Will “States’ Rights” Derail Telecom Deregulation?

March 14, 2003 • TechKnowledge No. 49

During the 11th hour of a heated Federal Communications Commission debate last month over the complicated rules governing local telecommunications networks, a disagreement about the ongoing role of the states in the regulatory process became the key stumbling block to a much‐​needed revision of current regulatory policies. Although this dispute over “states’ rights” and telecom markets may seem like an arcane matter of fleeting importance, in reality it will have profound ramifications for the long‐​term liberalization and economic revitalization of the ailing telecom sector.

The FCC’s February 20 decision in the Unbundled Network Element Triennial Review, which reevaluated the unbundled network element platform (UNE-P) that incumbent local exchange carriers (ILECs) or Baby Bells must share with competitive local exchange carriers (CLECs) at regulated rates, came down to a split 3–2 decision. Republican commissioner Kevin Martin ended up siding with the two Democratic FCC commissioners to thwart the deregulatory alternatives favored by FCC chairman Michael Powell and Commissioner Kathleen Abernathy. Commissioner Martin’s maverick move was premised on the notion that a more “granular” regulatory approach was advisable, meaning state regulators should be given an ongoing or even expanded oversight role. The theory behind his endorsement of such state oversight is that it will help “preserve local competition,” primarily by allowing state regulators to secure continued low‐​priced access to UNEs by rivals. During this process, a handful of conservative groups also initiated an advertising campaign to lend their support to Martin’s “granular / states’ rights” position.

Sharing Is Not Competing. There are three primary deficiencies in the logic espoused by Commissioner Martin and these conservative groups. First, the states’ rights rallying cry has become a convenient front for the forces who oppose serious telecom reform. Commissioner Martin and these conservative activists have now become the unwitting champions of those who believe that only extensive and ongoing regulatory interventions will bring about a competitive nirvana in telecom. That ethos was formulated and enshrined into law by former FCC commissioner Reed Hundt, whose expansive reading of the Telecommunications Act of 1996 focused on encouraging short‐​term entry by guaranteeing rivals cheap access to virtually every element of the Baby Bells’ networks. Enter they did, by the dozens, but only on a resale basis for the most part. The rules encouraged infrastructure sharing over facilities‐​based investment.

More important, Hundt’s FCC encouraged creative interpretations of the rules by the states that went beyond what the FCC required. State regulators were all too happy to oblige pushing access prices lower and lower in the name of competition. The theory behind all this subsidized network sharing was that (1) no rival would seriously consider competing against local wireline network providers (apparently 137 million cellular subscribers don’t count for much!), and, therefore, (2) we might as well let everyone share existing networks at the cheapest rate possible so that consumers can enjoy the myth that infrastructure socialism offers them credible competitive alternatives.

With Commissioner Martin’s recent coup d’état, this truly Orwellian “sharing‐​is‐​competing” philosophy has received renewed justification at the FCC despite Powell’s best effort to curtail this corrupt regulatory regime. The fact that telecom markets have tanked‐​and lost $12 billion more in market capitalization in the wake of this latest decision‐​challenges the wisdom of extending the UNE-P infrastructure sharing regime, especially now that 51 different state regulatory agencies have been given expanded authority over national telecommunications carriers.

Dividing the Indivisible? The second problem with this logic is that it is based on an improper interpretation of federalism principles as applied to telecommunications markets. Federalism is a two‐​sided coin; the flip side of “states’ rights” is interstate commerce. There is little doubt that the vast majority of tasks undertaken by the federal government since the New Deal era have been an unjustifiable usurpation of the powers that the Constitution granted to the states or the citizenry. But the Constitution was also an explicit rejection of the Articles of Confederation: the disadvantages of untrammeled “states’ rights” were trade disputes, protectionism, and interference with the flow of interstate commerce. Consequently, the Founders wisely granted Congress the authority to take steps to regulate commerce among the states‐​that is, to keep open the channels of interstate commerce to ensure that free trade would win out over factionalism.

Applying the Founders’ vision to high‐​tech markets they could not have envisioned is tricky, but not impossible. Fifteen years ago, Brookings Institution economist Roger Noll argued, “The notion that there is a meaningful technical and economic distinction between federal and state services was always a fiction, but it has become increasingly so.” That is, the idea that telecom markets can be neatly carved into geographical units and regulated differently has always been based on a fundamental misunderstanding of the nature of the beast in question. After all, at the very heart of telecommunications is the notion of transcending boundaries and making geography and distance irrelevant. And from an economic viewpoint, the marginal cost of placing a call a mile away is about the same as placing one 1,000 miles away. So it seems that if ever there was a good case to be made for an activity being considered interstate commerce, this is it. And yet, America’s telecom market remains riddled with a patchwork of policies that actually thwart that goal and seek to divide the indivisible and place boundaries on the boundless.

Is Deregulation an Impossible Dream? Which leads to the final problem with Commissioner Martin’s logic: In endorsing a more “granular,” state‐​led approach, does he honestly believe that serious deregulation will be achieved any time in the near future? Thanks to his efforts, 51 state regulatory commissions are now free to continue their experiment with telecom markets. Where is the end to this process? Will state regulators ever say that enough is enough, lay down their guns, and call it a day? Not likely. More likely, they will find creative ways to expand their powers and justify their continued existence. Open access for cable systems is still on the agenda for some, as is the question of universal service for broadband. And what about the Internet? Is a more “granular” regulatory approach advisable there as well? We’ll see what happens as Internet telephony begins to catch on.

It is important to recall that not so long ago, before the Telecom Act preempted it, most states had laws on the books well into the 1990s that made it illegal to compete in telecom markets at all. It is difficult to recall any case in which state regulators have proposed freeing up a communications service; almost all serious deregulatory initiatives began at the federal level. And that has been the case in other industries as well. If the United States is ever to see the “pro‐​competitive, deregulatory national policy framework” mentioned in the first line of the Telecommunications Act of 1996, misguided states’ rights logic like that espoused by Commissioner Martin must be overcome.

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