Cato Policy Analysis No. 264 November 27, 1996

Policy Analysis

How To Treat The Costs Of Shared Voice
And Video Networks In A Post Age

by Alfred E. Kahn

Alfred E. Kahn is the Robert Julius Thorne Professor of Political Economy, Emeritus, Cornell University and Special Consultant with National Economic Research Associates, Inc. (NERA).

Executive Summary

The Telecommunications Act of 1996 is not perfect. An elaborate compromise of the diametrically conflicting interests of such major warring parties as the long-distance and local telephone companies (local exchange companies or LECs) and cable operators--an attempt at one and the same time to free the Bell Operating Companies to enter the long-distance business while curbing their power to exclude competitors from fair access to their ubiquitous wired local networks--it is a forbiddingly complex if not schizophrenic document. But its central goal is exactly right: to establish "a pro-competitive deregulatory national policy framework designed to accelerate rapidly private sector deployment of advanced telecommunications and information technologies . . . by opening all telecommunications markets to competition." In other words, by removing regulatory obstacles to competition while also using regulation to pry open monopoly bottlenecks, the Act frees local and long-distance phone and cable television companies to enter one another's markets and compete with one another. Any telecommunications company will be free to offer a full range of telecommunications services. Cable and wireless companies may offer phone; phone companies and wireless companies may offer video programming; all of them may offer all sorts of information services; and consumers will reap the benefits of that competition.

In preparation for this new era of competition, phone companies are making or contemplating making huge investments in new facilities to provide both video programming and phone services. As the rates consumers will pay for video programming services will be unregulated, while telephone rates will continue to be regulated, construction of the multipurpose facilities raises a familiar regulatory problem: what portion of the costs should be recovered in the regulated telephone rates, what portion left to be recovered (or not recovered) by the companies through sales of unregulated services?

The increasingly pervasive introduction of competition has added a second purpose of the cost allocation exercise to the historical one of shielding purchasers of regulated services from the costs of telephone company entry into the offer of competitive services, namely to protect competitors in the latter markets from unfair competition by the telephone companies. The perceived danger is cross-subsidization. The fear is that the telephone companies would price the competitive services below cost, shifting those costs to the regulated services and recovering them from their monopoly customers.

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1996 The Cato Institute
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