Set it and Forget it? Market Power and the Consequences of Premature Deregulation in Telecommunications Markets

Abstract

Fifty years ago, U.S. Supreme Court Justice Felix Frankfurter warned the Federal Communications Commission not to view competition in an abstract, sterile way. To illustrate the dangers of using such an abstract approach to the key issue of ILEC market power, this paper uses the Commission's 1999 decision to de-regulate the prices for Special Access telecommunications services as a case study, wherein the Commission abandoned its own general framework for competition analysis in favor of using abstract notions of potential competition. As demonstrated herein, the Commission's deregulatory scheme for Special Access has produced substantial and sustained price increases for Special Access services where pricing flexibility is granted. Based on the results of an econometric model, these price increases are found to be the consequence of ILEC market power rather than price adjustments reflecting costs. The empirical model suggests that Special Access service is priced at about three times incremental cost, and this results is in line with other recent studies of market power in Special Access markets (e.g., Rappoport, Taylor et al., 2003), which find that the Bells receive a 40 percent return on Special Access revenues of $13.3 billion.

This evidence suggests that while admittedly imperfect prognostications about competition and market power may be acceptable ex ante, continued agency review of incumbent market power is not only warranted, but virtually mandatory. Further, when abstract measures of competition are found, ex post, to be inadequate checks on market power such as in the case of Special Access services, the continued use of such abstractions by regulatory agencies should be immediately reviewed and potentially eliminated, particularly where such failure has a significant adverse impact on consumer welfare and a deleterious effect on U.S. telecoms competition and, by extension, the economy overall.

The Commission's abstract approach to encouraging new entry and mitigating incumbent market power in the Special Access context should be a canary in the coal mine as to the consequences of using abstract notions of competition in the major rulemakings now pending before the Commission to facilitate Chairman Michael Powell's vision of a digital migration via so-called inter-modal competition. Indeed, as the D.C. Circuit recognized over twenty years ago: Complex regulation must still be credible regulation and any failure by the FCC to meaningfully enforce the Communications Act deprives regulated entities, their competitors [and] the public of rights and economic opportunities without the due process the Constitution requires. Viewing competition in an abstract way failed miserably for Special Access services and this fact cannot be ignored in future proceedings at the FCC. U.S. consumers deserve far more than a perfunctory Ron Popiel Chicken Rotisserie Oven - set it and forget it approach to the very real problem of ILEC market power, lest the negative effects of Special Access deregulation be replicated in other markets. While no doubt reducing its work load, the FCC simply cannot assume-away ILEC market power and, as Chairman Powell has recently attempted to do, eliminate it from the public lexicon altogether. Instead, responsible public policy requires the Commission to return the core unresolved issue of incumbent market power to center-stage and address it in an intellectually honest and definitive manner. As such, it is incumbent upon the FCC to fulfill their core function under the Communications Act - i.e., prevent dominant firms under their jurisdiction from gouging consumers and stymieing competition via the unfettered abuse of their market power.

Equally as important, if the evidence suggests a regulatory failure to mitigate the incumbents' market power that produces clear adverse effects on U.S. consumer welfare and the economy, then we come back full circle regarding the FCC's overall analytical approach of how we should move from one to many - i.e., given the obvious fact that the ILEC's can and will seek to exercise their market power to deny, delay and degrade new entry, then a more thorough look at the incumbents' market power by the Commission in the first instance is in order as the FCC attempts to facilitate Chairman Powell's vision of a Digital Migration.

Keywords: Special access, telecommunications, market power, de-regulation

JEL Classification: K23, L10, L50, L96, O33, 038