After investing $900 million in Avantel, its Mexican joint venture, MCI says it may now scrub plans to invest $900 million more. The reasons: a lack of impartial regulation, and rules that divert about 70% of Avantel's international revenues to Telmex, the dominant national carrier.

This is unusual news from Mexico, an economy generally favorable to foreign investors. And it's a surprise to those who equate soaring Telmex stock with a healthy telecom market.

But what's good for Telmex is not necessarily good for Mexico. There are serious market distortions in Mexico, and regulatory failures there and in Washington, that are denying Mexicans the benefits of a fully competitive market and could soon lead to the telecom equivalent of a trade war.

Like other former monopolies, Telmex knows how to pull every available political and economic lever to retain its competitive advantages for as long as possible.

As a result, Mexico has been very slow to introduce competition in local phone service, even though the cost jumped 63% last year, according to Mexican consumer analyst Arturo Lomeli. Long distance competition has started, but is hampered by high network access fees charged to Telmex' competitors, and by a fledgling regulatory environment that lacks transparency.

Resale, the secondary marketing of phone traffic that levels and lowers prices in competitive markets, is permitted by Mexican law, but it's banned in practice, because Mexican regulators won't issue the rules to permit it.

By far, the most dramatically tilted playing field is in international long distance. There, Telmex has competitors, but no real competition.

For example, only Telmex may negotiate the "settlement rate," the base price for international calls. It is set at 39.5 cents per minute, at least four times over cost, and other companies may not undercut it.

Telmex is also subsidized by an extraordinary 58% tax that it -- not the government of Mexico -- collects from its competitors on all revenue on incoming international traffic. This tax ostensibly finances new phone lines and keeps local service costs low, but the funds go into a black hole. Telmex publishes no data on their amount or allocation.

Given all the above, it's little wonder that a bullish 1997 Merrill-Lynch analysis of Telmex stock cited government regulation "tilting in Telmex's favor." It noted that because Avantel and the AT&T joint venture Alestra have "too aggressively" challenged certain regulations in the courts (a "very un-Mexican thing to do," the analysts said), "we now expect any close regulatory calls to be decided in favor of Telmex." The carriers have a simple explanation: they challenge regulations in the courts because judges respond, while the telecom regulatory commission frequently does not.

Mexicans alone would be debating their regulatory policies, but for the fact that Telmex wants to enter a joint venture with Sprint to sell long distance and international service in the U.S. That requires FCC approval, and allows the FCC to set conditions. The entire tangle of issues is now in the lap of William Kennard, the new FCC chairman.

Mexico's government is pressing hard for a decision favorable to Telmex. Kennard surely doesn't want a confrontation with Mexico, but his more important imperative is to set the right policy. So far, the FCC's international bureau has favored Telmex. Kennard should reverse course.

Telmex and Sprint want more than approval of their joint venture. In tandem with that decision, they asked the FCC to approve a scheme to maintain high settlement rates for the next two years (two pennies reduction in 1998, three in 1999). This would break new ground for the FCC; it would prevent other U.S. carriers, those not tied to Telmex in a joint venture, from negotiating greater reductions that would save hundreds of millions of dollars for U.S. and Mexican consumers. Worse, it would mock the FCC's own bold policy, initiated by former chairman Reed Hundt, of attacking monopoly-based phone rates worldwide. This policy, in place only six months, is already beginning to cut the bloated rates that cost U.S. consumers about $5 billion annually, 20% of that on the U.S.-Mexico route.

Kennard should start by turning down the Telmex/Sprint petition to lock in the high rates. This will keep other carriers free to negotiate for lower rates even if -- here's the possible trade war -- it means some carriers might make partial payments as talks proceed.

He should then grant Telmex' request to enter the U.S. market -- once resale is allowed in Mexico, and once Telmex competitors are permitted to set their own international rates.

The 58% tax also has to go. As a discriminatory levy, it would not pass a WTO challenge, and Mexico can replace it with an equitable, transparent tax to finance the expansion of telephone service. More important for the FCC, maintaining the tax would distort competition in the U.S. once Telmex begins service here. Since the tax is paid only by Telmex' competitors, it would enable Telmex to set predatory prices as builds U.S. market share.

It's fair to ask whether U.S. consumers would benefit from an opportunity to contract with this low-cost provider, albeit a company whose low costs are due to a rigged tax system. The answer is no. Telmex would have an incentive to price its U.S. service just below its competitors' break-even point, but no lower. As long as that tax is in place, the competition that drives prices toward cost -- below a dime a minute on calls to Britain or Canada -- would not occur.

More than most countries, Mexico stands to benefit from new, low-cost voice and data communications technologies. But there is no guarantee that consumers will reap lower costs -- or that these technologies will spur development in countries like Mexico -- if true competition is not allowed to drive prices down, and if governments don't prevent former monopolies from distorting markets.

Having failed to achieve the competition envisioned in the U.S. telecommunications act, Americans cannot afford to be smug about Mexico's market opening. But neither would it make sense for the FCC to reward Telmex' anticompetitive behavior with an automatic green light to its joint venture. William Kennard's first major international policy decision gives him an opportunity to promote a real market opening in Mexico and lower costs on both sides of the border, while protecting competition in the U.S. He should seize it.

Peters is a senior fellow at the Alexis de Tocqueville Institution and edits the InfoAmericas 2000 website