6

Peru after Privatization:

Are Telephone Consumers Better Off?
MÁXIMO TORERO, ENRIQUE SCHROTH,
and ALBERTO PASCÓ-FONT

Over the last decade, Peru’s telecommunications market has undergone

fundamental changes resulting from market liberalization, privatization,
technical progress, and changes in consumer demand. These forces have
had direct, long-term effects on consumers and providers. To evaluate this
process and assess the effects of these changes, this chapter focuses on one
of the greatest forces that has changed Peru’s telecommunications industry:
privatization of the Peruvian Telephone Company (CPT) and the National
Telecommunications Company (ENTEL), which Telefónica de España pur-
chased in 1994.
Today, a decade after privatizing Peru’s telecommunications market,
its overall effect is still puzzling. More people, mainly at the lower socio-
economic levels (SELs), have access to a telephone. On the other hand, many
potential consumers do not take advantage of this option, presumably
because they cannot afford the flat monthly charge.
In this chapter, we estimate the effects that various changes in telephone
services resulting from privatization have had on consumer welfare at dif-
ferent SELs. We analyze the benefits to consumers of having greater access
to telephone lines, along with the cost of the simultaneous increase in
monthly telephone tariffs. We measure changes in consumer welfare to

Máximo Torero is a research fellow at the International Food Policy Research Institute. Alberto Pascó-
Font was the director of the Group of Analysis for Development (GRADE). Enrique Schroth is assistant
professor at the University of Lausanne, Switzerland. This research was supported by a research grant
from the Tinker Foundation. The authors are indebted to the comments of Sebastian Galiani, Miguel
Urquiola, Paul Gertler, John Nellis, and a remarkably talented team of research assistants: Virgilio
Galdo, Eduardo Maruyama, and Gisselle Gajate.

219
determine whether the gains (i.e., more people with access to a tele-
phone line) offset the higher tariffs, particularly the increased, flat
monthly charge.

Sector Overview: The Road to Privatization

Before 1994, the Peruvian telecommunications sector was state-owned. The

sector was characterized by a high, unmet demand for access to basic tele-
phone services. Lack of investment and the political control of policies within
the firm were responsible for much of this great imbalance. It was assumed
that privatization would close the demand gap by boosting efficiency and
relaxing the investment constraint, while encouraging development of a
competitive market. Indeed, given its degree of development in the mid-
1900s, as measured by GDP per capita, Peru should have had a 6 percent ratio
of penetration (i.e., 6 out of every 100 households should have had a tele-
phone). Until 1993, the ratio of penetration was 2 percent. The distribution of
telephone lines was concentrated in Lima and in wealthier households.
Peru’s telecommunications sector was also characterized by distorted
tariffs. Installation costs were high (close to $1,000 per residential telephone
line in 1993), compared to the international average; however, the flat
monthly charge was relatively low. By contrast, tariffs for long distance and
additional local calls were high. Like many other countries, Peru assumed
that only wealthier consumers used international long distance service;
thus, the privatized Telefónica del Perú (TdP) provided a cross subsidy
between that service and local telephony. Parallel to the decision to priva-
tize the sector, the Peruvian government decided to rebalance tariffs to
reflect the marginal costs of providing the service. The plan was to phase
in the adjustment over five years since a full, immediate adjustment was
considered too harsh for the welfare of consumers (indeed, the monthly
charge for basic service would have increased from $1 to $17). During the
five-year adjustment period (1994–98), TdP was permitted to reduce the
cross subsidies gradually and finally eliminate them.

Privatization Strategy

The economic reforms implemented in early 1990 by the administration of

Alberto Fujimori included privatization of companies in which the state
had held a sizeable share. Between November 1991 and February 1992, the
Peruvian government put into effect a comprehensive privatization strat-
egy; it defined the methods and prioritized sectors according to their eco-
nomic significance, potential ease of privatization, and degree of crisis faced.
It created Special Privatization Committees or CEPRIs to promote and facil-
itate this process.

220 REALITY CHECK

 Until 1994, two state-owned companies—CPT and ENTEL—provided
telecommunications services. CPT provided local telephony service in
metropolitan Lima, while ENTEL served the rest of the country and handled
national and international long distance services. The government had
organized the sector in this way through the 1970 Telecommunications Act,
which considered the sector strategic and therefore kept domestic and for-
eign private businesses from participating in it.
Under this scheme, all infrastructure investment was undertaken by the
public sector. However, because of low tariffs and limited management
capacity, the sector experienced little growth, inadequate coverage, and
low-quality service.
To manage privatization of the sector, the Fujimori administration passed
the Telecommunication Law in 1991 and formed the Telecommunications
CEPRI, which issued an international call for bids and set the base price at
$546 million. Three consortia responded to the call for bids:

 Telefónica de España, Graña y Montero, Backus, and Banco Wiese;

 Southwestern Bell, Korea Telecom, Daewo Telecom, Condumex-Carso,
and Banco de Crédito; and
 GTE, Compañía Portuguesa, and Empresa Brasilera de Telecomuni-
caciones.

The winning consortium, headed by Telefónica de España, offered

$2.002 billion, almost four times the base price, for a 35 percent share
in CPT and ENTEL. Of the remaining 65 percent of shares, minority share-
holders held 36 percent and the Peruvian state retained 29 percent. Con-
sequently, the privatization process did not conclude in 1994. In July 1996,
the state sold off 26.6 percent of its shares through a diversified operation
to small and individual shareholders.

Toward a Competitive Sector

The privatization agreements called for a merger of CPT and ENTEL.

However, the two entities were required to keep separate accounts. The
agreements also established a five-year period of limited competition, dur-
ing which new competitors could not provide basic telephony services.
Remaining telecommunications services (value-added services, mobile tele-
phony, data transmission, e-mail, and cable television) were open to imme-
diate competition.
In exchange for granting this partial natural monopoly, the government
required the operator (the winning bidder) to meet goals for expanding
service and improving quality. Consequently, expansion and moderniza-
tion goals in the concession contract called for a total of 1,197,600 lines.

PERU AFTER PRIVATIZATION 221

Table 6.1 Maximum rebalancing tariffs, 1994–98
(in 1994 Peruvian soles)
Service tariff 1994 1995 1996 1997 1998
Basic residential 12.970 14.600 18.640 25.290 31.930
Basic commercial 21.800 25.990 29.430 30.520 31.930
Local call (three minutes) 0.144 0.140 0.135 0.128 0.120
Domestic long distance call
(one minute) 0.575 0.519 0.458 0.416 0.371
International long distance call
(one minute) 3,532 3,205 2,834 2,398 2,035
Residential installation 924 798 672 546 420
Commercial installation 1,848 1,428 1,092 756 420

Note: Exchange tariff in 1994 was 1.6 Peruvian soles per US dollar.
Source: OSIPTEL, CPT, and ENTEL concession contract.

The privatization process also established a tariff-rebalancing period in

which to gradually reduce existing tariff distortions. The goal was to
increase monthly service charges considerably, while reducing the cost of
local calls (table 6.1). For reasons discussed below, this period of limited
competition ended in August 1998, one year before the date established
under the contract.
In July 1993, the government created the Supervisory Agency for Private
Investment in Telecommunications or OSIPTEL to replace the Telecommu-
nications Regulatory Commission and regulate and oversee development
of the telecommunications market. The 1991 Telecommunication Law,
which established a competitive sector framework, gave OSIPTEL techni-
cal, economic, financial, functional, and administrative autonomy.

End of Limited Competition

The period of limited competition for TdP was to have ended in August
1999. However, as noted above, TdP and OSIPTEL mutually agreed to end
it one year earlier (August 1998). OSIPTEL decided that TdP had met most of
the goals set forth in the 1994 concession contract. The agreement between the
two entities called for a series of changes. Two of the most important were

 setting maximum tariffs for the service, applicable until 2001 (this
delayed what the contract established—i.e., that the new calculation of
prices, including the productivity factor, would enter into effect in
1999); and
 reducing the installation charges from $270 to $150.

With the end of the limited competition period, the government opened
the market to new operators willing to provide local, national, and inter-
national long distance telephony services. To do so, new operators had to

222 REALITY CHECK

 Table 6.2 Telephone density of selected
countries, 1993
Telephone Telephone GDP per capita
Country densitya penetrationb (US dollars)
Argentina 12.3 27.9 6,910
Bolivia 3.0 11.0 700
Brazil 7.5 21.0 2,550
Chile 11.0 39.1 3,035
Colombia 11.3 33.9 1,305
Ecuador 5.3 19.7 1,150
Mexico 8.8 25.3 3,880
Peru 2.9 10.1 1,450

a. Lines per 100 inhabitants.

b. Lines per 100 households.
Source: World Telecommunications Indicators, International Tele-
communications Union (ITU 1993).

pay TdP an interconnection fee, 1 i.e., a charge for using TdP-owned infra-
structure. As has been the case in other countries with liberalized telecom-
munications sectors, new entrants have not, to date, been able to reach
agreement on the fee TdP should charge new competitors.

Supply-Side Changes

The major supply-side changes that resulted from privatization can be

summarized in terms of five indicators: coverage, service quality, tariffs,
the company’s earnings structure, and its economic efficiency and results.

Coverage

In 1992 and 1993, Peru’s penetration was a mere 2.6 lines and 2.9 lines,
respectively. This was a low density compared with other countries in the
region (table 6.2).
Declining fiscal revenues, the debt crisis, and subsidized tariffs that did
not reflect the cost structure limited network expansion. These, in turn,
resulted in low levels of telephone density and growing unsatisfied demand.
In 1993, Peru’s customers had to wait an average of 118 months for line
installation, compared with 17 months for customers in Colombia and
11 months for those in Mexico.
In response, one of the first actions of the privatized TdP was to expand the
telecommunications network to satisfy unmet demand. Figure 6.1 clearly

1. The maximum fee for daytime interconnection was first set at $0.029 per minute, which
was much higher than fees charged in Chile ($0.017) or Mexico ($0.022).

PERU AFTER PRIVATIZATION 223

Figure 6.1 Evolution of the number of lines installed and in
service, 1993–98
number of lines (millions)
2.2
Installed
2.0
1.8
1.6
1.4 Lines in service
1.2
1.0
.8
.6
1993 1994 1995 1996 1997 1998

Source: OSIPTEL (1998b).

shows the process of network expansion between 1993 and 1998 and the over-
all increase of approximately 167 percent in the number of lines installed.
In terms of coverage, TdP amply met the goals set forth in the concession
contract (table 6.3). By 1998, TdP had already covered the entire market for
basic telephony, which may explain why it decided to advance the date for
ending the limited competition period. Decreasing growth in the number
of lines in service, which occurred around 1998, could have indicated over-
coverage in the sector (figure 6.1).

Service Quality

Before privatization, service quality was well below international stan-

dards. In 1992, only 35 to 40 percent of all phone calls were successfully
completed. Such low efficiency was caused, in part, by the network’s small
size and obsolete technology. In addition, inadequate maintenance of tele-
phone cables affected quality of communications (cables have a useful life
of 15 years; by 1993, some had been in use for more than 60 years). In 1993,
only 33 percent of the network had been digitized. By 1998, 90 percent had
been digitized, and 99 percent of international long distance and local calls
were successfully completed.

Tariffs

The low level of investment by CPT and ENTEL can be partially attrib-
uted to the companies’ low earnings as, over time, telephone-service
charges fell increasingly behind costs. This kept these state-owned compa-
nies from generating the funds needed to finance network expansion or

224 REALITY CHECK

quality improvements. In effect, sociopolitical, rather than technical, cri-
teria guided tariff administration. The government subsidized local tele-
phony services by charging well above the cost of tariffs for international
long distance and other services. As a result, approximately 5 percent of
ENTEL clients provided 29 percent of its earnings, and 6 percent of CPT
clients provided 28 percent of its earnings.
Though many other countries in the region had this type of cross sub-
sidy, Peru differed substantially in its telephone-service tariff. For exam-
ple, in 1993, the price of installing a telephone line in Peru was $1,500 (well
above the average for Latin American countries), while it had a low basic
monthly tariff of $2; for those who used more than the minimum service,
the excess tariff was extremely low. Conversely, the tariff for international
long distance service was extremely high.
The contract established the average maximum rebalancing tariffs,
which increased basic monthly tariffs and lowered costs of local, national,
and international long distance calls. Figure 6.2 shows the evolution of the
index of the basic tariff and cost of a local call. Table 6.4 shows the evolu-
tion in real terms of the tariffs for local, national, and international long
distance calls.
TdP markedly raised the price of monthly service, almost doubling it in
nominal terms, and raised the charge for a local call by changing the unit
of measurement, in 1998, from a three-minute to a one-minute pulse.

Earnings Structure

During the period of state ownership, the amount of international traffic each
company handled was markedly disproportionate to its assigned sector. CPT
generated 86 percent of outgoing and 90 percent of incoming international
traffic, while ENTEL generated the remaining 14 percent and 10 percent,
respectively. This situation, along with ENTEL’s exclusive concession to
outgoing, international long distance service and lack of an interconnection
policy, resulted in conflicts between the two companies over interconnection
charges. As a consequence, they stopped making transfers for interconnec-
tion services.
Following privatization, important changes have occurred in earnings
composition. Local telephony has become the most important service
category, while earnings for national and international long distance ser-
vices have fallen proportionately. These results were foreseen in the tariff-
rebalancing scheme. Furthermore, an observable increase in earnings has
occurred in mobile telephony, business communications, and publicity.

Efficiency and Economic Results

CPT and ENTEL had an excessive number of employees proportionate to

their scale of activities and low productivity. For example, at one time,

PERU AFTER PRIVATIZATION 225

Table 6.3 Compliance with the program to expand and modernize
the sector, 1994–98 (thousands)
Item 1994 1995 1996 1997 1998
Additional lines to be installed 104.00 140.00 216.00 259.30 259.30
Additional lines installed 116.68 439.24 445.71 203.92 n.a.
Lines to be replaced 20.00 30.00 50.00 50.00 50.00
Lines replaced 63.49 111.78 45.10 n.a. n.a.
Public telephones to be installed 2.10 3.50 4.40 4.50 4.50
Public telephones installed 5.17 15.54 14.64 3.64 n.a.
n.a. = not available
Source: Telefónica del Perú, annual reports (1994–98).

ENTEL’s Lima office had 3,700 employees, an extremely high figure,

considering that the company’s scope of operations did not include Lima.
Another indicator of the inefficiencies within both CPT and ENTEL was
their structure of operating costs. In 1992, CPT allocated 40 percent of its
costs to wages and salaries, in contrast to ENTEL, which allocated 20 per-
cent (Coopers & Lybrand, Morgan Grenfell, and ProInversión 1993). The
results were high operating costs per telephone line and low profits.
Table 6.5 presents the results achieved by TdP in terms of efficiency and
profits. The gains in efficiency are obvious (measured by the number of
lines per employee). Accordingly, profitability is also high.

Methodology for Measuring Consumer Welfare

To determine whether privatization was regressive and which types of

households (classified by their observable characteristics) bear a greater
portion of the burden or enjoy a greater portion of the benefits of the price
changes resulting from privatization, this study used an approach that dif-
fers from previous efforts (e.g., Galal et al. 1994; Martin and Parker 1997).
Unlike the cited studies, we did not build welfare measurements for
each interest group involved in the privatization to obtain indicators of
aggregate welfare.2 Although we used certain concepts developed by the
cited works, we devised a different model to put a value on consumer wel-
fare before and after privatization and to measure the net effects on con-
sumers: We estimated a partial demand equation for access to and use of
the various telecommunications services. This allowed us to evaluate the
effects of privatization of all services offered by TdP on consumer welfare.
We used a specific panel of households surveyed by GRADE, a Peruvian
research institute, in 1997, concerning household use and consumption of

2. Jones, Tandon, and Vogelsang (1990, 21–51) discuss in detail the construction of these
indicators.

226 REALITY CHECK

Figure 6.2 Evolution of the basic local-tariff index, 1991–97
fixed charge local rate
400 80

350 70
Local rate
300 60

250 50

200 40

150 30

100 Fixed charge 20

50 10

0 0
1991 1992 1993 1994 1995 1996 1997

Source: Central Bank of Peru Weekly Notes.

telecommunications services for which monthly consumption for each ser-

vice had been collected over the previous year.
Two prior GRADE studies conducted at OSIPTEL’s request (Escobal,
Fry, and Schroth 1996; Gallardo and Galdo 1998b) and a third study by
OSIPTEL (1995b) provided data that allowed us to estimate key parame-
ters.3 The GRADE studies estimate functions of residential demand for
access to and use of local and long distance services, using a household
survey. The OSIPTEL study reports average costs of each service pro-
vided by TdP (e.g., residential access, local calls, long distance calls,
mobile calls, and value-added services).

Market Models

The next step was to model the market for each product under the prepri-
vatization and postprivatization scenarios. The model envisioned the
demand for specific telecommunications services as a two-stage decision
rule. In deciding whether to request a telephone line, and given the price

3. Using studies from other countries is often arbitrary because the characteristics of these
experiences differ from the Peruvian context.

PERU AFTER PRIVATIZATION 227

Table 6.4 Evolution of telephone tariffs, 1993–98
(in 1995 Peruvian soles)
Nominal Real
Year IPC Rent Local DLD ILD Rent Local DLD ILD
1993 0.820 5.000 0.170 0.484 4.860 1.000 0.034 0.097 0.972
1994 0.946 11.990 0.180 0.628 3.860 1.000 0.015 0.052 0.322
1995 1.000 14.166 0.185 0.629 3.871 14.136 0.185 0.629 3.874
1996 1.166 25.150 0.207 0.618 3.824 1.000 0.008 0.025 0.152
1997 1.241 36.670 0.213 0.603 3.477 1.000 0.006 0.016 0.095
1998 1.316 43.220 0.234 0.444 3.360 1.000 0.005 0.010 2.547

DLD = domestic long distance

ILD = international long distance
IPC = indice de precios al consumidor
Note: 1995 average, otherwise end of the period.
Source: OSIPTEL (1998b).

for use of the telephone service, consumers compare their surplus to the
service charges they would have to pay. Using this framework, we esti-
mated functions of demand from private households and businesses for
access to and use of a range of services. Using these estimations, we com-
pared the situations before and after privatization.
The estimated demand functions identified all relevant factors for deter-
mining the position on the demand curve, given observed price, quantity,
and, in the case of access, statistics of waiting lists. Because the demand
functions were estimated from a panel of households that evidenced vari-
ations in prices, income, and demographic characteristics, we could directly
calibrate the position of each curve at different points of time without need-
ing additional assumptions for unobserved variables.
Furthermore, the calibration could be less arbitrary than those used in pre-
vious studies since it was unnecessary to assume linearity for the demand
curves. In fact, we chose the functional form of the demand curves in order
to obtain the best fit rather than achieve algebraic simplicity (Escobal, Fry,
and Schroth 1996).
In this study, we associated access to the main telephone services with
each of their corresponding services. We identified the following access
services that TdP has provided for residential lines:4

 local calls,
 domestic long distance calls, and
 international long distance calls.

4. This study covers only the cities of Arequipa, Chiclayo, Cuzco, and Trujillo and will be
complemented by a similar study financed by the Tinker Foundation for the city of Lima.

228 REALITY CHECK

Table 6.5 Performance indicators, 1994–98
Indicator 1994 1995 1996 1997 1998
Lines installed (per employee) 98.0 155.0 281.0 329.0 355.0
Lines in service (per employee) 87.0 132.0 228.0 282.0 275.0
Lines in service (per 100 inhabitants) 3.8 3.8 3.8 3.8 3.8
Waiting time (months) 33.0 5.0 2.0 2.0 1.5
Net profits (in millions of US dollars) 35.5 305.1 348.3 400.5 213.0
Net profits/earnings (percent) 5.0 29.4 28.8 24.9 16.9
Net profits/equity (percent) 2.9 21.1 28.8 24.9 15.7

Source: Telefónica del Perú, annual reports (1994–98).

Changes in Access and Use

The next step aimed to discover changes in welfare caused by privatization

only, not by other changes that may have occurred had the telecommunica-
tions sector remained under state ownership and control. For this purpose,
we assumed that the magnitude and levels of price increases would not
have occurred in the absence of privatization.
After calibrating the demand functions to approximate the result observed
using the information on lines of access, changes for basic service and instal-
lation, and number of potential subscribers on a waiting list, we then mea-
sured consumer welfare five years before and five years after privatization.
It became clear that the reduction in installation costs and the progressive
reduction in the waiting time for installation would significantly raise con-
sumer welfare above its preprivatization levels.
Figure 6.3 illustrates how simultaneously increasing the number of lines
installed and reducing access charges affect consumer welfare. In this partic-
ular case, the average charge for monthly service (the sum of the charge for
basic service and the one-time, installation payment divided into monthly
installments) falls from rp0 to rp1. The demand function, qda = qda (p, y, x), in
which p is a vector of all relevant prices (average charge for basic monthly ser-
vice, complementary and substitute goods), y is the income, and x is a vector
of other causal variables, can also be expressed inversely, rpda = rpda (q, y, x),
to reflect the maximum price that a home defined by the pair (y, x) is will-
ing to pay for access to a telephone line. Given these charges and a restric-
tion on supply, expressed as q0, a waiting list is given by the difference of
qda (rp0, y0, x0) − q0. Given that the number of lines installed increased to a
level of q1, the new waiting list time is then qda (rp1, y1, x1) − q1.
According to figure 6.3, the components to be estimated would be the
areas ACFrp1 and ABDrp0. The difference between them (the shaded area)
would yield the increase in consumer surplus resulting from more house-
holds having access to residential lines.5 Once the demand function was

5. The method of estimation would be the same for commercial users.

PERU AFTER PRIVATIZATION 229

Figure 6.3 Welfare effects of relaxed supply restrictions and
the change in regulated prices on telephone-line
access market
installation charge new installed lines

rp0
D
q0da
F
rp1

q0 q1
number of lines

Source:

known and its position calibrated, one could directly register this increase,
as follows:
q1

∫ p( q , x
q0
0 , y 0 ) + rp0  q0 − rp1  q1 (6.1)

As mentioned above, one also needed to estimate the welfare effects of

using a specific service (i.e., a telephone line) on consumer surplus. During
the first five years of the concession, cross subsidies were eliminated,
charges for access and international long distance service were reduced,
and tariffs for local services were increased. Consequently, a complete mea-
surement of the change in consumer surplus for basic telephony services
requires adding the welfare gains resulting from access to the potential
reductions derived from increased local-service tariffs.
Once the demand functions and the observed quantities and prices were
known, registering the consumer surplus would become a straightforward

230 REALITY CHECK

Figure 6.4 Welfare effects of changes in regulated prices
and increase in number of users on market
for telephone-line services
price per minute and fixed rent
A
B

C
rp1

q1da
rp0
D
q0da

q1 q0
total traffic

task, given that consumers no longer have to be on a waiting list for service.
The demand functions estimated for the use of local and long distance
services (i.e., demand for calls) include the effects of a new equilibrium
on the access market, which is reflected by a displacement of the demand
function from q d0 to q d1. The specifications include the number of lines in
service, as an explanatory variable, as a way to incorporate network exter-
nality effects (Taylor and Kridel 1990).
Figure 6.4 provides an example of the effects of simultaneous increases in
access lines and charges per minute for any type of call available to resi-
dential lines (local, national, and international long distance calls). The
increase in number of access lines is caused by the reduction in cost of access
(from rp0 to rp1) and is represented by the displacement of the demand curve
to q1da . Furthermore, the increase in the charge per minute for calls is repre-
sented by the change in price (from p0 to p1).6
Thus, to register the change in consumer welfare, we simply evaluated
the following:
q1 q0

∫ p(q, x1 , y1 )dq − ∫ p( q , x 0 , y 0 )dq + p0  q0 − p1  q1 (6.2)

0 0

6. Based on the tariff-rebalancing program shown in table 6.1.

PERU AFTER PRIVATIZATION 231

This equation is equivalent to the difference between the areas ACp1
and BDp0.
Clearly, there was no reason to infer an increase or reduction in consumer
surplus as a result of the simultaneous changes. Furthermore, in some mar-
kets, regulated charges per call had increased (local exchange), while charges
for other services had decreased (international long distance). Consequently,
to evaluate the consumer-welfare implications of privatizing CPT and
ENTEL precisely, we had to compare the gains arising from relaxing sup-
ply restrictions on the access market with changes in welfare arising from
all associated consumer services.
We next estimated and then evaluated the income-distribution effects
of price increases, and determined which types of households shouldered
a greater portion of the burden or enjoyed more benefits of these price
changes. This allowed us to estimate the effects of privatization and delin-
eate whether these changes in price scenarios were a net gain or loss to the
welfare of Peruvian households.

Estimating Demand
We started from the premise that household preferences are represented
by a utility function:

u = u( xlocal , xldn , xldi , z) (6.3)

in which xI is the total amount that a residential customer consumes

of each service available (local, national, and international long distance
calls), and z is an index of the consumption of other goods. Solving the
optimization problem, we derived the indirect utility function, V (p,y), in
which y is the income of each household and p is a vector with the prices of
the three basic services and a general index of prices for the remaining goods.
A household chooses the services it will use on the basis of access to lines.
In making its decision, it compares the value of using the services V (p,y),
given the prices, with the cost of access attributable to that period. In this
case, having access to a line allowed a customer to make any of the three
types of calls mentioned. In households for which we were able to obtain
a telephone bill, we observed that some made only local calls while others
made local and long distance calls. This characteristic allowed us to order
the households based on their consumption decisions. However, data
restrictions prevented our demand estimations from capturing changes in
quality of telephone services.
Econometrically, we modeled the demand for a specific telecommunica-
tions service as a two-stage decision rule. First, we modeled the decision to
access the network using a probit model. From this equation, we obtained
the Mills inverse ratio to correct for the access problem. This ratio was
included in demand estimations to obtain price elasticities and consumer

232 REALITY CHECK

surpluses for the three services under study, correcting for the bias for lack
of access.

Measuring Consumer Surplus

Using the estimations of demand at the residential level, we obtained a
functional form for the demand for use of local, national, and long distance
services. This demand curve represents households that, at that point in
time, had access to a telephone line.
According to the Living Standards Measurement Survey (LSMS), the
functional form that yielded the best fit—for all of Lima’s SELs, those sur-
veyed in four other major Peruvian cities, and later for the whole of urban
Peru—was

qitn = exp( xitβ n + pit α n + ε it ) (6.4)

The superscript n indicates the SEL, i equals the household, and t equals
time. The relevant prices are pit; thus, the elasticities are recovered from the
estimators of the parameters, α, for each SEL. Lastly, qit is the traffic mea-
sured for each of the three services considered in this study.
The basic idea is to measure consumer surplus as the difference between
the surplus for making a certain number of calls at a specific point in time and
the fixed amount paid for access to the line.7 Thus, for a given SEL, we define
Pmax

Sitj ( pit , .) = ∫ qitj ( p , .)dp , ∀j ∈ {Local , DLD, ILD} (6.5)

Pt

as the consumer surplus for using the line for any of the three services and
rit as the annual installment made on the flat installation charge. Then

S˜ it ( pit , rit ) = ∑ S (p ) − r
j
j
it t it (6.6)

measures the total net surplus of all services.

Replacing the functional form given in equation 6.6, and solving the
equation, one obtains the surplus as

1
S˜ it ( pit , rit ) = − j exp( xitβ n + pit α n + ε it ) pp max − rit
α
it

1
S˜ it ( pit , rit ) = − j exp( xitβ n + p ′α n + ε it ) − rit (6.7 )
α
in which α j is the elasticity of the price itself.

7. The value of the flat installation charge converted into a perpetuity (e.g., annualized) value.

PERU AFTER PRIVATIZATION 233

Household Survey
For Peru’s urban population, we used a household panel surveyed especially
for this study. We applied the survey to 7.6 million residents, who accounted
for more than 50 percent of the country’s urban population and more than
80 percent of its fixed telephone installations. The total sample size of 1,708
urban households, selected during the 1996–97 period, was constructed to
be representative of residential demand for telephony services in metropol-
itan Lima and Peru’s principal provincial cities. In metropolitan Lima, the
907 households selected were grouped into high, middle, low, and very
low SELs. In the four other cities—Cuzco, Arequipa, Chiclayo, and Trujillo—
801 households were chosen and grouped into the four SEL categories
(Pasco-Font, Gallardo, and Fry 1999).
The survey questionnaire consisted of five sections:

 present use and quality of telecommunications services,

 household’s potential use of services,
 household characteristics,
 household-member characteristics, and
 information from the household telephone bill.

The study also required information, by SEL, on the number of families

and the telephone penetration tariff. For metropolitan Lima, the data
source was the SEL report prepared by Apoyo S. A. The penetration tariffs
reported in the tables were weighted by size of households in each SEL. No
similar information was available for the provincial cities for the period
studied.8 Consequently, we estimated the number of households and used
the penetration tariff of the middle SEL of metropolitan Lima. As input for
estimating the number of households, we used the final results of the 1993
National Census.

Results Using Household Surveys

for Lima and Four Major Cities

Based on estimates of demand for basic telephony services, we computed

household welfare changes for the four SEL categories (A, B, C, and D).9
We also used Torero’s results for households in SELs A and B in Cuzco,
Arequipa, Chiclayo, and Trujillo (Torero and Pasco-Font 2000).

8. Information was available only for 1996 for the cities of Arequipa, Chiclayo, and Trujillo.
9. SELs were grouped according to income and other characteristics, with category A com-
prising the wealthiest households and category D the poorest.

234 REALITY CHECK

 Tables 6.6 and 6.7 provide details of the results obtained and the demand
estimates for the cities studied. Each table presents three models. The first
corrects for the selection bias resulting from (1) whether consumers had a
telephone, and (2) households for which telephone bill information could
not be obtained. The second model corrects only for the first selection bias.
The third model includes a dummy variable identifying whether the house-
hold has a cellular phone.10 Although all three models are correct, the third
is more econometrically sound because it incorporates both types of selec-
tion (i.e., by access and charges billed).
Results for the cities studied exhibited the expected signs and coefficients.
Thus, the tariff for the respective service is significant and has the expected
negative sign. Furthermore, the price of international long distance service is
significant (and has a positive sign) in explaining the use of local service and
national long distance service, indicating a degree of substitution between
the two products. Lastly, household demographic characteristics (educa-
tion and income) are significant and have the expected signs. We also
included fixed-district effects for the Lima estimates and those of the cities
included on the panel for the rest of Peru. In both cases, the F statistical test
demonstrated that the fixed effects were significant overall.
Based on these estimates and deriving equation 6.4 with regard to price,
we recovered the price elasticities of use demand for each of the three ser-
vices studied. As table 6.8 shows, demand for local and domestic long dis-
tance services was inelastic in the cities studied. This result is consistent
with many other studies,11 including those of Pasco-Font, Gallardo, and Fry
(1999);12 Doherty (1984); Zona and Jacob (1990); Gatto et. al. (1988); Duncan
and Perry (1994); and Levy (1996).
Using the demand elasticities obtained from these estimates, the next
step was to measure the welfare effects for local, national, and international
long distance calls. We also included the effect of increases in the flat,
monthly service charge on each household’s surplus, in terms of having the
fixed residential service, following the methodology set forth in the pre-
ceding section.

10. Accounting for access to cellular phones is crucial, especially since 1997, when intensity
of use increased substantially. From 1993 to 1998, the density of cellular phones jumped from
0.2 to 3; however, as this study’s results show, cellular phones complement, rather than sub-
stitute for, possession of a fixed-line phone, thereby increasing expenditures resulting from
calls from fixed-line phones to cellular ones.
11. Elasticities in these studies ranged from −0.21 to −0.475. See Pasco-Font, Gallardo, and Fry
(1999) for further details.
12. Although this study used the same data that Pasco-Font, Gallardo, and Fry (1999) used,
it estimated demand using a different method that incorporated people who did not provide
information from their telephone bills into the correction for selection bias. In addition, this
study included the difference in price, based on the time calls were made, into the calculation
of implicit prices.

PERU AFTER PRIVATIZATION 235

236
Table 6.6 Estimate of local telephone demand in metropolitan Lima
Local calls National long distance calls International long distance calls
Variable Model 1 Model 2 Model 3 Model 1 Model 2 Model 3 Model 1 Model 2 Model 3
Local rate −2.50** −2.44** −2.70** −3.62 −3.45 −3.61 3.28 3.27 3.63*
(1.08) (1.065) (1.145) (2.388) (2.366) (2.386) (2.069) (2.067) (2.017)
International long distance rate 0.47*** 0.47*** 0.57** 0.23** 0.22** 0.23** −0.30** −0.30** −0.30**
(.145) (.145) (.229) (.101) (.1) (.101) (.133) (.133) (.129)
Domestic long distance rate −0.03 −0.03 −0.07 −0.76** −0.77** −0.76** 0.47** 0.47** 0.17
(.026) (.026) (.069) (.375) (.375) (.375) (.257) (.258) (.312)
Rate of penetration in Lima 1.55*** 1.50** 1.68***
(network externality) (.481) (.479) (.478)
Relatives in provinces 0.80*** 0.80*** 0.80***
(.101) (.101) (.101)
Relatives abroad 0.42*** 0.42*** 0.44***
(.08) (.079) (.08)
Household with cellular phone 0.25* −0.06 0.82***
(.13) (.203) (.212)
 Constant 4.33*** 4.27*** 4.41*** 0.33 0.46 0.33 −0.31 −0.21 −0.25
(.378) (.37) (.447) (.729) (.715) (.73) (.697) (.691) (.687)
Mills inverse ratio (reported bill) −0.35*** −0.36*** −0.16 0.16 0.16* 0.15*
(.075) (.075) (.115) (.115) (.091) (.091)
Mills inverse ratio (has telephone) −0.48*** −0.34** 0.16
(.102) (.156) (.126)

Observations 2021 2021 2021 1993 1993 1993 1940 1940 1940
F-test 39.18 39.27 37.71 14.94 14.89 14.47 8.63 8.61 8.72
Prob > F-test 0.0000 0.0000 0.0000 0.000 0.000 0.000 0.000 0.000 0.000
R-squared 0.4472 0.4471 0.4489 0.1802 0.1813 0.1802 0.107 0.106 0.129

* = significant at 90 percent
** = significant at 95 percent
*** = significant at 99 percent
Note: First three regressions correspond to the demand for local calls (minutes), the second three for the demand of national long distance calls, and the
last three for the demand of international long distance calls. Within each dependent variable, three models are presented. The first model corrects not only
for the selection bias resulting from whether consumers have a telephone but also for the selection bias caused by households for which telephone bill infor-
mation could not be obtained. The second model, on the other hand, corrects only for the selection bias for consumers having a telephone. Finally, the third
model includes a dummy variable identifying whether the household possesses cellular phones. Standard errors are in parentheses. Robust standard errors
account for sample clustering and stratification. Demographic controls include: household income, household income squared, percentage of young peo-
ple in the household (13–24 years old), percentage of young females in the household (13–24 years old), household size, and education-degree level of
household head. Additionally all regressions include district fixed effects, and the F-test was significant, with p < 0.001.

237
 Table 6.7 Estimate of local telephone use demand outside metropolitan Lima

238
Local calls National long distance calls International long distance calls
Variable Model 1 Model 2 Model 3 Model 1 Model 2 Model 3 Model 1 Model 2 Model 3
Local rate −2.52** −2.50** −2.74** −4.12*** −4.12*** −4.44*** −0.02 −0.02 −0.07
(1.09) (1.086) (1.026) (1.613) (1.612) (1.469) (.393) (.395) (.406)
International long distance rate 0.13 0.14 0.09 −0.13 −0.12 −0.17 −0.43** −0.43** −0.43**
(.174) (.175) (.174) (.155) (.155) (.162) (.197) (.195) (.194)
Domestic long distance rate −0.17** −0.16** −0.20** −0.89*** −0.88*** −0.93*** 0.04 0.04 0.03
(.085) (.083) (.08) (.267) (.267) (.266) (.147) (.145) (.148)
Relatives in provinces 0.65*** 0.65*** 0.61**
(.248) (.248) (.246)
Relatives abroad 0.23*** 0.22*** 0.22***
(.032) (.032) (.033)
Household with cellular phone 0.49*** 0.67*** 0.13
(.105) (.191) (.138)
Constant 5.03*** 4.99*** 5.33*** 2.72*** 2.51** 3.05*** 1.49** 1.68** 1.55**
(.605) (.513) (.594) (.98) (.885) (.987) (.762) (.738) (.753)
Mills inverse ratio (reported bill) −0.22* −0.23* −0.11 −0.11 −0.06 −0.06
(.126) (.125) (.197) (.197) (.101) (.102)
Mills inverse ratio (has telephone) −0.48*** −0.06 −0.30
(.153) (.264) (.119)

Obs. 1367 1367 1367 1348 1348 1348 1356 1356 1356
F-test 18.84 19.99 20.70 9.04 8.89 9.31 5.56 5.7 5.25
Prob > F-test 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000
R-squared 0.143 0.147 0.154 0.094 0.094 0.103 0.094 0.098 0.096

* = significant at 90 percent
** = significant at 95 percent
*** = significant at 99 percent
Note: See table 6.6.
 Table 6.8 Price elasticities of use demand
City Service Elasticity
Lima a Local –0.494
Domestic long distance –0.478
International long distance –1.095
Province citiesb Local –0.689
Domestic long distance –0.548
International long distance –1.585

a. Metropolitan Lima (SELs A, B, C, and D).

b. Arequipa, Chiclayo, Cuzco, and Trujillo (SELs A and B).

Given the functional form of our directly estimated demand functions,

when the percentage of change in the tariffs is the same, the percentage
of change in a household’s welfare is also the same—i.e., the latter does
not depend on total consumption, but on the parameters of the demand
function. However, the measure of change in consumer surplus varies
by household because the flat, monthly service charge represents a dif-
ferent proportion of each household’s spending on telephony services.
Obviously, this variance is less within the respective SELs because each
level comprises households with similar spending patterns for basic tele-
phony services.13

13. Appendix table 6A.1 presents detailed results obtained for the four SELs of metropolitan
Lima. It first shows the percentage change in the average welfare of the households sur-
veyed—i.e., the changes projected for the years outside of the survey period are representa-
tive of the average household in SELs A, B, C, and D that had a telephone at the time the
survey was conducted. This part does not incorporate the welfare gains for households that
obtained a connection to the fixed network after privatization. By 1995, all households in SEL
A had a telephone; thus, the dynamics of joining the network did not affect this calculation.
However, for SELs B, C, and D, one would expect the average change in consumer surplus to
be underestimated if the dynamics of new entrants joining the fixed network were not con-
sidered. Thus, the second half of the table attempts to incorporate the gains in household wel-
fare that resulted from obtaining a connection to the fixed network after privatization. We
quantified the number of new households that obtained a telephone line in the following
period (t + 1). Also, because households that had just obtained a line were not expected to
place as much value on the service (because they had not spent a long time on the waiting
list), we assigned them the minimum welfare for households in their SEL and pertinent year.
Lastly, we again weighted the surplus per home and obtained the change in surplus
weighted by access (last column). It should be noted that they performed various simula-
tions assigning different surplus values to the last households that acquired telephone lines,
and the percentages of change were not substantially affected. Finally, the table reports the
average change in consumer surplus, weighting the change of each component by its relative
importance in the total surplus.
Results for other cities are presented in appendix table 6A.2. Although the results are simi-
lar to those for metropolitan Lima, the degree of change is smaller because of lower consump-
tion by SELs A and B and a lower penetration ratio. Thus, Chiclayo has practically no drop in
percentage of change, while Cuzco experienced the largest drop.

PERU AFTER PRIVATIZATION 239

 Tables 6.9 and 6.10 summarize this study’s main results (appendix
tables 6A.1 and 6A.2). Since privatization in 1994, consumer surplus has
seen an absolute gain, both by service and SEL, with only a small reduction
in growth rate since 1997. However, this analysis of per-household con-
sumer surplus shows that results have not been uniform across SELs.
As tables 6.11 and 6.12 illustrate, while high and medium SELs (A and B,
respectively) have experienced a clear gain in welfare, that of SELs C and D
has decreased since 1996. For the lowest-income consumers (SEL D), wel-
fare is lower than preprivatization levels, and low-income consumers (SEL
C) have received increasing gains per household only since 1996. Moreover,
the per-household consumer surplus has a relatively regressive distribution.
The main explanation for the decline in consumer surplus is the perma-
nent increase in the fixed monthly payment (figure 6.2). This price increase
had a greater effect on lower SELs because these households use the service
less (i.e., they make fewer calls). As a result, a greater proportion of their
spending goes to pay the flat monthly charge. There is also a cross-price
impact with local calls since the proportionately larger reduction of long
distance tariffs has led to a substitution of local calls for long distance ones.
To make matters worse, in 1997, OSIPTEL reduced the unit of measure-
ment for local calls from a three-minute to a one-minute pulse (at a higher
equivalent tariff) and expanded the definition of the geographic area.
These measures, which translated into an increase in the price of a local
call, help to explain the reduction of growth in total consumer surplus since
1997. When Peru’s prices for local calls and fixed monthly fees are com-
pared with those of Argentina and Chile—two countries that have also
undergone privatization—it is clear that Peru still has room for tariff reduc-
tion (figure 6.5).
Thus, although gains have accrued from privatization in terms of increased
efficiency, productivity, access, and consumer welfare, further tariff rebal-
ancing is needed to avoid disruption of the benefits of privatization. The
steep rise in the fixed monthly tariff, together with higher charges for local
calls, has had a direct, negative effect on consumers.

Summing Up

In the early 1990s, Peru’s telecommunications service was characterized by

long waiting times, outdated technology, poor service, artificially low prices
that failed to cover costs and provide for capital investment, and the cap-
ture of firms by workers and unions. As the country became mired in reces-
sion, inflation, budget deficits, and balance of payments crises, the situation
worsened. However, by the end of the decade, the situation was much
improved, mainly as a result of privatizing Peru’s two national telecom-
munications companies, CPT and ENTEL, by Telefónica de España.

240 REALITY CHECK

 Table 6.9 Estimated total welfare gains in metropolitan Lima, 1993–98
Service 1993 1994 1995 1996 1997 1998
With direct and cross effect in prices
Local 11,771,097 20,085,738 25,000,310 29,356,177 35,349,003 28,826,896
Domestic long distance 1,409,310 1,991,975 2,852,576 4,496,533 5,862,459 7,534,980
International long distance 817,119 1,755,544 2,432,837 3,750,699 5,148,160 6,061,222
Total 13,997,525 23,833,262 30,285,719 37,603,409 46,359,621 42,423,095
Total-fixed charge 11,322,804 17,449,544 21,763,703 23,703,544 27,104,010 18,700,779
Without cross effect in prices
Local 13,002,981 19,516,369 25,000,310 31,807,954 39,417,483 40,193,995
Domestic long distance 1,997,683 2,183,086 2,852,576 4,074,443 5,008,968 7,106,803
International long distance 1,503,654 1,966,274 2,432,837 3,188,643 3,976,477 4,882,022
Total 16,504,318 23,665,729 30,285,723 39,071,040 48,402,929 52,182,820
Total-fixed charge 13,829,596 17,282,011 21,763,707 25,171,175 29,147,318 28,460,504

241
242
Table 6.10 Estimated total welfare gains in rest of Peru, 1993–98
Service 1993 1994 1995 1996 1997 1998
With direct and cross effect in prices
Local 573,530 1,334,367 1,792,757 2,207,613 2,594,140 2,576,037
Domestic long distance 194,091 444,578 782,187 1,143,480 1,430,908 2,031,302
International long distance 75,795 121,203 142,409 170,852 195,439 219,337
Total 843,415 1,900,147 2,717,353 3,521,946 4,220,487 4,826,676
Total-fixed charge 638,937 1,178,908 1,522,214 1,664,320 1,884,881 1,793,080
Without cross effect in prices
Local 749,316 1,401,535 1,845,421 2,234,657 2,594,140 2,575,566
Domestic long distance 674,745 753,934 952,687 1,235,154 1,430,908 2,093,021
International long distance 76,722 121,108 142,178 170,907 195,439 221,892
Total 1,500,783 2,276,577 2,940,286 3,640,719 4,220,487 4,890,479
Total-fixed charge 1,296,305 1,555,337 1,745,147 1,783,093 1,884,881 1,856,884
Table 6.11 Estimated average per-household welfare gains
in metropolitan Lima, 1993–98
Service 1993 1994 1995 1996 1997 1998
With direct and cross effect in prices
Local 40.5 57.1 59.9 54.2 55.3 37.9
Domestic long distance 4.6 5.3 6.3 8.1 8.7 9.7
International long distance 2.7 4.9 5.6 6.7 7.6 7.9
Total 47.8 67.3 71.8 69.0 71.7 55.4
Total-fixed charge 39.1 50.2 52.9 44.4 43.6 24.8
Without cross effect in prices
Local 44.7 55.5 59.9 58.7 61.7 52.8
Domestic long distance 6.5 5.8 6.3 7.3 7.5 9.1
International long distance 5.1 5.4 5.6 5.7 5.9 6.4
Total 56.3 66.8 71.8 71.7 75.0 68.3
Total-fixed charge 47.6 49.6 52.9 47.2 47.0 37.7

Table 6.12 Estimated average per-household welfare gains

in rest of Peru, 1993–98
Service 1993 1994 1995 1996 1997 1998
With direct and cross effect in prices
Local 12.4 25.8 30.5 34.5 37.7 36.9
Domestic long distance 4.2 8.6 13.3 17.6 20.9 29.2
International long distance 1.6 2.3 2.4 2.6 2.9 3.1
Total 18.2 36.7 46.2 54.7 61.4 69.2
Total-fixed charge 13.8 22.8 25.9 26.0 27.4 25.7
Without cross effect in prices
Local 16.2 27.1 31.4 34.9 37.7 36.9
Domestic long distance 14.6 14.6 16.2 19.0 20.9 30.1
International long distance 1.7 2.3 2.4 2.6 2.9 3.2
Total 32.5 44.0 50.0 56.6 61.4 70.1
Total-fixed charge 28.0 30.1 29.7 27.8 27.4 26.6

From 1993 to 1998, the Peruvian telecommunication sectors dramatically

expanded their network by approximately 167 percent. Moreover, in the
early 1990s, telephone density per 100 residents rose from 2.9 to 7.8 lines.
Improvement in coverage, quality, and technology was dramatic. By 1998,
TdP amply met the expansion and quality goals set forth in the concession
contract and covered virtually the entire market for basic telephony.
Apparently, this explains why Telefónica and OSIPTEL decided to shorten
by one year the limited competition period established under the contract.
With the end of limited competition, the government opened the mar-
ket to new operators willing to provide local, national, and international
long distance telephony services. It also established that new operators
could provide these services using TdP infrastructure by paying an inter-
connection fee.

PERU AFTER PRIVATIZATION 243

 The privatization process established a tariff-rebalancing period in
which to gradually reduce existing tariff distortions. Tariff rebalancing
increased monthly service charges considerably, while reducing the cost of
local, national, and international long distance calls. This rebalancing sched-
ule affected consumers directly through shifts in prices and access to tele-
phone services.
Compared with other utility sectors, such as water and electricity (Torero
and Pasco-Font 2000), Peru’s telephony sector has improved dramatically
since privatization. While the coverage and quality improvements regis-
tered since privatization have been welcome and positive, there is still room
for substantial improvement in terms of the distributional impact of privati-
zation. This is largely because more competition is required to reduce tariffs
to international standards.
During 1997–98, following three years of postprivatization growth, a sig-
nificant reduction in household consumer surplus occurred. For Lima, the
growth rate of total consumer surplus, compared to the previous period,
was −2.4 percent and −3.1 percent when the cross-price effects of this study’s
equation are included.14 Outside Lima, the decrease was less important
because of the significant increase in access. The negative growth in con-
sumer surplus was even larger, both within and outside Lima, when viewed
in terms of average, per capita consumer surplus.15 Explanations for this
reduction in consumer surplus include an increase in the price of local calls,
a permanent increase in the price of fixed rent, and the cross-price effect of
local calls because of the proportionately greater reduction in prices of
long distance calls.16

Conclusions and Recommendations

Although privatization is associated with increased efficiency, productivity,
access, and total consumer welfare, a further rebalancing of tariffs is needed
to maintain and consolidate its benefits. The steep rise in the fixed monthly
tariff, together with the increase in charges for local calls—by reducing the
unit of measurement from a three-minute to a one-minute pulse at a higher
equivalent tariff—has had a direct, negative effect on consumers.
The principal remaining problem is that sector competition is insuffi-
cient. Newbery (2000) once mentioned that it should be easy to introduce
competition into long distance telephony via entry of new fiber-optic

14. In both cases, we took the fixed tariff into account.

15. For Lima, the decline in consumer surplus was −19.83 when only the direct price effect is
included, and −43 percent when the cross-price effect is also included. Outside Lima, the
decrease was −2.9 percent and −6.2 percent, respectively.
16. This result implies that local calls are relatively inferior to long distance ones.

244 REALITY CHECK

Figure 6.5 Comparing fixed tariff and local call prices
with Chile and Argentina
Fixed rate
US dollars
20

15

10

0
January 1997 January 1998 February 1999

Local tariff per minute

(weighted average by number of hours available
for regular and reduced rate)
US dollars
.030

.025

.020

.015

.010

.005

.000
February 1997 January 1998 February 1999
Argentina Peru Chile
Source: Regulatory agencies of each country.

backbones.17 However, Peru’s market for long distance is not yet com-
petitive, and prices remain higher than in many other South American
countries. To date, contrary to expectations, no substantial increase in
consumer gains has accrued from the privatization of long distance
national and international calls.18

17. These will likely be needed for Internet and data traffic.
18. In Chile, the average tariff of its major international long distance providers (BellSouth
and Manquehue) is significantly lower than that of Peru; for example, a one-minute call from
Lima to the United States is 71 percent more expensive in terms of the regular tariff and 55 per-
cent more expensive in terms of the reduced tariff than is a one-minute call from Santiago to
the United States, even though BellSouth also operates in Peru.

PERU AFTER PRIVATIZATION 245

Figure 6.6 The three stages of Peru’s telecommunications reform

Stage 1 Stage 2 Stage 3

State-owned Regulated private Regulated, privately

monopoly monopoly owned, competitive
market

Prior to Immediately after Five to ten years

privatization privatization after privatization

Source: Ramamurti (1996).

We expect that the entry of new firms—hindered to date by disputes

concerning interconnection fees—will generate more competition for the
dominant provider and exert downward pressure on prices in the future.
This will require strengthening OSIPTEL, the telecommunications regula-
tory agency, allowing it to create and enforce the conditions needed to
encourage new entry.
All observers agree that the greatest difficulty in liberalizing telecommu-
nications is creating a competitive choice at the local level (Newbery 2000).
Partly because of the technology involved, competitive markets are more
easily introduced for long distance than for local services. Local companies
can offer a bundle of local and long distance services, whereas long distance
firms find it difficult to offer the full range of local services unless they can
secure access to all local facilities. In the case of the Peruvian telecommuni-
cations market, lack of adequate interconnection policy and fees prevent
other companies from using the incumbent infrastructure to compete in the
local market. For more complete and larger welfare and distributional ben-
efits to accrue, the obstacles to competition and new entry must be resolved.
Peru’s privatization of telecommunications has involved a three-step
process, as shown in figure 6.6. The government did not transform the
telecommunications sector from a state monopoly (stage 1) into a compet-
itive, privately owned sector (stage 3) in one swift step. Instead, it opted for
a more gradual achievement of its aims, via an intermediate stage of regu-
lated, private monopoly (stage 2). This decision was understandable and
had much to do with the critical lack of infrastructure inherited from the
state monopoly. The major risk with this intermediate step, however, was
that the incumbent firm might become entrenched during stage 2, making
it difficult even for industry giants, such as AT&T Latin America (FirstCom)
or BellSouth to dislodge it in stage 3. New entrants might be expected to
contest the incumbent firm’s grip. To do so, however, the regulatory agency
OSIPTEL must ensure in stage 3 that new entrants can readily interconnect
with the monopolist’s network on reasonable terms and compete with it
fairly. Regulation is key.

246 REALITY CHECK

 Initially, OSIPTEL recommended an interconnection tariff of 2.9 cents,
which gave TdP, the incumbent firm, excessive protection.19 Then, in late
August 2000, OSIPTEL reduced the interconnection fee, proposing that the
average charge should fall to 1.68 cents by June 2001. OSIPTEL claimed that
this fee was close to the average mid-2000 interconnection fee of 1.67 cents
charged by a sample of 25 countries.20 However, when one compares this
fee with that of the three South American countries with the lowest inter-
connection costs—Brazil, Chile, and Colombia—one finds that their aver-
age interconnection cost by mid-2000 was 1.24 cents, significantly lower
than the converging tariff proposed by OSIPTEL. We conclude that
Peru’s interconnection fee is still too high.
Increasing competition is a medium-term measure. To increase consumer
surplus and more equitable distribution in the short run, we recommend
two other measures. The validity of both requires that our estimated-
demand calculations accurately describe the observed household-level
consumption patterns.
First, we recommend reducing the unit of measurement for local calls
from minutes to seconds (already done in many countries), which would
indirectly reduce the local charge and therefore benefit consumers. Because
most of the network is digitized, the costs of this switch would be negligible—
although not necessarily neutral for the private provider.
Second, we recommend even more strongly the use of optional calling
plans, in which volume discounts are given to large users (second-degree
price discrimination). Conceptually, and as mentioned in Pasco-Font,
Gallardo, and Fry (1999), introduction of differentiated prices can simulta-
neously generate a greater benefit for the company and larger consumer
surplus for families. This is possible when consumer heterogeneity exists,
allowing an increase in aggregate welfare of consumers on the regulatory
side and the potential to discriminate prices from the company perspective.
For example, decreases in long distance prices have little benefit to low-
income households, who purchase little or none of this good, either at the
original, higher price or the new, lower one.21 Therefore, balancing local-
service price reductions with increases in long distance access charges
would likely result in net welfare gains for many households.

19. The European Economic Commission’s recommended range of interconnection cost was
1.10 to 2.11 cents, which it derived by taking the average of the three lowest charges of mem-
ber countries. OSIPTEL adjusted these numbers to the Peruvian reality, taking into account
the higher cost of capital and tax difference (see OSIPTEL 1999).
20. The 25 countries were Argentina, Austria, Belgium, Bolivia, Brazil, Canada, Chile, Colombia,
Denmark, Finland, France, Germany, Greece, Holland, Ireland, Italy, Mexico, Norway, Portugal,
Spain, Sweden, Switzerland, the United Kingdom, the United States, and Venezuela.
21. As more low-income people migrate to other areas and countries in search of work, they
and their families will likely use more long distance services.

PERU AFTER PRIVATIZATION 247

 Moreover, it is reasonable to think that households from the lowest SEL
use their phones primarily for receiving calls; therefore, their major burden
is the fixed monthly rent. A calling plan with a low, fixed monthly tariff and
a higher charge for local calls could also improve the welfare of low-income
households. The opposite is true for wealthier households, whose major wel-
fare gain is through intensive use of the phone. Their welfare would increase
if local and long distance tariffs were reduced and the fixed monthly tariff
increased. In either case, the central objective of not breaking the equilibrium
in tariffs must be maintained to avoid entry of inefficient competitors.
From this discussion, it appears that Peru could have done better by mov-
ing directly from stage 1 to stage 3, without spending several years in stage 2.
Admittedly, doing so might have robbed the government of the chance to
solve fiscal problems through privatization or signal their commitment
to market-oriented policies. Moreover, in the absence of those incentives,
the sector might not have been reformed at all. The adage, better late than
never, may well apply here. Nonetheless, while the overall results of tele-
communications privatization have been good, we believe they could have
been—and still could be—better.

References

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PERU AFTER PRIVATIZATION 249

 Appendix 6A Tables

250
Table 6A.1 Estimation of change in total welfare, discounting the fixed charge, for metropolitan Lima, 1993–98
OLS estimations using Mills inverse ratio (reported bills)—discounted fixed charge
New Welfare per Welfare
households household changes
Socio- Households with (weighted for (weighted for
economic Average Welfare Minimum Total with Penetration telephone access) access)
level Year welfare changes welfare households telephone ratio in t+1 ( W: 0 ->Min ) ( W: 0 ->Min)
High (A) 1993 86.10 44.54 55,400 50,968 0.92 732 86.10
1994 124.46 0.446 60.87 51,700 51,700 1.00 0 122.70 0.425
1995 131.01 0.053 64.12 56,800 56,800 1.00 0 131.01 0.068
1996 133.20 0.017 63.45 56,400 56,400 1.00 0 133.20 0.017
1997 138.87 0.043 65.02 62,100 62,100 1.00 0 138.87 0.043
1998 99.86 −0.281 44.03 62,100 62,100 1.00 0 99.86 −0.281

Medium (B) 1993 38.68 10.46 240,900 153,754 0.64 21,878 38.68
1994 52.90 0.368 9.80 252,000 175,632 0.70 31,868 48.09 0.243
1995 55.87 0.056 10.23 273,700 207,500 0.76 9,922 47.78 −0.006
1996 55.01 −0.015 6.84 259,200 217,422 0.84 25,134 53.29 0.115
1997 56.23 0.022 4.92 278,800 234,192 0.84 5,954 50.32 −0.056
1998 37.03 −0.342 2.54 278,800 248,510 0.89 13,562 36.28 −0.279

Low (C) 1993 18.44 2.50 494,700 50,693 0.10 24,632 18.44
1994 22.22 0.205 3.45 471,700 75,325 0.16 37,049 16.65 −0.097
1995 23.88 0.075 2.75 528,300 112,374 0.21 67,938 17.67 0.061
1996 22.28 −0.067 1.87 491,500 180,312 0.37 26,708 14.16 −0.198
1997 21.92 −0.016 2.12 470,500 207,020 0.44 48,915 19.59 0.383
1998 12.05 −0.450 2.05 470,500 255,935 0.54 35,775 10.04 −0.488

Very low (D) 1993 9.53 2.45 562,900 5,629 0.01 316 9.53
1994 8.45 −0.113 1.25 594,500 5,945 0.01 −765 7.84 −0.177
1995 8.90 0.052 0.57 518,000 5,180 0.01 32,326 13.77 0.755
1996 5.66 −0.364 1.20 535,800 37,506 0.07 41,664 2.11 −0.846
1997 3.83 −0.323 1.11 609,000 79,170 0.13 73,080 2.84 0.342
1998 1.40 −0.634 1.32 609,000 152,250 0.25 6,090 0.78 −0.725

OLS = ordinary least squares

 Table 6A.2 Estimation of the change in total welfare, discounting the fixed charge, for principal cities
outside Lima, 1993–98
OLS estimations using Mills inverse ratio (reported bills)—discounted fixed charge
New Welfare per Welfare
households household changes
Socio- Households with (weighted (weighted
economic Average Welfare Minimum Total with Penetration telephone for access) for access)
City level Year welfare changes welfare households telephone ratio in t+1 (W: 0 ->Min) (W: 0 ->Min)
Arequipa High/medium 1993 22.99 10.06 24,815 13,400 0.54 3,861 22.99
(A/B) 1994 34.59 0.504 11.37 25,383 17,261 0.68 2,005 28.17 0.225
1995 40.35 0.167 11.25 25,687 19,265 0.75 2,647 37.70 0.338
1996 40.15 −0.005 7.51 26,401 21,913 0.83 664 35.52 −0.058
1997 41.99 0.046 6.60 26,877 22,576 0.84 1,517 41.20 0.160
1998 38.16 −0.091 1.64 27,379 24,093 0.88 821 35.82 −0.131

Cuzco High/medium 1993 9.90 3.79 9,280 5,011 0.54 1,357 9.90
(A/B) 1994 11.12 0.123 0.14 9,365 6,368 0.68 795 8.77 −0.114
1995 11.57 0.041 −3.63 9,550 7,163 0.75 815 9.88 0.126
1996 8.39 −0.276 −9.83 9,611 7,977 0.83 191 7.29 −0.262
1997 7.73 −0.078 −12.41 9,724 8,168 0.84 496 6.79 −0.069
1998 4.23 −0.453 −19.75 9,846 8,665 0.88 295 3.31 −0.512

Trujillo High/medium 1993 15.18 4.69 22,223 12,000 0.54 3,437 15.18
(A/B) 1994 21.14 0.393 2.39 22,702 15,437 0.68 1,826 16.72 0.101
1995 24.28 0.148 −0.64 23,017 17,263 0.75 2,550 21.62 0.293
1996 22.82 −0.060 −6.27 23,587 19,813 0.84 4,206 18.55 −0.142
1997 23.41 0.026 −8.53 24,019 24,019 1.00 432 19.16 0.033
1998 21.17 −0.096 −14.96 24,451 24,451 1.00 0 20.79 0.085

Chiclayo High/medium 1993 17.77 6.71 10,324 5,575 0.54 1,575 17.77
(A/B) 1994 25.83 0.454 5.92 10,515 7,150 0.68 927 20.91 0.177
1995 30.05 0.163 4.92 10,769 8,077 0.75 1,015 27.22 0.302
1996 29.20 −0.028 0.91 10,954 9,092 0.83 1,186 26.06 −0.043
1997 30.30 0.038 −0.43 11,171 10,277 0.92 1,122 26.76 0.027
1998 28.02 −0.075 −3.96 11,399 11,399 1.00 0 25.27 −0.056

251
OLS = ordinary least squares