Telecommunications policy and the persistence of the local exchange monopoly

Business Economics, April, 1998 by David L. Kaserman, John W. Mayo

Telecommunications policy has never been without controversy. Yet since passage of the Telecommunications Act of 1996, debates that traditionally have been reserved for staid and often obscure public utility commission hearing rooms have spilled over to far more visible forums, such as state legislatures, editorial pages, and courtrooms. These debates center on the various rules and policies that will govern market structure and pricing throughout the telecommunications industry; the answers that emerge will have profound effects on the degree of consumer choice, prices, and quality of service across virtually the entire range of telecommunications services.

Given the increasingly vital role of information gathering, transmission, and dissemination for advances in productivity and competitiveness, these debates - which otherwise might be of interest to a relatively limited number of regulatory economists and telecommunications specialists - are taking on extraordinary and widespread importance for the broader economy. Indeed, it is probably safe to say that no sector of the U.S. economy will be unaffected by the outcome of this ongoing policy formulation process.

BACKGROUND

The modern era of telecommunications policy began with the divestiture of the Bell operating system in 1984. That divestiture was the culmination of a Department of Justice antitrust case that had been initiated in 1974. The widely accepted theory behind this case was that the long-distance portion of the telecommunications industry could, if separated from the monopolistic local exchange industry, realize effective competition. Consequently, this segment of the industry could then be deregulated.

The actual divestiture agreement, known as the Modification of Final Judgment, or MFJ, is a short but substantive document. Its principal requirement was the structural separation of AT&T from the regional Bell operating companies (RBOCs).(1) Upon separation, the former would provide inter-local access and transport areas (LATAs), long-distance services (both interstate and intrastate), while the latter would provide local exchange and relatively short-haul intraLATA long-distance services. The rationale for this structural separation was that the vertically integrated Bell system had both the incentive and wherewithal to disadvantage its fledgling rival long-distance firms through either outright denial or discriminatory provision of access to local exchange facilities whose control was exclusively in the hands of the Bell operating companies. Indeed, at the antitrust trial against the Bell system, substantial evidence was presented that the integrated Bell system had indeed acted upon these incentives to stifle the emergence of competition in the long-distance marketplace.(2) With ownership of the facilities of the local exchange monopoly (the Bell operating companies) separated from those of its former long-distance arm (AT&T), the former companies would no longer have any financial incentive to distort competition in the long-distance marketplace.(3)

Another key element of the MFJ was Judge Harold Greene's specification of the conditions under which the Bell operating companies could re-enter the interLATA long-distance marketplace. Specifically, section VIII(c) of the MFJ allowed for such Bell company reentry upon a showing that "there is no substantial possibility that it could use its monopoly power to impede competition in the market it seeks to enter."(4) Given this condition, reentry would be authorized upon a showing that the (upstream) local exchange market had become competitive. With competition at this stage of production, the ability to injure competition at the downstream stage vanishes and reintegration is warranted.

Industry structure, then, was governed under the MFJ from 1984 until the passage of the Telecommunications Act of 1996. This Act was the first substantive revision of the 1934 Federal Communications Act, which had first initiated federal government oversight of the telecommunications industry. This new legislation is not only a comprehensive revision to the 1934 Act, but it forges a completely new and bold path for telecommunications policy in the United States. Specifically, whereas in the past the principle aim of regulation might best be characterized as "protection" of incumbent utility providers of telecommunications from entrants and of consumers from the consequent monopoly power of the incumbent providers, the new Act seeks to promote competition in every telecommunications market. It does this by explicitly adopting policies that:

1. Remove legal and regulatory barriers to entry;

2. Allow for purchases of unbundled "elements" of the telecommunications network;

3. Establish pricing guideposts for the purchase of access to these unbundled network elements and wholesale services that are to be provided by incumbent local exchange carriers;

4. Require nondiscriminatory access to the operational support systems needed by entrants to process their customers' orders and render bills in an accurate and timely fashion.