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Since the early 1960s, the Hong Kong Telephone Company (HKTC)—the dominant firm in Hong Kong's local telephone market—has undergone several regulatory reforms. The company has been subject to price control, rate-of-return regulation and price-cap regulation. This paper estimates the total factor productivity (TFP) growth of HKTC. The empirical results show that the estimated TFP growth of HKTC was 2.31–3.56% per year between 1964 and 1998. TFP growth varied substantially under different regulatory regimes, and the importance of the scale effect relative to the technological effect diminished over time.

In recent years, there has been a growing interest in measuring the productivity and efficiency of telecommunications companies. Various methods have been used for measuring productivity change, including the growth accounting approach to total factor productivity (TFP) measurement, the Divisia aggregation method, the Malmquist index of TFP, the Törnqvist productivity index and data envelopment analysis (DEA). The reasons are many for the increased interest in the study of productivity growth. Productivity studies have been carried out partly due to academic interest and partly due to regulatory purposes. Over the last two decades, there has been a global trend of liberalisation and privatisation in the telecommunications industry. In addition, new regulatory systems such as price caps have emerged to replace traditional rate-of-return (ROR) regulation, with the aim of facilitating the transition to competition. Faced with this regulatory challenge, academics have been interested in evaluating the performance of telecommunications companies in terms of productivity growth under different regulatory regimes. Moreover, under incentive regulation, the estimation of productivity growth has been an obligation thrust upon regulators. This paper estimates the productivity growth of the Hong Kong Telephone Company (HKTC), which was the monopolist in Hong Kong's fixed-line local telephone market before 1995. This study compares the productivity growth of HKTC under different regulatory regimes, and considers whether the company has shared the productivity gains with its customers. The paper is structured as follows. Section 2 provides a brief background of the telecommunications industry in Hong Kong. Section 3 summarises empirical studies of productivity growth in telecommunications, and describes the methodology and data used in this productivity study. The empirical results are presented in Section 4, and Section 5 concludes the study.

Since the early 1960s, HKTC has been subject to various regulatory controls—from price control before 1975 and rate-of-return regulation from 1975 to 1991, to price-cap regulation from 1992 to 1998. As part of the compensation for HKT's early surrender of its international licence, HKTC was allowed to raise the residential tariff by 30% in 1999, and then by HK$10 (US$1.28) each year in 2000 and 2001. Since 2001, the company has not been subject to any maximum price control. The Hong Kong government believes that competition in the local market is sufficient to constrain price increases. Based on the Divisia aggregation method and the growth accounting approach, the average TFP growth of HKTC was 2.31–3.56% per year over the period between 1964 and 1998. The TFP growth rate varied substantially under different regulatory regimes. HKTC allowed its customers to enjoy most of the productivity growth by lowering the real price of local telephone service. The contribution of the scale effect was small, which might have been due to the small market size. The importance of the scale effect relative to the technological effect in TFP growth diminished over time. This study has indicated that TFP growth was sensitive to HKTC's pricing policy. In the 1990s, HKTC's revenue growth was artificially restrained by HKT's cross-subsidisation policy. HKT subsidised local services with international revenue, and the policy might have reduced HKTC's TFP growth. In other words, the measured TFP growth could have been higher if local telephone services were not priced below costs. These results are similar to the findings of Denny et al. (1981), who argued that the ROR regulation lowered the TFP growth of Bell Canada. Empirical studies using revenue as a proxy for output have to consider the effects of government regulation and pricing policy on TFP measurement. In 1999, the price-cap regulation imposed on HKTC was removed and the company was allowed to raise its residential tariff to compensate for the fall in international revenue. After the merger between PCCW and HKT, the new company laid off a large number of staff to reduce operating costs. The number of staff employed by HKTC declined from more than 10,000 to less than 7,000. The significant reduction in labour input, coupled with the increase in total revenue after tariff increase, should have had the effect of improving HKTC's TFP growth since 1999. Lastly, it must be noted that this study is limited by the availability of data. Since liberalisation, HKTC has been reluctant to disclose information about its operations, for fear that such information might be utilised by its competitors. Hence, the study is mainly based on publicly available data such as HKTC's annual reports and government reports. If more information was available, such as the revenues obtained from different groups of customers, quantities and costs of quasi-fixed factors, then it would be possible to extend the study to estimating a cost function with multiple outputs and quasi-fixed factors. Such an estimation would allow the estimation of economies of scope, which definitely affect the TFP growth of the telecommunications industry.