Toward a unified theory of access to local telephone networks.

• Author: Spulber, Daniel F.
• Position: The Enduring Lessons of the Breakup of AT&T: A Twenty-Five Year Retrospective

1. INTRODUCTION II. THE HISTORY OF THE REGULATION OF LOCAL TELEPHONY A. Early State and Federal Regulation B. The Emergence of Competition in Complementary Services C. The Emergence of Competition in Local Telephony D. The Telecommunications Act of 1996 III. THE RATIONALES FOR REGULATING LOCAL TELEPHONE NETWORKS A. Natural Monopoly B. Network Economic Effects C. Vertical Exclusion D. Ruinous/Managed Competition IV. THE DIFFERENT TYPES OF ACCESS TO LOCAL TELEPHONE NETWORKS A. Retail Access B. Wholesale Access C. Interconnection Access D. Platform Access E. Unbundled Access F. Regulatory Arbitrage V. CONCLUSION I. INTRODUCTION

   The breakup of AT&T represents perhaps the most dramatic landmark of a fundamental shift in U.S. telecommunications policy. (1) Until the 1960s, policymakers generally regarded the entire telephone network as being inherently monopolistic. (2) Over time, technological developments made competition possible in complementary products and services offered through the local telephone network, such as the telephone equipment located in residences and business offices (known as "customer premises equipment" or "CPE"), (3) long-distance service, and the new set of services that combined computing power with transmission to provide innovative new services that went far beyond traditional voice communications (originally called "enhanced services" and later called "information services"). The order mandating the breakup of AT&T, commonly known as the Modification of Final Judgment (MFJ), attempted to promote competition in those services by mandating that the newly created Bell Operating Companies provide rival providers with equal access to their local telephone networks. (4)

   The MFJ only provided for access to providers of complementary services. It did not envision direct competition in the local telephone network. (5) Technology would soon transform that portion of the network, as new fiber-optic and wireless-based technologies allowed competition in local telephone service to emerge as well. As a result, Congress enacted the Telecommunications Act of 1996 (6) (1996 Act) and included in it a range of access requirements that went far beyond those required by the MFJ. (7) The FCC implemented these new requirements through a regime known as Total Element Long Run Incremental Cost (TELRIC), which based access prices on the long-run, forward-looking cost of elements to which the requesting company sought access. (8)

   This approach taken by Congress and the FCC suffers from several conceptual shortcomings. It overlooks the fact that the emergence of competition undermines many of the basic rationales for regulation. In addition, a cost-based approach to access pricing, in effect, treats each network element as if it existed in a vacuum. In so doing, it fails to capture the interactions between different network components that allow networks to compensate for limitations in capacity and unexpected changes in network flows by routing traffic along different pathways. It is quality that causes networks to behave as complex systems in ways that can be discontinuous and quite unpredictable. Finally, using the same methodology to implement many of the access requirements currently embodied in U.S. telecommunications policy in effect treats them as if they were conceptually the same. The lack of an overarching theory of network design ignores the fact that different forms of access have different implications for network configuration, capacity, reliability, and cost.

   This Article seeks to rectify these shortcomings. Part II describes the early state and federal efforts to regulate local telephone networks and traces the emergence of competition and the ways in which the regulatory regime adapted in response. Part III reviews the basic rationales for regulating local telephone networks and critiques their continued applicability. Part IV analyzes access through an approach we have developed based on the branch of mathematics known as graph theory that captures the interactions between network components that are one of the most distinctive qualities of networks. (9) In so doing, we apply a five-part system that we have developed for classifying different forms of access (10) to gain insight into the problems and distortions caused by the existing regulatory regime.

2. THE HISTORY OF THE REGULATION OF LOCAL TELEPHONY

   1. Early State and Federal Regulation

      Under the system of federalism enshrined in the U.S. Constitution, the authority of the federal government is limited to interstate commercial activities. The regulation of intrastate telephone rates fell within the jurisdiction of the states. (11) Although early legislation in five states had authorized some degree of regulation over local telephone companies, state regulation of local telephone service did not begin in earnest until 1907 when states began authorizing their public utility commissions to oversee the reasonableness of local telephone rates. By 1921, all but three states had instituted some form of regulation of local telephone rates. (12)

      Federal regulation of interstate telephone service began in 1910 with the enactment of the Mann-Elkins Act, (13) which declared interstate telephone and telegraph companies to be common carriers subject to the duty to provide service upon any reasonable request at "just and reasonable rates." (14) The Act also gave the Interstate Commerce Commission (ICC) the power to overturn rates that it found to be "unjust or unreasonable or unjustly discriminatory or unduly preferential or prejudicial," (15) but it did not give the ICC the authority to require the filing of tariffs or mandate interconnection ex ante, which had the effect of limiting it to ex post review of rates. (16) In addition during this period the ICC focused its attention primarily on the railroads. As a result, the ICC did little to exercise the scant regulatory jurisdiction over telephone service that it did possess, undertaking only four telephone rate cases during the twenty-four years during which it had jurisdiction over the telephone industry. (17)

      Congress addressed many of the deficiencies of the Mann-Elkins Act when enacting the Communications Act of 1934. (18) In addition to giving the newly created FCC the authority to ensure that interstate telephone rates were just, reasonable, and nondiscriminatory, the Act also addressed the ICC's lack of authority to require tariffs by requiring all interstate carriers to file schedules of charges. (19) At the same time, the Act preserved the preexisting division between federal and state authority by including language providing that "nothing in this chapter shall be construed to apply or to give the Commission jurisdiction with respect to ... charges, classifications, practices, services, facilities, or regulations for or in connection with intrastate communication service ... of any carrier." (20) The Act also gave the FCC the authority to oversee what became known as the "separations" process, through which the agency would determine what proportion of the costs of capital equipment used for both local and long distance would be allocated to each service. (21)

   2. The Emergence of Competition in Complementary Services

      From the time of the enactment of the 1934 Act until the mid-1960s, regulators and the Bell System entered into a symbiotic relationship. The regulatory authorities condoned the Bell System's monopolization of all aspects of the telephone network. Monopoly control allowed regulators to authorize charging above cost for certain services and to use the excess returns to cross-subsidize other services that were more popular with regulatory constituencies. For example, the FCC used its control over the separations process to allocate to long-distance rates an ever-increasing proportion of the costs of the capital equipment used to provide both local and long-distance service--such as CPE, the wires connecting individual customers' premises to central offices (commonly known as "local loops"), and the switching equipment located in central offices. (22) The higher long-distance charges were thus used to keep monthly charges for local telephone service low. Similarly, state regulatory authorities used higher charges on business users to cross-subsidize the rates paid by residential users. Finally, regulatory authorities used a system known as "rate averaging" to mandate that all telephone subscribers in the state pay the same rates for service. The effect was to require lower-cost urban users to cross-subsidize the service for higher-cost rural users. The Bell System, which by this time had established a pattern of cooperating with regulatory authorities, acceded. So long as the resulting rates protected its aggregate rate of return, it had little concern over the allocation of that revenue across different customers and services. (23)

      Over time, outside forces began to undercut this cozy arrangement. First, after a long period of rate decreases during the 1940s and 1950s, the Bell System began to seek increases in long-distance rates. Complaints from members of Congress and the General Services Administration prompted the FCC to initiate its first systematic analysis of the Bell System's costs, which revealed wide disparities in rates of return across seven different classes of interstate service. As a result, the FCC abandoned its system of "continuing surveillance," in which long-distance rates were established through informal negotiations between AT&T and the FCC, in favor of a more formal regulatory regime based on cost-of-service ratemaking. (24)

      In addition, competition began to emerge from providers of complementary services. For example, producers of CPE began to seek access to the Bell System's local telephone networks. "Foreign attachments" provisions contained in the Bell System's tariffs prohibited the interconnection of any CPE not manufactured by the Bell...