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37
Estimating the Costs of Telecommunications Regulation

Peter W. Huber, Manhattan Institute
Boban Mathew, Yale University
John Thorne, Bell Atlantic

The licensing schemes embodied in federal telecommunications regulation forbid people to sell goods or services without the say-so of a federal regulator. They frequently reflect the conclusion that regulators can allocate goods and resources and set prices more efficiently than can market forces. In some instances (declining in number as new technology and the globalization of most markets spur competition) this may be true. Unregulated "natural monopolies," for example, may price too high and produce too little.

But the beneficial effects of regulation (such as they are) can only be realized if regulators perform their functions efficiently, on schedule, on the basis of up-to-date information, and to protect the public, not industry incumbents. The record of federal telecommunications regulation is not good. Routine licensing decisions take far longer than they should. When issued, licenses are loaded up with restrictions and conditions that serve mainly to promote bureaucratic control. Regulation often solidifies the economic status quo, protects incumbents against would-be competitors, and deprives the public of new services at lower prices.

This paper examines the costs that restrictions on the use of both the electromagnetic spectrum and the wireline impose. The largest component of costs attributable to such zoning is the lost opportunity cost of preventing higher-value uses of the airwaves, and of restricting socially desirable uses of wireline media. Outright restrictions and delays in approving new uses of the two media also hamper competition in existing markets for telecommunications services, to the detriment of consumers in those markets. Finally, zoning often leads to the existence of large economic rents actively sought by market players through socially wasteful activities. It is, of course, impossible to measure precisely the total social cost of zoning restrictions.1 But conservative calculations of specific restrictions suggest that the costs are very high.

In this paper, we describe the zoning process and estimate the economic costs that several of the restrictions entail.

Wireless Zoning

The airwaves are "owned" by the federal government. The government licenses private users for fixed periods. With few exceptions, the licenses are given away; they are not sold. For the most part, the licenses strictly prescribe how the spectrum is to be used.

NOTE: Peter Huber is a senior fellow, Manhattan Institute for Policy Research; Boban Mathew, M.A./M.Phil Economics 1995, Yale University, is a J.D. candidate 1996, Harvard University; John Thorne is vice president and associate general counsel, Bell Atlantic. The authors wish to thank Evan Leo for significant assistance and research in the preparation of this paper. The views expressed in this paper are those of the individual authors; they should not be attributed to any company or client.



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Page 292 37 Estimating the Costs of Telecommunications Regulation Peter W. Huber, Manhattan Institute Boban Mathew, Yale University John Thorne, Bell Atlantic The licensing schemes embodied in federal telecommunications regulation forbid people to sell goods or services without the say-so of a federal regulator. They frequently reflect the conclusion that regulators can allocate goods and resources and set prices more efficiently than can market forces. In some instances (declining in number as new technology and the globalization of most markets spur competition) this may be true. Unregulated "natural monopolies," for example, may price too high and produce too little. But the beneficial effects of regulation (such as they are) can only be realized if regulators perform their functions efficiently, on schedule, on the basis of up-to-date information, and to protect the public, not industry incumbents. The record of federal telecommunications regulation is not good. Routine licensing decisions take far longer than they should. When issued, licenses are loaded up with restrictions and conditions that serve mainly to promote bureaucratic control. Regulation often solidifies the economic status quo, protects incumbents against would-be competitors, and deprives the public of new services at lower prices. This paper examines the costs that restrictions on the use of both the electromagnetic spectrum and the wireline impose. The largest component of costs attributable to such zoning is the lost opportunity cost of preventing higher-value uses of the airwaves, and of restricting socially desirable uses of wireline media. Outright restrictions and delays in approving new uses of the two media also hamper competition in existing markets for telecommunications services, to the detriment of consumers in those markets. Finally, zoning often leads to the existence of large economic rents actively sought by market players through socially wasteful activities. It is, of course, impossible to measure precisely the total social cost of zoning restrictions.1 But conservative calculations of specific restrictions suggest that the costs are very high. In this paper, we describe the zoning process and estimate the economic costs that several of the restrictions entail. Wireless Zoning The airwaves are "owned" by the federal government. The government licenses private users for fixed periods. With few exceptions, the licenses are given away; they are not sold. For the most part, the licenses strictly prescribe how the spectrum is to be used. NOTE: Peter Huber is a senior fellow, Manhattan Institute for Policy Research; Boban Mathew, M.A./M.Phil Economics 1995, Yale University, is a J.D. candidate 1996, Harvard University; John Thorne is vice president and associate general counsel, Bell Atlantic. The authors wish to thank Evan Leo for significant assistance and research in the preparation of this paper. The views expressed in this paper are those of the individual authors; they should not be attributed to any company or client.

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Page 293 The Modified Final Judgment (MFJ)—the consent decree that broke up the old Bell system—imposes further zoning requirements on the networks of the Bell operating companies.
2 Zoning the Airwaves The federal government began to nationalize the airwaves in 1912, when Congress gave the secretary of commerce authority to license broadcasters.3 But most empty airspace could still be occupied freely. "Homesteaders" simply had to register their claims with the Department of Commerce. No exclusive rights were assigned.4 By the mid-1920s, courts were beginning to affirm private property rights in spectrum.5 The Radio Act of 1927, however, placed almost every aspect of radio broadcasting under the control of the newly created Federal Radio Commission (FRC).6 Seven years later, the provisions of the 1927 act were rolled, largely intact, into the Communications Act of 1934.7 The FRC became the Federal Communications Commission. The licensing of broadcasters is conceptually straightforward. The FCC first zones the real estate, allocating blocks of spectrum for particular uses such as AM radio, FM radio, VHF TV stations, UHF TV stations, and so on. Within each block, it then assigns licenses to particular users. The commission has virtually unbounded discretion in both regards. The law simply requires distribution of broadcast "licenses, frequencies, hours of operation, and power among the several states and communities so as to provide a fair, efficient and equitable distribution of radio service to each of the same."8 However chosen, licensees do not get a formal property right in their spectrum. The 1927 Radio Act expressly declared that licensees were entitled to the "use of channels, but not [to] the ownership thereof."9 Licenses were to run for only "limited periods of time."10 (Only in 1981 were the original 3-year broadcasting license terms extended to 5 years for television and 7 years for radio.11) Licenses may not be transferred without commission approval.12 The commission may revoke a station license for any reason that would have warranted refusing a license in the first place.13 Zoning of Cellular The provision of cellular service is zoned in several ways. The allocation of spectrum for cellular services was originally split between telcos and other nonwireline carriers.14 In 1981, the commission decided that two (and only two) cellular carriers would be licensed in every cellular service area.15 A quite different and independent set of zoning requirements has come into existence by way of the MFJ. The MFJ's line of business restrictions preclude Bell cellular affiliates from offering "interexchange" services. Bell cellular affiliates thus may not arrange with a particular interexchange carrier to provide discounted service to their customers. Wireline Zoning In contrast to the airwaves, wireline networks are privately owned. But wireline media are zoned even more strictly than the airwaves. Local telephone facilities are still "zoned" to provide mostly voice services. For years, cable television operators were strictly "zoned" to supply simple carriage of broadcast video signals; to this day they still operate under an array of quasi-common-carrier and other zoning obligations that sharply diminish the value of cable networks and greatly reduce economic welfare.

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Page 294 Zoning of Telephone Section 214 of the 1934 Communications Act prevents phone companies from constructing new facilities or discontinuing existing service without advance permission.
16 Section 201 of the act enables the commission to regulate what sort of devices can be connected to the telephone network, and thereby what kind of add-on services can be offered over telephone lines.17 The FCC has used its authority under both statutory provisions to zone the telephone to provide basic voice services, and not much else. The franchising of telephones was initially a way of reducing the confusion and hubbub of competition.18 The useless duplication of facilities, Congress believed at the time, would lead to higher charges to the users of the service.19 What started as a means of suppressing excessive telephone competition in an industry marked by declining average costs, however, has become a tool for suppressing telco involvement in broadband services and, when such services are permitted, regulating them in minute detail. Video services are largely zoned out of the telephone franchise, too, though phone companies have recently been successful in challenging some of these regulations on First Amendment grounds. In 1968, the FCC declared that cable television was an "interstate" service and that telephone companies therefore needed FCC permission to build or operate cable networks.20 In 1970, the commission barred telephone companies from providing cable TV service.21 In 1984, Congress codified this prohibition in the new Cable Act.22 The "cable television service" language of the 1970 rules was replaced with "the provision of video programming."23 The prohibition extends to everything that can be characterized as ''providing" video over the telephone company's own network, including selection and packaging for resale of programming created by others.24 A second sphere of telephone-wire zoning involves the FCC's two-decade crusade against allowing "enhanced services" into the telephone network. In 1966, the commission undertook to examine the convergence of computers and communications.25 In an abundance of caution, the commission insisted that "enhanced services" should not under any circumstances be intermingled with basic phone service. For a 20-year period, from the mid-1960s to the mid-1980s, the commission enforced a policy of "maximum separation" between familiar voice services and network-based data processing, electronic services, and computers.26 It has since attempted to back off from that somewhat, but has been thwarted (so far) by litigation. Zoning of Cable Cable operators may not operate without a franchise.27 For many years, the FCC sharply curtailed cable's right to bid for programming, accept advertising, and generally compete unhindered against broadcast television. To this day, cable is required to devote one-third of its channels to carry local TV stations28 and is required to set aside additional channels for lease and "public access.29 Like the rules that zone telcos out of video, some of the cable-zoning rules are also under First Amendment attack. For now, however, they remain in place. Costs of Federal Zoning Calculating the welfare consequences of zoning restrictions is an inherently speculative task. The most potent criticism of such calculations is that they generally entail a partial equilibrium analysis. The introduction of new products and services and the infusion of greater competition in existing markets will necessarily affect other sectors of the economy. To be theoretically sound, one ought to consider such effects. For example, the introduction of electronic voice mail may adversely affect the answering machine market. Competition-induced reduction in the price of long-distance calls may reduce the demand for overland mail services. To remain tractable, empirical welfare calculations abstract from such considerations. If and when such effects are large and observable, they ought to be included. Otherwise, the welfare calculations must be interpreted cautiously.

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Page 295 The social costs of zoning restrictions can be broken down into four categories: 1. Use of spectrum by low-value users as dictated by zoning artificially reduces social welfare by not allowing higher-value users to employ the scarce resource. Analogous costs do not result from restrictions on the use of wireline, which faces no capacity constraint. 2. Zoning restrictions reduce the extent of competition in existing markets and thus reduce consumer welfare. Spectrum zoning, for example, makes it extremely difficult for a third cellular provider to enter most markets. The prohibition of video delivery by Bell operating companies stunts competition in cable television markets. Even if cost penalties due to scale economies are present in these markets, greater competition would likely improve social welfare (the sum of consumer and producer surpluses). 3. Zoning that prohibits or delays the provision of innovative services reduces the welfare of consumers willing to purchase these services. 4. Zoning creates economic rents pursued by the providers of telecommunications services through socially wasteful rent-seeking activities and reduces government revenues that could be generated through auctions by effectively excluding bids by higher-value users of the spectrum. Although these various costs are analytically separate, they are not mutually exclusive. For example, a third cellular provider that displaces a current low-value-use occupant of the spectrum could spur competition in the cellular market. Similarly, an innovative video delivery system could generate more competitive pricing in the cable market. Lower-Value Use of Spectrum In 1992, the Office of Plans and Policy of the FCC completed a study analyzing the welfare implications of reassigning spectrum currently earmarked for use by a UHF channel in the Los Angeles area for purposes of providing cellular phone services.
30 The calculations are based on alternative uses of spectrum during the years 1992 to 2000; numbers are expressed in 1991 dollars. Under plausible assumptions, the study estimates the welfare loss attributable to the loss of a single UHF channel in the Los Angeles area to be approximately $139 million for the years 1992 to 2000. This figure is the sum of welfare foregone by consumers and the producer of UHF television services. The study also estimates that the welfare gains in the absence of any competitive effects (no price or output effects) of two incumbent cellular providers would be approximately $118 million. Reassignment of the spectrum under such a scenario would, of course, not be welfare-enhancing. Consider, however, the strategy of Nextel (formerly "Fleet Call"). The company purchased spectrum previously licensed for other purposes—mostly dispatching taxis. In 1991, Nextel persuaded the FCC to permit it to use that spectrum to provide digital wireless telephone service.31 Nextel has aggressively developed new digital radio services, and is now positioned to be the third major wireless operator in many urban markets. It has already launched its digital mobile network service in many regions of California, including Los Angeles and San Francisco; in 1995 it will roll out service in New York, Chicago, Dallas, and Houston.32 With its acquisition of several regional SMR companies and Motorola SMR frequencies across the country, Nextel will have the spectrum to serve all 50 of the largest U.S. markets.33 In the Los Angeles market, it purchased approximately 9 MHz of spectrum for roughly $45 million.34 Assume that the two cellular incumbents in the Los Angeles market rather than Nextel had purchased equal shares of the 9 MHz of spectrum. If this spectrum had been evenly divided between the two existing cellular providers, the increase in social welfare (inclusive of the purchase price) would have been in the range of $37 million and $73 million for the years 1992 to 2000. To the extent that radio dispatching services were continued, one need not consider the foregone welfare of those customers. If spectrum zoning had prevented the use of the previously assigned frequencies for cellular service, it would have reduced social welfare by roughly $50 million for 9 years alone. Zoning of the spectrum may prevent socially efficient transfers of a scarce resource from low-value to high-value users even in the absence of any competitive effects.

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Page 296 Zoning-induced Reduction in Competition The case for allowing transfers from low-value users to high-value ones becomes even more compelling if such transfers have the effect of spurring competition in existing markets. Assuming that Nextel faced no competitive disadvantage vis-à-vis incumbent cellular providers, the presence of a third competitor would likely increase competition and drive down prices. Assuming unitary elasticity of demand for cellular services, the authors of the FCC study estimate that a reduction in cellular prices of 25 percent would lead to an increase in total welfare in the Los Angeles cellular market of $799 million for 6 MHz of additional spectrum and $893 million for 12 MHz of spectrum. If such a price reduction were indeed to occur because of competition from a third supplier, net social welfare would increase by approximately $750 million to $850 million. The Nextel story would be replayed hundreds of times if spectrum were dezoned across the board. The FCC study that forms the basis of the Nextel calculations also found that if a UHF television station in Los Angeles were to shut down and transfer its spectrum to a third cellular provider, the overall public gain would be substantial. The FCC study explicitly took into account the possibility of loss in scale economies in their estimates. Even with duplication of vital inputs by the new entrant, the net welfare gain is substantial: $63 million for a 5 percent reduction in cellular prices and $783 million for a 25 percent decline. Comparable gains are almost certainly possible by dezoning spectrum licenses across the board. In other words, the simple deletion of a few lines of legal boilerplate from FCC spectrum licenses could create a substantial increase in social welfare nationwide.
35 The case for transfers of rights in spectrum is extremely compelling when such transfers are likely to boost competition in existing markets. Zoning of wireline media, including the cable-telephone cross-ownership rules and the inter-LATA restrictions placed on the Bell companies, has also imposed welfare losses. Cable and telephone companies could make deep inroads into each other's markets if freed to use their wires to compete. Cable operators estimate that their telephone service could achieve a 30 percent penetration rate of their basic cable subscribers within 5 to 7 years. Telephone companies estimate they could acquire 45 percent of cable subscribers.36 Restrictions that ban Bell companies from providing video program services have enabled cable television companies to maintain a monopoly position in most markets. In the absence of such zoning, the Bell companies could have provided viable competition to the cable television companies to the benefit of customers. In the few markets where duopolistic competition exists in the provision of video programming, cable television rates have been estimated to be 20 to 30 percent lower than in monopolistic markets.37 Assuming demand elasticities of -1.0 to -2.5 and price reductions of 15 to 25 percent, consumer welfare in the years 1983 to 1993 would have been higher by anywhere from $1.4 billion to $2.9 billion (1993 dollars) annually in the absence of zoning restrictions.38 Using average revenue per subscriber yields even higher annual welfare loss estimates ranging from $2.7 billion to $5.4 billion. Our calculations are summarized in Table 1. TABLE 1 Consumer Welfare Loss Attributable to Cable Monopolies, 1983 to 1993   Dp=-15% Dp=-20% Dp=-25% Basic Rate Calculation (1993 $billions)       e=-1.0 15.8 21.6 27.6 e=-1.5 16.4 22.6 29.1 e=-2.0 16.9 23.6 30.7 e=-2.5 17.5 24.5 32.2 Average Revenue Calculation (1993 $billions)       e=-1.0 29.3 40.0 51.2 e=-1.5 30.4 41.8 54.0 e=-2.0 31.4 43.7 56.8 e=-2.5 32.4 45.5 59.7 Dp, decline in prices; e, elasticity. Assumptions most consistent with observed facts (20 percent decline in basic rates and demand elasticity of -2.0)39 yield foregone consumer welfare of approximately $2.1 billion annually (basic rates) for the years

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Page 297 1983 to 1993. These savings account for approximately one-tenth of the total revenues in the cable television market in 1993. Even if overbuilding were to lead to nonsignificant cost penalties, it is unlikely that total producer surplus would decrease by enough to swamp the much larger savings to consumers. The true measure of foregone consumer welfare should also take into account the provision of more channels (greater variety of programming) in competitive markets relative to monopolistic ones. Consumers lost out during every year that the Bell companies were prohibited from providing video programming services. Had phone companies been authorized to provide such services two decades ago, they would almost certainly be doing so by now absent the no-video zoning of their networks. The costs imposed by the cable/telco cross-ownership restriction can be independently estimated using an event study. On the day Judge Ellis of the U.S. District Court in Alexandria, Virginia, declared the telco/cable cross-ownership restriction unconstitutional, the stock price of the plaintiff, Bell Atlantic, rose 4.6 percent above the previous day's close.
40 On the day of the court decision, Reuters released a story about the decision in which it stated that "shares of Bell Atlantic and other Baby Bells soared."41 On the day after the court decision, a Dow Jones News Wire headline announced, "Cable, Telecom Equip[ment] Stocks Soar on Bell Atlantic Ruling."42 An event study of the effect of the ruling on the value of Bell Atlantic stock suggests that the market believes Bell companies to be viable competitors in the provision of services provided by cable companies. Assuming that the judge's decision was unanticipated (a reasonable assumption considering that no other phone company had prevailed in any remotely comparable First Amendment suit before), that the market absorbed the implications of the ruling in a single day, and that no other significant value-affecting information was revealed that day, the excess return attributable to the ruling was roughly 4 percent and accounted for roughly $856 million of the day's increase in Bell Atlantic's value.43 Despite the imperfection of this estimate, the rise in the company's value suggests two facts. First, Bell companies can be profitable entrants in the cable market. Second, the restrictions on cross-ownership unduly suppressed viable and potentially welfare-enhancing competition. Cellular zoning also imposes great welfare losses as well. Richard Higgins and James Miller have calculated that if the MFJ restrictions were removed, Bell cellular customers alone would potentially realize annual savings of $200 million in long-distance charges.44 They arrive at this estimate by comparing the prices of toll long-distance and cluster services. They demonstrate that retail prices for toll long-distance services exceed bulk wholesale prices by at least 110 percent.45 The Wharton Econometric Forecasting Associates (WEFA) Group has independently estimated that if MFJ restrictions were eliminated, over the next 10 years cellular consumers would save $107 billion.46 WEFA estimates that monthly wireless bills would fall 30 percent within 10 years.47 They base the estimate on the following three factors. First, Bell cellular customers currently pay about 40 percent more for long-distance calls than customers of independent cellular companies.48 Second, in metropolitan service areas (MSAs) where neither cellular provider is a Bell company subject to inter-LATA restrictions, local cellular service is 7 percent cheaper (because of unrestricted competition) than in MSAs where there is a Bell cellular provider.49 Third, Bell cellular providers are unable to cluster service areas and offer large local calling areas as can independents.50 For example, an 84-mile, 10-minute cellular call from Indianapolis to Terre Haute is $2.10 cheaper using GTE than using BellSouth.51 One further example of the costs of cellular zoning involves AirTouch. In 1994, Pacific Telesis spun off its wireless affiliate into a wholly separate entity, renamed AirTouch. A primary reason for the spin-off was to free AirTouch from the MFJ's restrictions. When Pacific Telesis announced it was considering the move, investment analysts predicted that spin would increase shareholder value. Before the spin, one analyst valued PacTel's cellular business at $140 per point of presence (POP),52 while comparable independent cellular companies traded at an asset valuation of $160 per POP.53 Using the difference ($20) between Morgan Stanley's $140 valuation of PacTel's cellular interests and its valuation of independent cellular companies at $160 per POP, the domestic cellular operation as an independent company is worth $700 million ($20 × 34,893,721 POPs54) more than the cellular operation as a part of PacTel. Assuming that half of the valuation increase is the result of AirTouch's superior financial standing relative to the other independent cellular providers, the company is worth $350 million (6.25 percent) more when freed from the MFJ.

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Page 298 The MFJ's ban on Bell provision of interexchange services has further facilitated tacit collusion among the three major suppliers of such services—AT&T, MCI, and Sprint. Evidence of high price-cost margins in various interexchange services supports the hypothesis of tacit collusion among these firms.
55 The FCC's tariff process has also facilitated such collusion by allowing competitors to monitor and to match each other's pricing strategies, thereby reducing the value of deviating from a collusive outcome. Removing the restrictions on Bell provision of long-distance services—even just to permit Bell entry out of region—would eliminate several of the conditions facilitating such tacit collusion. First, the number of viable competitors would rise from three to nine. Second, the current stability of market shares among the three dominant suppliers would be destroyed; Bell companies would likely pursue new customers through aggressive pricing strategies. Finally, the regulation-imposed barrier to entry in long-distance services would simply be eliminated. The welfare costs of the inter-LATA restrictions imposed on Bell companies are substantial. Such entry would stimulate more competitive pricing of long-distance services, driving down the price-cost margins. The FTC estimates that if Bell entry caused prices to fall to marginal cost, it could lead to the elimination of deadweight loss.56 The welfare gain would then be between $17 million and $119 million per year (0.03 percent and 0.36 percent of industry revenue). Consumer welfare gains would be many times more this reduction in deadweight loss. Furthermore, Bell companies might enjoy cost advantages for some routes because of economies of scope with their existing local networks. Restrictions and Delays in the Provision of New Services Potentially the greatest cost imposed by zoning restrictions is the opportunity cost of the inability to introduce unhampered new services for which consumers are willing to pay. That cost is also the most difficult to quantify with precision. Nevertheless, it is useful to highlight those services and provide rough measures of foregone consumer surplus. One has to estimate not only demand for a service that has never existed but also the "virtual" or "reservation" price at which demand is choked before proceeding with consumer welfare calculations. Relying on survey data on demand for advanced services that could be offered by Bell companies, WEFA estimated the loss in consumer welfare attributable to zoning restrictions for a number of services.57 We summarize below their estimates of foregone yearly consumer welfare for services that Bell companies can but may not provide under MFJ restrictions: • Residential Customers     1. Advanced portable phone—$1.6 billion     2. Return voice mail—$1.7 billion • Small and Medium Size Businesses     1. Fax overflow service—$1.4 billion     2. Return voice mail service—$720 million     3. Call manager service—$320 million If one adds producer surplus from the provision of these services, the total welfare gain will be substantially larger. Furthermore, the above list is only illustrative, not exhaustive. As described above, one large obstacle to the provision of new services has been the FCC's policy against allowing "enhanced services" into the telephone network. Today, some 1.3 million customers buy voice mail service from Bell Atlantic. The service was first offered in 1988, when both Judge Greene and the FCC finally agreed to dezone telephone company wires to permit them to provide such services. At roughly $5 a month per mailbox, and 10 million mailboxes nationwide, it is reasonable to estimate that in this single market, excluding Bell Atlantic from the market needlessly suppressed over $460 million dollars of service a year to willing consumers in Bell Atlantic's area alone. Unable to buy the on-line service from U.S. enterprises and U.S. workers, most consumers probably turned to stand-alone answering machines manufactured in Singapore or

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Page 299 Taiwan. Extrapolating this figure nationwide, the no-voice-mail zoning (part of the much broader no-computer-services zoning) of phone companies cost the U.S. economy some $600 million a year for at least a decade. Even if the restrictions are eventually lifted, the delay in the provision of socially desirable services imposes enormous costs to the economy.58 In 1985, an FCC OPP working paper estimated the costs of a comparative hearing for a cellular license application, breaking it down into cost of the delay in awarding the license, cost to the government, and cost to applicants.59 The paper found that the typical 18-month delay in awarding cellular licenses eroded the value of the license by $90,000 and cost the government $20,000 per hearing and each applicant $130,000 per hearing.
60 Finally, the possibly anticompetitive effects of lifting such restrictions must be weighed against the foregone welfare of consumers willing to purchase and of producers willing to provide such services. The net welfare effect may indeed be positive in many or most instances where zoning is imposed because of alleged anticompetitive effects. Professor Paul Rubin, for example, has analyzed the costs and benefits of the MFJ waiver process.61 Rubin estimated the cost of the waiver process—the delay of waivers that would have had procompetitive consequences, administrative burdens and rent-seeking, and the deterrence of procompetitive activities due to the waiver process—at over $1.5 billion since 1984.62 Rent-Seeking Activities In addition to the opportunity costs described above, a number of other social costs can be identified. Zoning has led to the existence of substantial economic rent in a number of telecommunications markets. Evidence of such rent includes estimates of Tobin's Q-ratio for a number of markets as well as the observed decline in stock value of incumbent firms in response to announcements of regulatory measures that enhance competition in their markets. To the extent that much of the economic rent results from government protection from competition, one could expect substantial resources devoted to gaining such protection. Although the expenses directed at socially wasteful rent-seeking activities are difficult to quantify precisely, they are certainly in the hundreds of million of dollars.63 Models of Dezoning The costs of telecommunications regulation are not immutable. Limited dezoning has already begun. Recent direct broadcast satellite (DBS) and broadcast regulation are small examples of what can be applied. Moreover, a property-based system of spectrum allocation could replace the current system of government ownership. DBS Dezoned Regulation of the relatively new DBS services broke new ground—it severely blurred the formerly clean lines between private carriers, common carriers, and broadcasters.64 The owner of a DBS satellite can lease under contract, or sell outright, transmission space to private users. It may operate others on a common carrier basis for independent programmers. And it may send its own programming over others, either scrambled and paid for by subscribers, or "in the clear" and paid for by advertisers.65 The owner is thus free to use its satellite, and the spectrum the satellite uses, for any mix of carriage, broadcast, or none-of-the-above activities like subscription services or purely private transport. It may change the mix as it pleases. This is perfectly sensible; it is also a radical departure from 50 years of FCC regulation under the 1934 act. The satellite broadcaster is the first spectrum licensee that has been told, in effect, to use spectrum for any useful purpose it can find. Spectrum licenses have been issued without cumbersome "zoning" restrictions for the first time. No other spectrum licensee has been this free since the enactment of the Radio Act of 1927.

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Page 300 Broadcast Dezoned Conventional broadcasters have crept forward in the deregulatory wake of other wireless operators, one small step at a time. They have begun, for example, overlaying some modest carrier-like services on top of their basic broadcast operations. Radio stations, for example, transmit paging services using the "subcarrier"66 portions of their assigned frequencies.67 Television broadcasters broadcast video programming, but also broadcast electronic newspapers, data, computer software, and paging services within the otherwise unused "vertical blanking interval" of their spectrum licenses.68 Market-based Allocation of Spectrum The most significant alternative to the current zoning approach to spectrum allocation is a market-based one. The idea is not new. As far back as 1959, Nobel economist Ronald Coase proposed that property rights be accorded to radio licenses, that license owners pay for the right to use spectrum, and that bidding for that right was the most efficient way to allocate spectrum.
69 In contrast to spectrum, the lack of any substantial capacity constraints in the wireline medium suggests that the costs of zoning can be alleviated by simply lifting most of the restrictions on the medium's use. In 1991, the National Telecommunications and Information Administration (NTIA) studied the idea, reviewed the considerable literature and past proposals on the subject, and concluded that a "market-based system for spectrum management would improve considerably the efficiency and fairness of the current U.S. system, and, if properly designed and implemented, can fully address concerns about such issues as competitive equity, spectrum 'warehousing,' and the preservation of socially desirable services."70 As part of its recommendation, NTIA supported private transfers and subleasing of spectrum rights directly from one user to another.71 Australia and New Zealand are ahead of the United States in selling spectrum. The Australian Federal Spectrum Management Agency recently auctioned 196 wireless cable licenses.72 The government will also receive yearly license fees on the auctioned spectrum.73 The Australian Broadcasting Authority plans to auction new television and radio licenses.74 New Zealand has auctioned off 20-year rights to new radio spectrum and receives additional revenues from user fees.75 It has also auctioned off spectrum for cellular service76 and broadcast television.77 Conclusion The social cost of zoning the electromagnetic spectrum and wireline media is extremely high. While it is impossible to quantify exactly the total social cost of such zoning, the welfare effects of specific restrictions suggest that zoning imposes large opportunity costs on society. Zoning misallocates resources; it reduces competition; and it delays or prevents the provision of desired services. These costs are rarely considered carefully when restrictions are imposed. Notes 1. A study by the Wharton Econometric Forecasting Associates (WEFA) Group attempts to quantify the total costs of all legal and regulatory barriers in the telecommunications, information services, equipment manufacturing, and video programming markets. The study compares a baseline economic forecast with a forecast assuming that all legal and regulatory barriers to competition are removed and that rate-of-return regulation is replaced by pure price cap regulation in all jurisdictions. The study concludes that "competition and the expected lower prices that competition will bring result in nearly $550 billion in consumer savings cumulatively over the next ten years." In its analysis, WEFA first develops pricing models for long-distance, local, cellular, and cable service, and then estimates the impact that competitive entry will have on prices for long-distance, local, cellular, and cable television service. The study predicts that prices for these services will fall dramatically over the study period (1995 to 2005), with both sharp one-time price adjustments (to reduce prices to competitive levels) and steadily decreasing prices over time due to technological efficiencies. The main impetus

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Page 301 for these price changes, WEFA asserts, will be entry of the Bell operating companies into the various markets, after the lifting of the video programming ban and the MFJ restrictions on inter-LATA service. The WEFA Group, Economic Impact of Deregulating U.S. Communications Industries, February 1995 (hereinafter 1995 WEFA Study). 2. For further discussion on the federal regulation of telecommunications, see generally Kellogg, Michael, John Thorne, and Peter Huber. 1992. Federal Telecommunications Law, Little, Brown & Company; Thorne, John, Peter Huber, and Michael Kellogg. 1995. Federal Broadband Law, Little, Brown & Company, New York. 3. Stat. 302 (Comp. St. §10100–10109) (1912). 4. See Hazlett, T. 1990. "The Rationality of U.S. Regulation of the Broadcast Spectrum," 33 J.L. & Econ. 133. 5. See, for example, Tribune Co. v. Oak Leaves (Cir. Ct., Cook County, Ill. 1926), reprinted in 68 Cong. Rec. 216 (1926). 6. Radio Act of 1927, 44 Stat. 1162 (1927). 7. See Emord, Jonathan W. 1992. "The First Amendment Invalidity of FCC Content Regulations," Notre Dame Journal of Law, Ethics, and Public Policy 93, 185. 8. 47 U.S.C. §307(b). 9. Radio Act of 1927 §1. Cf. 47 U.S.C. §301; 47 U.S.C. §304; 47 U.S.C. §309(h)(1). 10. Radio Act of 1927 §9. 11. See 47 U.S.C. §307(c). 12. 47 U.S.C. §312. 13. 47 U.S.C. §312 (a). 14. An Inquiry Relative to the Future Use of the Frequency Band 806–960 MHz, 19 Rad. Reg. 2d (P & F) 1663, 1676–1677 (1970). 15. An Inquiry into the Use of Bands 825–845 MHz & 870–890 MHz for Cellular Communications Systems, 86 F.C.C.2d 469 (1981). 16. 47 U.S.C. §214(a). 17. 47 U.S.C. §201. 18. See 78 Cong. Rec. 10314 (1934). 19. See Robinson, Glen O. 1989. "The Federal Communications Act: An Essay on Origins and Regulatory Purpose," in A Legislative History of the Communications Act of 1934, Max Paglin (ed.), p. 40. 20. General Telephone Co. FCC 13 F.C.C.2d 448 (1968), aff'd sub nom. General Telephone Co. v. FCC, 413 F.2d 390 (D.C. Cir.), cert. denied, 396 U.S. 888 (1969). 21. Applications of Telephone Companies for Section 214 Certificates for Channel Facilities Furnished to Affiliated Community Antenna Television Systems, 21 FCC.2d 307, 325 (1970). 22. 47 U.S.C. §533(b). 23. Id.; see also, 47 C.F.R. §63.54(a). 24. See Telephone Company-Cable Television Cross-Ownership Rules, 7 FCC Rcd 5781, 5817–18 (1991); see also H.R. Rep. No. 934, 98th Cong., 2d Sess. 57 (1984). 25. Regulatory Pricing Problems Presented by the Interdependence of Computer and Communication Facilities, Final Decision and Order, 28 F.C.C.2d 267, 269 (1970). 26. Amendment of §64,702 of the Commission's Rules & Regulations, Second Computer Inquiry, 77 F.C.C.2d 512 (1981). 27. 47 U.S.C. §541(b). 28. 47 U.S.C. §534(b)(1)(B). 29. 47 U.S.C. §§531, 532. 30. Kwerel, Evan, and John R. Williams. 1992. "Changing Channels: Voluntary Reallocation of UHF Television Spectrum," Office of Plans and Policy Working Paper No. 27, Federal Communications Commission, Washington, D.C., November. 31. Memorandum Opinion and Order, Request of Fleet Call Inc. for a Waiver and Other Relief to Permit Creation of Enhanced Specialized Mobile Radio System in Six Markets, 6 F.C.C. Rec. 1533 (1991). 32. Edge. 1993. "Fleet Call Becomes Nextel; New Company Name Reflects New Business Designed to Serve Broader Wireless Communications Market," March 29. 33. Business Wire. 1994. "Nextel Reaches Agreement with U.S. Department of Justice," October 27. 34. Land Mobile Radio News. 1994. "Motorola Gains Long-awaited Foothold in Los Angeles SMR Market," November 13, at Section No. 46. 35. As Janice Obuchowski, former Department of Commerce assistant secretary for communications and information and former NTIA administrator, has said, "Efficient use of the spectrum will be maximized only if licensees are given the widest possible latitude in determining which services to offer within their assigned frequencies. In

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Page 302 principle, the flexibility granted to licensees should be limited only to the extent necessary to prevent radio frequency signal interference with other users." Obuchowski, Janice. 1994. "The Unfinished Task of Spectrum Policy Reform," 39 Fed. Com. L. J. 325, pp. 328–329. 36. Yokell, Larry. 1994. "Cable TV Moves into Telecom Markets," Business Communications Review, November, p. 2. 37. Affidavit of Thomas W. Hazlett, attached to Motion of Bell Atlantic Corporation, BellSouth Corporation, NYNEX Corporation, and Southwestern Bell Corporation to Vacate the Decree, No. 82-0192 (D.D.C. July 6, 1994). 38. Following is a brief summary of the data and methodology we employed to make the consumer welfare calculations. (1) We performed two sets of calculations—one based on subscribers and prices of basic service and another based on subscribers and average revenue per subscriber. (2) Basic rate calculations were based on data found in the appendix to Hazlett (July 3, 1994). Calculations were for the years 1983 (the year after the MFJ) through 1993. We assumed that 98 percent of all basic service subscribers were in monopoly markets. This assumption was maintained for all the years under consideration, while in reality competition did not exist every year in markets that were competitive in 1992. This assumption therefore is likely to provide a downward bias in the estimates. (3) Average-revenue-per-subscriber calculations were also based on data found in Hazlett. We assumed that the total number of subscribers was the same as the number of basic service subscribers (since premium service subscribers are also basic service subscribers). We further assumed that 98 percent of total subscribers were in monopoly markets. Again, downward bias should be expected. (4) We used average basic service prices and average revenue per subscriber as the monopoly price. The correct numbers to be used are averages in monopoly markets only. (5) We assumed that income effects due to decline in cable prices are negligible. The assumption is generally valid if the share of cable television expenses is small relative to total income. (6) We assumed demand was locally linear. (7) We converted all calculations to constant 1993 dollars using the Consumer Price Index for all goods with 1993 equal to one. (8) We performed the welfare calculations assuming various elasticities of demand and expected decline in prices due to duopoly competition. We considered own-price elasticities of -0.5, -1.0, -1.5, -2.0, and -2.5 and price declines of 15, 20, and 25 percent. To the extent that a monopolist always operates in the region where elasticity of demand exceeds one, the first two elasticities are valid only if monopoly pricing behavior is somehow constrained. 39. Crandall, Robert. 1990. "Elasticity of Demand for Cable Service and the Effect of Broadcast Signals on Cable Prices," Attachment TCI Comments to the Federal Communications Commission, MM Docket No. 90-4; Levin, Stanford L., and John B. Meisel. 1990. "Cable Television and Telecommunications: Theory, Evidence and Policy," Telecommunications Policy, December; Emmons, Willis, and Robin Prager. 1993. "The Effects of Market Structure and Ownership on Prices and Service Offerings in the U.S. Cable Television Industry," paper presented to the Western Economics Association 68th Annual Conference (22 June); Federal Communications Commission, FCC Cable Rate Survey Database (Feb. 24, 1993). 40. "Tradeline Database," Dow Jones News Retrieval, April 21, 1995. 41. Talking Point/Bell Atlantic Court Decision, Aug. 24, 1993. 42. Dow Jones News Wire. 1993. "Cable, Telecom Equip[ment] Stocks Soar on Bell Atlantic Ruling," August 25. 43. This study assumed Bell Atlantic's Beta to be 0.78 and that the relevant market was defined by the S&P 500 basket of stocks. It used outstanding shares and prices at the end of calendar year 1992 to calculate the benchmark valuation. A one-day window using the previous day's valuation as the benchmark yielded an increase in Bell Atlantic value attributable to the ruling of roughly $950 million. Two-day and three-day windows yielded a cumulative excess return of 7 percent and increased valuation of roughly $1.5 billion. A longer window would yield an even larger estimate of increased return and valuation. 44. Affidavit of Richard S. Higgins and James C. Miller III, attached to Motion of Bell Atlantic Corporation, BellSouth Corporation, NYNEX Corporation, and Southwestern Bell Corporation to Vacate the Decree, United States v. Western Elec. Co., No. 82-0192 (D.D.C. July 6, 1994). 45. Because of the MFJ's interexchange and equal access restrictions, the BOCs cannot obtain bulk wholesale rates and therefore cannot offer these savings to their customers. 46. 1995 WEFA Study, supra n. 1, at p. 4. 47. Id., p. 30. 48. Id., pp. 30–32. 49. Id., p. 32. 50. Id., pp. 32–33. 51. Id., p. 34. 52. A POP is derived by multiplying the total population of a service area by an operator's interest in the license. 53. Morgan Stanley & Co., Pacific Telesis Group—Company Report, Report No. 1219882, Apr. 21, 1992.

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Page 303 54. Donaldson, Lufkin & Jenrette. 1994. "The Wireless Communications Industry," Summer, p. 68. 55. MacAvoy, Paul W. 1994. "Tacit Collusion by Regulation: Pricing of Interstate Long-Distance Telephone Service," Working Paper #37, Yale School of Organization and Management, August, pp. 37–47. 56. Ward, Michael R. 1995. "Measurements of Market Power in Long Distance Telecommunications," Bureau of Economics Staff Report, Federal Trade Commission, Washington, D.C., April. 57. 1995 WEFA Study, supra n. 1. 58. Milton Mueller has explained that "as a barrier to entry, getting an allocation through the administrative process can be far more formidable than paying for access to spectrum." Mueller, Milton. 1988. "Technical Standards: The Market and Radio Frequency Allocation," Telecommunications Policy, March, p. 51. 59. Kwerel, E., and A.D. Felker. 1985. "Using Auctions to Select FCC Licensees," FCC OPP Working Paper, May, pp. 12 and 17. 60. Id. 61. Affidavit of Paul H. Rubin (June 14, 1994), attached to Motion of Bell Atlantic Corporation, BellSouth Corporation, NYNEX Corporation, and Southwestern Bell Corporation to Vacate the Decree, United States v. Western Elec. Co., No. 82-0192 (D.D.C. July 6, 1994). 62. Rubin averaged data provided in several waiver requests on the fixed and annual costs of delaying approval of the waiver, and extrapolated these costs over all waivers. Because over 96 percent of waiver requests are approved, and thus presumed to be procompetitive, and because individual anticompetitive requests are less harmful than individual procompetitive waivers are beneficial, the waiver process results in significant wasted resources, time, and money. The costs due to rent-seeking and deterrence of procompetitive activities are specified in less exact terms, but Rubin's reasonable estimate places them in the hundreds of millions of dollars. 63. Id. 64. Report and Order, Inquiry into the Development of Regulatory Policy in Regard to Direct Broadcast Satellites for the Period Following the 1983 Regional Administrative Radio Conference, 90 F.C.C.2d 676 (1982), recon. denied, Memorandum Opinion and Order, Regulatory Policy Regarding the Direct Broadcast Satellite Service, 94 F.C.C.2d 741 (1983), aff'd in part sub nom. National Association of Broadcasters v. FCC, 740 F.2d 1190 (D.C. Cir. 1984). 65. See World Communications v. FCC, 735 F.2d 1465 (D.C.Cir. 1984). 66. Spectrum can be subdivided into a main channel and a number of "subchannels" or "subcarriers," both of which can be transmitted simultaneously. 67. First Report and Order, Dkt. No. 82-536, 48 Fed. Reg. 28445 (1983); Second Report and Order, Dkt. No. 21323, 49 Fed. Reg. 18100 (1984); Amendment of Parts 2 and 73 of the Commission's AM Broadcast Rules Concerning the Use of the AM Sub-carrier, 100 F.C.C.2d 5 (1984). 68. Amendment of Parts 2, 73, and 76 of the Commission's Rules to Authorize the Offering of Data Transmission Services on the Vertical Blanking Interval by TV Stations, 101 F.C.C.2d 973 (1985). 69. Coase, R.H. 1959. "The Federal Communications Commission," 2 J.L. & Econ. 1, pp. 14 and 25. 70. National Telecommunications and Information Administration. 1991. U.S. Spectrum Management Policy: Agenda for the Future, February, p. 7. Henry Geller, former NTIA administrator and former general counsel for the FCC, co-authored a report that explained that "charging for the spectrum is particularly appropriate now in light of the weakness of traditional broadcast public trustee regulation and the growing demands on the spectrum overall." Geller, Henry, and Donna Lampert. 1989. "Charging for Spectrum Use," Benton Foundation Project on Communications and Information Policy Options, p. ii. 71. National Telecommunications and Information Administration. 1992. U.S. Spectrum Management Policy: Agenda for the Future, February, p. 8. 72. Market Reports. 1994. "Australia—Pay TV Overview," September, p. 19. 73. Ellis, Stephen. 1994. "Australia: MDS Pay-TV Auctions Net $90.6M," Australian Financial Review, August 19. 74. Davies, Anne. 1995. "Australia: Facts Lay Groundwork for ABA Legal Challenge," Sydney Morning Herald, January 27. 75. New Zealand Herald. 1991. "New Zealand: Seven Radio Frequencies for Auckland," January 12. 76. New Zealand Herald. 1990. "New Zealand: Telecom Free to Bid for Mobile Phones," May 17. 77. New Zealand Herald. 1990. "New Zealand: Space on Airwaves Costs Sky $2.2M," March 28.