A consumer-welfare approach to the mandatory unbundling of telecommunications networks.

• Author: Hausman, Jerry A.

1. INTRODUCTION

   In January 1999, the Supreme Court decided AT&T Corp. v. Iowa Utilities Board,(1) the Court's first interpretation of the provisions of the Telecommunications Act of 1996 by which Congress intended, among other goals, to open markets for local telephony to competition. The precise issues before the Court in Iowa Utilities Board were arcane, but the case principally involved two questions: First, does the Federal Communications Commission (FCC) have jurisdiction to set prices for unbundled network elements--the building blocks of the local telecommunications network--or does such power reside with the states? Second, which such elements do incumbent telephone companies have the legal duty to unbundle--that is, to offer for sale on a disaggregated basis--at cost-based rates to competing local-exchange carriers (CLECs), so that the CLECs can produce their own services? In addressing the second question, both Justice Scalia's majority opinion and Justice Breyer's separate opinion in Iowa Utilities Board alluded to the essential facilities and market-power analyses familiar to antitrust jurisprudence, and invited the FCC, on remand, to consider that body of law as a possible approach in determining when a network element would satisfy the "necessary" and "impair" standards of [sections] 251(d)(2) of the Telecommunications Act, which govern when a network element is subject to mandatory unbundling.(2)

   Responding to that invitation by the Justices, this Article explains how economic analysis and antitrust jurisprudence would inform the Commission's statutory interpretation of [sections] 251(d)(2). We propose a consumer-welfare model for the mandatory unbundling of telecommunications networks. In this Article, we reconcile the "necessary" and "impair" standards of [sections] 251(d)(2) of the Telecommunications Act with the economic principles that provide the basis for antitrust and competition analysis. Our approach is responsive both to the Court's decision in Iowa Utilities Board and to the FCC's subsequent Second Further Notice of Proposed Rulemaking.(3)

   To advance the ultimate goal of encouraging the development of a competitive market for local telephony, the Telecommunications Act of 1996 sets forth rules governing the unbundling of local telecommunications networks.(4) The essence of the Iowa Utilities Board ruling is that the FCC must devise a limiting principle for implementing these rules. In the 1996 Local Competition First Report and Order,(5) its first stab at implementing the unbundling rules, the FCC had no serious limiting principle. The FCC defined a "necessary" unbundling under the statute to be any technically feasible one, and the First Report and Order gave the definition of "impairment" a similarly limitless scope. The Commission found that an incumbent local exchange carrier (ILEC) had to unbundle any nonproprietary network element if, in the absence of such unbundling, a telecommunications carrier seeking to offer a service would suffer even the slightest "impairment" of its ability to do so. The Court, in Iowa Utilities Board, rejected this approach and strongly suggested that the economic analysis underlying antitrust law provided the Commission with a useful model for interpreting [sections] 251(d)(2).(6)

   That is not to say that the Commission's interpretation of [sections] 251(d)(2) must incorporate by reference all of antitrust law. Rather, addressing the issue within the legal context of an agency interpretation of a newly enacted statute, the Court identified two discrete points along a continuum. The first point, embodied by the FCC's Local Competition First Report and Order, authorized any technically feasible unbundling. The second point incorporated the lessons of the essential facilities doctrine. Only a portion of the continuum constitutes a zone of reasonable statutory interpretations for purposes of the Chevron doctrine.(7) The First Report and Order was, in the Court's determination, plainly outside the zone of reasonable interpretations of "necessary" and "impair." The Court's opinion implies that the essential facilities doctrine and related economic analysis of demand and supply substitution would produce definitions of "necessary" and "impair" that would safely fall within the zone of reasonable interpretations of [sections] 251(d)(2). It does not follow, of course, that the Commission should pick any point that lies in the zone of reasonableness along the continuum of possible statutory interpretations. Rather, the Commission should adopt an interpretation that represents its best efforts to identify the optimal point along the continuum, where "optimality" is realized through consumer-welfare maximization.

   The FCC intimated in its Second Further Notice that it intends to adopt an approach remarkably similar to that in the Local Competition First Report and Order. We urge the Commission to accept the invitation of Justices Scalia and Breyer to bring its interpretation of [sections] 251(d)(2) in line with established antitrust principles. Indeed, the leading antitrust treatise recently echoed such advice.(8) The purpose of this Article is to explain how the Commission can successfully put that advice into practice.

   In Part II of this Article, we review the pertinent legal and economic developments in the telecommunications industry that preceded Iowa Utilities Board, and we provide a context for subsequent examination of the meaning of the "necessary" and "impair" standards of [sections] 251(d)(2). In particular, we review the AT&T divestiture of 1984, the Telecommunications Act of 1996, and the relationship between mandatory unbundling of incumbent local-exchange networks and the prohibition on Bell company provision of long-distance services.

   In Part III, we examine the reasoning used by Justices Scalia and Breyer to interpret the "necessary" and "impair" standards of [sections] 251(d)(2). Our analysis begins with the proposition that Congress did not intend to create a conflict in objectives between the Telecommunications Act and the existing body of antitrust jurisprudence. Antitrust law primarily seeks to maximize the well-being of consumers.(9) Similarly, Congress stated that the purpose of the Telecommunications Act of 1996 was to "promote competition and reduce regulation in order to secure lower prices and higher quality services for American telecommunications consumers and encourage the rapid deployment of new telecommunications technologies."(10) Both antitrust law and the Telecommunications Act seek to promote the competitive process and to protect legitimate returns to private investment, not the returns to particular competitors or particular market structures. The opinions of Justices Scalia and Breyer recognized these principles. Both Justices indicated that, although the Commission has the discretion under Chevron to promulgate roles predicated on reasonable interpretations of the Telecommunications Act, it would not be reasonable in light of Iowa Utilities Board for the agency to interpret [sections] 251(d)(2) in a manner that diverged from the essential facilities and market power principles in antitrust law. In dismissing such economic analysis as irrelevant to the interpretation of the Telecommunications Act, the FCC failed to recognize consumer-welfare maximization as the proper objective of the 1996 legislation.

   In Part IV, we set forth a number of guiding principles that together demonstrate the need for substantive limiting principles for the mandatory unbundling of network elements. The first principle is that unbundling roles should emphasize consumer welfare and competition rather than competitor welfare. A competitor-welfare standard would in effect impose no limit on mandatory unbundling. Second, the issue is not whether the ILECs will unbundle their network elements for use by CLECs, but whether the government will compel the ILECs to do so at regulated prices set on the basis of total element long-run incremental cost (TELRIC), which would force ILECs to subsidize CLECs. The third principle is that the social costs of a particular unbundling regime may outweigh the gains. Fourth, the "necessary" and "impair" standards should not rely on an economic misconception of sunk costs in local telecommunications. Finally, the apparent justification for mandatory unbundling can be endogenously distorted by the FCC's own policies, particularly the inefficient and noncompensatory pricing of unbundled network elements (UNEs).(11)

   In Part V, we offer, as appropriate limiting principles for network unbundling, those inherent in the essential facilities doctrine and in the competitive analysis of demand and supply substitution that informs traditional antitrust analysis of market power. We use antitrust jurisprudence to suggest economic definitions for "necessary" and "impair."

   One immediate lesson is that sound economic analysis counsels the FCC to interpret [sections] 251(d)(2) to impose geographic and temporal limitations on mandatory unbundling. That conclusion flows directly from an established body of antitrust jurisprudence on market definition and market power. Before the Commission will be able to conclude with any degree of confidence that its order of mandatory unbundling would serve the public interest and enhance consumer welfare,(12) it--or, preferably, the state public utilities commissions--would be well advised to make market-power determinations in each relevant geographic market for each network element for which the agency proposes to mandate unbundling. That market-power analysis should be based on a specified time horizon, after which the requirement of unbundling for that network element should sunset unless the access-seeker successfully carries the burden of proving that consumer welfare would suffer without the Commission's continuation of such mandatory unbundling.

   Second, the definitions of...