IASPS

December 28, 1999

To:

Alex Weisman

Assistant Director for Economic Analysis and Budget

Ministry of Communication

23 Yaffo St.

Jerusalem 91999

Dear Sir,

RE: Your Letter Concerning Internet Infrastructure in Israel

First, let me thank you for taking the trouble to read Policy Paper 43 and to respond to some of the points brought up in it. There is no doubt that a public debate is essential for clarifying the issue of regulation in the communication sector and particularly the Internet market. This sector is pivotal to Israel’s integration into the information age.

I regret to say that some of the points brought up in your letter reveal a basic lack of understanding of the content of the Policy Paper and, in some cases, of the issue in general. As will be demonstrated below, the result is a series of distortions and errors and the presentation of only partial data.

Let it suffice at this stage to give just one example which is taken from the Ministry of Communication’s comments on Table 5. It is claimed there (based on 1998 data) that the business sector is already connected to the Internet through a wide bandwidth infrastructure (defined there as optimal) and therefore does not have to endure the slow Internet connections available to the public in Israel. However, the term wide bandwidth has for many years referred to an infrastructure which is at least 20 times faster than the one referred to by the Ministry.

We hope that this response to your letter will assist decision makers at the Ministry of Communication in realizing their errors and will increase their understanding of the real problems in the Internet market in Israel.

This document is structured as follows: a quote from the Ministry’s letter will be presented followed by our response (first to the cover letter and then to the accompanying letter). The conclusion of the document will present a summary and conclusions.

We will be more than happy to assist the staff at the Ministry of Communication in order to put the Internet market on the right path of development.

Yours sincerely,

Amir Etzioni

Policy Analyst

The Institute of Advanced

Strategic and Political Studies

Cc: Benyamin (Fuad) Ben Eliezer, Minister of Communication

MK Michael Eitan, Chairman of Knesset Internet Subcommittee

Daniel Rosen, Director of Ministry of Communication

The Israel Internet Association

Response to Cover Letter

Paragraph 4: “As a result of the above problems in the Policy Paper, the authors reach incorrect conclusions and make inappropriate recommendations: a) Reform in the area of regulation – The report of the Boaz Committee was written in 1996, prior to the opening of the market to competition, and its recommendations apply to the circumstances at that time. At present, the Ministry of Communication is encouraging competition in the market so that there is no longer any need for a communication authority. The lack of such an authority does not constitute any sort of bottleneck.”

Fact: The points brought up in the letter are in total contradiction to the official policy of the Ministry of Communication as it appears in the central policy document of the Ministry itself. This document was written in September 1998 by a committee headed by Daniel Rosen, Director of the Ministry. The document (herein the Rosen report) specifies the guidelines for opening the communication market to competition.

a. The second recommendation of the Rosen report states that: “The establishment of a national communication authority (emphasis in the original) which will replace the Ministry of Communication should be considered. It will have the authority to regulate a competitive communication sector.”[1] The previous Minister of Communication also stated her intention in 1997 to establish such an authority.[2]

b. In addition to the fact that there has been no change for the better in the communication sector since the Rosen Committee, the government decision that the market should be opened to competition by January 1999 has not been carried out.[3] This has resulted in an annual loss to the economy of hundreds of millions of dollars as shown in Policy Paper 43. The previous Minister of Communication stated that she did not want to change the status quo before the elections while the present minister claims that he is still studying the issue. These types of excuses in fact strengthen the argument for a communication authority which will not be influenced by political considerations. Thus, the delay in its establishment does indeed constitute a bottleneck in the market’s development.

Paragraph 4 (continuation): b) “The steps being taken to open the communication market to competition are based on principles set out in Ministry of Communication policy documents and no change is required in this policy.”

Facts: The claim that the opening of the market is based on principles set out in the Ministry’s policy documents is not accurate. The first recommendation (No. 1a) in the Rosen report states that “the opening of the market to competition, with emphasis on the domestic telephone market, should take place no later than January 1999.”[4] This recommendation has still not been carried out, eleven months after the deadline. Thus, the Policy Paper’s criticism on this point is absolutely justified.

Paragraph 4 (continuation): c) “Competition in the international communication market. As stated earlier, the domestic communication market is now competitive and rates have fallen by 20 percent as a result. No further government intervention is required at this point.”

Facts: It is unclear what the words “as stated earlier” refer to. In fact the meaning of the whole sentence is unclear. I will thus relate to two possible interpretations of this claim. No matter what the correct interpretation is, it is clear that this statement has no connection to reality and the claim that no further government intervention is necessary contradicts official Ministry of Communication policy.

Possibility A: The sentence refers to competition in the domestic telephone market. As far as we know there is no competitor to Bezek in the local market through which households can connect to the Internet. If such a competitor does exist, we would be interested in knowing who it is.

It is true that telephone rates have fallen by 20 percent but this was the result of a Ministry of Communication directive rather than competition. As will be discussed below, this reduction was accompanied by a steep rise in fixed charges and data communication rates. Thus, the claim that rates have fallen by 20 percent is misleading.

Possibility B: The statement refers to the state of quasi-competition in the international market. This interpretation is forced since rates in this market have fallen by 70 percent rather than 20 percent.

a. It cannot be claimed that full competition exists in this market, especially in the case of data communication on the Internet. Only three companies now operate in this market and they enjoy full protection against the entry of competitors until the year 2002. Two of the companies are also leading Internet Service Providers (ISPs) and thus enjoy a clear advantage over other providers who are unable to operate in the international market (due to Ministry of Communication regulations which include the prohibition of commercial cooperation).

b. The conclusion that no further government intervention is required contradicts official Ministry of Communication policy. The report of the committee established by the Ministry to study Internet services in Israel (the Rahav Committee) states that additional government intervention is in fact required. The third recommendation of the Rahav report states: “The Committee recommends that the Ministry of Communication should cancel the protection of the long-distance providers and grant additional licenses as soon as possible.” [emphasis in the original] [5]

Policy Paper 43 recommends the cancellation of fees paid by the long-distance providers to Bezek and the government. This would provide at least partial compensation for their agreement to open the international communication market to full competition before 2002.

Paragraph 4 (continuation) + concluding remarks in letter: “d) The paper concludes that the excess cost to the public as a result of slow Internet connections and high prices totals $100 million; at the same time, the total annual expenditure on dial-up Internet services totals $123 million according to the survey. It is unclear how this conclusion was arrived at since most of the expenditure on Internet service would then be excess cost. The implication is that Internet services should essentially be provided for free, resulting in heavy long term financial losses for service providers…accepting this assumption…would lead to the conclusion that the expenditure on Internet services should only be $20 million…”[our emphasis]

Facts: This paragraph is totally in error and completely distorts what is stated in the Policy Paper. The excess cost calculated in the Policy Paper is in fact a conservative estimate:

a. As pointed out in the Policy Paper, the excess cost resulting from Ministry of Communication regulation is actually much higher than $100 million. Most of these costs arise from lost economic potential and accumulated lags in technology. The costs mentioned in the Policy Paper are in fact only the tip of the iceberg. Lacking the tools to analyze the full extent of these costs, the author presented an estimate of only those costs which could be quantified. The cost of lost work and leisure time and lost economic potential is expressed in the reduction of national product and has nothing to do with the expenditure on Internet services (which is much smaller than the total excess cost to the economy).

b. “Dial-up” – The Policy Paper dealt with total expenditure on Internet services whether dial-up or otherwise. If we had assumed that the figures apply only to dial-up connections, the total Internet expenditure would have been much higher.

c. It is unclear to how the Ministry of Communication came to the conclusions in this paragraph and furthermore they have nothing to do with the contents of Policy Paper 43.

Response to Accompanying Document: Policy Paper 43 – Main Problems

Paragraph 1.1 – Report of the Grunau Committee

General: Policy Paper 43 deals with policy issues and recommendations which have economic and strategic implications for the economy. The Grunau Committee report, in the view of the Ministry of Communication, was only a tactic used to reduce Bezek’s domestic rates (even though at the same time they were permitted to increase fixed charges and the rates for data communication).

The authors of Policy Paper 43 do not see this as the solution which will encourage growth in the communication sector, particularly in the data communication market. The fact that the regulator will be dictating prices for the next five years (as stated in the Ministry of Communication letter) is a bad omen for the Israeli economy.

The optimal solution in the view of Policy Paper 43’s authors is the opening of the communication market to competition. This strategy is worth considering and will certainly result in a much more significant reduction in Bezek’s rates. Thus, the Grunau Committee report receives little attention even though some of its recommendations have significant consequences for the Internet market, as will be discussed below.

Paragraph 1.1 – “The Grunau Committee report led to a 21 percent reduction in domestic phone rates…an in-depth analysis of the report reveals that the government will have brought about an unprecedented 50 percent reduction in rates over the next five years.”

Facts: The Ministry of Communication chose to present only one change of many which the Grunau Committee recommended. Furthermore, this claim doesn’t say anything beyond what was stated in Policy Paper 43 and doesn’t change any of its conclusions.

a) As mentioned above, the Ministry of Communication “forgot” to mention that the reduction in rates was only for variable charges; fixed charges were raised by 16 percent such that the average telephone bill was reduced by only 8 percent (according to an official press release by the Ministry of Communication in early August 1999).[6] In addition, your letter didn’t mention the fact that at the same time Bezek was permitted to raise prices for computer communication by an average of 51.5 percent and the rates for frame relay service by an average of 42 percent.[7] This fact is also “unprecedented” and has serious implications for the data communication market and particularly for the Internet.

b) There is a difference between the Ministry of Communication making a decision and actually carrying it out. What is certain is that these decisions cannot be relied upon for a meaningful economic analysis. As seen above, the Ministry of Communication recommended the establishment of a communication authority and the opening of the communication market to competition in early 1999. Not only has policy changed but anyone who dares to mention these recent decisions becomes a target of criticism.

Paragraph 1.2 – International Phone Rates

The claim that Policy Paper 43 ignores what is happening in the international communication market is simply untrue and in fact it is discussed in detail in the section on regulation entitled “Correcting a distortion with another distortion”.[8] At the same time, it should be noted that the reduction in international phone rates has no direct bearing on data communication and since Policy Paper 43 does not deal with Ministry of Communication policy in all sectors of the communications market, this is not the appropriate place to deal with the issue in detail. Therefore, we will focus on issues related to data communication.

The Ministry’s policy toward opening the international communication market to competition was formulated in the mid-1990s. This policy had two main features: a) Shlomo Wax, the Director of the Ministry of Communication at the time, publicly expressed the opinion at the convention of the Israel Internet Association that the Internet was only a passing fad; b) As mentioned in Policy Paper 43, the government granted Bezek a long list of concessions in order to win its “agreement” to give up monopolistic control of the international communication market.

It is no wonder therefore that the Internet, and data communication in general, received little attention in the decision making process of the Ministry of Communication during that period. And indeed there are serious problems in this area which have hindered the development of the Internet in Israel and which would not exist in a competitive international communication market.

Paragraph 1.2 (continuation): “The Policy Paper ignores these trends and chooses to present the connection fee and royalties, which constitute no more than 10 percent of costs, as the principal reasons for high operating costs and the consequent high price of service.”

Facts:

a) Even 10 percent constitutes excess cost and the fact that we are speaking of “only” 10 percent is not a reason to ignore the issue. In actual numbers, we are speaking of an amount similar to the turnover of the whole Internet market in Israel and as mentioned in Policy Paper 43, the connection fee alone totaled $75 million in 1998.

b) The central problem lies in the fact that in compensation for the fees which the long-distance providers must pay to Bezek, the government has granted them protection from competition for an extended period. As already mentioned, this protection has serious consequences for the Internet market and the Policy Paper recommends ways to end this protection in an agreed-upon manner.[9]

c) It is ironic that, in addition to government protection against competition, the Ministry of Communication has permitted the long-distance providers to supply Internet services. This constitutes a significant advantage over other ISPs who are not permitted to operate in the international communication market.

d) The main competition between the long-distance providers is in the area of telephone calls and therefore data communication has not seen the same dramatic fall in rates.

Paragraph 1.2 (conclusion): “The paper also ignores the fact that the connection fee, which is part of the financial stability agreement [signed between the government and Bezek in order to gain its agreement to opening up the international market], has been reduced by some 30 percent per year and will be cancelled completely in 2001. This is one of the factors which made it possible to open up the communication market to competition and to reduce prices so significantly.”

Facts: A close reading of Policy Paper 43 reveals again that there is no basis for this claim (whether or not it has any significance). It is stated in the paper that “this tax, called a “connection fee”, will be gradually phased out by the end of 2001…”[10]

In contrast to the Ministry of Communication, which supports the payment of the connection fee and views it as having contributed to the reduction of long distance rates, the authors see this concession to Bezek as a setback for the Israeli communication market. These concessions were achieved by striking Bezek workers who ignored back-to-work orders and by means of Bezek’s monopoly status which was of course granted to them by the government itself. As a result of these concessions, Bezek has reported higher than forecast profits in spite of the inefficiencies described in the Grunau Committee report.

Paragraph 1.3 – The Cost of Internet Usage

a. “The cost of Internet usage is on a downward trend…in the future [the trend will continue as a result of] the consolidation of Internet services with cable and other types of communication services.”

This paragraph speaks of events in the future which should have already taken place. This is the main thrust of Policy Paper 43 – that regulation is delaying technological progress in Israel while protecting Bezek from competition. It is worthwhile reading the International Survey section in the Policy Paper in order to understand the trends in the US.

b. Regarding the Ministry of Communication data see the response in Appendix B below.

Paragraph 2 – “The claim of excess costs borne by the public as a result of high prices is untrue.”

Sub-paragraph 2.1 a) “…a direct Internet connection provides a high and optimal level of service.” [our emphasis]

Facts: The claims appearing in this sub-paragraph and in the rest of the paragraph as well not only lack any basis in fact but reveal an unfamiliarity with what is going on in the Internet market both in Israel and abroad.

a. The Industrialists’ Association carried out a survey of its members (which are industrial concerns with significant financial resources) in 1998 with regard to the speed of their Internet connections. The survey found that the most common connection was 64K per second.[11] It also found that 70 percent of respondents were interested in a connection which was at least twice as fast as the one they were currently working with.

In this regard, it is worth mentioning that the Ministry of Communication has not permitted Internet connections through cable, wireless connection (LMDS or WLL), satellite or other infrastructures which are able to supply Internet connections at much higher speeds and at much lower prices than that considered optimal by the Ministry. For example, in January 1999, a DSL connection from Atlantic Bell with a speed of 640K per second cost $70 per month with a one-time fee of $200.[12] In other words, in comparison to the “optimal” speeds mentioned above, this connection is ten times as fast and costs much less.

Furthermore, Bezek continues to enjoy full government protection and does not have the threat of competition hanging over it. As a result, ADSL services, which allow communication at speeds tens of times faster than those defined above as optimal, are not offered by Bezek either. During a discussion held by the Knesset Science Committee on October 31, 1999, Herzl Ozer, Vice-President at Bezek, stated that the cost of this service would be $10 per month for unlimited connection time.

b. Furthermore, the letter deals with only one segment of the data communication system. A solution for this segment is only one part of the general solution described in Policy Paper 43. Only by opening up all of the segments to competition, including the domestic and international markets, will optimal results be achieved.

Sub-Paragraph 2.1 b + c: “The model assumes that time spent downloading data cannot be used for other purposes whether on the Internet or otherwise. This is an exaggeration and biases the results downward. Netvision has found that 10 percent of connection time is devoted to the downloading of software…”[our emphasis]

Facts: This statement is a distortion of Policy Paper 43 and is totally unfounded. Furthermore, it indicates that the author did not read the paper closely.

a. The source of the figure of 10 percent for downloading of software is unclear. The figure appearing in Policy Paper 43 does not refer to the downloading of software and, in any case, the words attributed to the Policy Paper do not in fact appear there. The figure of 10 percent refers only to time spent waiting for material to download from the Internet which ranges from several seconds to several minutes. The estimate was received from Netvision and is defined as “the time spent in front of the computer waiting for material to download.”[13] This is indeed lost time.

b. According to data received by the editor of Policy Paper 43 from Netvision, 6 percent of connection time is spent downloading software and a similar proportion downloading games. Thus, a total of 12 percent of connection time is used for downloading software. Policy Paper 43 did not deal with the excess costs arising from this usage of the Internet.

c. Since the letter from the Ministry of Communication claims that 20 percent of time spent downloading software, i.e. 2.4 percent of connection time, is unproductive, its inclusion in the analysis in Policy Paper 43 would result in even higher excess costs than those arrived at.

Sub-Paragraph 2.1 c) “Netvision estimates that 10 percent of connection time is spent on downloading software. The fact that the paper assumes a higher percentage without any apparent reason [our emphasis] indicates bias on the part of the author.”

Facts: Again, this claim has no factual basis (without relating to what was stated in the previous paragraph) since three explanations are given in Policy Paper 43 for using a higher figure than that of Netvision:

a. According to research done in the US by the firm “Relevant Knowledge”, the proportion of time spent waiting for material to load onto one’s computer constitutes 25 percent of connection time.[14]

b. Netvision’s figure does not include time required to initially connect to the Internet for dial-up subscribers. This time can be significant especially for subscribers who connect for only short periods each time. Savings can be realized on this time as well.

c. The figure can vary between ISPs. Netvision enjoys a significant advantage over other providers since it has a monopoly in the hosting of Internet sites. A report published by the Ha’aretz newspaper in late 1998 found that 90 percent of sites in Israel were hosted on Netvision servers.[15] Thus, Netvision subscribers do not experience the same delays as other subscribers when surfing within Israel. The Ha’aretz report stated as follows: “…the only subscribers who no not experience a delay when connecting to 90 percent of the sites in Israel are of course Netvision subscribers. They do not require interchange (IIX) services since they are already connected to the provider hosting the sites.”[16]

Sub-Paragraph 2.1 d): “The model assumes that at least 30 percent of connection time is at the expense of other creative activity. This assumption is totally exaggerated since the author ignores the possibility that in places where there is a fear of productive time being lost, fast direct Internet connections are usually installed. It also ignores the fact that during the downloading of software, one can be engaged in other activities.”[our emphasis]

Facts: Policy Paper 43 uses a figure of 30 percent for the proportion of connection time from one’s place of work (whether for work or leisure purposes) and from home for work purposes. This estimate is in fact a conservative one.

a. The above-mentioned survey was carried out by Netvision, one of the two largest ISPs in Israel. The results appear in Chart 2 of Policy Paper 43. The survey shows that 29 percent of time on the Internet is clearly for work or for studies while the rest is divided among applications which could either be for work or for leisure (such as Email) or which are done at work.

The survey also found that “77 percent of subscribers use the Internet for personal needs while 23 percent use it for business or work.”[17] Since business users spend more time on the Internet than personal users, the proportion of Internet time used for business purposes clearly exceeds 30 percent. To this must be added the time of users with a direct connection who, as the Ministry of Communication letter points out, are almost all businesses. The percentage of time spent on business or personal uses during work time at these businesses is close to 100 percent which clearly increases the average.

b. The Ministry of Communication’s claim that businesses which are concerned about productivity will install a direct Internet connection is incorrect as pointed out in sub-paragraph 2.1a above. Accepting this claim as true would lead to false conclusions as in the following example: Any business, public organization or other institution which uses the Internet must put up with the slow speed of their connection and the resulting waste of time. The Ministry of Communication claims that these organizations usually install direct Internet connections. A survey carried out by the IDC company in 1998 found that 63 percent of business in Israel are connected to the Internet.[18] During a presentation in February 1999, Daniel Rosen, Director of the Ministry of Communication, reported that 1500 businesses have a fast direct Internet connection.[19] This number represents only a small percentage of the businesses which are connected to the Internet in Israel and certainly contradicts what is stated in your letter.

In fact, in many businesses the situation is even worse than it appears at first glance. The high cost of connection as a result of over-regulation has resulted in the use of software such as RideGate which allows the compression of several users onto one telephone line but which results in a reduction of the effective speed of the Internet connection. Furthermore, in many of the businesses with a direct Internet connection, many users share the limited capacity of the connection and again the effective speed of the connection is reduced.

c. Regarding the claim that “during the downloading of software, additional activities can be engaged in”, see our response to Paragraph 2.1 b) above.

Sub-Paragraph 2.1 e) “The paper is based on the general statement that Internet connection rates can be cut by 50 percent. This claim has no solid foundation.”

Facts: This “general statement” is based on the words of Mark Gazit, the Vice-President of Netvision. He stated that, “If there were an alternative to Bezek and there existed the possibility of purchasing cheap lines for connection to the Internet as in the US, the relative price of Internet service would fall by 50 percent.”[20] This of course implies a market which is competitive in all its segments and which uses the full variety of available technologies mentioned above. In fact, this estimate was the most conservative of those given by those interviewed for the paper and therefore it was chosen.

Policy Paper 43 mentions a number of estimates which predict more drastic price reductions as a result of free competition and the use of the latest technologies. It also worth repeating the claim made by the Vice-President of Bezek that an ADSL connection would cost only $10 per month and would provide speeds several times faster than those available today.

Sub-Paragraph 2.2 f) “…This assumption [a 50 percent reduction in the cost of connection resulting from the abolishment of excessive regulation] is not only without foundation as already mentioned, but also ignores the product life cycle. Thus, during the penetration stage, prices are high and can only be reduced gradually over time.”

Facts: This claim relates to statements which do not appear in the Policy Paper. However, if they had appeared there, the Ministry of Communication argument would not contradict them.

a. There is no necessity in assuming a sharp immediate reduction in rates and Policy Paper 43 does not in fact do so. Nevertheless, a delay of a year in opening the market to competition results in excess costs whether rates are reduced gradually or all at once. In order to illustrate this, let us assume that the turnover in the Internet market was $120 million in 1998. Let us further assume that prices fall by 12.5 percent ($15 million) during each of the four successive years until they reach a stable equilibrium which is 50 percent of the original level. We wish to show that the accumulated excess cost in this scenario is identical to the case in which prices are reduced by 50 percent all at once. In other words, the resulting excess cost is $60 million (half the annual expenditure in 1998) in both cases.

Table: Accumulated Excess Cost to the Economy as a Result of a One Year Delay in the Switchover to Competition

	1998	1999	2000	2001	2002	Accumulated Cost
Beginning of process in 1999	120	105	90	75	60	450
Beginning of process in 2000	120	120	105	90	75	510
Excess Cost (delay of one year in reform)	0	15	15	15	15	60

In other words, the accumulated excess cost to the economy of a year’s delay in the opening of the market to competition is equal to 50 percent of the total expenditure in 1998. This was shown for the case of a gradual reduction in prices as advocated by the Ministry of Communication.

b. Policy Paper 43 did not assume that the cost of Internet usage could be immediately reduced by 50 percent; however in view of what has been said so far, this assumption could be adopted without any hesitation.

c. “…during the penetration stage, prices are high” – The above table demonstrated that this statement has no relevance to the discussion. Moreover, it is unclear whether this assumption applies to communication and Internet services. These products have motivated new models of the product life cycle. The economic literature began to deal with these models during the 1970s (the two classic articles in the field are Rohlfs (1974)[21] and Kats and Shapira (1985)[22]). Based on these articles, a theory developed according to which the prices of new products are low or even equal to zero during penetration in order to create a critical mass of consumers. The less competitive the market (as in Israel), the higher the prices predicted by the economic model during the penetration stage; it appears that this is the case which is familiar to the Ministry of Communication. However, in countries without regulatory distortions, penetration is characterized by low prices for these products.

Paragraph 2.1 (conclusion): “The correction of the errors in this economic analysis would have led to the conclusion that there are in fact no excess costs to the economy as a result of slow connection speeds.”

Facts: As shown above, this claim is a result of the failure to understand the content of Policy Paper 43 and of erroneous assumptions lacking any foundation in economic theory. Not only have we shown that the analysis in Policy Paper 43 has a solid foundation, we have also shown that its estimates are in fact conservative.

Paragraph 2.2: “It would be interesting to see the results of the comparison if, instead of 100 hours of connection time, the author had assumed the actual average in Israel [17.8 hours of dial-up connection per month].”

Facts: Table 9 in Policy Paper 43 shows the situation for “heavy” users who, for the most part, are businesses. The fact that in terms of monthly wages, the price of Internet usage for large business users in Israel is between 4 and 20 times higher than in the US should be setting off alarms bells. It indicates a regulatory failure which should be a cause of concern at the Ministry of Communication. The Ministry must realize that the extent of Internet penetration and of business usage would be at much higher levels if prices in Israel were equal to those in the US. To a large extent, this will determine Israel’s place in the information age.

Paragraph 2.2 (continuation): “In addition, if the necessary corrections were made to Table 8, the paper would show that the costs of ISPs and of the telephone company in Israel are lower than those of their counterparts in the US.”

Facts: This claim is incorrect. Since it is unclear what corrections are being referred to, it is difficult to respond to this claim. However, the table in the Policy Paper is taken from a publication of the World Communication Organization. The Organization’s updated publication, which appeared in October 1999, also shows that for a dial-up connection on a line used for regular telephone calls, Israel is ranked nine places after the US. Note that this is based on downwardly biased data supplied to the World Communication Organization by Bezek. For example, the figure of $2.50 (including VAT) for 20 minutes of Internet usage during non-peak hours is inaccurate.

Paragraph 2.3: “The paper states that the ISPs must pay high prices for communication services which they pass on to the consumer. This claim ignores the following facts: a) The international communication market has been opened up to competition and prices have been reduced by 70 percent; b) The connection fee is gradually being phased out; and c) ISPs are hesitant to pass costs on to the consumer.

Facts: 1. It is unclear how a) and b) relate to the working assumption. In any case, the reduction in long-distance rates is not relevant, as made clear earlier, and has perhaps even been at the expense of the Internet and data communication market.

2. The Policy Paper claims that the excess costs of the ISPs are passed on to the consumer and that their reduction will reduce prices to the consumer. From c), which is meant to contradict the working assumption, we see that the Ministry of Communication believes that if ISPs’ costs were reduced, the savings would not be passed on to the consumer. This claim is hard to accept and is not a reasonable one in a competitive market. If this is not the intention of c), then its relevance is unclear. Thus, none of these statements a) through c) support the claim that the authors of Policy Paper 43 ignored facts or important details.

3. Only limited competition between three firms presently exists in the international communication market. This will continue to be the case until the end of 2001.

Paragraph 3: “The overall policy of the Ministry of Communication is to open the communication market to competition.”

General: The author of Policy Paper 43 has no reservations in principle concerning the future planned for the communication market by the Ministry. However, it is worth asking why this process is being delayed and at what price. Indeed, these are the central questions of the Policy Paper.

Paragraph 3.1 a): “The Policy Paper ignores the steps already taken by the Ministry of Communication even though they were explained to the author. This undermines the value of the analysis and casts doubt on its conclusions.”

Facts: A whole section of Policy Paper 43 discusses government involvement in the Internet sector. This section mentions all the relevant facts presented to the author as well as others not presented. Since no specific facts are mentioned which were not responded to, I cannot relate directly to this criticism.

Paragraph 3.1 b) “…During 1998-1999, these two processes began to take shape [necessary technological changes and the enactment of regulations for the communication market]. This places Israel on the verge of a breakthrough which will change the face of the communication market.

Facts: According to the government decision mentioned above, these regulations should have been ready at the end of 1998.[23] The fact that a year later the process has only just begun is a scandal rather than an achievement to be proud of.

Paragraph 3.1 d) “Implications of the Expected Changes.”

Facts: Although the description in the letter is enlightening, the question asked by Policy Paper 43 is why these steps are not being carried out. If, according to the Ministry, conditions must “ripen”, then those decision makers who are as yet undecided as to the correct policy should sit and thrash out the issues until conclusions are reached.

Paragraph 3.2 a): Special licenses for ISPs – “The Policy Paper mentions the necessity of a Ministry of Communication license in order to offer Internet services as one of the main barriers to entry in this sector. However the paper ignores the fact that the Ministry of Communication does not in fact constitute a barrier of any sort. All applications for a license have received approval within a short period of time.”[our emphasis]

Facts: Again, the paragraph distorts what is written in the Policy Paper and avoids dealing with the real issues. Furthermore, the data and facts presented in this regard are totally lacking in foundation.

a. Following is an excerpt from a letter dated April 2, 1998 from Avi Rahav, head of the Engineering and Licensing Branch at the Ministry of Communication, to Gilat Communication Engineering Ltd.:

“RE: Request of Gilat Communication Engineering for Permission to Offer Internet Services by Satellite – your letter dated September 18, 1997.

a. Your request for a license to offer Internet services by satellite was discussed by the Licensing Committee on March 23, 1998. The Committee decided to turn down your request.

b. The justification of the decision: According to Ministry of Communication policy, no licenses are being granted at this time for wireless or satellite Internet service.”

The following facts are brought to light by the letter: First, the answer was given seven months after the request. Thus, we must question the Ministry’s definition of a “short period of time”. Second, the claim that so far all applicants have received a license is untrue. Third, the justification given for the refusal indicates the extent of the problem.

a. The Ministry’s claim evades the central issue which is their refusal to grant licenses for Internet service on any infrastructure other than Bezek’s. This is one of the principal factors delaying the development of the Internet in Israel and is discussed at length in Policy Paper 43.

b. An additional example of the Ministry’s interference in the development of the Internet market can be found in the letter sent by the Ministry to the two largest ISPs (and probably to the rest of them as well). The letter stated that with the renewal of licenses in early 2001, an additional clause would be added. It will state that, among other things, ISPs will be prohibited from providing phone and fax services and Internet connections other than by means of a computer and modem connected to Bezek’s (!) local phone system. In the opinion of Internet Zahav, this amendment is intended to prevent the offering of Internet services by means of cable or other technologies. There is no doubt that this is a tightening of restrictions rather than progress towards a free market.[24]

c. The letter criticizes Policy Paper 43 for its claim that the requirement of a license constitutes “one of the central barriers” to development of the Internet. This criticism is unfounded and distorts what is actually stated in the paper. The restrictions placed on the ISPs are indeed the principal barrier to development. If these restrictions were removed, the requirement of a license would be tolerable.

Response to Appendix A

Although the table in this appendix does summarize the regulatory powers of the Ministry, it makes no contribution to the discussion. In any case, the table does not contradict any data presented in the analysis of the Policy Paper as we will see below. Furthermore, although the date of the table does not appear, the table does not seem to refer to the period during which Policy Paper 43 was published.

Response to Appendix B

General: All the data in Policy Paper 43 is from reliable sources which are named in the paper. It is true that the Internet market and communications in general are in a state of transition which is liable to affect the analysis in the paper. However, the Ministry’s letter shows bias in their correction of data. Examples of this were presented above (such as the presentation of only a partial picture with regard to Bezek rate changes). This is especially true in Appendix B. First, we should mention that at least two of the figures used in Policy Paper 43 are based on very conservative estimates and replacing them with more realistic numbers would only serve to increase excess costs.

a. The prospectus of Internet Zahav, which was published in August 1999, states that there were a total of 375,000 subscribers in Israel in June 1999. The figure used in the Policy Paper is only 260,000. It would be a mistake to recalculate the analysis taking into account the reduction in Bezek rates while ignoring the increased number of subscribers.

b. The average value of an hour of work for Internet users in Israel is many times higher than the average for the economy as a whole. This is a result of regulation which has restricted Internet usage to a relatively small and well-off group. The figure used by the paper is based on a general average which includes segments of the population that cannot afford to use the Internet. As a result the estimate of excess cost is in fact biased downward.

Table 2

a. The Ministry of Communication assumes for some reason that all Internet service in Israel is on the basis of a local call only. This assumption is not correct at present and was even less so during the first quarter of 1999. Regional calls and inter-regional calls are up to 6.25 times more expensive than a local call and this cost must be averaged into the Ministry’s calculation (no matter how small the proportion of these calls is).

b. Policy Paper 43 uses a figure of $1.06 (including VAT) for the average cost of an hour of connection time. The Ministry of Communication claims that the figure should only be $1.00. Although we do not agree with their figure, it is clear that this change would have no significant effect on the unambiguous results of Policy Paper 43.

c. Regarding direct payments to Bezek (not including those paid by the ISPs), the Ministry ignores for some reason the title of the table which states that the rates are correct for the first quarter of 1999. Instead they present a figure which is not relevant to the period dealt with in the Policy Paper. The figure presented in the original Table 2 (average payment to Bezek of $0.44 per hour) is accurate and is in fact an underestimate.[25]

Table 3

a. The sum of all the “corrected” figures appearing in the new table prepared by the Ministry gives a total of $72 (32+10+30) and not $62 as stated.

b. The Ministry’s claim that the cost of fifty hours of usage during the day and fifty hours at night would be $32 is not based on Bezek’s figures and is totally incorrect. Using Bezek’s figures, the total cost of 100 hours of usage as stated would be NIS 170.10, which is approximately $41, in the case of local calls only.[26] If we assume that some of the calls are not at the local rate, the resulting cost would be at least $43 as stated in the Policy Paper. In any case, the cost is much higher than the Ministry’s figure of $32.

c. The comment that the monthly fixed payment to Bezek is $10 and not $12 as stated in Policy Paper 43 is the only instance in which an actual error was pointed out by the Ministry of Communication. The error was unintentional and in any case does not affect the analysis, conclusions or international survey appearing in the paper.

Table 4-6

We have show above that the Ministry’s claims are without foundation and that the figures used in the paper are conservative ones. In view of this, there is no basis for Tables 4-6. Nonetheless, I will deal with a few points in the Ministry’s letter which were unclear:

a) It is worth mentioning again the statement at the beginning of the letter that in the Ministry’s opinion, businesses have access to an optimal wide bandwidth infrastructure (bottom of Table 5). This statement clearly shows that the Ministry is out of touch with reality.[27]

b) In the notes to Table 4, it is stated: “6. The source of this assumption is unclear but, for the sake of simplicity, we will accept it.” Since it is not stated which assumption is being referred to, and which paragraph the comment relates to, we cannot assist the Ministry in understanding the source of the assumption.

c) From the comments to Table 6 we learn that the Ministry assumes, “in order to remove any doubt”, that if all the recommendations of Policy Paper 43 were adopted and the market were opened to full competition including the use of technologies such as cable, ADSL, satellite, WLL, LMDS and others and the elimination of restrictions in the overseas segment and on ISPs, the resulting reduction in the cost of Internet usage would be no more than 10 percent. This conclusion hardly “removes any doubt” and, in view of what appears in the Policy Paper, is ridiculous.

Afterword:

The Ministry’s claims have been dealt with one by one in a clear and concise manner and were shown to be baseless. It is unfortunate that the Ministry concluded that the paper was superficial and biased. We have shown that this claim is unfounded and is based on a series of statements taken out of context, incorrect assumptions and a lack of understanding of the text.

Unfortunately, the conclusions of Policy Paper 43 are still valid today. Over-regulation and the lack of competition in the domestic communication market continue to cost the Israeli economy hundreds of millions of dollars every year. We suggest an in-depth rereading of Policy Paper 43 which will show that the Internet is of pivotal importance to economic development and that the continuation of over-regulation will lead to missed opportunities for the Israeli economy. This should be a cause for grave concern.

The editors of the paper are more than willing to assist you in making the right decisions which will lead to a free and competitive Internet market. Your success is our success.