Hellerstein Regulatory and Industry Review November 21, 1998 HELLERSTEIN REGULATORY & INDUSTRY REVIEW - - Sixth Issue: November 21, 1998

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This month's topic concerns a panel discussion on competition in the telecommunications market held by the Brookings Institute on November 20, 1998. Robert Litan, Director of Brookings Economic Studiesprogram, and Roger Noll urged the FCC and the Department of Justice to reject the mergers of SBCCommunications with Ameritech and GTE with Bell Atlantic because of the lack of progress in opening upthe market for local competition. Litan and Noll argue that until there is ample competition in the local phonemarket, all 271 applications by the RBOCs to get into long distance should be rejected. This they claim is theonly protection competitors have against the monopoly powers of the incumbents and their control over thelocal loop.

All panelists, Noll, Litan, Geller, and Crandall, gave their opinions on many of the familiar problems of thetelecom act , such as interconnection, resale, unbundled network elements, and lack of incentives forcompanies to become facilities based competitors.

Noll and Litan proposed a market test that all RBOCs must pass; they urged the FCC to deny an RBOC longdistance approval until such time as there are two other competitors to the RBOC in the marketplace.However, rather than having to compete on a statewide basis, they propose that the RBOCs be allowed tooffer long distance on a regional or subregional basis in those areas where there are two othercompetitors.While the Telecom Act does not prohibit regional or sub regional entry, it leaves this to thediscretion of the State Public Service/Utility Commissions who will likely not look kindly on this approach.This approach will likely be rejected by these State Commissions because it encourages cream skimming andforecloses any incentive to compete in rural and non-urban areas.


Hellerstein & Associates believes that getting the price right for resale and unbundled network elements iscritical to the success of local competition. The lack of an accepted figure for the cost of local access hasresulted in the continuation of market distortions. Until State regulators can accurately determine the costs oflocal phone service, and have sufficient time and the flexibility to initiate changes, incumbents will continueto have the upper hand. All panelists spoke about the difficulty in determining the actual cost for localservice; Noll remarked that it was fundamentally impossible to get the pricing system right so that prices donot distort an individuals behavior.

The lack of agreement on prices directly affects the calculation of the correct amount of universal servicesubsidy to offer carriers. Arriving at an agreed upon price for service is essential since without it there isknow way of correctly calculating the prices to charge for unbundled elements and network platforms. Litanand Noll suggest that the FCC rather than arrive at a set price for unbundled network elements instead set theprice of unbundled network elements at the average cost of incremental local access investments made duringthe prior year. This calculation they believe is the only way to maintain the principle of setting prices equal tomarginal costs. They also suggested that the FCC should phase out UNE rates within five years, rather thancontinue them indefinitely. All panelists agreed on the problems and economic efficiencies that continuedsubsidization of local phone service has on the marketplace and that any solution to the problem would bebetter than what exists today.

Henry Geller stated he thought the current UNE platform structure was a disaster and urged the FCC to startphasing out UNE platforms, subsidies and of the current price structure until you reach completederegulation after four years. Geller remarked that it was the States' or Congress' role to decide jurisdictionalissues and not the Courts. This theme of complete deregulation was picked up by Robert Crandall ofBrookings who argued instead for a complete deregulation similar to what occurred with the airlines. Heurged the FCC to completely remove all the regulations on the marketplace and push for completederegulation. He found no evidence to disprove why complete deregulation of all prices and regulationwould result in higher consumer benefits and economic efficiencies, than any other approach. Thus, heurged the FCC to grant all RBOCs the ability to sell long distance in their region and also to be allowed tocharge whatever prices the market allows. Crandall stated that although prices would increase in some areas,the costs of operating this system would be far cheaper on average than the costs of operating todays bloatedand economically inefficient system and todays $15 billion Universal service fund.

While Crandall urged a complete elimination of all price controls and regulations, Noll and Litan arguedinstead for a phase out of subsidies and price controls. They argued that controls should be gradually phasedout over a four to five year period. Litan and Noll stated that although they do not believe the presentstructure that relies on unbundled network elements is correct and helpful to facilities based competition, it isthe best process the FCC has to encourage competition in the local access market. Hellerstein & Associatesbelieves that subsidies or price controls should only be used for a limited time and then be gradually phasedout once they are no longer needed. Subsidies and price controls were adopted to correct a market distortionand once corrected should be removed before they create economic inefficiencies.

Joel Klein, the Assistant Attorney General for Antitrust, in his remarks reaffirmed that the Act was openingup the market to competition, but at a slower pace than people had expected. The speed of implementation isslower than hoped for two reasons, the lack of a second wire to all homes and two, the problem of crosssubsidization. Within the next few years technological developments and new innovations will take care ofthe first problem, leaving the FCC with the difficult job of trying to correct the thorny cross subsidizationproblem; a problem with no easy answers.

Klein's prediction that in the next few years there will be only a few players in the market could be a signalthat the Department of Justice is likely to approve the three mergers, AT&T-TCI, Bell Atlantic-GTE, andSBC-Ameritech as long as each party agrees to a number of conditions similar to those adopted in the BellAtlantic-NYNEX merger. This impression was reinforced by the examples that Klein used to explain pastDOJ merger decisions.

Hellerstein & Associates is interested in learning what its readers think of these issues. Please send allcomments directly to Judith Hellerstein at Judith@jhellerstein.com. If you would like more information on this topic please e-mail Judith Hellerstein at Judith@jhellerstein.com.

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