Econ 100
Mar 11 2009
Increasing Market Competition:
Deregulation &
Incentive Regulation
Definition of Terms
• Deregulation (1970-2000)
– process by which governments remove, reduce, or simplify restrictions
on business and individuals with the intent of encouraging the efficient
operation of markets.
– rationale for 'deregulation' is that fewer and simpler regulations will lead
to a raised level of competitiveness, therefore higher productivity, more
efficiency and lower prices overall.
• Liberalization: liberalized market, has less and simpler regulations,
can also have regulations in order to increase efficiency and protect
consumer's rights,
– However, terms are often used interchangeably within
deregulated/liberalized industries.
• Distinction between deregulation and privatization.
– Privatization can be seen as taking state-owned service providers into
the private sector.
Examples of Deregulation
• Airline Deregulation Act (or ADA) October 24,
1978.
– avowed purpose was to remove government control
from commercial aviation and expose the passenger
airline industry to market forces
– Since 1938, the federal Civil Aeronautics Board
(CAB) had regulated all domestic air transport as a
public utility,
• setting fares, routes, and schedules.
• CAB promoted air travel by generally attempting to hold fares
down in the short-haul market, to be subsidized by higher
fares in the long-haul market.
Deregulation in the Airlines Industry
• ADA (1978)
– Removed the CAB’s authority to set prices,
determine/allocate routes
• Allowed markets to determine these
– Overlooked strategic behavior in long term
gate leases by larger/better financed airlines
• As the text points out, one of the major problems
with deregulation is: “difficulty in developing
an effective regulatory strategy”
Incentive Regulation
• Sappington & Weisman
– Implementation of rules that encourage a regulated
firm to achieve desired goals by granting some, but
not complete, discretion to the firm
• Three features of incentive design
– Regulatory goals must be clearly specified before
design
– Regulated firm is granted some discretion
– Regulated firm is not granted complete discretion
Why Not Complete Discretion?
• Firm has better information than the
regulator about key aspects of the
regulated industry
– e.g., costs structure/production technology,
customer preferences/demand
• Firm may have different goals than its
customers/society
Deregulation in
Telecommunications
• A brief history
– 1939 Telecommunications Act
• Established the FCC as the administrating
authority (agency)
– 1960’s
• AT&T essentially had monopolies in:
– Local phone service (80%)
» No one owned their phone; rented from AT&T
– Telecommunications switching equipment, cabling
(Western Electric)
– R&D (Bell Labs)
A Brief History
• 1984 Modified Final Judgment (MFJ,
Judge Green)
– Ended AT&T’s monopoly in long distance,
and equipment provision/manufacturing
– Divested AT&T of the Baby Bell’s (RBOCs)
• AT&T and the 7 Dwarves
– RBOCs allowed to provide local service and short- and
mid-distance toll (local and intraLATA); but not LD
(interLATA)
– MCI and Sprint allowed to compete in the LD market
against AT&T
» AT&T no longer provides local service or local toll
MFJ Consequences
1996 Telecomm Act
• Objective
– Increase competition in the local phone market where RBOCs
and GTE held a monopoly
• Price and technological innovation
– Facilitate (manage) competition, through 3 entry patterns
• Facility based competition, resale and unbundled network elements
– Major roadblock
• “bottleneck” or “essential” facilities
– Local network necessary for access by competitors for call termination
– Local network is also where the scale economies are
» Don’t want to duplicate these facilities
• Interconnection agreements between CLECs and ILECs will be
instrumental
Competitive Entry: Facility Based
• Facility-based
– Competitors co-locate at ILECs central office
and provide upstream facilites/switching
• Compensate for terminating calls on local network
and transferring calls from ILEC
• Only path adopted by UK, Canada, Aus, NZ
Competitive Entry: Resale
• CLECs allowed to purchase entire service
(line, switching, features) from the ILEC’s
retail tariff
– Rates established by Efficient Component
Pricing Rule (ECPR)
• Difference between wholesale rate and retail rate =
avoided costs (e.g., marketing and billing)
• In practice: arbitrarily set at 10%
Competitive Entry: UNEs
• Unbundled Network Elements
– Intent: allow CLECs to use a hybrid approach
of mixing facilities competition with leasing of
“essential” elements (e.g., loops) from ILECs
• Catalyst to full, facilities based competition
– Rates set using total element long-run
incremental costs (TELRIC)
• Engineering based models (hypothetical)
• Reflect forward-looking economic costs, rather
than historical (embedded) costs
TELRIC Pricing
• TELRIC
– Attempt to estimate marginal costs using the
most efficient technology deployed and the
incumbent’s network
• Ignored facilities in place (historical costs)
• Modeled using current demand and customers
– No uncertainty – network sized for current demand with
no “insurance/reserve” capacity
– Hatfield model
• Generally adopted by regulators
• Built by folks without an Telecomm experience
TCA 1996: Pricing Impacts
• Resale
– Wholesale prices about 10% lower than retail prices
• Res – $16 per month retail (cost ~$30)
– Subsidized by business lines and LD rates
» Universal service
• Bus - $60 per month retail (cost ~$30)
• UNE
– If the CLEC reassembled all of the UNE elements ->
45-50% discount on TELRIC costs
What Would You Do?
• Suppose you’re a CLEC
– You can enter through any/all of three modes: facilitybased, resale, UNEs
– Would you build your own facilities?
• Consider that the FCC has developed TELRIC costs from
assuming that the most efficient technology is used and
demand is known perfectly
– Would you use Resale or UNE?
• Might the strategy be different for Residential and Business
customers?
• Given the cross-subsides in the old rates, which customer
would you target first?
Telecommunications Act of 1996
• The Act both deregulated and created new regulations.
Congress forced local telephone companies to share
their lines with competitors at regulated rates if "the
failure to provide access to such network elements
would impair the ability of the telecommunications carrier
seeking access to provide the services that it seeks to
offer."
• This led to the creation of a new group of telephone
companies, "Competitive Local Exchange Carriers"
(CLECs) that compete with ("ILECs" or Incumbent Local
Exchange Carriers).
Telecomm Act
• TCA permits new telephone companies to lease the
incumbent telephone companies’ network facilities at
wholesale prices far below costs.
• Rules encourage entry of firms that avoid building
alternative networks and depend on subsidized
networks’ facilities.
– Few entrants that built alternative networks are now abandoning
these networks (chart) for subsidized leased facilities.
• Because regulated wholesale prices are set far below
costs in many states, incumbent telephone companies
have also cut their investments.
– Neither incumbent nor new entrant investing, equipment
manufacturers have closed plants and industry employment has
fallen by half a million jobs.
www.newmillenniumresearch.org
•
CLECs are abandoning their own networks to lease UNEs at bargain prices The
recent increase in leased lines is coming at the expense of lines built and owned by
CLECs themselves.
•
UNE prices are set so low that they discourage CLECs from investing in alternative
telecommunications infrastructure.
•
Low UNE prices make the ILECs’ wholesale services unprofitable, which discourages
continued ILEC investment.
•
As a direct result of low wholesale prices, industry-wide telecommunications
investment has fallen 40% over the last two years.
•
This study finds that the fall in telecommunications investment results in an annual
decline in economic output equivalent to $101 per average household annually. In
contrast, the benefits of price reductions resulting from local competition are
estimated to be $11.41 per household annually.
•
This study finds finds that the economic costs associated with setting artificially low
wholesale prices far outstrip the consumer financial benefit
Brookings Institute
• Robert Crandall of the Brookings Institutehas argued that
the forced-access provisions of the 1996 Act have had
little economic value, and the primary, sustainable
competitive forces in phone and related, non-'radio',
telecommunications are the wireline telephone
companies, the cable companies, and the wireless
companies.
• The Act was claimed to foster competition. Instead, it
continued the historic industry consolidation begun by
Reagan, whose actions reduced the number of major
media companies from around 50 in 1983 to 10 in 1996 ,
reducing the 10 in 1996 to 6 in 2005.
So What was the Goal?
• Goals of regulation
– Efficiency in Production
– Promote Technological Innovation
– Efficiency in Allocation