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Regulation Magazine

Telecommunications Policy
in the Reagan Era

Robert W. Crandall

Robert W. Crandall is a senior fellow at the Brookings Institution.

While overall the outgoing administration can find relatively little to boast about in regulatory policy, there is one bright spot in the Reagan record: the progress made in liberating telecommunications form the heavy hand of government. The AT&T antitrust case was settled by a court decree that broke up the company and thereby facilitated a substantial increase in competition in both telecommunications equipment and telephone services. Regulatory shackles on broadcasters were loosened. Legislation was passed that further weakened government control over cable television. And the Fairness Doctrine was set aside-at least temporarily. These were no mean feats given the considerable political opposition to reform.

This article reviews the remarkable changes in telecommunications regulation during the eight years of the Reagan administration. While the focus is on the unfolding saga of the telephone industry, I also provide a brief review of the more important developments affecting broadcasting and cable television.

The End of the Bell System

Twenty-five years ago, few would have believed that the government would break up AT&T to promote competition in telephone services or equipment. Indeed, few would have believed that such competition was desirable or even feasible. It was, and is, a widely held belief that the telephone industry is a "natural monopoly"-a belief actively promoted by most national post office, telephone, and telegraph authorities who still cling to the notion that any private offering of telephone service is essentially antisocial.

The Evolution to Competition. In the United States (though not in most other developed countries) the telephone monopoly has all but disappeared. AT&T's share of the long-distance market now stands at less than 70 percent. Competitive vendors of telephone equipment have eroded what was once a virtual AT&T monopoly. Even local telephone companies are facing limited competition from cellular systems, fiber optics, and shared tenant systems.

Competition in both long-distance services and equipment was ushered in when the Federal Communications Commission (FCC), in the late 1960s, permitted MCI to enter interstate long-distance service. At first the FCC thought that it was permitting competition only for private-line services used by medium to large businesses. By 1977, however, it was clear that the commission had lost control of its limited-entry policy and was unable to keep MCI from offering ordinary (switched) long-distance service.

Proceeding more deliberately, the FCC also moved to liberalize entry into the offering of terminal equipment used on the national telephone network. In the late 1970s, after several years of battling with AT&T over the dangers that competitive equipment might pose to the integrity of the network, the FCC finally prevailed by requiring that any manufacturer's appropriately certified terminal equipment be permitted to connect to the network. Federal courts repulsed state challenges to the commission's preemption of state authority in this matter.

By 1981 the liberalization of entry was essentially complete. Two tasks remained for the Reagan administration: litigation of an antitrust suit brought against AT&T during the Ford administration, and the adaptation of federal and state regulatory policies to the new competitive world.

The AT&T Suit. For more than six years before President Reagan took office, the justice Department had been preparing to try a massive suit against AT&T under Section 2 of the Sherman Act. The suit was brought on the theory that AT&T had monopolized long-distance service and equipment manufacture largely through the exclusionary practices of its local operating companies. Initially there was considerable speculation that the Reagan administration would either drop this case or settle it with relatively little damage to AT&T-much as the Eisenhower administration had settled an earlier suit that sought to break up AT&T. The "Reagan revolution" was not built on a platform of trustbusting. Several attempts were made to settle the AT&T suit, but each failed, including an attempt in 1981 by the Reagan Justice Department.

In the fall of 1981, after the government had completed its case against AT&T, AT&T received a rude jolt. The presiding judge in the case, Judge Harold Greene, ruled against AT&T's motion for summary judgment, noting that the corporation would be hard-pressed to succeed in defending itself against the government's charges. With this
ammunition, the Reagan antitrust chief, William Baxter, was able to negotiate the largest antitrust divestiture since the 1911 breakup of Standard Oil. A decree was entered in 1982 that required the Bell operating companies to be spun off from AT&T, effective January 1, 1984. In return AT&T was freed from the Eisenhower-era decree limiting it to regulated telecommunications services.

The court order includes other important changes as well. It requires that the divested Bell operating companies provide equal access to all competitive long-distance carriers, and it limits these BOCs to the provision of service within Local Access and Transport Areas (LATAs). The BOCs are prohibited from offering long-distance service among the LATAs, from providing enhanced "information" services, and from manufacturing equipment.

Since the divestiture, long-distance markets have become increasingly competitive as MCI and Sprint have increased their share of the market substantially. There has been a rush of investment in expensive fiber-optic networks to compete with AT&T, triggering concern that capacity may exceed demand and that many of the new carriers may prove not to be economically viable. Since AT&T is still regulated by the FCC, there is a distinct possibility that political pressures will force the commission to keep a floor under AT&T rates to preserve the viability of the newcomers.

Equipment manufacture also has become much more competitive because the BOCs are no longer compelled to purchase from AT&T. Switching equipment, transmission equipment, and terminal equipment are now supplied by a number of different sellers, including an increasing number of foreign firms.

Repricing the Telephone System. Prior to the AT&T divestiture, federal and state telephone regulators had succeeded in allocating a large share of local telephone plant costs to interstate long-distance services. This kept long-distance rates from falling as rapidly as they would have in a competitive market, and allowed local access rates (the fixed monthly telephone bills) to remain artificially low. This strategy was defended as a means of assuring universal service, but it was also very appealing to hundreds of politically sensitive state regulators. Since business customers accounted for a significant share (now about 60 percent) of long-distance revenues, residential subscribers were essentially being subsidized by business subscribers. The overpricing of long distance became an important attraction to new entrants.

Until divestiture the division of long-distance revenues between AT&T's Long Lines and the operating companies took place through a complex settlement process among AT&T's divisions. After divestiture the FCC was forced to institute a formal system of interstate access charges to be paid by long-distance carriers to the divested BOCs and the independent telephone companies.

To its credit the FCC quickly realized that charging high interstate access charges just to keep local rates low is inefficient; it also contributes little to universal service and invites bypass of the local companies' circuits. By 1981 fully 27 percent of the fixed (nontraffic-sensitive) costs of local subscriber plants were being recovered from interstate long-distance calls that accounted for only 8 percent of minutes of use.

After announcing the AT&T divestiture the Reagan FCC began to look for alternative, more efficient ways to defray these costs. It proposed a set of fixed 'subscriber line charges" (SLCs) to be paid on a monthly basis by all subscribers regardless of their use of the network. These charges were scheduled to be raised gradually over time, eventually reaching $6 per month for residential users. The logic of such charges is that because a large share of subscriber plant costs do not vary with calling volume, subscribers should pay for these nontraffic-sensitive costs on a fixed monthly basis, not through usage-sensitive charges on long-distance calls.

State regulators and members of Congress, of course, were loath to allow such a repricing of telephone service simply because it was efficient. Facing a popular backlash against rising local rates, they pressured the FCC to keep the residential SLC from rising above $2.60 per month through mid-1988. In 1989 this charge will rise to $3.50 per month. The multi-line business rate, by contrast, was allowed to rise to $6 very quickly.

The imposition of SLCs, as well as regulatory lag, caused local rates to rise much more rapidly through 1986 than the general rate of inflation. As a result, the FCC received a storm of criticism for its sensible decision to reprice telephone service. Now that local rates have once again begun to fall relative to the overall rate of inflation, this political opposition seems to have abated. The share of households subscribing to telephone service continues to rise. (This fact should put to rest the notion that requiring American households to pay the true cost of connecting to the network will cause very many of the poor, old, and disadvantaged to abandon service.)

Deregulation of Long Distance? Generally lost in the debate over telephone repricing was the fact that the AT&T decree was based upon a theory that equipment manufacture and long distance would quickly evolve into competitive markets and thus be free from regulation. Deregulation of terminal-equipment markets was complete by the time of the decree, but long-distance services continued to labor under the heavy hand of the FCC and state regulatory commissions-as they still do today, even though 87 percent of all local lines are reached by switches that offer equal access to long-distance competitors. The FCC continues to regulate AT&T's interstate long-distance rates under its "dominant carrier" policy. The smaller competitors essentially escape regulation, but they have a considerable stake in making sure that the FCC continues to regard AT&T as dominant. The FCC appears unwilling to consider lifting the regulatory yoke from AT&T, preferring instead to search for more efficient regulatory schemes.

Realizing that rate-of-return regulation stunts a carrier's incentive to be efficient, the commission this year proposed a system of price caps as a substitute form of regulation. These price caps would allow AT&T to raise rates by an amount not to exceed the rate of inflation less 3 percent per year. Responding to the political pressure created by AT&T's rivals, the commission also proposed to limit AT&T's right to reduce rates.

Swimming Against the Tide. Throughout the period since divestiture, the Reagan FCC has been battling Congress and state politicians who resent the disappearance of the old residential and rural subsidies. Congressional leaders have threatened to block the price-cap proposal. They have succeeded in limiting the use of SLCs in pricing a subscriber's local loop. And state regulators remain generally hostile to competition in intrastate markets because subsidization obviously requires that some services be priced above cost.

If one were to fault the FCC at this point, it is for not articulating a clear vision of how the interstate telephone market can be totally deregulated. Given the history of transportation regulation, we know that continued rate regulation and liberalized entry are a potentially lethal combination. Regulators inevitably find themselves hostage to inefficient competitors.

It now appears that investment in interstate telephone transmission has been excessive. The frantic investment in fiber-optic networks reminds one of the rush to build railroad lines in the last century. It would be propitious for the regulators to find a way to exit before they are either pressured to keep long-distance rates artificially high or are engulfed in a series of politically embarrassing bankruptcies. Price caps should be seen as a transition to deregulation, not as a substitute for older, inefficient regulatory mechanisms.

Broadcasting

Broadcasting remains a government-created and-protected oligopoly that no administration seems willing to confront directly. Frequency allocations in the television and radio service bands are politically inviolate. Over time, however, new media arise to compete with the entrenched oligopoly. Video cassettes, cable television, and direct satellite broadcasting have emerged as potent competitors, but they have not yet driven the value of FCC-conferred broadcasting licenses to the scarcity value of the spectrum.

The major issues in broadcast regulation addressed by the Reagan FCC include program ownership, license renewal procedures, and the Fairness Doctrine. Of these, only the Fairness Doctrine is of major moment.

Fairness Doctrine. For decades the FCC has struggled with the consequences of its own decision to create market power in broadcasting by limiting the number of stations in each market. To protect the "helpless public" from the caprice of powerful station owners, it erected the Fairness Doctrine, requiring broadcasters to air controversial issues in an impartial manner. Critics claim that this policy inhibited broadcasters from addressing many controversial issues, and that such a policy was inconsistent with the promotion and protection of free speech. They point out that newspapers are not bound by such a doctrine.

There have been many attempts to modify or limit the application of the Fairness Doctrine, but the Reagan FCC was the first to vote for its abolition. Congress reacted by approving legislation to reinstate the doctrine but the president vetoed it. The legislation then was attached to a major spending bill, and when the president threatened to veto this bill, Congress blinked. The Fairness Doctrine is no more, although it is likely to return in a Democratic administration. If it does return, there is a good chance the Supreme Court will be asked to decide whether it violates the First Amendment.

Program Ownership. The battle over financial interests in television programming was shod-lived. In the 1960s the FCC developed yet another fit of conscience over its creation of monopoly power in television. Rather than reduce this monopoly power by expanding television-frequency allocations or by liberalizing restrictive rules on cable television, the commission enacted new limits on networks' ownership rights in the programs they aired. In the same proceeding, the FCC limited network hours during prime time (thereby making millionaires out of Goodson Todman and Merv Griffin, who rushed into the vacated half-hour each evening with socially uplifting game shows).

The limitation on network programming during prime time remains, presumably because the FCC believes that the best antidote to network power is a requirement that the oligopolists reduce output even further. The FCC flirted with the idea of repealing the rule that barred networks from owning interests in future "syndication" of their programs. This proposed change in rules was, however, quickly abandoned when the antagonists, the motion picture companies, discovered that they had an ally in the White House.

License Renewal. In 1984 the commission eliminated its nonsensical "ascertainment" requirements for television station licensees. Under this policy station owners were supposed to canvas their communities to ascertain the breadth of interest in various types of programs and events. They were then supposed to structure their program offerings to reflect the findings.

In practice the ascertainment procedure was simply used as a lever for extortion. Because most programming of any substantial value is produced for a national market, station owners are forced to choose their programming from national networks or national syndicators of network reruns, movies, or other film-tape programming. The fact that, say, 1.63 percent of the local audience has a Polish heritage and that 5.67 percent of them say that they would like one hour per week of programs dealing with Polish-American culture is of little consequence. No station owner in his right mind would offer such programming unless it were free and could be aired at 4 a.m.

In practice the FCC simply buried ascertainment reports, dusting them off only occasionally when it received either a petition to deny the renewal of a license or a competitive application for the license. These applications never succeeded, of course, but applicants could persist until they were satisfied that the local broadcaster had fulfilled his requirement to broadcast in the public interest. (Satisfaction may have peaked in the late 1970s when a challenger to a New York television station licensee dropped his challenge after the broadcaster agreed to pay him several million dollars.)

Mercifully, the FCC eliminated most of the silly programming, commercial-minute limitation, and ascertainment requirements from the excess baggage of television regulation. A similar decision had been reached for radio broadcasting three years earlier. It would be desirable if it now followed up with a proposal to increase competition in broadcasting through changes in frequency allocations, but this may be hoping for too much. It is more likely that we will have to rely upon cable, VCRs, and other "new media" to effect the competition necessary to improve performance in video markets.

Cable Television

In the late 1970s the Carter FCC liberalized cable television rules considerably, removing restrictions on signal carriage that had been established in the previous decade. Unfortunately local municipalities continued to control the franchising process; they thereby regulated cable subscriber fees and siphoned off a large share of the economic rents into the hands of politically favored clients. For years this situation was viewed without alarm except when cable officials went to prison for bribing local politicians.

A change occurred, however, when would-be entrants went to court to challenge a municipality's right to grant a monopoly to a cable franchise. After at least one community lost this battle, Congress enacted a bill in 1984 essentially deregulating cable. If the FCC determines that there is "effective competition" in a broadcast market, cable rates are deregulated for all new systems. For older systems, only "nonbasic" services-the nonbroadcast signals-are deregulated. The commissions standards for effective competition under the new law have been rather lenient. As long as there are three local broadcast signals, a market is deemed to be effectively competitive. Municipalities still grant franchises in these markets, but they may not control rates.

Must-Carry Rules

Although the deregulation of cable was clearly a good idea, it placed the FCC in a difficult position regarding copyrighted programming. As cable spread to more than half the population, the commission was forced to reassess its "must-carry" regulations for local broadcast signals. Under an earlier policy, invalidated by the courts on constitutional grounds, the commission had required all cable systems to carry all local broadcast stations. For older systems with 12 channels or less, this requirement could mean that an attractive service-such as ESPN or HBO-would have to be excluded in order to make room for a PBS station or a marginal UHF commercial station. If HBO displaced a weak local station o the cable, a cable household would no longer be able to tune in this station, even occasionally, without disconnecting its cable lead. This was regarded as unacceptable.

In1986 the commission reinstituted a limited must-carry rule that required cable systems to offer all local stations until switches were installed that allowed subscribers to switch from cable to an external antenna. This policy makes little sense, except that it reflects the pressures brought by broadcasters. One would have though that broadcasters industry official negotiated a compromise, the FCC simply instituted it.

Perhaps more important was the FCC's reexaminiation of the policy that granted compulsory licenses of broadcast material to cable systems at legislated copyright rates. This strange policy evolved as a means of subsidizing an infant cable industry so that it could compete with broadcast stations. Under 1976 copyright legislation, cable systems were given a compulsory license to retransmit commercial broadcast signals. At the time, the FCC limited the number of such signals that a cable system could import and essentially prohibited pay services.

By 1980 the limitation on broadcast-signal carriage and pay services had been eliminated. Nevertheless, the FCC expanded the scope of the compulsory license by giving cable systems the right to retransmit copyrighted programs that a local broadcast station had bought under an exclusive agreement. Broadcast stations, of course, had no reciprocal right to air exclusive cable programs.

This year the commission revoked its 1980 policy and once again granted to broadcasters the right to negotiate for exclusive use of a syndicated program in its geographic market. Cable operations are now forbidden to offer imported programs that infringe upon the exclusive agreements. This policy change reflects the commission's conclusion that attempts to limit contractual arrangements in distributing competitive syndicated programming reduce program supply and thereby reduce economic welfare. It remains to be seen if the compulsory license provision in the 1976 Copyright Act also comes under attack as an anachronism in this era of mature cable television.

Conclusion

The Reagan administration's record on telecommunications has been remarkable. The breakup of AT&T and the attempt to bring some rationality to telephone pricing will surely look better and better in the coming years. Competition in telephone equipment and services in growing rapidly. Equipment prices are falling. With private users free to choose among various equipment suppliers and service venders, service offering are proliferating. It is no accident that Japan and the United Kingdom are now following our lead in telecommunications policy.

In the area of broadcast and cable there has also been substantial progress-despite the political land mines in regulating a medium that offers nightly editorial comment on local and national leaders. We are moving steadily to a less regulated video environment, one in which the public's demand for more movies and sports is amply supplied. Several major questions loom ahead. Will the cable industry be asked to shed its subsidized compulsory licenses of broadcast signals? When will the nation's telephone companies be allowed to bring even more channels into the home via fiber optics? And to what extent can the allocation of property rights in the electromagnetic spectrum be made more efficient?

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