Part 2
Regulation and the Emerging Telecommunications Infrastructure



The National Academies | 500 Fifth St. N.W. | Washington, D.C. 20001
Copyright © National Academy of Sciences. All rights reserved.
Terms of Use and Privacy Statement



Below are the first 10 and last 10 pages of uncorrected machine-read text (when available) of this chapter, followed by the top 30 algorithmically extracted key phrases from the chapter as a whole.
Intended to provide our own search engines and external engines with highly rich, chapter-representative searchable text on the opening pages of each chapter. Because it is UNCORRECTED material, please consider the following text as a useful but insufficient proxy for the authoritative book pages.

Do not use for reproduction, copying, pasting, or reading; exclusively for search engines.

OCR for page 105
The Changing Nature of Telecommunications/Information Infrastructure Part 2 Regulation and the Emerging Telecommunications Infrastructure

OCR for page 105
The Changing Nature of Telecommunications/Information Infrastructure This page in the original is blank.

OCR for page 105
The Changing Nature of Telecommunications/Information Infrastructure Introduction to Part 2 Roger G. Noll National policy regarding the information infrastructure is often debated as if it were a novel idea; however, the current debate is in many ways old wine in new bottles. The backbone of the information sector of the economy—the telecommunications network—has been regulated by both national and state governments since the Bell system first perfected reasonably high quality long-distance interconnection in the first decade of the 20th century. From the beginning, at the center of the policy debate has been the importance of nationwide interexchange traffic to the welfare of consumers and the long-term economic growth of the nation. Thus, any attempt to implement a dramatic new initiative regarding the national telecommunications infrastructure must deal explicitly with the presence of an elaborate regulatory superstructure that, despite two decades of liberalization, still extensively controls the decisions of the most important players in the telecommunications industry regarding prices, investment, technology, and system integration. And, in the mid-1990s, many of the policy proposals for encouraging enhancements to the telecommunications infrastructure amount to recommended changes in regulatory rules and processes. The purpose of the papers in this section is to examine the role of regulatory policy in shaping the evolution of the nation's information infrastructure, with special attention being given to how regulation affects the rate and pattern of technological change. In both public discourse and the scholarly literature in law, economics, and political science, the debate about the merits of regulatory policy deals with two quite separate and distinct issues. The first is philosophical and deals with the legitimate uses of the coercive power of government. The second is more prosaically practical and deals with the actual effect of regulation on the performance of industry. Although this section deals primarily with the latter, we must first briefly deal with the former in order to clarify the range of issues of concern. REGULATION AND POLITICAL LEGITIMACY The first focus of debate about the merits of regulation concerns the enduring philosophical question about the legitimate boundaries to the use of the coercive powers of government. Regulation makes rules about how people can spend their incomes, use their wealth, and engage in transactions, and so infringes upon private property rights. From this fact has emerged a debate concerning whether regulatory policy goes too far, or not far enough, in making a trade-off between individual liberty and collective welfare. Thus, this form of the debate about regulatory policy deals with the principles that should be adopted through a nation's constitutional and legal system to define the proper role of the state in economic affairs.

OCR for page 105
The Changing Nature of Telecommunications/Information Infrastructure An important feature of this debate is that the instrumental value of regulation—its effects on the performance of regulated industries—plays a minor role. Causing the trains to run on time is not regarded as a compelling defense of fascism, for example, nor is the production efficiency of antebellum southern agriculture regarded as a serious argument against the Emancipation Proclamation. More importantly, this form of the debate about regulation is most likely incapable of resolution regarding such prosaic issues as how, or even whether, government should attempt to control the development of infrastructural industries. Whereas the philosophical debate about the proper scope of state interference with private property rights does provide a compelling case against the more outrageous forms of authoritarian government, it does not contribute much to the debate in advanced western democracies about the appropriate methods for making and implementing economic policy. Among advanced western countries, for example, although no nation leaves the sector totally unregulated or has nationalized every aspect of it, national telecommunications policy does vary from near laissez-faire (New Zealand, United Kingdom) to an extensive nationalized enterprise (France, Italy). One cannot convincingly argue that any of these nations have organized telecommunications policy in a morally indefensible way. Hence, because the philosophical debate about the proper scope of government is, and is likely to remain, unresolved among the range of policies that are likely to be considered in a modern western democracy, this aspect of the debate about regulation is largely irrelevant and forms no part of the analysis in the remainder of this section. INSTRUMENTAL ANALYSIS OF REGULATION The papers that follow examine the second focus of debate over regulatory policy, which is concerned with the instrumental value of regulation.1 At the most general level, the instrumental issue is how the presence of government supervision of an industry, regardless of the details, affects its performance. The existence of regulation redirects the time of a firm's management from ordinary business activities, such as production supervision, technological innovation, and customer relations, to dealing with and strategizing about political affairs and the regulatory process. An inherent feature of regulation is that, no matter how enlightened, it creates costs and affects the rate and pattern of technological change in an industry. Some specific instrumental issues are how the performance of the regulated industry depends on the details of regulatory policy, such as the decisions about who will be regulated, what powers will be given to the regulators, how the regulatory authority will be organized and what procedures it will be required to follow, which level of government will be responsible for each element of regulatory policy, and what role will be assigned to the courts in overseeing regulatory policy. In the case of telecommunications, examples of specific issues that have been especially prominent in recent years are the debates about the jurisdictional separation of regulation of prices and entry between the Federal Communications Commission (FCC) and state public utilities regulators, the continuing judicial intervention in structuring the market for telecommunications services and equipment arising from antitrust litigation, and methods for regulating prices by a monopolist (e.g., rate of return, price caps, residual pricing, and so on). The instrumental issues about regulation can be phrased in either a negative or a positive way. The negative version inquires about the extent to which regulatory policies and institutions distort the evolution of the telecommunications infrastructure, to the detriment of the welfare of society. The positive version seeks to identify ways that regulatory policy should be changed to improve the performance of a regulated industry. Of course, the way in which the question is put is primarily a rhetorical device, revealing more about the conclusion of the person addressing the issue than the actual nature of the debate. Regardless of how the issue is phrased, the core of the relevant

OCR for page 105
The Changing Nature of Telecommunications/Information Infrastructure policy debate is the following question: What will be the effect of different approaches to regulatory policy on the performance of regulated industry? SOME GENERAL CAVEATS By way of introduction to the papers that follow, the current debate about the national information infrastructure should be considered in the context of over a century of U.S. experience with regulatory policy in a variety of infrastructural industries. Economic regulation in the United States takes a peculiar form that is not found anywhere else in the world. It evolved as it did because of certain unique features of the U.S. political and legal system: the federalist system of government, the separation of powers among the three branches of government, the unusually strong role of the courts in the American system, and the specificity of certain rights in the U.S. Constitution, such as the guarantee of the sanctity of contracts, the protection against expropriation of property without compensation and due process of law, and the guarantees of free speech and freedom of the press. These special features of the U.S. system thwarted numerous attempts to establish economic regulation during the 19th century and continue to affect how regulation is implemented today. The first important consequence of the U.S. system of government is that it makes policymaking very difficult. A significant change in policy requires a statutory mandate, and statutes are very difficult to enact. Both houses of Congress and, in the absence of a two-thirds majority in either, the President, elected on the basis of different principles of representation, must agree before a statute can be passed. And, if someone then protests the new statute, the Supreme Court can declare it invalid—a power that was controversial at the time it was asserted by the court early in the 19th century, and that is shared by almost no other high court anywhere in the world. The second important consequence of the U.S. Constitution is the elaboration of economic protection accorded citizens in the Constitution, as enforced and interpreted by an especially powerful court. Numerous statutes, mostly enacted by states, have been overturned by the Supreme Court because they were judged to interfere with one or another constitutional provision. Judicial skepticism of regulatory interference with the private economy persisted into the early years of the New Deal, when, under the threat of increasing the size of the Supreme Court to accommodate a more interventionist political philosophy, the "switch in time to save nine" finally permitted extensive interventionist policies. But even the post-New Deal courts placed important constraints on economic regulation. These constraints have been derived from both constitutional principles of economic rights and the details of statutes that elaborate how the constitutional role of the courts and protection of individual rights should be embodied in the details of regulatory policymaking. Constitutional and statutory requirements impose substantial burdens on regulators to prove that their decisions are justified. Regulators bear a legal burden to show that their decisions are based on a constitutionally valid statutory mandate, and an evidentiary burden to show that their decisions are rational means to pursue a statutory objective and take into account all of the relevant facts and arguments presented by those who might be affected by the decision. Again, the structure of the Constitution has the effect of making policy change slow and difficult, and subject to veto by the courts. Moreover, these requirements advantage large business interests with a major financial stake in regulatory outcomes, because they are more likely to provide detailed evidence in support of their interests than are consumers and other less well-organized user groups, and more likely to appeal adverse regulatory decision to the courts.2 The history of telecommunications regulation illustrates these points. The origins of telecommunications regulation can be traced to the middle of the 19th century and the battle to establish railroad regulation.3 Many states attempted to regulate railroads for the purpose of eliminating the "long-haul, short-haul" price differential in railroad prices. Typically, railroads

OCR for page 105
The Changing Nature of Telecommunications/Information Infrastructure competed for long-haul traffic but were monopolists at intermediate rural terminals along their networks. Railroads exploited these local monopolies by charging far higher prices for shipments to and from these rural locations than for more competitive transportation between large urban centers. Except for a brief period between 1877 and 1886, the Supreme Court persistently declared as unconstitutional these attempts by states to deal with short-haul monopolies. In 1887, after the 1886 Wabash decision in which the Court declared all state regulation of any aspect of an interstate railroad to be an unconstitutional interference with interstate commerce, the federal government enacted the Interstate Commerce Act (ICA). This statute had two important elements. The ICA established federal regulation of railroads, and it gave states the authority to regulate railroad tariffs for shipments between terminals in the same state. Two decades later, the scope of the ICA was expanded to include telecommunications.4 The Mann-Elkins Act of 1910 enabled the Interstate Commerce Commission (ICC) to regulate the interstate portion of telecommunications; however, this business was then so inconsequential that the ICC ignored its new responsibility. The important effect of this extension of the statute was that it legalized state regulation of intrastate telecommunications. Then, in 1934, the Communications Act created a new institution to regulate the interstate portion of the industry, the Federal Communications Commission. But most of the telecommunications sections of the 1934 act were transferred wholesale from the ICA, despite many failed attempts within Congress to alter these provisions to match the differences in the technologies and market structures between railroads and telephones.5 In the ensuing decades, Congress has made numerous attempts to rewrite the Communications Act to reflect the realities of new technologies and changing market structures in the industry. Except for a handful of exceptions (laws dealing with satellites, cable television, and radio telephony), these attempts have failed. In 1994, Congress again failed to pass a reform bill (S. 1822, sponsored by Senator Ernest F. Hollings) that died in the Senate after passing overwhelmingly in the House. Consequently, the 1934 statute remains the basis for almost all telecommunications regulation today, including the scope and methods of regulation by the FCC and separation of authority between the FCC and the states. Thus, as the United States attempts to make policy about the information infrastructure of the 21st century, it does so in the context of a regulatory statute that was written in the 19th century to deal with local railroad monopolies. The significance of the U.S. courts is clearly evident in telecommunications regulatory policy. Most of the important changes in telecommunications regulation since the passage of the Communications Act of 1934 are the result of court decisions, rather than new statutes or policies adopted by the FCC. Examples are the Execunet6 decisions, which led to competition in ordinary long-distance telephone service, the restructuring of the industry in the settlement of U.S. v. AT&T,7 and the Louisiana8 decision, reversing 50 years of precedent to give more regulatory authority to the states over aspects of the local exchange that have a significant effect on interstate elements of the industry. The preceding history is crucial to understanding why the academic literature is so skeptical about the value of economic regulation, both in general and with respect to telecommunications. As an instrument of public policy, regulation—at least in the U.S. system of government—has inherent properties that limit its effectiveness. Regulation is intrinsically slow, and changing regulatory policy is extremely difficult. The U.S. system of government exalts the status of individuals and private property like no other, and so imposing costly rules on anyone is difficult. In the United States, policies are developed and changed by an elaborate process that is designed to protect individuals against significant, targeted economic harm by government, and to allow change only when a broad consensus supports it. Thus, regulation is especially problematic as an institution for channeling the development of an industry in which technology is evolving rapidly and involves an ever-changing cast of companies and user groups.9 The fact that the "information superhighway" of the 21st century is being constructed under the aegis of a 19th-century statute for regulating railroads is not the result of stupidity, corruption, or

OCR for page 105
The Changing Nature of Telecommunications/Information Infrastructure inattentiveness on the part of government, but a highly significant example of a fundamental feature of U.S. governance. The United States operates under a system that is based on a deep skepticism of government intervention in economic affairs and that makes rational national planning of industrial development extremely difficult. It is important to note that making industrial policy difficult and cumbersome, and hence less extensive, is not necessarily bad. To illustrate the point, consider the differences in the performance of the telecommunications sector in Japan and the United States10 In Japan, judicial supervision and authority over economic policy are far less extensive, and legislative and executive functions are not formally separated. As a result, the legislature can more easily change policies by statute, and the implementing bureaucracy is less constrained about the scope of its decisions. In 1986, the Japanese passed new laws that in many ways are very similar to the combination of court decisions and regulatory policies that took place in the United States in the previous two decades. By statute the Japanese created a structurally competitive telecommunications industry, but they retained their traditional system of ubiquitous government control over prices, investment, and entry into facilities-based telecommunications services. As a result, the number of facilities-based domestic telecommunications companies grew from 1 to 38 in 6 years, counting all satellite, wire, and over-the-air carriers. Because the core economic decisions of the industry continued to be controlled by the government, the new structural competition did not lead to real economic competition. The new entrants were permitted to charge much lower prices for dedicated circuits, which are typically purchased by very large, multifacility businesses; however, in other aspects of the industry companies were prohibited from competing on the basis of either price or the quality of service. The objectives of this policy were in part to allow more companies to participate in the lucrative telecommunications services business, and in part, like U.S. policy objectives, to encourage more rapid development of a ubiquitous, integrated, high-performance telecommunications infrastructure. By the criteria most Americans would use to evaluate the success of the Japanese policy change, the outcomes are not attractive. In 1992, a Japanese customer of telephone service paid about $560 for the installation of new telephone service, which is about 10 times the price charged for initial residential installations in the United States. Consequently, the number of telephones per capita in Japan is about 20 percent lower in Japan than in the United States. Thus, the more extensively regulated, less competitive system does a significantly worse job of achieving universal service. After paying $560, a Japanese residential subscriber paid about $20 a month for basic access service in 1992, but this service does not include any calling. In addition, a Japanese consumer paid 8 cents for each 3-minute interval of a local telephone call, a charge that has since risen to 15 cents. In addition, the Japanese consumer faces significantly higher prices for long-distance calls, especially for calls at distances over 100 miles. As a result of this pricing system, the Japanese use their telephone system much less intensively than do Americans. Minutes of use per line per year in Japan are about one-sixth the amount of usage in the United States. The Japanese place many fewer telephone calls and have much lower average connect time than is the case in the United States. Higher prices, lower penetration, and less usage in Japan obviously result in lower consumer welfare; however, the problems with Japanese telecommunications policy go beyond these effects. If an important social objective is to facilitate the introduction of new telecommunications services, the Japanese policy thwarts them. New services require more calls and connect time, and their ubiquitous availability requires universal service. The Japanese system accommodates neither, and so serves to retard the evolution of the Japanese information infrastructure in comparison to that in the United States. Japan differs from the United States in many respects other than the legal and institutional structure of industrial policy, and so broad conclusions drawn from these facts need to be strongly qualified. Nevertheless, a slow-moving but limited regulatory system, coupled with greater reliance

OCR for page 105
The Changing Nature of Telecommunications/Information Infrastructure on competition, actually produces relatively good performance in comparison with the systems in other advanced, industrialized nations. IMPLICATIONS FOR EVALUATING REGULATORY STRATEGIES Of course, the preceding observations do not fully resolve the debate about regulation. Regardless of the problems associated with regulation, both citizens and government officials will seek to interfere with private economic decisions if they believe that these decisions do not adequately take into account important collective values. Although regulation has inherent features that limit its effectiveness, these effects are only one part of a larger concern. Inherently imperfect regulation can be better than nothing when dealing with a firmly entrenched monopoly or an economic activity that imposes significant social costs, such as creating pollution. This introduction is intended to make a simple point that is often overlooked in the debate about regulatory policy: citing a meritorious policy objective is not sufficient to justify the conclusion that regulation is warranted. Moreover, even a strong case for a serious market failure leaves another important issue unaddressed: how to design the details of regulation to ameliorate to the maximum feasible extent the inherent infirmities of the regulatory process. Questions about how best to divide jurisdiction between federal and state authorities, or between regulators and the courts, and about what principles to adopt in controlling prices and service attributes, must be answered in part on the basis of their feasibility in the U.S. legal and political system. Because the process of policymaking is important in the American system, the instrumental value of regulatory policies is often strongly influenced by the details of its implementation. An important illustration of these points is the ongoing debate about cable television regulation. In 1992, Congress enacted a statute, over presidential veto, to reregulate cable television. A veto-proof two-thirds majority was obtained by constructing an elaborate statute, carefully defining what could and could not be regulated, how regulation was to be implemented, and who was to implement each aspect of regulation among the FCC, states, and local government. A year later, the FCC implemented the statute by issuing detailed pricing rules and a process for certifying local regulation. On the basis of initial studies, the effects of this elaborate process appear to have been minimal. Some prices went up, others went down, but on average the changes were small. Most local governments have decided not to attempt to become certified regulators, regarding the cost as not worth the candle. The main observable effect has been a reshuffling of the channel numbers assigned to various programmers, a step necessary for most cable systems to minimize the effect of the new rules on their total revenues from subscribers. At the heart of the new cable regulations was an important economic fact: cable television systems are enormously profitable, selling for several times their construction costs, because typically they have considerable monopoly power. But the question posed by the history of the construction and implementation of the 1992 statute is whether any cable regulatory system that is politically feasible and constitutionally valid can yield benefits that exceed its costs. Thus far, the preliminary results indicate that the answer is no, even though cable does enjoy revenues that substantially exceed the economic costs of service. The problem with cable regulation is not the validity of the objective, but the thus-far unsolved problem of implementing a regulatory system that can make significant progress in achieving that objective. Of course, the cable lesson does not translate directly to telecommunications. Cable is a far less important industry than telecommunications, at least for now. Unlike telecommunications, cable is not an important factor determining the performance of many other rapidly growing, high-technology industries, and for consumers cable does not yet offer the highly valued, almost indispensable services that are accessible only through the telephone. Thus,

OCR for page 105
The Changing Nature of Telecommunications/Information Infrastructure the prospective benefits of telecommunications regulation are larger and would justify considerable inefficiency in an imperfect regulatory system. Nevertheless, the cable debate makes clear the preference for competition rather than regulation that is expressed by numerous observers of the communications industry. The experience with cable adds weight to the argument that easing the entry of direct broadcast satellites, of off-air digital distribution systems, and even of second cable companies or telephone companies into the cable business will do a better job than regulation in holding down cable prices and expanding service offerings to consumers. Likewise, the cable experience raises important questions about whether the promotion of competition, perhaps accompanied by some direct, targeted subsidies for particular users, will do a better job than regulation of encouraging the development of the information superhighway of the 21st century. Congress, the FCC, the Justice Department's Antitrust Division, and the courts have before them numerous proposals to restructure telecommunications regulation. The failed Hollings bill combined with alternative proposals from Republican Senate leader Robert Dole will continue to be live legislative issues in the next session of Congress. Two competing visions of the future are embodied in these legislative proposals. One (Hollings) formalizes the importance of competition policy by placing a burden of proof on Bell operating companies for having their line-of-business restrictions removed, reestablishes the preLouisiana preemption authority of the FCC, and legislates a broad universal service requirement that, among other things, requires all telecommunications carriers to subsidize service to various educational and nonprofit institutions. The other (Dole) imagines a smaller role for federal intervention, eliminating the line-of-business restrictions without further requirements, and all but deregulating interstate service and interconnection among carriers.11 Nevertheless, these two bills share two important policies. First, both proposals would establish a tax on all telecommunications services for the purpose of subsidizing local exchange service in smaller communities. Second, both would eliminate restrictions against entry into local exchange service, including prohibitions against entry by cable television and other utility companies. (In Japan, electric utilities have been an important source of entry into facilities-based telecommunications services.) Meanwhile, significant restructuring proposals have been submitted to the Antitrust Division, the FCC, and the D.C. District Court that oversees the divestiture decree. These proposals involve the movement of local exchange carriers into long distance and manufacturing, and of long-distance carriers into local access. In the summer of 1994, the Antitrust Division allowed AT&T back into the local access business by allowing the merger of AT&T and McCaw Cellular, the nation's largest radio telephone company, after insisting that McCaw provide equal access to all long-distance carriers and that AT&T continue to supply cellular system equipment to McCaw's competitors on a nondiscriminatory basis. Later in the fall, implementing 1992 legislation that will eventually allow a competitive radio telephone industry, the FCC auctioned new spectrum for radio telephone services, which is expected to lead to the entry of several new access providers in all major metropolitan areas. Facing some access competition already in the downtown areas of large cities, and much more potential competition from radio telephony and, conceivably, cable television, some local exchange carriers have proposed deals that would allow them to enter manufacturing and long distance, both of which would increase the chance that they could be more effective competitors in markets for information services. The most imaginative of these proposals comes from Ameritech, the regional Bell operating company in the Great Lakes region. Ameritech proposes complete unbundling of the elements of local service and relaxing all regulatory barriers to the entry of competitive access providers in return for eliminating its line-of-business restrictions. Unbundling, accompanied with realistic, cost-based prices, would enable competitors to enter the local access market by leasing and reselling elements of the Ameritech network in combination with their own

OCR for page 105
The Changing Nature of Telecommunications/Information Infrastructure facilities. For example, MCI might lease copper wire connections between households and the local central office, but at that point branch the connections to its own local switch rather than use Ameritech's switch, and might provide metropolitan interexchange service by building some of its own trunks between switches, but leasing some trunk capacity from Ameritech. All of these proposals share a new vision of local access: because of encouraging prospects for radio telephony, independent local networks (most private, but a few public), cable television, other utility companies, and extension of the reach of long-distance carriers, local access ought not to be a protected monopoly, and may some day be reasonably competitive—and, perhaps, even unregulated. Disagreements arise about exactly when each type of company should be permitted into which markets and under what conditions, and about how to define, and to pay for, universal service. But the present reality is that more than half of investments in telecommunications networks are now being made for local systems other than the traditional monopoly local exchange network, and the political system, at least at the federal level, has pretty much reached accord that this diversity should be facilitated rather than retarded. VARYING VIEWS ON REGULATION The papers that follow provide a range of views about these developments, the prospects for competition in all elements of the industry, and the ways that federal and state regulators are responding to them. Robert Crandall summarizes the objectives and performance of telecommunications regulation. He points out that the objectives of regulation are more complex than simply protecting consumers against monopoly, and in particular that the objective of fairness—all citizens should have access to approximately the same range of services at roughly the same prices—conflicts with giving service providers proper incentives for operating efficiently and adopting warranted new technologies. Because of this conflict, regulation often is the primary barrier to competitive entry, made so because regulators fear that entry will upset the fairness of the system. Crandall explains that this sacrifice of efficiency for fairness is becoming increasingly costly as telecommunications technology progresses, and he advocates regulatory reforms that minimize the scope of regulation and, where regulation is necessary because of market power, that accord greater weight to economic efficiency. Robert Harris picks up Crandall's themes about the growing importance of an efficient telecommunications system and the desirability of less extensive regulation. According to Harris, telecommunications must be seen as part of an overall strategy for economic growth, much as railroads were a primary engine of economic development in the 19th century. The rationale for government intervention is gradually shifting from protecting consumers against monopoly to assuring complete interconnection, including among competitive carriers. The latter concern arises because the network is more valuable to each user as the number of accessible people and businesses increases. Harris concludes with a survey of regulatory reform activities in several states that appear to be placing a greater emphasis on efficiency, and in some cases to be proactively procompetitive. Dale Hatfield addresses the issue of competition between local telephone and cable television companies. Because of fundamental structural differences in the nature of these two local networks, Hatfield concludes that neither is likely to become an important competitor to the other in the next few years. Hatfield expresses concern that the movement by Bell operating companies into video services will be expensive and will be driven more by the distorting effects of regulation than by any efficiency or procompetitive advantage flowing from such entry. Nina Cornell focuses on the precise nature of the bottleneck monopoly enjoyed by local access providers. Cornell's main theme is that as long as local exchange carriers have control over termination, they will have market power over the entire network. And, according to Cornell,

OCR for page 105
The Changing Nature of Telecommunications/Information Infrastructure historical experience teaches that control over termination has inevitably led to actions to extend the monopoly to other elements of the industry. Thus, for a procompetitive, free-entry regime to work, policy must succeed in making both originating and terminating access competitive. To do so will require unbundling of termination and efficient pricing of the unbundled elements. Moreover, the pricing regime will require more than price-cap regulation, since price caps do not prevent, and sometimes reward, strategic pricing to harm competitors. Thomas Long expresses the common concerns of consumer advocates about the diversification of telephone companies and the adoption of efficient pricing systems for local access. The essence of Long's concern is that network upgrades for the few or that may not be efficient for anyone will lead to higher prices for all consumers. Reliance on access competition to prevent this outcome is, in Long's view, unrealistic, and regulators seem prone to believing that there is more competition than in fact exists. Long believes that allocating some of the fixed costs of the local network to services other than basic access is the best safeguard against consumers becoming involuntary investors in high-technology services that they do not want or need. Bridger Mitchell's paper clarifies the economics of local telephone networks, and in particular the concepts of subsidy that are relevant for policymakers. Cross-subsidy occurs when, given current prices, other customers and the network supplier would be better off if a service were abandoned. Basically, this means that a service is not being subsidized if its price exceed the incremental cost of service. Mitchell than examines the cost structure of California local access companies to ascertain exactly who is and is not subsidized. Mitchell's work indicates that: Flat-rate residential service is probably economically efficient (the gains from measured rates are more than offset by the measuring and billing costs); Because local access costs are driven primarily by the distance of customers to the local switch, state-wide rate averaging subsidizes customers in sparsely populated areas and discourages the efficient adoption of radio telephony rather than wirelines as the means of providing access in rural areas; and The incremental cost of service is less than half of the average cost, indicating that in most areas wireline access is a natural monopoly and that most residential subscribers are not being subsidized. Eli Noam provides a conceptual framework for understanding how regulatory issues evolve over the life of a communications network. Initially, because of economies of scale and the fact that each consumer values the network more highly as it acquires more customers (the ''network externality"), the primary issue is promoting the growth of the system. This phenomenon applied to basic access for the early history of telephony, and applies today to new capabilities such as Internet and, perhaps, digital transmission. Once these scale and externality factors become less important, the primary policy issues shifts—to promoting competition and mandatory interconnection where warranted, but to protecting "cream-skimming" entry driven not by efficiency but by price distortions arising from the "fairness" objective. Finally, in the late stage of a system, costs are rising and further expansion of the system is not worthwhile, and policy focuses more on encouraging migration to another, usually more advanced system and making certain that those with investments in the old system do not succeed in artificially maintaining its dominance by erecting barriers to entry—including regulatory, legal, and political barriers. Collectively, the papers in this section reflect the dilemma of regulatory policy as technology and market structure rapidly evolve in the telecommunications industry. The core economic uncertainty is how important the new technologies will be, whether that importance is limited to a minority of sophisticated customers or a large fraction of the businesses and residences in the

OCR for page 105
The Changing Nature of Telecommunications/Information Infrastructure FIGURE 4A Cost and benefits in relation to increasing availability of telecommunications services. P=AC, price = average cost; U(n), utility as a function of the number of users. FIGURE 4B Three issues basic to provision of telecommunications services. Thus, the economic incentives can be in favor of being the second, not the first, entrant. There will be less early investment, and some of the funds necessary to create a critical mass of users might have to come from outside. In Washington and elsewhere, this is an approach technologists are advocating. Many would like to see an injection of government money to deal with the critical mass problem. But subsidies are not the only alternative. There are essentially three ways to deal with the critical mass problem. One approach for the government is to do nothing and let markets function independently. The second approach is to deal with the cost curve by reducing the initial cost of supplying the service. A final strategy involves demand-side policy, which implies increasing the utility curve by enhancing the value of the fixed services.

OCR for page 105
The Changing Nature of Telecommunications/Information Infrastructure The National Science Foundation, by supporting the "industrial policy" approach in the Internet, has both increased demand and reduced cost. Typically, in the United States and elsewhere, the approach has been to concentrate on developing the supply side of the graph (Figure 4A)—for example, by aiding the carriers that would do the upgrading. The alternative, supporting users at the demand side and thus reaching a critical mass, can be done by partly supporting leading-edge, technology-driven uses and also community-based applications. This is where the libraries and schools come in; they do not use leading-edge-technology, supply-side applications but rather demand-side, low-sophistication applications. The second problem is indicated on the far right of Figure 4A,B, and it concerns universal service. Here the problem is that, because of competition, the network cannot maintain an internal subsidization scheme as in the past with some users subsidizing other users. When entry is free, the new competitors first target the users presenting the largest potential profits, and eventually the support system vanishes. To prevent such a collapse, a very elaborate system of access charges has been established. It is a system that is so opaque that hardly anyone can understand its workings. But in a democratic society there should be accountability, with an understanding about who is paying whom and how much. There is a relationship between the critical mass and universal service problems. We will never get to the latter without having solved the former. However, it will be harder and will take longer for critical mass to be created unless there is also a willingness to deal with the universal service issue. Consider the Burns-Dole-Gore bill of a few years ago. In essence it said that in order for the government to aid (i.e., to support) by regulation the upgrade of the telecommunications network from copper-wire to fiber (the creation of a critical mass issue), it would also have to ensure that the rural United States would not be left behind (the universal service problem). In other words, it is not realistic to assume that Congress will pour money into the first problem without having some assurances that the universal service side of the network will also be taken care of. The universal service issue is not going to go away. Some are convinced that competition will take care of any problems that arise. However, they are confused about the difference between allocation distribution and production efficiencies. Competition will increase production efficiencies. It will not, however, resolve issues of distribution. The fact that food growing and processing are competitive and efficient does not respond to the question of how to feed the poor. Even though it is possible to reduce marginal cost and the absolute number of people not served by market forces acting alone, the universal service issue is not fully addressed that way. There are positive externalities to adding to the network, as depicted by the upward-sloping curve in Figure 4A. One alternative funding mechanism for universal service is a system that charges all carriers in proportion to their net transmission revenues and credits them for already existing contributions to universal service. The money would go to categories of customers designated by the political system. They would get vouchers for their subsidies and be able to select their own carrier. Competition for such customers would force the carriers to be efficient. Carriers serving low-density areas could also be benefited, although not on an exclusive basis. A further problem is represented by the middle range of Figure 4A,B. A competitive environment for telecommunications involves a complex arrangement of carriers providing services for different segments of the market: local, mobile, long distance, and international, in addition to vendors of hardware and software. In such a complex carrier system, specialized "systems integrators" will invariably emerge to put together packages of services. This is already happening today for large customers, and will most likely be available to smaller customers in the future. A restructuring plan by the Rochester Telephone Company is going in this direction by separating the service function from the network carrier function.

OCR for page 105
The Changing Nature of Telecommunications/Information Infrastructure These systems integrators will effectively undercut the underlying carriers. The basic economic reason is that in a competitive market, the integrators get the services and can resell them at marginal cost, while the carrier has to bear the full cost per unit, including an allocation of fixed costs. Since in network industries with large economies of scale the marginal cost will be below the average cost, the integrator will economically outperform the carrier providing the underlying service. Several things will therefore happen. One is that the whole notion of common carriage, which is based on similar conditions of service for similarly situated customers, will break down because the common carrier cannot compete against a systems integrator or contract carrier that can price-differentiate and select customers. Secondly, to the extent that the common carrier cannot recover its full cost, there will be underinvestment in the network infrastructure itself. In the future, policymakers will have to deal with the question of how the network system can maintain its financing in a situation like this. In a competitive environment of carriers, systems integrators make unnecessary many of today's regulatory interventions. For example, price regulation becomes largely irrelevant because systems integrators will shop for the best deal for their customers and will compete among themselves for those customers. But what is not going to go away under competition is the universal service issue, and the common carrier (open access) issues. Interconnection problems are also likely to remain in this environment. The final question is how to reform the existing regulatory system to deal with future issues. Although many people believe that state regulators are part of the problem, it is important to recognize that the decentralized reform process has worked reasonably well in the United States. The Japanese, French, and Germans, all of whom have a centralized decision-making process, have taken decades to reach what a decentralized system has accomplished much faster. Regulatory reform in the United States might not be a logical progression based on a national blueprint, but in most other places these blueprints have taken long to draft and are invariably timid. The United States, using a decentralized mechanism, has been able to reform its telecommunications system quite well. Those who believe that a decentralized Adam Smith-type mechanism is working well in decision making in the sphere of economics should not reject out of hand the same mechanism for decentralized decision making in the political sphere. In conclusion, liberalization of telecommunications does not mean libertarianism. Many regulatory issues will go away, but others will persist in new forms and new ones will emerge, as discussed. For better or worse, government will not vanish from this sector; the challenge is to orient it toward an open future.

OCR for page 105
The Changing Nature of Telecommunications/Information Infrastructure Discussion BRIAN KAHIN: I want to pick up on Nina Cornell's concerns about interconnection and the issue of the government's role. It is worth bringing up because it is very often overlooked. It is not even mentioned in the administration's information infrastructure document. The NSF [National Science Foundation] is involved in the program to restructure the NSFNET, which is in effect unbundling the NSFNET as it exists today so that NSF is no longer providing a single package in its main contract but has broken out the different roles of routing arbiter, a very high speed backbone that will be very restricted in use, and the newly conceptualized NAP [network access point]. In principle the NAP is an exchange or switch where anybody can interconnect, and it is a way to get onto the very high speed backbone if you have the right to do that. It is not clear how many NAPs there are going to be. NSF is going to fund them, and so we have the government funding something that is not subject to an acceptable use policy but that is general-purpose infrastructure investment. To what extent will this architecture catalyze the larger infrastructure? How will the commercial Internet crystallize around this concept? I wonder if we are seeing an inversion of the paradigm from the network as a carrier to the switch as a carrier and what that means for understanding the cost-price differential, because it seems to me it is a lot easier to get at that when the carrier is as simple as a switch. That is not going to solve the "last-mile" problem, but it might be progress. ROBERT CRANDALL: I still have some difficulty with imagining what the network or networks of the future are going to look like. I do not see any reason why there is one network, given what we know about what is happening to transmission switching costs. I can imagine lots of different networks into which I could connect with a piece of terminal equipment that has a set of switches that can connect me to lots of different networks and lots of different nodes. One of the problems of this discussion is that it is based on what we know is the current network, the current public switched network developed under regulation. One of the things we know about other industries is that once we deregulate, the technology changes and market organizations change in ways we could not possibly predict. In fact, it may be that regulation is condemning us to one particular model that is incredibly inefficient. KAHIN: Also, the network that we have been focused on is a homogeneous network, whereas now, especially in the Internet, we are entering an environment of heterogeneous networks, where the networks all differ in capability and functionality and speed. CRANDALL: That is right, but there could be a bunch of different backbones, too, not only a bunch of different LANs [local area networks]. ALFRED AHO: This panel spoke of some of the experiences learned from regulation in Japan. In the United Kingdom, there is ongoing competition between the telephone companies and

OCR for page 105
The Changing Nature of Telecommunications/Information Infrastructure the cable companies. Are there any lessons that we can learn from regulation in the United Kingdom? CRANDALL: I do not know much about what has happened with cable versus telco competition, but they have admitted that going from one carrier to two carriers—but making sure there was not a third, fourth, fifth, or sixth carrier—was a mistake, that a duopoly was not much better than a monopoly if it was protected by regulators from entry. ROGER NOLL: In the United Kingdom the regulatory system itself has not led to competition of the form that we think of in most of the U.S. system. It has led to a somewhat better but nonetheless regulated system whose prices are somewhat better than they were but are not as low as ours. Bob, do you want to talk about that? ROBERT HARRIS: Yes, just very briefly. The joint offering of telephony and cable entertainment services in the United Kingdom is very different because they basically did not have a cable system. The cable system being deployed was originally designed and engineered to provide both telephony and video and hence does not have a lot of the problems that Dale Hatfield talked about that the U.S. cable system has. It does suggest, however, that as we modernize cable plants in the United States, they can perhaps be reengineered if enough cable operators get the idea that there may be a market for telephonic-type services. But in comparing a de novo situation in Britain to an existing cable plant in the United States, I think you had better be very careful about any kind of lessons you draw from one to the other. NOLL: I think the main lesson Americans have tried to draw from the United Kingdom concerns how they regulate prices, and there are two lessons to draw on. The first is that they have price regulation; that is to say, all prices taken together, indexed, are capped by the rate of inflation minus 3 percent. It turns out that that system has demonstrated two important principles. The first is that the rate of technological change and advances in productivity inside British Telecom substantially exceeded historical experience, and the second is that the politics of the system requires that they change the rule to make prices fall even faster. That is to say, the second important lesson is that the notion that you can have price regulation that leads to better price performance but enormous profits of the regulated utility is obviously incorrect on the basis of the experience in Britain. COLIN CROOK: One interesting early indication in the United Kingdom in the cable area is that when the cable companies had basic telephony on the cable system, the turnover on the cable side went down to essentially zero. People will not disconnect their telephones like they will disconnect their cable systems, so some very interesting business is going to be lining up when we start to merge these areas together, I would forecast. GEORGE GILDER: Two questions. First, it seems to me that digital wireless technology is going to destroy that differential between the cost of rural and urban service almost entirely, and I wonder what Dale Hatfield, for example, thinks about that prospect and what its effect will be. Second, it seems to me that the price of nodes drops about 50 percent every 18 months and that they just multiply increasingly and that nodes are no longer a bottleneck. Nodes are dropping radically in price and moving rapidly to the fringes of all the networks, so the nodes are really in the command of all the users rather than in the command of the transport people, and I wonder how this process is going to affect the vision of the node as a bottleneck that allows monopoly power to be exercised. DALE HATFIELD: Let me comment first on wireless. I think that there are some very attractive possibilities with wireless, so I think you are absolutely on the right track. However, you are still faced with most of those other issues I talked about, the terms and conditions of interconnection with the existing carrier and so forth. Also, there are probably some bandwidth issues, perhaps obviously less in rural areas, but to the extent that we are getting more bandwidth-intensive applications, even fairly generous spectrum allocations tend to look not quite so generous, and then I would also say it is not clear to me how all this will sort out.

OCR for page 105
The Changing Nature of Telecommunications/Information Infrastructure At one time, I looked on cellular as perhaps having some prospects, but it ended up being in relatively concentrated hands. With the spectrum that the [Federal Communications] Commission has now set aside for PCSs [personal communication systems], it is not clear to me who is going to end up winning that spectrum, and it is not clear to me that we will even then have a fully competitive marketplace. Generally the conclusions that I had before, which I could summarize by saying I am uncertain, still hold: I am still uncertain, even with the prospects of wireless, for those reasons. NINA CORNELL: I think there is one thing that is not well recognized. Radio may help with the rural-urban distinction, assuming you solve the bandwidth problems and the concentration problems. But to serve a location like the one where I live, you are talking about having to put in a number of radio transmitters to serve essentially 10 households, and so you are still going to have a very high cost per household because there is very little sharing of a particular set of technology. So you are still going to have that same phenomenon of, if you pardon the expression, "diseconomies of scale" for rural, because even though there are a few lovely places, probably in South Dakota and Nebraska, where they can go long hops and not meet mountains and convoluted terrain, a lot of the most sparsely populated areas happen to be in the mountains. The second thing about nodes is that it is not that the price or cost of nodes is so high; it is literally that they are—despite price, despite cost—a bottleneck because you have to get from the node to the end user. It is that link, if you will, and its connection at the node, that has been used so successfully—and continues to be able to be used so successfully—to control the system if there is not some regulatory control in the broad sense over how it is used and what the prices are. Even if I had continued to live in downtown Washington, I would not have the ability to call up and say, "Please connect my local loop to somebody else's node tomorrow. I have changed my mind." VINTON CERF: There are a number of reasons for regulating. The obvious one that comes up is abuse of monopoly power, but let me ask you, Nina, whether you sense other reasons for regulating, especially in this new information infrastructure environment, other than to avoid abuse of monopoly. Is there a public interest, a public good that needs to be protected, which is not necessarily subject to abuse by monopoly power? CORNELL: That is a tough one. I sit wrestling in a very personal way with the whole issue of rural telecommunications. Those of you who know me know that I live 20 miles outside of a town that has 362 people and the nearest city of any size is at least a three-hour drive away. I happen to believe it would be a very bad idea to see rural America disconnected from the network, and I am concerned about that. At the same time I can tell you that having looked up close and personally at the "subsidy" mechanisms, and having discovered that their present value is about to be handed to US West as a gift as they walk away, I am not very convinced that we are doing a very good job of it. Maybe it would be better if entry were permitted. I would love it if somebody wanted to do a voucher system so that it is not capitalized and given away, but I do not know the real answers to that. I am concerned about Eli Noam's third bubble, the universal service one [Figure 4A,B], because I am concerned about disconnecting—not me but everybody in the community around me—from the entire national network, which is, in fact, a real threat at the moment. GEORGE TURIN: I need some help here. Let me start with a disclaimer. I am not now, nor have I ever been, an economist, so I really need some help. Everything I have heard from this panel, even from those who defend some aspect of regulation, seems to be in the direction that regulation will stop entities from doing things that they might do if the free market had total play, and those things that they might do might be bad, so regulation has some role. That seems a very reactive statement about regulation. On the other hand, we heard in the first session this morning from several user communities, three out of four of which are going to need some real help. Now, here is where I need some help myself. Tomorrow's session concerns government investment. Is positive government investment

OCR for page 105
The Changing Nature of Telecommunications/Information Infrastructure the only way that those user communities are going to get help? Is there no way that regulation per se can act as a proactive force to help user communities that may be disenfranchised in some way—such as the library, education, and health care communities? NOLL: Who would like to speak for using regulation to help health care? CORNELL: Some of the kinds of concerns raised this morning were flat-out government: government pays for education, textbooks, and school buildings, and if pipes to the Internet are important, government should pay for that. But in the drive to price everything in telecommunications usage-sensitively versus flat rate is an issue that has some major implications, I think, for education, health care, and libraries. In that regard, there are some interests and some questions, and I do not think these are issues of subsidies. I was encouraged when Bridger Mitchell said he was not certain that flat-rate pricing was inefficient, because like one of the blind people trying to identify an elephant from a particular peculiar piece, I see measured usage often being used as a way to try to curb entry and to create barriers to use rather than being really efficient. I think there are some issues regarding flat-rate versus usage-sensitive pricing, particularly at the local level. It is a peculiar situation, particularly in the case of education and public libraries. We do view those as things we fund publicly, and so the issue is not really subsidy. The issue is funding, but I think, as I said, there is a different issue in regulation there. CRANDALL: I do not know anything about libraries, but if you think about public education and the health care sector, you think of two institutions in our society that are starved for funds. I think what is wrong there is the incentive systems—there is no incentive to be efficient or to adapt to the right technology. I do not see any reason why government subsidies for infrastructure would improve their performance in any way. NOLL: I agree, but in a certain sense the issue still is the reason that the educational system or the library system would choose to allocate as it has all of its previous budget increases. Recently there have been vast reductions in budgets for libraries, but the elementary and secondary education system budget has been growing in real terms for most of the post-war period but has by choice not been invested in telecommunications. Now, the explanation for that could be, as Eli Noam put it, a critical mass problem. But it is hard to imagine a state the size of California or New York having a critical mass problem. In California, the state educational budget is determined by the state legislature. The funding is all centralized, and the state could in fact take 3 or 4 percent of the educational budget and invest it in telecommunications for educational systems, but it has chosen not to. I think that before you get to George Turin's issue, you have to identify exactly why telecommunications hasn't been invested in for education and what the problem is for which we are trying to find a solution. In principle that is an enormous public-sector activity that does not choose to buy textbooks, let alone to invest in telecommunications. It chooses to do other things, and if the world is such that the politics of education selects against the delivery of information to students in favor of something else, it is exactly the same politics that will drive a regulatory institution. They are not separate. They are run by the same state legislature and governor. So what is it that regulation can solve that the state-centered budgeting of education cannot solve? TURIN: So in short form, the answer is no. NOLL: Yes. LAURA BREEDEN: I am the executive director of FARNET, which is an association of Internet service providers. I am neither an economist nor a political scientist, but I did have to do this for a long time using some government money and some money that we got from clients, so I have a certain practical feel for these issues. I do not know what the right answer is in terms of regulation, but I can tell you that when you sit down to do your business plan or your budget for the year, what you are looking at is a huge expenditure on lines. The cost of those lines for the long-haul sections has gone down and down. In fact, it does not much matter whether you are calling from Boston to Syracuse or Boston to San Francisco; it is

OCR for page 105
The Changing Nature of Telecommunications/Information Infrastructure still 22, 23, 24 cents a minute. The real cost is in the local loop facilities, which have not been deregulated. So when I hear someone ask if regulation is going to make a difference, I look at long distance and say, ''Has regulation made a difference in the price of service?" I am one of the systems integrators. The world that I come from is the world of the systems integrator, where you buy the raw material, in this case the transport, from the phone company or from the bypass vendor and then you add value, the routers and Internet service, and so forth. So can regulation help? Deregulation can help. Deregulation might bring the cost of the local loop down so that you are not looking at $37,000 for an Internet connection, $20,000 of which is in the local loop, which is an artificially high cost. Maybe deregulation is a form of regulation. Maybe that is the answer. NOLL: I am going to add one more item to the program and then we will go to discussion from the floor. Notice it was mentioned by both Tom Long and Eli Noam in their discussions that an important element of policymaking is to figure out what the costs are, not only of the existing system but also of alternatives. To my knowledge by far the most comprehensive and best study of the costs of the telecommunications system under the current technology was performed by a group at the Rand Corporation led by Bridger Mitchell, so I have asked Bridger to tell us briefly the basic story of that study. BRIDGER MITCHELL: I think Tom Long really raised one of the key questions by saying one of the fundamental issues is how to share a common cost, a cost that the telecommunications must incur in order to provide a whole range of services. Much of the debate in the regulatory commissions and the policy community has been confused; it has been about allocating that common cost among one or the other or several services. But the correct question in terms of a pure cross-subsidy is whether the prices are so low that the firm and the remainder of its customers would be better off by not supplying a particular group or a particular service. If the firm's actual net costs would go down or its net profit would go up by getting rid of the service, getting rid of the set of consumers, then that would be a cross-subsidy. Several years ago, the California Public Utilities Commission joined forces with Pacific Bell and GTE in California and Rand to actually look at the technologies for delivering current-generation access and local exchange service. They put together a building block model, as it were, of the technology that is in use there and pretty much throughout the country and using data from California. Now, what came out of this? We were looking at the cost of adding subscribers to the existing network where the telephone system was already operating or adding additional usage by subscribers who were already on the network. And the basic findings that I would summarize here are that most of the costs of additional use or additional subscribers are fixed on a per-subscriber basis when one is looking at access to the network and use in the immediate local environment. The variable costs that come out are primarily driven by the need to have additional capacity for peak or busy-hour utilization in order to provide and maintain quality of service. So one consequence of that is that flat-rate service for local calling, immediate local areas, does not look terribly inefficient when most of the costs of additional usage are primarily driven by peak-hour capacity. Another basic finding in that study is that the variation in costs across the state are driven primarily by the distance of the subscriber from the local switching center or the local wire center, and so rate averaging is discouraging entry in the high-cost, predominantly rural or suburban communities. Finally, incremental cost, which is really the numbers we were looking at, is substantially below the average cost of the total plant if you were to build the local exchange from the ground up. That would suggest that on a statewide average, incremental costs are considerably below the $25-per-subscriber-per-month number that was being used in these filings. NOLL: Just to put an important point on it, if you ask what is really subsidized, the bottom-line answer is, telephone services in small communities and rural areas, from the point of view of what the economist defines as a subsidy (which is actually paying less than the incremental cost of the service provided). So the really important point here regarding the debate about pricing

OCR for page 105
The Changing Nature of Telecommunications/Information Infrastructure and cost allocation is that there is a hunk of costs arising from the sort of economies of scale in the local telecommunications system and there is a fixed cost, so that the regulatory process becomes the mechanism whereby people fight out that battle in a legalistic and political sense about who is going to bear what cost. The outcome is that it is not the case that large numbers of people end up with subsidies. It is the case that rural areas and small towns end up with subsidies, but everybody else is basically paying more than their incremental cost. There are economics we could then bring to bear concerning how you divide up that fixed cost most efficiently, but the problem is not really lots and lots of people getting subsidies. The problem is the fundamental conflict that was represented in the session between the technical and economic features of the industry to begin with and the political determination of how the cost of the system will be borne. CHARLES JACKSON: Mr. Long, you stated, if I recall correctly, that the cost of the local loop should not be allocated just to basic service, and we have heard people talk about unbundling. Several questions here were about unbundling. I live in Maryland. In Maryland a company called MFSI has applied to offer competitive local exchange service, at least in Maryland, to business and government. I will quote from one of their filings: "MFSI proposes that C&P [the local exchange carrier] be required to allocate the costs of providing dial-tone lines between two fundamental functions, links and ports, and to tariff separate unbundled rate elements for links and ports." My first question, as a consumer advocate, is whether Maryland should approve or deny MFSI's request for such unbundling, and if they do unbundle, with or without your approval, whether all the cost of loops should be allocated to links and whether C&P should be allowed to geographically de-average link costs or should be required to maintain some sort of statewide average pricing of these things facing business or competitors? THOMAS LONG: You will have to excuse me. I am not quite sure what MFSI meant. NOLL: The idea being that somebody could get into the business of taking the C&P copper-wire loops but then connecting them to their own switch instead of the C&P switch. Or the alternative option. LONG: I am afraid you have stumped me for now. I want to think about it. HATFIELD: I would just add an anecdote. If you go back in the course of early history that we talked about, you find there were far more lines in the United States. One of the reasons we had rapid roll-out of telephone service is in part because farmers constructed their own lines and connected them to an existing switch in town. In this discussion, we have done a 360. We are back to the idea that maybe farmers should be able to construct their own lines and connect to an existing switch. NOLL: I think the question about de-averaging is really crucial, because it not only is the loops versus ports story, it is that within the same town, some people are going to be 100 yards from their first switch and some are going to be 5 miles. Concerning Bob's point about the network architecture being not necessarily the most efficient, the only way to find out if the current arrangement is the most efficient is to have a relatively small number of very large switches in cities with lots of people connected a long way away from them, and then to charge the people who are 5 miles away ten times as much for telephone service as the people who are 100 yards away. HARRIS: But by that, you do not necessarily mean they pay that out of their own pocket—have them face the price and decide? NOLL: That is precisely the point. The reason it is a test is because the people who live 5 miles away and who face $100 a month for a telephone bill, right now in the current environment would have a very, very strong incentive to go for a cellular telephone instead because it would be cheaper. WALTER BAER: Bob Harris spoke eloquently about the need for some federal preemption of state regulation. I would be interested in how the other panelists would comment on that,

OCR for page 105
The Changing Nature of Telecommunications/Information Infrastructure particularly regarding competitive entry. Also for Eli Noam's scheme: Eli, can that be implemented on a state-by-state basis, or does that require federal rules in implementation? ELI NOAM: It would require federal principles and state implementation, which I think is basically the way federalism in the United States should function in the future or to some extent functions today. If you have redistributive systems or support systems on a state-by-state basis, presumably you would have some kind of a race-to-the-bottom competition among jurisdictions and all kinds of manipulations by carriers to shift costs and revenues. At the same time, if you had it totally centralized, you would have early implementation problems or you would not let New York or Wyoming go their different ways. So I think within the principles of federally set principles, you can permit local variations. NOLL: Eli, address the following problem. I think this is the thrust of Walter Baer's question. Suppose the FCC takes the position that for state regulators that adopt the following state regulatory rules we will allow reintegration of the Bell operating companies. How would that work out exactly? Would you imagine that all 51 jurisdictions would adopt basically the same regulatory system for the local loop? NOAM: I do not think they would. It is not clear to me whether they should. Take local competition. I think some of the states, New York and Illinois, for example, have been at the forefront of it and in a way have provided some of the models that have been implemented on the federal level either by the FCC or by a federal jurisdiction right now. That is, in a way, the way the system should work. You have a kind of basis for experimentation in the states, and if I were to fault the states it would actually be for not being innovative enough, for not using more of the competitive ability to be flexible and to have variations but rather congregating around generic kinds of resolutions to lowest-common-denominator policies. That is really the problem, not state experimentation. Now, after a certain period for states to experiment, you can imagine a system in which the FCC or some other federal body will make this nationwide as long as you do not cut off the flexibility. I think it would be a real mistake. CERF: It seems to me that one of the things that gets in the way of effective competition is lack of continuous competition. There are a lot of examples where you do not get this opportunity—in the cable companies, for example, since it is a franchise arrangement. If there is any competition at all, it is at the beginning of the franchise and then there is some period of time before which there might be any other competition. Some of the government telecommunication system services are like that. FTS-2000 is an example of an intermittent competition, it seems to me. (If I get this all wrong, the economists will fix me up, I am sure.) But is there any way for us to assure that, as we enter into this new information infrastructure age, we are able to inject an opportunity for continuous competition so that consumers can change their minds and move from one supplier to another regularly? The first question is, Is that any good, is that useful, is that a helpful mechanism? and the second is, Is there anything getting in the way of doing that? NOAM: It is a big question, but I would say the one way to deal with this is to make possible competitive entry that is less than end to end, for example, so that would mean a certain amount of unbundling of services for the telephone industry. In the context of the cable industry, it would mean the unbundling of the set-top converter-box-type technology from the network provision and a whole range of intermediate access issues so that entry can be partial rather than full. That is only a partial answer to your question. CHARLES OLIVER: Eli Noam made the assertion that telecommunications is not price elastic and therefore it was okay to impose subsidy burdens on it. Does anyone else agree with that as a global assertion? Certainly we have seen the demand for access to interstate long-distance service more than double since the subscriber line charge was phased down. The implication is that

OCR for page 105
The Changing Nature of Telecommunications/Information Infrastructure basic local service is what should be bearing the subsidy burden and it should be cross-subsidizing long-distance service. NOLL: Well, to defend Eli, he was not attempting to defend any particular cross-subsidization. What he was saying is that if a "philosophy king" who also happened to be an economist descended upon the earth and decided he wanted to raise X dollars in tax revenue, what would he tax? The answer is he would tax only the most inelastic demanded things, and basic access to the telephone network is about as inelastic a demand item as there is. That is all he meant. OLIVER: So by that logic, if you could, you would tax oxygen and food? NOLL: No. It was discovered at the time of the Doomsday Book that the right way to tax people is proportional to the heads they have.