TCS Daily

Monopoly Matters

By Laurence J. Kotlikoff - October 31, 2003 12:00 AM

It's been seven years since the Telecommunications Act of 1996 (TA96) was passed with its promise to open local phone and broadband markets to competition. The plan was simple: Require the regional Bell companies to lease their bottleneck facilities at wholesale rates to local voice and broadband competitors. In exchange, let the Bell companies compete in the long distance voice market. Voila, the country would have open competition and low prices in all telecom markets.


Things haven't worked out exactly as planned. Although the Bells have gotten their half of the bargain (they're now marketing long distance throughout the country), they've fought tooth and nail to keep competitors from leasing the nation's phone lines. Indeed, the Bells have contested local competition in every possible venue -- in state court, in federal court, in Congress, with the FCC, and with state public utility commissions.


In the FCC's recent Triennial Review of telecom policy, the Bells won a major victory with respect to broadband. The Bells are now able to restrict competitors' use of their infrastructure with respect to data transmissions to the extent they upgrade portions of that infrastructure with new fiber.


Fortunately, the FCC maintained TA 96's leasing requirements when it comes to the local voice market. This partial victory comes at a critical juncture. Local voice competition is finally taking root in parts of the country, generating huge savings to consumers and small business.


But the Bells, who currently control 87 percent of the local voice market, haven't given up on their quest to regain a complete monopoly. Their current game plan is to make sure that wholesale leasing rates are set so high that competitors will be priced out of the market and forced to disappear. The game plan is working in at least one regard. The Bells' relentless and shrill complaints about wholesale rates being set too low is diverting attention from the real question at hand: Are wholesale rates being set far too high?


This question has taken on new urgency with the FCC's decision to implement a rulemaking on TELRIC (Total Element Long Run Incremental Cost). TELRIC is the Supreme Court-approved methodology used by state regulators to determine leasing rates for Bell facilities. If the FCC TELRIC review forces state regulators to increase leasing rates, local voice competition will be history.


The end result will be Bell monopolies -- a single monopoly provider per region and a stranglehold on every piece of the telecom world. Absent local competition, only the Bells and a small minority of cable companies will be able to market, albeit at a very high price, the bundles of local voice, long distance voice, and broadband services that are proving such a hit with consumers.


Given the stakes, it's critical that policymakers have a clear understanding of how the telecom sector operates and responds to government action. They need to know the real world impacts of their leasing rates on telecom competition, jobs, and investment. To date, the public discussion has been skewed by Bell company claims that their profitability, and, indeed, their profitability alone, is a sine qua non for increased telecom investment and employment.


The Bells' assertions defy economic theory as well as the facts. A recent study by me and Kevin Hassett of the American Enterprise Institute shows that competition permanently reduces consumer prices for voice and broadband services and spurs telecom investment. This is particularly the case when competitors are able to lease unbundled network elements from incumbent local exchange carriers at wholesale prices set in accord with TELRIC methodology. Setting prices that more fully accord with our estimates of TELRIC levels would mean lower local phone rates in all but a handful of states. On average, we estimate that residential consumers and business would save about $57 per year on each phone line, or $15 billion a year in total, if the states follow the FCC's competitive cost-based TELRIC pricing rules. The result would be expanded competition that delivers more choices to consumers as well as billions in new investment as companies compete for market share.

A review of empirical data, an examination of market practices, and the application of a new dynamic model of telecom entry, pricing, and investment shows that over a five-year period, the emergence of competition should mean $71 billion more telecom investment than under the monopoly structure that prevailed prior to the Telecom Act of 1996. Over 20 years, competition would add $155 billion to aggregate investment. The study conclusively refutes assertions that competition reduces telecom investment.


The Bells have chafed under the current regulatory structure, which requires them to lease the full network platform (UNE-P) at wholesale prices set by state regulators. Where states have set wholesale rates at or near the proper TELRIC level, the result has been vigorous new competition that has cut consumer phone bills by as much as a third and produced several billions in aggregate savings. These are the very fruits of competition that Congress anticipated in when it passed the 1996 Telecom Act and told the Bells to open their local networks.


To be sure, competition has complicated life for the Bells. Profits are no longer guaranteed by regulators and the cost of inefficiencies must now be borne by the companies instead of passed through to consumers. But, despite their whining, BellSouth, SBC and Verizon remain among the nation's healthiest companies and generated a combined $5.9 billion in operating profits and $4.6 billion in free cash flow during the second quarter of 2003.


The Triennial Review was a split decision that largely held the Bells to network sharing obligations, but relieved them of sharing new fiber infrastructure. But the Bells have refused to accept the decision. Instead, they have identified pricing as a way to effectively free themselves from network sharing rules. If leasing rates go up, competition will dry up. Higher wholesale leasing rates are not the answer. On the contrary, they are a large part of the problem.


Laurence J. Kotlikoff is Professor of Economics and Chairman of the Economics Department at Boston University. He recently published "Increased Investment, Lower Prices -- the Fruits of Past and Future Telecom Competition"


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