Access in Telecommunications
A Little Less Equality, A Little More Entry

by Lawrence Gasman

Lawrence Gasman is a senior fellow at the Cato Institute and president of Communications Industry Researchers Inc.

 

The telecommunications act of 1996 created an expansive new regime of universal service subsidies for users supposedly excluded or neglected by the marketplace. The Act’s interconnection provisions guaranteed newcomers access to the networks of established service providers, enabling the Federal Communications Commission to entangle the industry in a web of regulation.

Unfortunately, policymakers viewed the access issue romantically, blinding them to the adverse consequences of their policies and to practical approaches that might have prevented future problems. Further, rather than sound market principles, political concerns influenced the new access policy. The result: a situation that could hamper markets and require future changes to set it aright.

 

Interconnection and Universal Service

In recent decades, universal service referred to the regulatory policy that telephone companies provide fixed rate service for all customers seeking similar service. But costs vary. For example, it usually costs more to provide service to rural customers than to urban ones. Policymakers also argued that rates must not be too high, lest poor citizens not be able to afford phone service. Thus, to meet the universal service mandate, telephone companies have resorted to a kind of cross-subsidy or rate-averaging mechanism. At the state level, "lifeline" programs provide special discounts for low-income consumers.

Interconnection refers to the need of new service providers for access to existing networks. Without such access, new service providers would not be economically viable. They would not be able to connect their customers with customers of the existing local networks. Existing service providers (principally the Bell companies) enjoyed monopoly status before the courts divided AT&T and the little Bells, beginning in 1984. The Bell companies still own, and must maintain, most of the communication infrastructure, such as wires and telephone poles. Established companies have obvious economic incentives to resist interconnection proposals that force them to provide services for their competitors. But, it would be too costly and impractical for competitors to construct parallel sets of wires and other infrastructure, at least in the short term.

The term "universal service" was first used by Theodore Vail, the founder of the Bell System, to mean precisely what is meant today by "interconnection." However, the issues are not only related historically. Regulators also deal with them in the same mistaken manner. First, the alleged discrimination of a particular type of user or service provider is almost always accepted at face value. Second, new regulations and laws that will make for "fair and equal" access attempt to eliminate the alleged discrimination. The resulting policy has been of questionable value.

 

The Telecommunications Act of 1996

Supporters of universal service requirements maintain that without government mandates, certain groups (including low-income households and rural households, as well as schools, libraries, and some health care institutions) might be deprived of the benefits of modern telecommunications. Even if no such danger exists, they claim that those groups deserve special treatment.

The Telecommunications Act of 1996 established a joint board consisting of federal and state regulators and one consumer advocate. No industry representatives were included on the board. The board had a mandate to develop a formula for universal service in the twenty-first century. The Act directed the FCC to consider the formula when making its final decision regarding access policy.

The joint board’s report, issued in November 1996, did not support the more extravagant demands of various special interest groups. For example, except in cases of educational establishments, they did not suggest extending universal service mandates from telephony to Internet access and other advanced services. According to the much publicized 6 May decision, the FCC appears to be acting on the joint Board’s recommendation. Expect more to come.

The board did recommend the establishment of a universal service fund. All carriers subject to universal service mandates must contribute to the special fund. The fund will be used to compensate service providers for any mandated discounts they provide for privileged consumers. At least that arrangement replaces the system of hidden subsidies that, until now, have characterized the policies of the FCC and state utility commissions.

The Act did not establish a special board to make recommendations on interconnection policy. In fact, the Act is vague as to whether markets or federal and state regulators will shape interconnection policy. Free market advocates and established telephone companies had hoped the ambiguity would result in a more market-oriented policy. Instead, the FCC has interpreted the Act as an opportunity to establish rigid rules on how to carry out the interconnection process. Those rules set a government-determined price that the large, established providers would be forced to charge new market entrants. Complex formulae set the value of the existing telephone networks and thus, the supposed cost of providing interconnection services. The telephone industry regards the price-fixing as government confiscation requiring compensation.

They have challenged the FCC’s interconnection rules in federal courts. The Fifth Amendment to the U.S. Constitution forbids government regulations that devalue private property by restricting its use without just compensation. The telephone companies claim that the telecommunications rules constitute a regulatory taking of property. They are forced to use their infrastructure to provide services for their competitors at fire sale prices. Their competitors then offer the discounted services for resale to consumers. The court challenge prevents the FCC from implementing its interconnection plan. Meanwhile state regulators are pushing ahead with plans for a scheme much like the FCC’s.

No clear cut approach to the interconnection problem exists. After all, no company would get into the local telephone business unless it could assure future customers that they could call neighbors without paying a toll. Arguably, the Bell companies should be under no obligation to allow strangers onto their private network territory. But much of the territory was gained using the power of a monopoly protected by an exclusive government franchise.

 

Playing Favorites: The Politics of Access

The events leading to the policies of access issues in the Telecommunications Act should call into question the soundness of those policies.

In decades past, certain parts of the broadcast spectrum were reserved for radio and later, television. The FCC parceled out rights to the spectrum licenses. Not surprisingly, political supporters of the party in power often received preferential treatment. In the 1980s, a lottery system allocated parts of the spectrum for cellular phone use. The system was somewhat less politicized, although small business and minority groups (until the Supreme Court barred the practice) received special considerations. Thus, spectrum auctions are hardly free markets in the strictest sense.

The bipartisan support for the Telecommunications Act of 1996 and claims that it represents a move to freer markets should not obscure the intense lobbying effort prior to passage of the Act. The lobbying came from both the corporate world and from a variety of special interest groups ranging from self-appointed consumer advocates, such as the Consumer Federation of America and AARP. The same organizations reemerged a few months after the 1996 Act was passed to testify before the joint board of state regulators and FCC representatives who were examining the future of universal service.

Corporate lobbyists favoring universal service mandates included telecommunications equipment manufacturers, especially fiber-optics producers. They believed that mandates and special privileges for education, health care, and rural customers, plus the establishment of a fund to subsidize those customers, would mean large orders for their products.

The non-profit groups that lobbied for universal service (library and educational communities, for example) were equally self-interested. But they were less susceptible to criticism. Criticizing telecommunications subsidies for schools easily translates into an anti-education position. But in some cases the calls from non-profit special interests were quite crassly self-interested. For example, the American Hospital Association called for special funding support for high-speed data links to hospitals.

 

Universal Service

Debate over the Telecommunications Act found nearly unanimous support for universal service mandates. Obviously, lawmakers supported provisions that benefited their constituencies. Republican lawmakers from rural areas thought universal service subsidies for their districts were well worth supporting. Democrats from inner cities wanted telecommunications service discounts for their schools. Both groups supported universal service mandates. The only question was the kind of mandates that were appropriate.

To support universal service mandates, the current generation of policymakers looked not just towards the future but also to the past. The 1934 Telecommunications Act governed policy for over six decades. Although it did not set up any specific mechanism, the Act sought to promote the nationwide availability of affordable telephone service. Universal service meant that everyone with a telephone would be able to reach everyone else with a telephone. Service required either a national telephone system or arrangements for the connection of separate telephone networks.

A deal between the federal government and AT&T created such a system. The former guaranteed the profits to the latter in return for a national telephone network and high quality telephone service. Other countries took different approaches. In Great Britain, a universal system was established by nationalizing all but one of the many small telephone companies. In most countries, the national government created and ran a national telephone system from the very beginning.

In the years before the passage of the 1996 Act, a complex system of cross-subsidies resulted in higher prices for urban telephone customers. Those inflated prices subsidized rural users.

Legitimate questions and concerns should be raised about universal service regardless of the political clout backing it. First, exactly why do rural customers deserve a special subsidy at the expense of other customers? Many farmers are financially secure.

Second, why shouldn’t rural residents pay more for telecommunications service? After all, every location has advantages and disadvantages. Living in a large city means easy access to a wide variety of restaurants, museums, and entertainment. It also means traffic jams and higher costs for housing. Living in a suburb usually means easy access to malls, large grocery stores, and nearby convenience stores. Living on the top of a mountain means beautiful vistas and no traffic jams. It also means that one cannot easily run to the corner store for milk; the store might be ten miles of mountainous roads away. It also might mean higher costs for telecommunications. No reason exists for government mandates to hold those costs down.

Third, should there be no consideration of costs to companies under universal service mandates? In a recent case, a wealthy Arkansas resident moved to a remote area and demanded that the local telephone company supply him with a phone at rate-payer expense. Although the case went to court, no one ever doubted that the telephone company would be required to install the phone line and offer the service.

Fourth, is it worthwhile to channel subsidies to "high cost" wire-based technology? In the past, running a wire to a location was the only way to connect to a system. New telecommunications technologies relying on broadcast spectrum and satellites are currently making access to telephone, television, and the Internet much less expensive.

Supporters of universal service mandates argue that low-income customers deserve special subsidies. They include discounted monthly rates and discounted installation fees. The subsidies may be extended to include specially priced toll restriction services allowing low-income users to prevent family members from making long distance calls.

Low income customers on average, spend only about one percent of their incomes on telephone service. Basic service in most areas costs roughly $20 per month. The notion of subsidizing a service that lower income Americans can afford to purchase is senseless. Urban residents, rich and poor alike, already pay more to subsidize rural residents.

For two main reasons, it is bad policy for the government to require that service providers offer special discounts for privileged institutions. First, the subsidy creates a complex and burdensome regulatory regime to deliver benefits to target groups. Second, like all entitlements, there will be political pressure to expand its scope. In the future, universal service mandates would likely extend Internet service to schools, churches, non-profit groups, and so on.

 

Connecting Competitors

Starting in the 1970s, decades-old interconnection requirements came under strain. All over the world, government telecommunications monopolies found it increasingly difficult to keep pace with digital communications technology. The monoliths generally lacked the technical and marketing skills (and the capital) to bring the newer services to the consumer.

New service providers solved that problem by creating competition with the old line telephone companies. Nobody agreed on how to define "competition" in that context. Whatever the interpretation, the emergence of new carriers also raised the problem of how and under what terms the carriers should connect their networks to those of other carriers.

Interconnection of that type involves more than just the physical connection of the networks, a relatively trivial matter. New service providers generally wanted the established companies to unbundle the services they offered, allowing the new companies to purchase them selectively. For example, for billing purposes, a new company might want the established one to provide access to its databases. Or the new company might want special arrangements to make the calling process a user friendly experience, by eliminating lengthy access codes for example. Such codes might reasonably be regarded as a barrier to entry for future competitors.

Supporters of interconnection mandates have generally favored the emergence of new companies that merely resell the services of the existing telephone companies rather than build their own networks. That approach can happen almost over-night, allowing local telephone competition to develop rapidly.

In the long run, companies must build their own networks or alternatives (such as wireless networks) in order to truly compete with local telephone companies. Connecting those networks to the existing networks is mostly a matter of physical interconnection easily settled through negotiation and arbitration. For re-sellers, the interconnection issue is much more complex. Someone must decide exactly how and at what price the existing features of the telephone network should be packaged for sale.

The FCC overlooked the consequences of mandated interconnection prices. Bureaucrats or even entrepreneurs cannot predict the market price of a product. Thus, absent sheer luck, the FCC mandate either underprices or overprices the service components of the existing networks. The rush of new companies waiting to set up (pending the court decision) evidences that the current FCC proposals underprice the existing networks.

If services were overpriced, potential market entrants would complain that the market was inaccessible. That has not happened. In fact, companies are lining up to move into the local telephone market. They make money repackaging and reselling the services they purchase at the government-established price.

Providers of repackaged services will never challenge the existing dominant carriers. Only existing long-distance companies, cable companies, cellular companies, and new entrepreneurial operations have the resources to contend.

The FCC’s pricing policy will resonate beyond its impact on the economics of resale. The rush of entrants will turn the subsidy into a new entitlement. New entrants will fight hard to preserve it. Lobbying groups of weak local telephone companies, in need of FCC price controls for survival, will further politicize the interconnection issue.

Ultimately, much more than just local service rests on sorting out the interconnection mess. The local telephone companies view the existence of local competition and hence of interconnection as prerequisite to expansion into long distance service and manufacturing.

 

Markets vs. Mandates

Current FCC interconnection policy ignores past regulation failures and past market-oriented successes. Even when the Bell system was king, there were more than one thousand small telephone companies mainly serving rural regions. Since neither the Bell companies nor the independent telephone companies were rivals, interconnection was not a very contentious matter.

In the 1980s, the large telephone companies began to face competition from access providers such as Multi Fiber Systems and Teleport (now TCG). But again, interconnection rules were not critical since the competition was limited to private lines offering point-to-point connectivity rather than connections to the local public telephone network. If interconnection debate arose, the private businesses negotiated with little interruption from local regulators. For the most part, the system worked well. The Bell system had an incentive for connecting to smaller systems; Bell wanted its customers to be able to call any phone in the country.

In comparison, interconnection regulations devised by the FCC at a national level have usually swelled into unworkable schemes that collapsed under their own weight. For example, FCC rules allowing video and audio information providers access to the Bell networks became so complex that none of the participants could accurately gauge their chances of making money.

Electronic mail networks pose equally complex interconnection problems. After all, three or four major national companies (such as America Online) and numerous smaller ones provide e-mail. It seems a daunting task to guarantee that an e-mail from one service provider could arrive in a competitor’s box. The matter was left entirely to the private sector and has worked superbly.

The latest interconnection problem shows signs of the same ineffective approach as the video and audio information provider problem. While the 1996 Act mandates interconnection between newcomers and the existing networks, it does appear to allow a high level of flexibility for local arrangements (similar to that used when the new private line carriers emerged in major cities in the 1980s). Unfortunately, the FCC has not promoted that approach.

To attract many entrants into the emerging local telephone marketplace, the FCC seems bent on making the cost of interconnection artificially low. The FCC assumes that more competitors means more competition and that any competitor is as good as another. But that egalitarian premise ignores the fact that a mix of large and small suppliers might be the best arrangement for providing services. Additionally, artificially low prices might slow the creation of much needed new infrastructure. The FCC has again taken on the role of centralized planner, almost guaranteeing an inefficient result. The consumer is the ultimate loser.

 

A Better Way

As has happened so many times in the history of telecommunications, industry is being shaped in Washington and not in the marketplace. Despite the veneer of deregulation, service and pricing flexibility, so necessary to that dynamic industry, is being curtailed. The solutions to the problems do not lie in centralized planning. Nor do they lie in egalitarian or political practice.

The Bells need persuasion to abandon their inherited monopoly power. That would be better left to local negotiations. And, while the Internet and other networking are increasingly necessary in schools, individual school districts rather than national price controls for educational telecommunications should determine policy. That approach enables local decision makers to trade off the educational value of different expenditures based on real costs.

Some think the Telecommunications Act settled such issues for good, but that is not necessarily the case. The FCC is beginning to suggest that things are not working out as expected and Congress may revisit such matters before too long.

 

Suggested Readings

Mueller, Milton. "On the Frontier of Deregulation: New Zealand Telecommunications and the Problem of Interconnecting Competing Networks."Gabel, D. and D. Weiman, eds. Opening Networks to Competition: the Regulation and Pricing of Access. (Kluwer: 1996).

Cato Institute. Cato Handbook for Congress, Chapter 33.

Lawrence Gasman. "Telecommunications Act of 1996," Regulation , vol. 19, no. 3, (1996).

Thorne, John, Huber, Peter W., and Kellogg, Michael K. "Federal Broadban Law," 4.3.4, Little, Brown and Company.


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