TCS Daily

Telecom at the Crossroads

By Kevin Hassett - March 18, 2004 12:00 AM

Perhaps nobody outside of the beltway has noticed, but the regulation community in Washington is going absolutely bananas. Emails are firing around asking for influential folks to sign petitions. Meetings are being rushed together to discuss strategy and diagram decision trees. And if rumors are correct, administration analysts are working late nights preparing position papers for the White House. This frenzy of activity is occurring because telecommunications is at a crossroads in America. At this moment, two dramatically different potential future paths coexist in a kind of quantum harmony. Any day now, one of those paths will be snuffed out.

For those who have been following telecom developments, the issue, of course, is the D.C. court decision challenging FCC regulations that require the Bell companies to lease their telephone lines to competitors. Supporters of that requirement have argued that it will lead to higher consumer welfare and lower prices for telecommunications services. Opponents have accused supporters of subscribing to an outdated liberal view that the heavy hand of government can improve industry outcomes. At his very moment, the White House has unfortunately been drawn into this fight. If the government asks the Supreme Court to review the case, it will likely do so. If the government does not beg for reconsideration, then the D.C. ruling may stand. If the ruling stands, then many of the new competitors in local telephone markets will have to abandon their business plans. In the alternative scenario, these competitors will likely thrive.

At the center of this storm has been FCC commissioner Kevin Martin, who has been ridiculed by Bell supporters for crafting the very regulations the court does not like, and sticking to his guns in the face of a negative court ruling. Mr. Martin favors an appeal to the Supreme Court, but many conservatives in Washington are lobbying the administration to reject Mr. Martin's analysis and accept the court's ruling. Mr. Martin, the argument goes, is no conservative, and hardly a reliable policy guide for a conservative president. While the legal issues involved are complex, the key economic question involved is a simple one. Is it advisable for the government to require the Bells to lease their old-fashioned copper lines to competitors?

By answering that question yes, Mr. Martin has incurred the wrath of a number of free marketeers. Where are they coming from? From the minimum wage to marginal tax rates, conservative often distinguish themselves from liberals by their devotion to economic reasoning. In economic models, high marginal tax rates reduce economic activity. Minimum wages reduce employment. Liberals often look askance at these models, and rely on a "real world" intuition to guide policy choices instead. Minimum wages, for example, are assumed to help poor workers abecause they increase compensation for those employed, and because any economically rational response to these wages by employers is assumed to be improbable.

In regulation, an economically guided man might appeal to his elementary textbook and reason that a monopoly (like a local phone company) will increase its profits by reducing output and increasing price. If a regulator could accurately estimate demand and cost, then the market could be fixed by government regulation which would require higher output and a lower price. Such a motivation conflicts, however, with another key conservative principle that dates back to Adam Smith. Decentralized decisionmaking is likely to be more efficient than central planning. Federal regulation reminds one uncomfortably of the former Soviet Union. Added to this concern has been the work of Chicago-school regulation specialists dating back at least to Nobel Laureate George Stigler, who have noted that regulators in practice, have done little historically to improve the lot of consumers.

My own reading of that literature suggests that regulation has failed at the federal level because regulators themselves tend to be captured by the monopolists they regulate. If a monopolist has lots of profit and no competitors, then the regulator has lots to do, (and impressive job prospects when he moves into the private sector.) If thriving competition emerges, then the regulator needs to find an alternative line of work. Accordingly, it seems that the conservative school has wandered to the position that, while a regulator could theoretically improve a market, in practice he will be captured by the monopolist and used to wall off the monopoly market from competitors. Hence it is advisable to just shut the regulator down, because in that case, new entrants will have to compete against a monopolist alone, as opposed to against a monopolist and an adversarial regulator.

Now suppose that one were to introduce into this an omniscient and benevolent regulator (for argument sake, let's call him "Mr. Martin") who cannot be captured, and cares only for the consumer. Should conservatives be willing to allow that person to intervene in the market? Alternatively, if a current deregulatory policy falls short of closing down the regulator and clearly appears to have been crafted by a "captive" regulator with the objective of maximizing the monopolist's profit and defeating competition, then should a conservative object when he wishes in his heart of hearts that the regulator did not exist?

These questions are hardly philosophical and are much trickier than traditional fodder like "should we cut taxes?" Yet this is, by my estimation, the exact circumstance that we are in. If the D.C. decision stands, then local to long distance telephone monopoly will be handed to the Bells. Numerous competitors will be put out of business. Moreover, the Bells are aggressively buying up cellular companies to wall off their local monopolies. If they succeed, then exactly how might a free market work to unwind their harmful monopolistic advantage? Wouldn't it be better to let the competitors continue to carve away at the Bell monopoly until they have a big enough footprint to compete without regulation? Couldn't we then envision a world where it would indeed be feasible to shut down the regulator?

Regulation is an especially contentious area for conservatives because two key principles -- "decentralize" and "use economic reasoning" -- conflict. I have yet to see anything close to rigorous analysis of these questions by the Bell supporters, but have found the arguments provided by those who have Mr. Martin's ear fairly compelling. Accordingly, the accusations that Mr. Martin is not conservative enough are nothing more than thuggish attempts to intimidate voices on one side of a debate at this critical juncture for the White House. It would be wholly appropriate to craft an argument against his position. But to imply that it is counter to some existing canon is a misrepresentation of the state of the debate, and the history of thought in this area.

Kevin Hassett recently wrote for TCS about "Tales Out of School: The Financial Disaster That Everyone Missed."


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