Costs and consequences of federal telecommunications regulations.

• Author: Ellig, Jerry

1. INTRODUCTION II. THE BASICS: EFFECTS OF ECONOMIC REGULATION A. Below Competitive Prices B. Above Competitive Prices C. Inflated Costs D. Stifled Innovation and Entrepreneurship E. Expenditures to Acquire or Maintain Wealth Transfers III. CLASSIFYING REGULATORY COSTS AND REGULATORY OUTCOMES A. Costs B. Outcomes IV. ANALYSIS OF COSTS AND OUTCOMES A. Regulatory Expenditures B. Long-Distance Access Charges 1. Costs 2. Outcomes C. Universal Service Funding 1. Costs 2. Outcomes a. Low-Income Programs b. High-Cost Support c. Schools and Libraries D. Local Number Portability 1. Costs a. Wireline Number Portability b. Wireless Number Portability 2. Outcomes E. Enhanced 911 Services 1. Costs 2. Outcomes F. Miscellaneous Wireless Mandates 1. Number Pooling 2. CALEA G. Spectrum Management 1. Costs 2. Outcomes H. Satellite I. Unbundled Network Elements 1. Costs 2. Outcomes J. Resale of Incumbent's Services 1. Costs 2. Outcomes V. CONCLUSION I. INTRODUCTION

   Economic regulation has substantial effects on telecommunications consumers in the United States. Regulation determines which services are priced above cost, which services are priced below cost, and which consumers will be overcharged in order to subsidize others. Regulation also affects which kinds of technologies and services will be offered to consumers and when, and whether consumers can decline to purchase certain services. It even helps determine who is allowed to compete and how.

   Telecommunications companies, cable companies, Internet service providers, equipment manufacturers, and various other interest groups spend millions of dollars each year to bend regulations to their liking. Economists have analyzed the effects of many individual regulations on both consumers and producers. Despite the surfeit of interest group interest and scholarly inquiry, no one has yet undertaken a comprehensive survey of the costs and outcomes of federal telecommunications regulation. This Article seeks to fill that gap by compiling scholars' estimates of the costs and outcomes of these regulations, identifying gaps in knowledge, and in some cases offering original estimates based on established methodologies. The research covered includes studies published in academic journals and books, academic working papers, and Federal Communications Commission ("FCC") reports. It includes studies sponsored by industry or advocacy organizations only when they offer novel information, data unavailable elsewhere, or empirical analysis based on academic work.

   The focus here is on federal regulation of telecommunications. Key issues of interest are the effects of regulation on the prices, quantity and quality of service, along with the associated effects on consumer welfare and overall economic welfare. Regulations that primarily affect applications or uses of information that pass through the infrastructure are outside the scope of this study.

   As in a number of other regulated industries, the federal government and states split jurisdiction. Traditionally, states have regulated intrastate services, such as local telephone service and intrastate long-distance service. The federal government regulates interstate services, such as interstate long-distance, wireless, and Internet. The 1996 Telecommunications Act redrew these boundaries somewhat. Congress prohibited states from giving local telephone companies exclusive franchises; henceforth, states could no longer create barriers to entry. (1) To stimulate competition, this legislation also requires incumbent local phone companies to lease elements of their networks to competitors and permits competitors to purchase their service at wholesale rates and resell it at retail rates. (2) The FCC decides which elements and services are subject to these requirements and establishes pricing methodologies. State regulatory commissions, however, determine the actual prices. Most recently, the FCC decided that Internet telephony, or "Voice over Internet Protocol," service is under federal rather than state jurisdiction. (3)

   Part I of this Article outlines the principal effects of regulation predicted by economic theory. Part II explains how the Article classifies costs and outcomes, employing basic concepts from price theory. Part III presents estimates of costs and assessments of outcomes for ten types of federal telecommunications regulatory activity: telecommunications regulatory spending, long-distance access charges, universal service funding, local number portability, enhanced 911, miscellaneous wireless mandates, spectrum management, satellite regulation, unbundled network elements, and resale of the incumbent's services. Part IV outlines the principal conclusions one can draw, given the state of existing research.

2. THE BASICS: EFFECTS OF ECONOMIC REGULATION

   Economic theory suggests that price regulation can improve consumer welfare when the regulated firm has monopoly power. If the firm charges a price that exceeds the price it would charge if it faced competition, ideal regulation can mimic the results of competition and force the firm to charge the "competitive" price. When this occurs, regulation has two beneficial effects for consumers. First, consumers who were already buying the service receive it at a lower price; the gains to these consumers can be measured by the amount of the price reduction multiplied by the amount they were already buying at the monopoly price. Second, the lower price induces consumers to purchase more, and this increased consumption further increases consumer welfare. Conceptually, this gain to consumers equals the difference between the regulated price the consumer pays and the price the consumer would have been willing to pay, summed over all of the additional units that are consumed. (4)

   The Telecommunications Act of 1996 assumes that competition is possible and desirable in all markets. In some cases, it directs the FCC to promulgate regulations that are intended to move the industry from monopoly to competition, rather than substitute regulation for competition. To the extent that such regulations accomplish this goal, they should have a similar effect on consumers as ideal regulation, reducing price and increasing the amount of service purchased. In addition, the move from monopoly to competition could produce other consumer benefits that regulation rarely delivers, such as innovative new services.

   Some regulations mandate that firms must offer, and consumers must pay for, particular services or network functionalities. Examples include 911 emergency service and local number portability. Such mandates may be intended to remedy market failures, such as public good problems or market power. Alternatively, they may simply be adopted because lawmakers and regulators believe they are good things that consumers should have, even if there is no market failure.

   Regulation is intended to make consumers better off by producing a price equal to the competitive market price or by correcting for other market failures. (5) However, there is no guarantee that this will occur in practice. There are at least five reasons: (1) prices below competitive market levels can create shortages; (2) regulation can hold prices above costs; (3) regulation and monopoly inflate costs; (4) regulation stifles innovation and entrepreneurship; and (5) expenditures to acquire and maintain wealth transfers increase costs.

   1. Below Competitive Prices

      If regulators set prices below the competitive level, they create shortages. History suggests that regulators frequently succumb to this temptation. (6) The temptation is especially strong in capital-intensive industries that require high up-front investments that have few good alternative uses. After the investment is made, public policy can reduce prices below the competitive level without immediately creating a shortage, as long as the price is high enough to cover the firm's ongoing costs of operation. Such prices harm consumers in the long run because firms will refrain from investing if they expect the unremunerative prices to continue. Eventually, this reduction in investment creates shortages, deteriorations in the quality of service, or other problems that diminish consumer welfare.

   2. Above Competitive Prices

      Price and entry regulation imposed on a competitive industry can actually increase prices and reduce consumption. This can occur either because policymakers imposed regulation on a competitive industry mistakenly or because they consciously did so in response to political incentives.

      Political incentives to regulate a competitive industry could come from the industry itself, which may seek regulation in order to forestall competition and increase profits. But political pressures may also come from certain segments of customers, who use regulation to obtain service at subsidized rates with the subsidies funded through excessive charges imposed on other consumers. The history of telecommunications, as well as the actual structure of telecommunications regulation, suggests that policymakers have responded to both types of political pressures. Traditionally, telecommunications regulation created market power, then mandated that some of the monopoly overcharges must be used to make local residential phone service available at prices that failed to cover incremental costs. Mandated services and functionalities may also contain an element of cross-subsidy. All consumers must purchase these services, and consumers for whom the cost exceeds the value might subsidize those for whom the value exceeds the cost. Regulation thus becomes an opaque way of taxing some services to fund a highly visible "free lunch." (7)

      When regulation elevates prices above costs, it reduces consumer welfare both by increasing price and by reducing output. Cross-subsidies can reduce producer welfare as well. If a monopolist is allowed to overcharge and use the money to fund cross-subsidies, the firm sacrifices...