It seems that the United States and Mexico may be on the verge of a trade war in telecommunications.

The dispute has to do with the fundamentals of international telecommunications policy -- the rates charged to complete international phone calls, the legal and regulatory regime in each country, and the degree of reciprocity in each country's treatment of the other.

The dispute is precipitated by some very specific actions -- the FCC's effort to drive down the cost of international phone calls; the bid by Mexico's largest carrier, Telmex, to enter the U.S. market in a joint venture with Sprint; and the entry into force ninety days ago of the commitments contained in the WTO's basic telecom services agreement under the General Agreement on Trade in Services.

"Trade war" is not the term we are accustomed to using between two neighbors that are partners in the most comprehensive free trade agreement between a developing and an industrialized country; between two countries that find ways to cooperate on most issues because they generally see eye to eye on economic policy, and because they have common interests that are best served through cooperation.

And it's ironic considering that Mexico and the U.S. are in many ways similarly situated in telecommunications. We can argue about degrees -- but both are coping with the transition from regulated monopolies to competitive markets; both have brought competition to long distance markets; and both have been frustrated in achieving competition in local markets.

Let me begin with some thoughts on what the dispute is about, and what it is not.

First, for all the criticism we hear of Telmex, this dispute is not about a variety of anti-competitive behavior that is particular to Mexico.

Telmex is not unique. Telmex is behaving just as Adam Smith saw actors behaving in markets everywhere -- in its own self-interest. Telmex acts as a typical former monopoly telco, pressing every advantage it has and doing everything it can to retain its market advantages even though its legal monopoly has ended.

We are familiar with this in the United States, where our Telecommunications Act of 1996, a well conceived law, seems not to be working because in a critical aspect it goes against human nature. It asks former monopolies, the regional Bell operating companies, to open their markets to competition -- and even though they were given incentives to get into the long-distance market, they have instead opted to protect their local customer base from competition.

So the great tradeoff -- Baby Bells in long distance, long distance companies in local service -- hasn't occurred. And it's not stopping at that -- there are now efforts to redefine key terms of the Act, such as those that define Internet services as "information services" and keep them free of the taxation and FCC regulation imposed on common carriers. Suffice it to say that here, as in other liberalizing markets, there is abundant evidence to show that Telmex is no different than former monopolies elsewhere.

Second, with all deference and best wishes to the owners of Telmex, the prosperous shareholders who are spread all around the world, the dispute is not about the price of Telmex stock, or the health of any individual company.

Very often there is a tendency, especially in emerging markets, to pay a great deal of attention to the word of equities analysts. This makes sense, especially in places where the phone company represents the lion's share of the local stock market.

But equities analysts are concerned with their companies' financial condition, they don't pretend to be concerned with a country's economic health, nor do they analyze the health of a telecommunications market. Whatever the outcome of the current issues involving Mexico, it is no more appropriate to judge it by the fortunes of one company than it would be to judge the opening of the U.S. long distance market by the fortunes of our former monopoly, AT&T.

Third, if the dispute is not about companies, it is indeed about the welfare of consumers on both sides of the border.

In the short term, changes in rates will have an impact on consumer pocketbooks. But over the long term, the results we see in the coming months will tell us what kind of telecom market Mexico wants to have, and in the United States, it will tell us how the government intends to govern its own market, and how it will use its leverage to shape the course of global market liberalization in the WTO era.

The dispute begins with accounting rates, and the FCC's effort to drive those rates down worldwide.

And I'll begin this part of the discussion by drawing a sharp difference between my analysis and many of the investment-oriented analysts I mentioned a few moments ago.

I support accounting rate reform. The sooner we do away with this outdated system -- a vestige of a world where national monopolies were blissfully free to set high international rates among themselves -- the better.

Better for ratepayers in the short term. And better too for the consumers who never make a single international call, and even for consumers who have no phone. The ITU has recently reminded us that for all the hoopla we generate about the communications revolution, 1.5 billion people -- one fourth of the world's population -- live in countries where there is less than one phone per hundred population. And about half that number lacks phone service because they can't afford it.

What is the connection to high accounting rates? The connection is economic and political. Rates set far above cost, and the undue revenues they generate, act as brakes on the process of market liberalization. They give incentives not just to dominant telcos, but to governments who get a share of those revenues, to go slow in introducing competition.

Now, every time this subject comes up, we hear that cost-based rates will kill universal service, and drain the treasuries that invest in the upkeep and extension of national networks. The collectors of monopoly-based settlements payments tell us this.

With all due respect, my advice is to believe what they do, not what they say. For all the talk about investment in infrastructure, the reality is that these funds typically go into a black box, and from there they go with no transparency whatsoever into a host of projects that may or may not bear a relation to the national communications network. World Bank studies of the developing world show that there is higher teledensity and higher total employment in the telecom sector in markets that are open to competition as opposed to markets still dominated by monopoly carriers

It's no secret that accounting rate reform is of particular importance as much of the world is liberalizing, because high rates have distorting effects when they are present in otherwise open markets.

And it's particularly important to the United States and a handful of similarly situated countries, where huge outbound settlement payments have come to constitute a growing, unlegislated foreign assistance program. Here, it's about $5 billion a year, with the largest single outpayment, about $800 million annually, going to Mexico.

The FCC's "benchmark" order of last August, which has drawn a great deal of fire, intends to resolve this problem. This is somewhat ironic, considering that virtually the entire world is on record favoring cost-based international rates. Yet in the five years preceding the order, and in the seven months since, no multilateral alternative has emerged, and there is only a slim prospect that the ITU will craft one.

But in the meantime, progress is being made. The FCC gets part of the credit. A great deal also belongs to other factors: the wonderfully leaky nature of the market, the ingenuity of the players in it, and new technologies such as IP telephony. Where multilateral committees are stalling, arbitrage is succeeding.

So we're seeing carrier agreements achieving cost-based rates in countries such as Venezuela and the Dominican Republic.

And we see Mexico taking on the difficult task of seeking an agreement in Latin America to lower rates in tandem, so that no single country will be able to become the lucrative hub through which much of the hemisphere's voice traffic flows. We should applaud Mexico for this initiative; it's in the interest of the hemisphere's consumers, and it is appropriate for a region that is trying to build a single, integrated market.

The first connection between all this and the specific U.S.-Mexico dispute is the bold proposal of the Telmex-Sprint joint venture, known as TSC, to lock in high accounting rates for two years.

Essentially, TSC proposes to get the FCC to pre-empt accounting rate negotiations, which in practice are private negotiations among carriers. The U.S. government has no role in these negotiations, except to ensure that all U.S. carriers get the benefit of the lowest rate negotiated with any single carrier. To judge from the record so far, it seems that the FCC has little stomach for taking on this role, as TSC proposes, to act as an umpire to lock in specific rates on specific routes.

But that is just the beginning.

On the Mexican side, there is the matter of a surcharge on incoming international traffic -- a 58 percent surcharge levied on the settlement rate, on top of interconnection charges.

What's wrong with the surcharge?

First, if you're a fan of transparency, there is the fact that this surcharge is intended to finance network expansion. But it goes to Telmex, not to the government, it goes into a black box where there is no accounting of its destination or use.

Second, if you consider the WTO basic telecom agreement, there is the fact that the surcharge is neither nondiscriminatory nor cost-based.

And third, from the U.S. perspective, if you prefer a competitive market, the surcharge creates what a former FCC official calls a "subsidy-exporting machine." That is, if TSC begins operations in the U.S. market, it has a huge cost advantage over its competitors because it pays the 58 percent to itself, a luxury other carriers do not have. And it's a cost advantage that derives not from more efficient operations, but from a particular regulatory advantage that Telmex enjoys in the Mexican market.

Other carriers in the U.S. can't address this issue by negotiating lower accounting rates with the other carriers in Mexico, because only Telmex is permitted to negotiate those rates.

That is where U.S. officials face a important precedent-setting test. It's not that TSC would in and of itself turn the U.S. market upside down, but it would distort competition and limit price reductions on the U.S.-to-Mexico route.

A simple green light to TSC under current conditions would reward anti-competitive behavior; it would send a signal encouraging dominant carriers in other countries to follow suit. Perversely, it would show monopolies a way to prosper in a liberalizing world not by reducing their market power, but by extending its leverage to international markets.

Then there's the issue of resale -- that great market mechanism that can level and lower prices, and drive them toward cost. Resale is permitted by Mexican law, and it's part of the Mexican government's offer in the WTO basic telecom agreement. But in practice, it is banned, because Mexican regulators have not issued the rules to permit it.

With all these issues in play, increased attention has been drawn to conditions in Mexico's domestic market.

I'll give you a litany:

• local service charges that jumped 63 percent last year, resulting in complaints from Mexican consumers;

 
• the highest line installation charges in the world;

 
• an 800 percent increase in rates for digital lines.

Taken together, these conditions are a powerful indicator of the importance of accounting rates in shaping a market, and how high international rates can create incentives to perpetuate anti-competitive behavior in general.

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 -- the analysts called this a "very un-Mexican thing to do" -- "we now expect any close regulatory calls to be decided in favor of Telmex." Of course, the carriers have a simple explanation for why they go to the courts: judges respond, while the telecom regulatory commission frequently does not.

Where will all this lead? One hopes it will lead to a fair negotiated settlement of all the issues. One guesses that the FCC is full of officials crossing their fingers, hoping that two sets of negotiations now underway will succeed. I'm referring to international talks on accounting rates, and domestic discussions on interconnection terms, where even the infamous 58 percent surcharge is apparently on the table.

Let's be realistic and recognize that when issues under discussion between the U.S. and Mexico reach this stage, with agencies of each government pressing the other to change, and with companies on both sides lobbying, then it is only a matter of time before the whole debate takes on a political coloration. The baggage of U.S.-Mexican history enters the picture. Words like "sovereignty" start getting tossed around, and the basic economics at stake begin to get foggy.

Mexico of course has the right to define and to defend its sovereignty as it wishes. And God knows that at times, history has given Mexico reason to watch out when certain of its neighbors come knocking, talking about grand principles and asking Mexicans to change. Fair enough.

But it's also fair to say that Mexicans would be mistaken to view the U.S. position as a high-tech Helms-Burton, a unilateral move seen in Mexico as having no chance of success, and rooted in ideas accepted in Washington only.

In telecom, there can be an outcome that benefits both sides, an outcome that is rooted in the enlightened Mexican policies that have done so much to advance Mexico's economy, and to make Mexico a place that attracts and deserves investment from around the world.

What is really at stake is the welfare of consumers on both sides of the border -- as measured by the prices they pay now for telecommunications services, by the kind of markets we create for those services, and therefore the kind of economy we will all inhabit for generations to come.

What's at stake is access to the greatest economic development program in the world -- free, open, and competitive telecom markets.

Free markets have brought opportunity throughout economic history, but there's something unique about the information technology revolution: It's egalitarian.

Never before has a cutting-edge technology come on the scene and become available so rapidly to every economy in the world. Geography is not a barrier, scale is not a requirement. Technology-based businesses can be set up in Dominica as easily as in Denver, software design can occur as easily in Quito as in Connecticut.

We don't conceive of this as an economic development program because governments don't institutionalize it. It's easy to miss -- it's just the market, doing its work. But it's real, and every nation can reap its benefits.

I won't make a prediction about the outcome, but I am an optimist. I believe people on both sides of the border will follow the right principles, and the result will be better access and lower costs to consumers and businesses, stronger telecom industries, and a stronger regulator in Mexico.