The Impact of Technological Change on Market Power and Market Failure in Telecommunications

Journal of Economic Issues, June, 2001 by Edythe S. Miller

Technological change is an historical constant--no era has lacked for it. But it cannot be denied that it waxes and wanes. Its pace has quickened recently, with dramatic impacts on telecommunications, broadening its very definition. No longer is it confined to voice sent over copper wire, but now also is applied to such applications as e-mail, data, and video transmitted over fiber optics, cable, and satellite (Blumenstein 2000b, R4). Recent years have seen the development of broadband, capable of high speed delivery of large quantities of voice and data, accessed through cable or digital subscriber lines (DSLs), copper telephone wires modified to boost capacity. Wireless telephony has become a mass phenomenon; broad usage of wireless Internet is thought to be imminent. Institutional economics consistently has recognized the inevitability and ongoing nature of technological change, and its importance in shaping the future. Where neoclassical models regularly hold technology constant or bury it in residuals, i nstitutionalists, though interpreting the term diversely (e.g., Hamilton 1986), uniformly view it as a causal force. Moreover, actual and perceived relationships among technological change, regulation, and market forces influence public policy in subtle and often poorly understood ways.

Among the many grounds upon which economic regulation is faulted is its hindrance of innovation. [1] Deregulation is advocated as an incentive to risk taking, including investment in new technology. Moreover, technology is portrayed as destructive even of natural monopoly and as decentralizing because, for example, it produces substitutes (Friedman 1962, 28-9), eroding both monopoly on the supply side and consumer necessity on the demand side, modifying the "affected with a public interest" nature of the product. In any event, it is contended, market forces are sufficient to prevent firm dominance and restrain monopoly, even in imperfect markets. There thus is no need for collective control. A policy of deregulation is advocated, equated with competition, and viewed as encouraging efficiency. The policy duly has been broadly adopted. The paper examines this process in application to telecommunications.

Telecommunications is an indispensable foundation for the conduct of business and personal interaction. For most, the telephone is the point of entry for many of the new services now offered. The structure of the industry and availability of service are consequential. However, telecommunications is characterized by inherent operating conditions that make questionable the potential for market control. For example, significant network and coordination economies impose requirements for large networks relative to size of the market. This, in turn, ordains the need for minimum efficient size, increasing the tendency toward concentration. These conditions, in combination with the requirement for large up-front investment, the existence of high sunk costs, and an obligation to build in advance of demand, comprise serious barriers to entry. Moreover, the need for high load and capacity factors virtually invites a strategy of price discrimination and cross-subsidization, a strategy facilitated by the segmented market s with market-specific demand elasticities that the industry serves. Further, control of access encourages abuse of monopoly power (Trebing 1994, 382-3; 1997, 31). In such industries, a common pattern is one of sequential selective price wars and consolidation.

Recent relevant legal and legislative history begins with the modified final judgment (MFJ) entered by a federal district court in 1984, concluding a Department of Justice anti-trust suit against AT&T. Among its provisions was the divestment of the twenty-two Bell operating companies as seven regional holding companies. In recognition of the market power conferred by control of the local distribution network (the local loop), the trial judge placed restrictions on the regional Bell holding companies (RBHCs, also the Bells), in respect to equipment manufacture, interstate and interLata transport, and information services generation and transmission. The RBHCs also were required to obtain line of business (LOB) waivers to engage in unrelated activities, to be limited to less than 10 percent of revenues. AT&T explicitly was granted the ability to engage in activities other than regulated communications. It was less generally recognized that the waiver process opened to the RBHCs a path to diversification. Waive rs that did not violate the named exclusions were granted quite liberally (Miller 1993, 24).

From the start, the Bells opposed the restrictions. Overtime, most were lifted. The ban on interstate transmission remained, however, and would be revisited in the 1996 Communications Act. In contrast, the admixture of conduit and content continues as an issue in a broadened context, but seems of late almost to have disappeared from the national dialog. Telecommunications restructuring at this time also took shape in an FCC program requiring the adoption by RBHCs of measures for physical and virtual colocation and unbundling, dubbed open network architecture and comparably efficient interconnection, designed to increase network accessibility to rivals. There also was a shift from rate base, rate-of-return regulation to variants of price cap or incentive regulation, ending controls on profits (Miller 1993, 25-26; Trebing 1994, 381).