December 2004

The Proper Direction for Telecommunications Reform Legislation

Robert W. Crandall summarized a chapter from his forthcoming book on telecommunications regulation that analyzes the economic impact of the legislation's mandate to unbundle local telephone services. He explained that unbundling was intended to promote competition by requiring large, potentially monopolistic local phone companies to share their infrastructure with new entrants at regulated rates, thereby lowering prices, encouraging innovation, and improving productivity. Once competitors entered the market using shared facilities, they would then invest in their own facilities, further contributing to competition in the industry.

Crandall argued, however, that expectations have proven incorrect and that the costs of implementing the unbundling provisions have far outweighed the benefits. He noted that local telephone rates have stayed about the same, or in some cases even increased since 1996, implying a wealth transfer from incumbent providers to new entrants with no downward pressure on prices and little innovation. Furthermore, the act reduced incumbents' incentive to invest in their own networks by forcing them to share the returns with other companies.

Crandall acknowledged that some studies have shown slight consumer savings, up to 15 percent, from the entrance of competitive local exchange carriers (CLECs) into the market. But he pointed out that at least part of these gains came from long distance services not subject to unbundling requirements, and that these improvements do not cover the social cost of over $8 billion per year to comply with the 1996 regulations. In the end, competition from CLECs using incumbent lines is artificial. CLECs provide essentially the same service as the original carriers with little, if any, reduction in consumer rates and high social costs. The 1996 act has thus reduced, rather than increased, welfare.

John Mayo
Georgetown University, McDonough School of Business

John Mayo agreed that the 1996 bill had not fully achieved its goal of promoting competition in local telephone service markets. Rather than join Crandall's call to abandon unbundling requirements altogether, however, he argued that three aspects of regulations stifled innovation and the desired price reductions: First, the universal coverage policy is inefficient in the way it raises revenues and the way it distributes subsidies, resulting in significant welfare losses. Second, the current system of subsidized network access pricing is distortionary, emphasizing that prices must be more cost-based in order to better facilitate competition. Third, he recommended that legislation include stronger antitrust liability provisions to discourage monopolistic behavior by incumbent providers. Mayo finished by suggesting that the fact that a large number of consumers switched to competitors undermines Crandall's argument that there was little gain to consumers, and that he may have overlooked some costs associated with the political economy of the old regime, such as rent-seeking and lobbying.

Harold Furchtgott-Roth
Furchtgott-Roth Economic Enterprises

Harold Furchtgott-Roth agreed that unbundling policy had not brought the expected level of competition, but he reminded the audience that few economists had criticized the legislation when it was passed. He did not dispute Crandall's general argument that the economy had suffered significant costs in implementing the regulation, though he suggested that there may have been more gains to business, if not consumers, than Crandall allowed. He also speculated that the problem with the law may be one of implementation as much as content, and that a better approach by the FCC could help the situation. Lastly, he attributed the economic failure of the CLECs at least in part to the complex and uncertain nature of the regulatory environment.

Walter B. McCormick Jr.
United States Telecom Association

Walter B. McCormick began by emphasizing the importance of the communications industry to everyday life and lamenting the ranking of the United States as thirteenth in broadband penetration in the world. He attributed the low ranking directly to a lack of investment resulting from over-regulation. He asserted that the communications industry was competitive with a range of choices for consumers and that government involvement hampered innovation and productivity. In particular, he expressed discontent with telephone unbundling regulations, noting that heavy-handed government involvement in such a narrow sphere of an industry is rare or nonexistent outside of telecommunications.

Question and Answer

Crandall countered contentions that unbundling had not hurt the thriving telecommunications industries in Japan or South Korea by calling attention to the differences in operating environments--Korea achieved widespread subscription before unbundling was implemented, and Japan did not possess an extensive cable network as an alternative source of high-speed communication.

The panelists each gave their opinions on universal municipal WiFi service. Furchtgott-Roth argued that the market for Internet access and broadband is competitive and that there is no need for the government to provide it. McCormick agreed and added that large investment requirements are not in themselves barriers to entry. AEI's J. Gregory Sidak suggested that local government utilities' prices could ultimately be viewed as predatory, making them targets for antitrust suits. Mayo was more optimistic about government-provided service, suggesting that a municipality should be allowed to compete with the private sector if its citizens elect to do so.

Crandall rejected criticisms that his analysis may have underestimated benefits to consumers and businesses resulting from the unbundling measures. He maintained that the lack of increase in demand for phone lines was an observable fact. While conceding that productivity and innovation may have been marginally improved, he reiterated the lack of supporting evidence for either and maintained that even if such benefits existed they were heavily outweighed by the costs incurred by the legislation.

Keynote Address

F. Duane Ackerman
Bellsouth Corporation

F. Duane Ackerman focused on the history of the Telecommunications Act of 1996, his view of the bill's shortcomings, and improvements that could be made in new legislation. He argued that communications policy has only a loose connection to reality, damaging consumers, investors, and the economy. He stressed the importance of communications to a vast range of products, services, and security needs and deemed it unacceptable for the United States to be so far behind other developed countries in broadband penetration. He echoed earlier arguments that communications is a competitive industry offering several options and that regulation hinders investment and innovation.

Ackerman described his vision for new telecommunications legislation in terms of two general goals: The first is increasing competition and decreasing regulation. He conceded that some basic regulations would remain but called for a phasing out of unbundling requirements, as well as more equitably distributed support for social responsibility services such as emergency and disabled communication access. His second major goal is improving the universal coverage mechanism. He conceded that the public has come to expect universal service, but argued that the current system is unraveling requires overhaul. He recommended that the costs of universal coverage be distributed more evenly and fairly, supported in part by general tax revenue. Ackerman reiterated his belief that reducing regulation and revamping universal coverage would cut unnecessary social costs and yield significant economic gains.

AEI-Brookings Joint Center research assistant Jesse Gurman prepared this summary.