Price Regulation and the Financing of Universal Services in Network Industries

The financing of universal service in network industries has traditionally relied on granting the universal service provider (USP) a reserved area. Liberalization policies promoting competitive entry put the traditional universal service at risk. Consequently, there is an increased interest in knowing the cost of the universal service obligation (USO) and an intensive policy debate about its financing. This paper explores the complementary roles of price regulation and universal service regulation in network industries. It analyzes compensation for the universal service provider by public finances and a USO fund. As long as the USP enjoys market power, also price regulation may serve as a means to finance universal services. This implies allowing for price increases to compensate for the net cost of the USO. It releases competing operators or the general budget from contributing to the financing of the USO but results in distorted pricing and reduced overall welfare due to inefficient entry. Generally, the analysis shows that current practices of costing and financing universal services may result in unintended market distortions. The paper quantifies these effects and demonstrates how such distortions can be avoided.