in 2004) might be more realistic. Their estimate implies that the share of electronic sales in total retail sales would have been a little over 1 per cent in 2004. In general, a number of studies conclude that B2C will continue to grow rapidly over the next few years, although the estimates have become more Greece Portugal Italy Spain Belgium France EU15 Ireland Austria Germany Finland United Kingdom Luxembourg Netherlands Denmark Sweden 0

5

10

15

20

25

30

Figure 7.1 EU citizens who purchased on the Internet, 2003 (%)

35

40

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reserved than before (European Commission 2001a: 25; NFO Infratest 2002: 343; TNS Infratest/IIE 2004: 264, Table). The number of online shoppers in particular is rising with the increasing use of the Internet by customers (Enigma GfK/TNS Infratest 2004: 8) and is expected to continue. At the same time, the relations in the degree of Internet e-commerce between these countries do not seem to have changed essentially in the last few years. As the Eurobarometer published in March 2004 shows, the percentage of citizens who have bought articles on the Internet is higher in Germany than in the EU-15 (Figure 7.1) and even more so compared to the EU25 because Internet penetration rates are relatively low in the post-accession countries. Yet Internet penetration in Germany is still lower than in the Scandinavian countries, the Netherlands and the United Kingdom. At the same time, the United Kingdom is behind Germany in B2B e-commerce, as we can see in the EITO figures (Table 7.1). Once again, one has to be very careful in interpreting these data. They result from population surveys that might not be very precise in gauging e-commerce activities. These numbers show the percentages of people who bought anything via the Internet (and related media), which does not say anything about the amounts spent nor the frequency of purchases and sales made. At the same time, however, the relevance of single groups of products in B2C can be traced, at least for Germany, fairly well on the basis of ongoing surveys. The relevance of groups of products is determined by a series of different factors, such as the target group, the need for consultation, the ability of the product to be individualized and transaction costs (Table 7.2). These criteria have been met for many years and have remained almost unchanged for the same group of products. The target group of this survey contained 17.59 million buyers who had made purchases of at least one product in the last 12 months via the Internet. If the breakdown of turnover by products rather than the frequency of purchases is considered, the result changes due to the average prices of products traded. In this category, clothing and shoes had the highest share Table 7.2 Products most frequently bought via the Internet in Germany, 2003 Item sold

Percentage of respondents

Books Music/CDs Clothing/shoes Gifts Admission tickets Computer hardware/accessories CD-ROMs/DVDs Train tickets User software

44.1 34.9 31.4 28.0 22.2 22.2 20.6 19.8 19.7

Source: AGIREV 2003.

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in 2003 at 11.5 per cent, followed by PC accessories (10.8 per cent) and consumer electronics/photo/video (8.7 per cent). Books, including cards and journals, at 6.1 per cent and CDs/CD-ROM at only 4.1 per cent are lagging behind (TNS Infratest/IIE 2004: 275). The diversity of the successful products in e-commerce shows that there seems to be no general and simple rule when it comes to whether a product can be marketed via the Internet or not. Nevertheless, it seems to be beyond dispute that the reasons behind success can be found to a certain extent in the nature of the products themselves: the sooner the potential buyer can determine the use and the quality of the product, the easier it is to be sold over the net. Only on that basis can potential price advantages of direct marketing be made clear to customers. On the seller’s part, there are also logistic factors which are important for success in direct selling via the net.5 One important aspect of e-commerce is that it potentially makes crossborder sales between different countries easier. Thus, national distribution systems in retail trade and consumer services could theoretically be undermined by cross-border electronic sales. In fact, considerable transactions costs, particularly cross-border transportation costs of goods, make orders in other countries less attractive than could be expected at first glance. In order to assess the cross-border relevance of products traded via the Internet it is not possible to revert to exact statistics. According to one consumer survey conducted by EOS Gallup Europe, almost half of the German households that had bought online declared that they had done this at least once through a foreign supplier (EOS Gallup Europe 2002: 62). In relation to total turnover, however, the share of this kind of purchasing from private customers in another country is still very low. Based on a survey carried out with general managers and marketing directors, one EU study estimates that in the 12 months between mid-2001 and 2002 only 3 per cent of the purchases made by consumers via the Internet were made outside their own country (Press and Communication Directorate-General, Public Opinion Analysis Unit 2002: 25). In evaluating such data, one has to bear in mind that it is sometimes difficult for the household to know where the Internet-supplier is actually located. The country of the location of the enterprise and of the website are not necessarily identical (OECD 2002: 68). Price differences play a decisive role in shaping private household decisions to purchase in another country. Goods suited for sale on the Internet have to be much cheaper in a foreign country in order to be considered as an attractive alternative. As is evident from the current and relatively low volume of Internet-based, cross-border distance trade, price differences that would be able to overcome consumer uncertainties do not appear to be widespread at the moment. This view is backed by a study commissioned by the European Commission for the period between March 1999 and March 2000 on price differences in the European Single Market (European Commission 2001b:

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18–19). So far, e-commerce has not yet become a very well-developed, and surely not, ‘borderless market’ (GFA Management 2002: 48).

Factors influencing the structure and volume of B2C e-commerce in Germany Differentiated picture As discussed above, international comparisons appear to be fairly complicated due to the novelty of the Internet and the general problem of data collection. Consumer and supplier surveys provide only a rudimentary, neither an authentic nor a reliable, picture of the actual development of electronic commerce. Solid market studies that incorporate all relevant aspects, such as total or partial number of electronic transactions, number of customers using the Internet as a complementary medium of information, supplier networks on the Internet, and substitution relations between electronic and conventional mail-order business, are missing. Moreover, when looking at international differences in the volume of e-commerce, several additional factors should be taken into account. First of all, Internet use originated in the United States and was diffused throughout the industrial world, eventually also reaching industrializing and developing countries. Different patterns of diffusion within Western European nations could thus simply be a result of time lags. Second, the English-speaking industrial countries and countries where the use of English as second language is widespread – e.g. Scandinavian countries – certainly show an advantage over Roman countries. Finally, cost factors, such as lower telephone fees (i.e. flat rates), might also have contributed to an earlier diffusion of the private use of the Internet in some countries. A broader acceptance of the Internet in the United States could likewise be a result of earlier technological distribution. The effect of the time lag qualifies the importance of other factors, including institutional factors. After all, it seems that the difference between the United States and other industrial countries has not increased to a noticeable degree. The development of B2C e-commerce has unfolded in a remarkably manifold way. Strong growth patterns in the electronic banking sector, electronic ticket sales and Internet-based hotel reservations contrast with very sluggish growth rates in other areas. Not at all astonishing is the fact that electronic products such as PCs, printers and digital cameras are often purchased online. Electronic book trade has become a serious competitor of the traditional book trade within a fairly short period of time. Nevertheless, limits to the growth of e-commerce have also become increasingly apparent as the development of e-commerce has been relatively sluggish in other consumer product markets. The main causes for these differentials can be found in three areas: supply-side factors, demand-side factors and institutional factors. These are analysed in more detail below.

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Technology The development of e-commerce is completely based on ICT. Rapid technological change in ICT automatically leads to improvements in the technical environment of e-commerce, and ICT’s remarkable progress over the last 30 years has often been described in the literature. The average hardware equipment of firms and private PC users in 2005 is incomparably better than the equipment sold in the ICT markets 10 years ago. For instance, the speed of PC calculation as well as PC memory capacity has multiplied. Software development has followed the increasing availability of advanced hardware equipment. There are acceptable software programs for nearly all standard business problems, even for SMEs for which the software solutions developed in the context of large enterprises had often not been attractive. Today, consumers can use highly sophisticated and reliable software programs on their personal computers. At the same time, software applications for the Internet are far more developed and reliable than ten years ago. The capacity of e-commerce enterprises to make attractive offers to consumers via the Internet is far better today than some years ago for purely technical reasons. Better technologies on the hardware and software side also make it possible to find convincing solutions for security problems, which are critical for the efficient use of the Internet for commercial purposes. Major developments in ICT that can decisively influence B2C in the next few years are the dissemination of broadband communications channels, which has just started on a wider basis, and the convergence of IT and telecommunication (EITO 2005: 25). Broadband communication not only allows speedier electronic communication processes but also the establishment of far better Internet portals for electronically trading firms as well. The convergence of IT and telecommunication will lead to the stronger penetration of Internet applications into the daily lives of consumers. This might foster the readiness of many consumers to make the Internet an integral part of their buying decisions in the future. Internet firms: supply-side factors The Internet and other data transmission channels existed before any firms could offer their products and services over these channels. The use of the Internet for commercial purposes started in the United States in the late 1980s and in Europe in the early 1990s. The presence of a critical number of consumers with access to the Internet was a precondition for the commercial use of the Internet. Among the pioneers of e-commerce in Germany were many young idealists without any experience in commercial activities, retail traders who discovered an interesting new business field, and who also established firms such as Amazon that tried to extend the geographic area of their activity to make use of economies of scale and scope. B2C via the Internet gained

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a decisive impetus in the second half of the 1990s as a ‘gold-digging euphoria’ developed around the Internet economy. At the same time, the market values of Internet firms exploded in the American and European stock exchanges, including the German ‘new market’. During these years of seemingly unlimited development, thousands of firms attempting to initiate ‘e-commerce’ in one way or another were founded in Germany. Many of these start-ups surely never traded with anything, while other hopeful firms came to an end already in the start-up phase. Unfortunately, there are no reliable figures on Internet start-ups that could reconstruct the development of the e-commerce firm population. The only thing that seems clear from the fragmented information available is that there was a very tough market selection process among Internet start-ups so that the chances of survival were very low. Only 5 to 10 per cent of the firms established between 1990 and 1995 are estimated to have survived ten years later. This picture of industry population dynamics is well known from economic history. A newly constituting branch at first attracts a large number of start-ups attempting to make commercial use of new technologies or product families. In the next phase of market consolidation, a hard selection process takes place among these newly founded firms. Competition leads to a strict selection among the market participants where the most efficient and innovative firms have the best chance of survival. This process occurred in the automobile industry during the first decades of the twentieth century, as well as in other durable consumer goods industries. B2C follows this same evolutionary pattern. Although the general pattern of early market dynamics in e-commerce is similar to the pattern found in industrial consumer and investment goods sectors, it would be wrong to assume that e-commerce should automatically evolve into a highly concentrated branch as, for instance, the automobile industry did. It is true that building up efficient Internet marketing organizations demands considerable investments, as Amazon’s example shows. In this case, it may take years to reach the break-even point in sales turnover, and high losses are unavoidable in the first phase of business operation. But it is also possible to enter the market on a far more modest scale with relatively low risks. Establishing a website and offering a product to customers is not necessarily associated with high set-up costs. The severe selection process among Internet suppliers was associated with a basic change in the patterns of ICT use in the surviving firms. The first generation of Internet firms concentrated on establishing a more or less impressive homepage and offered goods and services in an often arbitrary way. Limited sales and deceptive exchange results have led the focus of attention away from the presentation of the firm to the outside world via an Internet homepage to a better organization of ICT-based business structure within the firm (OECD 2004: 106). Thus, e-commerce and internal value creating processes are better integrated today.

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At present, e-commerce activities constitute only a small part of far more complex marketing activities by the firms that use the Internet as marketing channel. Pure Internet sellers have been supplanted by retailers who are conducting e-commerce along with other diverse marketing activities. Multi-channel firms that originally were not involved in the B2C market play a strong role in the field today. According to a recent survey, multichannel firms that offer online sales achieve only 3.8 per cent of their total sales through online transactions (Hudetz and Tanaskovic 2004: 11). E-commerce is a very young economic branch still in its infancy. It is thus no surprise that this young market has experienced major structural changes in recent years. At first, specialized Internet traders dominated a very small market. As soon as conventional retail traders realized the great potential of the Internet marketing channel, they eagerly took advantage of the opportunity and established their own Internet marketing departments. Hence, the combination between conventional channels of distribution and the possibilities opened up by the Internet, the so-called ‘bricks and clicks models’, is one of the current most promising avenues for further proliferation of online trade (European Commission 2001c: 12). This view is shared by the German Retailers Association (HDE), which expects total online turnover in Germany to increase from € 1.25 billion in 1999 to €14.5 billion in 2005, with multi-channel shops as the main winners (HDE 2005). EITO expectations for 2007 are even higher at €48 billion in online shopping turnover and an additional €40 billion offline turnover by 16 million crosschannel shoppers who have been influenced by information and price comparisons via the Internet before they actually buy in a traditional shop (EITO 2004: 181, Figure 14).

Demand-side fctors: Internet access, learning processes and fading fears of misuse To date, B2C has played a minor role in retail trade and in the marketing of services in general. At present, less than 2 per cent of all consumer goods are sold via electronic channels, even in the United States as the market forerunner. The fact that Americans spend more money on online purchases than Germans looks less impressive if we take into consideration the small share of their online transactions in total retail expenses (1.9 per cent in 2003). Nevertheless, the growth rates of this young market segment in the 1990s have been striking, and e-commerce is just beginning to consolidate its marketing position in relation to traditional marketing channels. The most important questions regarding B2C development are: What is the percentage of consumers who are effectively able to use online services because they have Internet access? Who buys online and why? Which goods and services are bought online and what are the interrelations between Internet purchases and traditional marketing channels? Finally, what factors impede or foster Internet purchases? These are the questions discussed in the following two sections.

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Adequate computer equipment and Internet access – ‘e-readiness’ – is an elementary precondition for participation in Internet-based e-commerce. The number of people who own a personal computer and have direct access to the Internet has grown steadily since the early 1990s. According to a BITCOM estimate (2005: 9), the percentage of the German population using the Internet was 54 per cent in 2004 (44.6 million). This percentage was lower than the percentage of Internet users in the United States (65 per cent), but Germany outranks Western Europe (45 per cent) and Eastern Europe (11 per cent). The Scandinavian countries are clearly ahead of the rest of Europe with their extremely high Internet user rates (73 per cent in Denmark and 69 per cent in Sweden). Internet users do not automatically resort to the Internet for shopping purposes. Not all consumers who have private Internet access order and buy goods or services via the Internet. According to the OECD ICT database, 44.9 per cent of German Internet users searched the Web for information about goods and services in 2002, but only 19.2 per cent used it for purchasing and ordering goods and services (OECD 2003b, Tables 4.3.3 and 4.3.4). This percentage was far higher in the United States (39.1 per cent), in Denmark (37.6 per cent), in Sweden (36.9 per cent) and in the United Kingdom (32.77 per cent), and all figures appear to be compatible with the data on Internet access and user practices cited above. The numbers of buyers on the Internet has also been growing over the past few years. At the same time, the frequency of purchasing transactions and the amount of goods and services bought via the Internet is also on the rise. Apart from the steady improvement in user equipment, other factors have contributed decisively to the growing amount of Internet sales to consumers. Trust is undoubtedly a decisive factor for the success of e-commerce (Kollmann 2004: 30). The clients have to be convinced that information they send via the Internet to the sellers, e.g. credit card information, is honestly used and that security standards against criminal misuse are reasonably high. As diverse analyses show, German B2C firms have succeeded in establishing relatively stable trust relationships and loyalty with their clients (see, for example: Mentzel 2003; Hudetz et al. 2004). The observation that a steadily increasing number of German consumers use the Internet for their daily banking transactions might indicate that the psychological barriers of German consumers towards perceived electronic transaction risks are not as high as to impede more use of this medium. The growing awareness of consumers of the shopping potential of the Internet and the increasing readiness to buy via the Internet are essentially due to learning processes. The Internet is still a relatively new medium. Consumers and suppliers alike have yet to learn to make the best use of it. The predominance of younger people among Internet shoppers shows that learning processes are very important for the acceptance of the Internet with regard to demand. In general, the prospects of B2C development seem to be better than many observers believed after the burst of the ‘dotcom

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bubble’. Nevertheless, while it does seem clear now that the Internet creates an additional marketing channel for retail trade in goods and services, it will also probably not replace stationary commerce on a broad base. Institutional factors: Regular settings and the development of B2C e-commerce E-commerce in Germany – as in other highly developed market economies – has not been subject to special restrictions that could have prevented its development. At the same time – and this appears to be the central aspect of the legal question – German law has in no way been prepared for the legal problems caused by the Internet medium. The same appears to be true for other countries. The German economy has gained a bad reputation for being highly regulated. With respect to consumer market regulations, such a judgement does not stand the test of unemotional assessments. The consumer goods markets in Germany are – in general – accessible both for domestic and foreign suppliers from other EU countries. In addition, as a consequence of the process of European integration, goods market regulations are decreasing in importance. A somewhat different situation prevails with respect to service markets. As most European countries regulate access to these markets, German regulations do not deviate from the neighbour countries in any essential way. Regulations that are specific for Germany are mainly concentrated in branches of the economy that are irrelevant to B2C, e.g. the recently (and only partially) liberalized German ‘Handwerksordnung’ for craft trades. This regulation makes market access dependent on an examination (Meisterprüfung). For the development of the Internet economy, however, this regulation is of no relevance. Internet suppliers in Germany are not subject to any more special restrictions than they are in the United States. Other regulations that restrict the free trade of goods in Germany – the German law for drug sales – are in danger of being eluded by electronic commerce. Since 2004, the law permits German pharmacies to sell nonprescription drugs via the Internet. It cannot prevent consumers from buying prescription drugs without a prescription from suppliers abroad. However, this practice is still unlawful in Germany.6 A striking example of the replacement of private contractual regulation by a law represents the book retail price maintenance (Buchpreisbindung) in Germany. The Uniform Fixed Retail Book Price Bill was enacted on 1 October 2002. This bill obligates publishers to set uniform, fixed retail prices for all their new publications regardless of the channel through which the book is distributed, e.g. small book store, large book chains or the Internet. This exemption from the otherwise reigning principle of price competition is culturally motivated ‘in order to safeguard the necessary width and variety of the offer’ because ‘by the book as a medium the fundamentals of our culture are communicated’ (Bundesregierung 2002).

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A system of fixed retail prices for books had already existed in the form of a contractual agreement between publishers and booksellers, but this agreement came increasingly under pressure from cartel concerns voiced by the European Commission. Eventually, however, the EC officially acknowledged the application of nationally regulated book-price systems (European Commission 2001c). By regulating the issue in a national bill, anti-cartel arguments became pointless, as these only address private parties agreeing on restrictions to competition. Moreover, the new German bill now makes it impossible for any publisher not to fix the prices for new books. Before the enactment of the bill, it had been possible to avoid the fixation of the book prices by not joining the voluntary contractual agreement. Even private persons selling new books in larger quantities on eBay are now subject to the prices fixed by the publishers, as a recent court ruling in Germany has decided (Börsenverein des deutschen Buchhandels 2004a). E-commerce has played an important role in stipulating the re-regulation of the book market as a reaction to Austrian direct marketer (LIBRO)7 attempts to undermine the German contractual fixing of book prices by cross-border trade (European Parliament 2002). As the German Association of Booksellers states, the German form of regulation has become accepted as the new EU standard (Börsenverein des deutschen Buchhandels 2004b). With the exception of Finland and the English-speaking countries exposed to the competition of the world market, all other European Community member states already have fixed-price systems on the market for books or are considered to be heading in that direction.

Regulation of B2C e-commerce in Germany How to regulate B2C e-commerce In Germany, as in all other industrialized countries, the development of B2C took place within a highly structured regulatory setting for commercial trade in general. The new channel of distribution for goods and services is subject to the same legal conditions for commercial, contract and corporate law as the older ones. This fact has partly been neglected by the discussion surrounding Internet regulation. The perspective that nothing would remain the same was part and parcel of the ‘stock market hysteria’. Initial scientific discussion was also inclined to stress the revolutionary changes that would accompany the dissemination of the Internet. Today, the question regarding ‘appropriate’ regulatory settings for B2C e-commerce can be discussed in a different light as some time has passed since the Internet boom and bust. Two central fields of scientific discourse, which also underlie the contributions of this volume, have emerged: (1) a discussion of whether existing regulatory frameworks on the national level foster the development of ICT in general and e-commerce in particular, which also concerns the question of possible path dependency inducing some countries

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to fall behind in the diffusion of e-commerce; and (2) a discussion about the extent to which the state should intervene by regulating the Internet, which also often points to private alternatives to state intervention (such as with regard to security in the Internet). In Germany, the discourse of similar questions – particularly to what extent the state should regulate economic activity – has a long-rooted tradition that goes back to the historical school and the Freiburg school in the 1920s. Some economists, such as Walter Eucken (1990), stressed the importance of instituting a strong state guided by strong principles of economic policy to prohibit the creation of cartels. This idea was complemented by the view that the complexity of economic processes poses a central obstacle for an economic policy oriented towards specific goals. Hence, every intervention into the economic process potentially impairs an economic system’s capacity to adapt to changes and makes the window of evolution smaller (Hayek 1972; Streit 2001). This problem has motivated some economists to postulate an economic policy in accordance with regulatory settings that do not affect the economic process in a negative way. Both aspects of state regulation – checking the individual market power of firms while not interfering with market activities – have influenced the emergence of the framework conditions for economic activity in Germany since the Second World War. Hence, many issues that are important for economic trade are not at all subject to any restrictive government regulation. The observation that there are no specific restrictions that could hamper economic trade also applies to B2C. Thus, we could ask whether we are in need of specific e-commerce regulations at all. However, when it comes to e-commerce regulations and possible hindrances for the development of B2C, this general question boils down to very concrete questions about specific deficiencies in the regulatory setting. What are the prerequisites for the diffusion of e-commerce? This topic somewhat overlaps with the regulatory agenda for the diffusion of the Internet in general (DTI (Department of Trade and Industry) 1998: 13–18) and could possibly make an adaptation of the regulatory framework to changing conditions necessary in the following respects: • • • •

to ensure inexpensive and nationwide access to Internet services; to keep markets open on the supply side in order to ensure a degree of consumer choice between alternative service providers; to enhance safety standards which raise customer acceptance of B2C (e.g. data transfer and payment security); and finally to eliminate Internet-based criminal activities.

Deficits with respect to these conditions for the development of e-commerce could, in fact, lead to a possible future backlog. It is therefore worthwhile to look at both the existing and the evolving regulatory framework for e-commerce in Germany and to ask what effect it is going to have on future development.

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E-commerce policy in Germany There are fundamental differences with respect to ‘regulation philosophies’ between the United States and the European Union. The United States seems to prefer a laissez-faire approach by which government only defines and enforces property rights for e-commerce, while delegating further regulation if necessary to the market. However, policy cannot always abstain from regulatory action, especially when ‘national interests’ are at stake. Apart from the United States, the European Union proactively promotes a political programme that very clearly focuses on federal regulation of e-commerce as a basis for electronic market activities. In general, the US approach is based on the assumption that the positive effects of the new technologies that are apparent in lower transaction costs will best flourish in markets that are to a large extent free of interference from authorities. One example of this philosophy may be found in the area of data protection as stated in the ‘Platform for Privacy Preference Project’ (P3P), which has set a private standard for the use of personal data. Another example of a private response to the challenges accompanying modern technology is represented by the creation of private escrow firms for source codes of computer programs. In this context, software piracy is the most striking example of the limits of private regulation. The US Software & Information Industry Association (SIIA 2000) has continually fought for internationally binding and enforced laws. Like all other forms of crime, fighting against ‘cyber crime’ sets narrow limits for private solutions because the use of a state’s monopoly of force might be necessary when it comes to interfering with individual rights. In Germany, the dispersion of e-commerce took place within the legal framework of commercial law, which also applies to electronically based trade transactions. The German commercial code (Handelsgesetzbuch) constitutes the basis for all business transactions in any form. Moreover, a large number of already existing institutions, laws and regulations are in one way or another way relevant to electronic transactions. Table 7.3 highlights only a few of the most important ones. Traditionally, national regulations determined the framework for commercial trade in general and B2C in particular. These have increasingly been amended and replaced, first by international regulations and second by private initiatives. Thus, many problems in competition policy, the protection of property rights and the protection of data and young people or consumers are already regulated on the national as well as on the European level. This co-existence of European and German regulations is also institutionalized in the form of two antitrust and two patent organizations. German federal and state regulation covers mainly the fields of radio/media and publications, both of which are potentially harmful to young people. Over the last few years, the EU has issued several important directives concerning e-commerce. These include the applicable law in B2C e-commerce (country-of-origin rule), transparency in contractual terms

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and conditions, the conclusion of contracts, data protection, liability for content, the use of electronic signatures and copyrights. The EU also aims at regulating data protection in international exchanges, which concerns mainly the protection of consumers and young people who, in the United States, are generally left to voluntary self-commitment. In 2000, the European Union and the United States joined together on the so-called ‘Safe Harbor Agreement’ concerning the protection of personal data that are transferred from the EU to recipients in the United States. In this instance, different European and US approaches constitute a general need for transnational regulation on the one hand, which led to the EU Data Protection Directive (Directive 95/46/EC) of 1998, and a patchwork of laws on state and federal levels complemented by self-regulation in the US economy on the other (Arkell 2001). On the supranational level, the protection of property rights has been pursued via an OECD directive on consumer protection. The rules of consumer protection set up there appear to be reasonable. However, they are not binding because the matters addressed fall under national jurisdiction. The World Trade Organization (WTO), especially through the General Agreement on Trade in Services (GATS), intends to deal with the new challenges arising from the emergence of e-commerce in subsequent rounds of negotiations. So far, the main outcome of the WTO meetings has been the TRIPS Agreement (Agreement on Trade-related Aspects of Intellectual Property Rights), which sets minimum standards for the protection and enforcement of intellectual property rights. The so-called ‘Ministerial Declaration on Global Economic Commerce’ took up a comprehensive work programme on e-commerce in 1998 to initiate the further evolution of GATT, GATS and TRIPS.8

How should e-commerce be regulated in the future? When examining the influence of regulations on the development of B2C e-commerce, we arrive at the somewhat paradoxical result that the problem is not over-regulation. In fact, adequate regulations are required in certain fields due to the nature of the new medium. Existing regulations – in Germany as well as in other countries such as the United States – do not take two problems adequately into account. First of all, many consumers mistrust the Internet because in their view the security standards are too low. Second, providers have to be sure that they receive payment for their products and services. E-commerce thus leads to specific legal problems that the existing framework does not deal with in a sufficient manner. The agenda for regulating different fields of e-commerce should mainly concentrate on three important aspects (Zerdick et al. 1999: 257): • • •

priorities and content of regulations; the regional level of regulation; and state or self-regulation.

Data protection

IT security

Telecommunications Act, Telecommunication Services Act (The Regulatory Authority for Telecommunications and Post) BSI Act – Gesetz über die Errichtung des Bundesamtes für Sicherheit in der Informationscechnik (Federal Office for Information Security – BSI) Data Protection Regulations (Federal Data Protection Act, Information and Communication

Media rights

Media Services Inter-State Agreement

Patent Law (Deutsches Patent- und Markenamt)

Property rights (patents, licences)

National German Commercial Code (Handelsgesetzbuch) Act Against Restraints on Competition (ARC) (Gesetz gegen Wettbewerbsbeschränkungen, GWB) (Bundeskartellamt)

Local–regional

Commercial transactions Competition policy

Policy fields

Directive 95/46/EC of the European Parliament and of the Council of 24 October 1995 on

EU Television Directive

Copy Right Directive, 22 May 2001; Convention on the Granting of European Patents (European Patent Office)

European Directives of GD Competition

EU

Table 7.3 Selected rules and regulations relevant to e-commerce and central institutions

US–EU Safe Harbour Agreement

GATT (General Agreement on Tariffs and Trade), GATS (General Agreement on Trade in Services), WTO (World Trade Organization) Treaties under the Umbrella of the World Intellectual Property Organization; TRIPS Agreement (Traderelated Aspects of Intellectual Property Rights)

Global

Concerted efforts on federal and state levels concerning publications that are morally harmful to young people

Source: author’s compliation.

Cultural and educational policy

Youth protection

Consumer protection

the Protection of Individuals; European Directive on Privacy and Electronic Communications of 12 July 2002; European Commission’s Directive on Data Protection of October 1998 Gesetz zum elektronischen E-commerce Directive of 8 June OECD Guidelines for Geschäftsverkehr (2001; enacts the 2000; Electronic Signatures Consumer Protection 2000 European E-commerce Directive); Directive of 13 December 1999; Telecommunications Customer Council Directive of 20 Protection Ordinance; Act on December 1985 to Protect the Digital Signatures; Act against Consumer with Respect to Unfair Competition enacted on Contracts Negotiated Away 3 July 2004 (therein: § 1 Against from Business Premises Spam), Distant Trade Act (85/577/EEC); Youth Protection Law EU Green Paper on the (Jugendschutzgesetz – JuSchG). Protection of Minors and Human Law Against the Diffusion of Dignity Media Harmful to Young Persons (Federal Department for Media Harmful to Young Persons; FSK (Freiwillige Selbstkontrolle der Filmwirtschaft); Board of Film Control) Uniform Fixed Retail Book Price Bill (Buchpreisbindungsgesetz)

Services Act), Voluntary IT Security Audit and Update Check, BSI-registered Protection Profiles

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Important issues with respect to the future development of e-commerce lie in creating reliable ‘framework conditions’, the protection of legal property rights and the possible emergence of monopolies.9 Obviously, the abovementioned fields require different regulatory responses depending on the level of regulation – state, self, national or international. The most important challenge is to establish ‘framework conditions’ that ensure frictionless transactions over the Internet (Schaaf 2002: 2). The new Internet medium brings supply and demand together. As a consequence, several aspects have to be settled, such as ensuring legal certainty, consumer data protection, electronic signatures and consumer protection. The open questions with respect to regulatory environment become more pressing in international transactions as different legal frameworks are involved. Legal certitude in B2C e-commerce poses no special problem as long as both buyers and sellers are in the same country, which is still the case in most B2C transactions by far. Here, national legislation applies, and for Germany there appears to be no reason to change the legal framework. For e-commerce on the European level, the EU directive on e-commerce enacted into national law in 2001 specifies the country-of-origin principle. Thus, in general the sellers do not have to orient themselves towards the country where they sell the goods. However, exceptions such as national consumer protection laws in a particular buyer’s country may still apply. As far as the fundamental legal framework is concerned, private solutions play only a minor role. However, markets for technical solutions that are closely connected to the legal framework, such as the provision of electronic signatures and encryption techniques, have emerged. Both services are provided by private firms and at the same time influenced by national legislation. Digital signatures are needed in order to be sure that a declaration of intent over the Internet can be attributed to one person without doubt (Grunwald 2001). With the signature directive, the EU has set the minimum standards for the use of signatures, thereby strengthening the diffusion of this service. For B2C e-commerce, however, digital signatures remain insignificant. The reason is that the expenses necessary for technical equipment are not worthwhile for most consumers who buy on the Internet. Along the same lines as signatures, encryption techniques aim to increase consumer trust in the Internet as a medium of transaction. They allow the sending of information through the Internet to proceed safely. In this case, the lack of state regulation in Europe entails a competitive advantage for producers of encryption software to the United States, where the sale of safe encryption methods is limited, so that the investigation of crimes is not obstructed (Zerdick 1999: 263). Consumer protection is an important arena of B2C e-commerce framework conditions as it is central to reducing reservations against the new medium for business transactions. The catalogue of important, general guidelines for consumer protection set by the OECD in 1999 (OECD 2003a) includes:

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(1) fair business, advertising, and marketing practices; (2) clear information about the identity of the businesses engaged and the goods and services offered; (3) transparent procedure for confirming transactions; (4) secure payment mechanisms; and (5) protection of privacy. Here, again, the existing legal rules offer an appropriate framework for national transactions. For international transactions, however, at least minimum requirements should be set by regulations on the international level. In some respects, consumer protection and overcoming consumer reservations can also be accomplished by private security labels. In Germany, the privately organized association for product certifications (TÜV (Technischer Überwachungsverein)) assigns a certificate (called ‘s@fer shopping’) for online shops and virtual tourist agencies. Criteria for the certificate are, among others, data security and data protection. For governmental promotion of B2C e-commerce there are also alternatives to regulations such as providing information about the possibilities of B2C e-commerce. The protection of legal property rights is, of course, also an important issue in B2C. Computer technologies render it easy and costless to copy software programs, music, electronic books and movies. The shrinking possibilities of capturing the monetary benefits from these products may in fact reduce incentives to produce and supply them. The Internet offers opportunities to circumvent property rights and can possibly make this problem worse. An additional necessity to regulate this issue, however, does not automatically follow from this concern. The above-mentioned TRIPS Agreement offers one international minimum standard. Thus, the crucial question here is less how to regulate property rights protection and more how to enforce the already existing rules. Technical solutions for copyright protection should play an important role. The consequences of the ICT technologies for competition policy have already been studied at length (WBWT 2001; Picot and Heger 2003). Of course, ICT opens up new opportunities to gain competitive advantages. At the same time, commentators suspect that competitive advantages might also be more prone to erode as innovation cycles become shorter. Meanwhile, a major share of the B2C turnover is concentrated on big business firms, which raises the question of whether possible economies of scale in the storage and delivery of goods and services make a difference. However, one important competitive advantage is that large firms are able to build on consumer trust associated with well-known brand names. Their existing creditability reduces consumer reservations to buy goods over the Internet. In discussing possible consequences for competition policy, one has to keep in mind that a well-established regulation regime for monopoly control exists on the national, as well as to a lesser extent on the international level. No additional state regulations are thus necessary for B2C. Do we

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need more private regulatory mechanisms? Such developments have to be seen in the context of the total retail trade sector. B2C will play an important role in only some branches. Smaller firms with no established brands do indeed have a competitive disadvantage due to the lack of trust. Instruments that increase trust in transactions with these firms such as certificates should be able to partly overcome these disadvantages. In summary, we can say that there are several important questions regarding international e-commerce trade that should be settled in the future. Some of these regulatory issues are important only for the further development of e-commerce trade (such as consumer protection), some are important only for B2C transactions, and others (such as cryptography) apply equally to B2B and B2C e-commerce. Most of these regulations are required on the international level, while national administrations should transform the international regulations into federal law and make both compatible. In general, the ongoing tendency to erode federal regulation by international agreements should continue in the future. B2C e-commerce represents a field of regulation where national law will be losing importance over the long term. This observation applies to all industrialized countries. Thus, national differences in the regulatory environment will become less important for differences in B2C trade. Self-regulation ought to receive attention as a more flexible alternative to state intervention. There is no evidence that state regulation of details is needed in addition to very general framework conditions and minimum standards. Thus, one should be careful in setting new rules. Too much regulation may well impede further development.

Conclusions The regulatory framework is important for the development of new markets. This is also the case with respect to e-commerce. However, one should not invest too much hope in the regulation of economic activity as a means stimulating B2C development. As our considerations show, the existing regulatory environment is in many respects suitable to ensure market functions. The fact that e-commerce has, as yet, not developed in a more dynamic manner is mainly due to other factors, such as the technical weaknesses of Internet solutions, costs, the sluggish development of attractive web shops, the customer learning processes enabling full use of the Internet supply and existing and changing consumer preferences. It also seems quite possible that savings in transaction costs and economic welfare effects of B2C have occasionally been overestimated. At the same time, there are clearly fields of action where framework conditions for the Internet economy could be improved. Yet doubts remain as to whether this has to be done by the government. From our analysis it becomes obvious that most of the remaining problems could be solved in a more efficient manner by private initiatives and co-operative action between

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market actors. Private firms and cooperative arrangements already provide security of Internet transactions and trust-creating devices, and this line of action should be pursued in the future. The task of the government would then be to establish general rules for electronic commerce without getting involved in detailed solutions. While these observations refer to e-commerce in general, national differences in e-commerce appear to be fairly persistent. The development of ICT and Internet sectors in general has been associated with varying levels of employment and productivity effects. The first-mover countries such as the United States have so far profited more than others, such as Germany. However, there are no indications that these developments have established a lock-in with respect to the use of e-commerce. It appears that the existing ‘backlog’ with respect to the United States can largely be explained by a time lag in the diffusion of the Internet.

Notes 1 2 3

4

5

6 7 8

The authors are grateful to Rainer Graskamp and Corina Zoch for their valuable help. Electronic transactions between firms are generally conducted via EDI networks, which often make use of a web-enabled gateway. However, they can also be based on other data exchange networks. The annual EITO report is published by the European Economic Interest Grouping (EEIG), a private research organization, with the support of the European Commission, DG Enterprise and DG Information Society and Media in Brussels and the OECD Directorate for Science, Technology and Industry in Paris. According to the online information of the company, the GfK Group (Gesellschaft für Konsum-, Markt- und Absatzforschung, www.gfk.com) is the No. 4 market research organization worldwide. The GfK Webscope survey is based on representative written surveys of 10,000 Internet users which are carried out both online and offline. There are also products that have played only a subordinate role in direct marketing up to now but that meet, in principle, the requirements of a successfully marketed product via the Internet and thus possess considerable sales potential. Currently, the best example for this group of products is motor vehicle parts. This is the result of a survey conducted in the context of the Online Shopping Survey (OSS), a joint survey by NFO Infratest and Enigma GfK (GfK 2003). Another prominent example is the highly regulated drug market in the United States, which is under increasing pressure from the less regulated and hence much cheaper market in Canada. LIBRO is one of the leading suppliers of office supply and entertainment (books, music, DVDs) in Austria. Its subsidiary, LIBRO online, tried to circumvent the contractual fixing of book prices. However, there is hardly much progress to be seen. There seems to be a political blockade in which, among others, efforts are made to find ways to maintain the difference between goods and services for digital transmissions. In its current form, the GATS Agreement is neutral concerning the technology by which the service is performed. Following this interpretation, e-commerce would already be subject to existing regulations. This is not beyond dispute and ongoing negotiations will show the extent to which the agreement’s existing regulations

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are appropriate for digital commerce (Arkell 2001). The process described here is a very slow one. There has been almost no progress over the last few years, as one can see by reading the respective e-commerce gate website of WTO accessed at www.wto.org/english/ tratop_e/ecom_e/ecom_e.htm on 17 February 2005. Other issues, such as tax policy and varying national regulations concerning consumer protection or national take-back obligations for producers, should become more important for B2C e-commerce as the share of international e-commerce trade increases.

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Part III

Industrial organization, enterprise structure and ICT Japan, the United States and Germany in comparison

Subsection A Effects of ICT on industrial organization and on firm structures

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ICT and corporate structure The diffusion of e-commerce across Japanese companies1 Dennis S. Tachiki

Introduction The 1990s is often referred to as the ‘lost decade’ in Japan, where the bursting of the asset bubble economy left it mired in a prolonged recession. In contrast, during the same period the ‘new economy’ in the United States and Europe is said to have taken off, spearheaded by highly innovative dotcom companies and a strong bull market. An International Data Corporation report (IDC 2000), however, paints a more mixed picture. Japan’s overall information society index score still ranks among the developed countries, while its Internet infrastructure and informatization scores are closer to those found in developing countries. The main research problem driving our analysis, then, is whether or not Japan lags behind other countries in the diffusion of e-commerce, and if so, what implications this lag has for the flagging Japanese economy. In answering this question it is easy to compare Japan with other countries, especially with the United States and the European countries. This approach, however, biases us towards a convergence model of economic development. If the United States is the exemplary model, for example, how can we account for the rapid increase in mobile commerce in Japan? Rather than assuming a strictly exogenous imperative, a recurrent question we ask is to what extent are endogenous factors also affecting the diffusion of e-commerce? Our analytical concern here is the extent to which e-commerce does and does not diffuse across industries and within establishments and the consequent impacts on firm performance. Our measure of e-commerce diffusion is based on revenues generated online over the Internet (CRITO (Center for Research on Information Technology and Organizations) 2002). The comparative merits and demerits of e-commerce against the existing Japanese style of management suggest it will diffuse unevenly across industries and within companies. For the past three years, the ECOM (Electronic Commerce Promotion Council of Japan) has been improving the definition of and data collection on e-commerce to create a more reliable database (ECOM 2002). Although the annual ECOM survey is getting better at capturing current trends, its

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Table 8.1 Market size of e-commerce, 1998–2005a 1998b 1999

2000

2001c 2002c 2003c 2004c 2005c

Total (million yen) 8,685 12,656 22,414 35,511 46,781 66,304 90,925 141,727 B2Bd 8,620 12,320 21,590 34,027 43,950 61,270 78,430 125,430 B2B ratio (%)e 99.3 97.3 96.3 95.8 93.9 92.4 86.3 88.5 EC rate (%)f – – 4.1 5.0 6.6 9.2 11.5 14.1 B2Cg 65 336 824 1,484 2,831 5,034 12,495 16,297 B2C ratio (%) 0.7 2.7 3.7 4.2 6.1 7.6 13.7 11.5 EC Rate (%) – – 0.3 0.6 1.1 1.9 3.1 4.5 Source: ECOM 2002. Notes: a The definition of e-commerce used for the ECOM study is ‘the conduct of commerce’ (e.g. exchange of goods, services, information and money between suppliers and buyers, associated with the commercial transfer of assets between economic units) ‘through computer network systems using the Internet technology’ (i.e. using the TCP/IP protocol. Network lines include the Internet, extranet, Internet VPN (virtual private network) and dedicated IP lines), ‘the transactional values of which can be identified’ (i.e. giving quotations, providing information and other pre-order conduct are included as long as it is clearly identified that the conduct has led to purchase and/or sales order). b First year of survey. c Projected figure. d B2B e-commerce is where businesses/government bodies pay businesses in exchange for commodities (goods, services, information, etc.). It includes both B2G (Business-toGovernment), where government bodies pay businesses in exchange for commodities (goods, services, information, etc.), as well as the e-marketplace, where B2B e-commerce takes place on platforms used by multiple selling and buying enterprises. e B2B or B2C per cent of total e-commerce. f The proportion of e-commerce against the total interim demands and final demands for the applicable segment. g B2C e-commerce is where households pay businesses in exchange for commodities (goods, services, information, etc.), such as mobile e-commerce using mobile terminals and e-commerce involving pre-order stages (quotes, commissioning, etc.) for automobile, real estate, etc.

future forecasts often fail to foresee emerging ones. Moreover, the future forecasts look suspiciously similar to the government policy goals of the e-Japan Strategy. Despite these caveats, we find that the ECOM survey is still slightly more reliable than many of the forecasts generated by consultants. According to the ECOM annual survey, Table 8.1 shows that the projected size of the e-commerce market in Japan in FY2002 (fiscal year) should amount to nearly 47 trillion yen (ECOM 2002). This is a fivefold increase over the amount of e-commerce transactions in 1998, when this survey first began. By FY2005, the ECOM predicts that the e-commerce market should triple in size to 142 trillion yen. During this same period of time, the B2C market should account for 12 per cent of total revenues, up from 6 per cent in FY2002. In the following sections we disaggregate the B2B and B2C data to examine (1) the diffusion of e-commerce across industries and (2) the nature of Internet use within companies.

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Diffusion across industries We seek evidence that the keiretsu (corporate groupings) fault lines across the industry sectors ease and channel the flow of B2B and B2C e-commerce. In addition, since the GEC Japan Database does not include ‘small-scale businesses’ (1–19 employees), we elaborate on the rise of Internet companies to flesh out this side of the diffusion story. Users of e-commerce According to a Ministry of Economy Trade and Industry survey, the diffusion of the Internet in Japanese companies has increased from less than 10 per cent to 96 per cent for ‘enterprises’ (>300 employees) and from 6 to 45 per cent for ‘establishments’ (