Phoenix Center Policy Paper Series

Phoenix Center Policy Paper Number 2:

Reconcentration of Telecommunications Markets After the 1996 Act:

Implications for Long-Term Market Performance

(Second Edition)

Lawrence J. Spiwak*

(July 1998)

? Phoenix Center for Advanced Legal & Economic Public Policy Studies and Lawrence J. Spiwak (1998).

I.       Prologue

?????Last year, I wrote an article entitled Reconcentration of Telecommunications Markets After the 1996 Act: Implications for Long-Term Market Performance. [1] In that paper, I attempted to analyze the underlying reasons for, and the likely economic effects of, the telecommunications industry?s massive attempt to reconcentrate almost immediately after the Telecommunications Act of 1996 (the 1996 Act) was enacted. Among the various analytical tools I used was the little-known, yet highly-accurate ?Reasonable Mother test? -- i.e., ?if you were one of the merging parties, would your mother be ashamed of your actions?? The reason I used this test at the time of the first edition of this article is because soon after the passage of the 1996 Act, my mother telephoned me and asked, given her observance of a demonstrable trend in telecommunications industry reconcentration (especially in the last month alone), whether or not she should be ashamed. After conducting my analysis using more conventional economic tools (i.e., examining elasticities of supply and demand, the presence of barriers to entry, etc.), I informed her that while emerging market trends were, in fact, starting to give me good reason to worry, it was still just a bit too early to tell whether we should be ashamed or not. [2]

????? Well, hell hath no wrath like a Jewish mother who thinks she?s been duped by her so-called maven son. Once again, my Mother recently called me at my office and repeated her same question of one year ago (although modified slightly to account for my current employment status): ?Son, you used to work for the Federal Communications Commission before they disbanded ignominiously the Competition Division, [3] so therefore you still should be a maven about telecommunications industry mergers. Not that I doubted the answer you gave to me last year, but -- maybe it?s just me -- I still can?t help noticing that since Congress passed that new telecommunications law two years ago, it really appears that they are trying very hard to reconstruct the old Bell system. Are you sure we shouldn?t be ashamed??

????? Because I remain a person who cannot lie to his own mother (and, one year wiser, a person who also remembers Bismarck?s caveat that: ?those who love both laws and sausages shall inquire how neither are made?), I once again attempted to reply honestly to her inquiry. The only difference is that this time I had to tell her regretfully that, given the remarkable events of the last year, the entire telecommunications industry (both the private and (especially) the public sectors alike) should be ashamed -- in fact extremely ashamed -- of the emerging structure of the telecommunications industry.

????? And so my story begins -- again . . . .

II.    Competitive Issues at Stake Raised by Industry (Especially Incumbent LEC) Reconcentration

????? When the 1996 Act was passed, politicians and pundits alike promised residential consumers that as the tectonic plates of industry and competition started to shift, they would soon enjoy the same type of competitive benefits for local (and bundled ?one-stop-shopping?) service as they now enjoy for long-distance service. What they failed to tell residential consumers when they made this promise, however, is not only are the challenges faced today really quite unlike the challenges the Department of Justice (DOJ) and the Federal Communications Commission (FCC) faced at the time of the breakup of AT&T, but that they would also use a paradigm completely inapposite to the one used to promote successfully competition for long-distance service 15 years ago when the Commission first promulgated its Competitive Carrier paradigm. [4]

????? To wit, fifteen years ago, the Commission basically was attempting to accelerate entry into a single, homogeneous, and nation-wide long-distance market dominated by one firm (AT&T). At that time, while AT&T no longer controlled local bottleneck facilities (which were given to the RBOCs), AT&T still controlled the majority of interstate transportation facilities. However, because: (1) ILECs were forbidden by law to enter the long-distance market; and (2) AT&T, with its exclusive monopoly for over 50 years, was the only game in town, the only source for potential new entrants would have to come from ?outside? of the traditional telecommunications industry. [5]

????? The Commission recognized this fact, and attempted to create sufficient incentives for rapid and accelerated facilities-based entry by new firms. How they did this was to use essentially a two-stage process: On one hand, the Commission continued to subject AT&T, as the ?dominant? carrier, to all existing regulations (i.e., rate of return and then later price cap regulation, all new tariffs would continue to be suspended for 45 days before any new rate could go into effect, numerous reporting requirements, and the like). Not more regulation, not less regulation, just the status quo. ?On the other hand, however, in order to accelerate entry into the long-distance market (and therefore improve market performance to a level of sufficient rivalry such that regulation could eventually be removed altogether), the Commission basically removed all regulatory barriers to entry for new entrants. In addition, the Commission -- via its 1980 MTS/WATS resale decision, see, e.g., Resale and Shared Use of Public Switched Network Services, CC Docket No. 80-54, 83 FCC 2d 167 (1980) -- helped new entrants, inter alia, to ?appear? to consumers that they had a nation-wide, facilities-based presence until their networks could be completed. Note, however, that this ?appearance? was supposed to provide only a short-term mechanism to help nascent firms establish a market presence, and not to establish a perpetual resale model (which was specifically considered and rejected).

????? The success of this approach cannot be disputed. As a result of the Competitive Carrier paradigm, the long-distance market was transformed from a market characterized by a single dominant firm with a small competitive fringe, to a market characterized by, inter alia, high elasticities of both demand and supply, low barriers to entry, de minimis switching costs among competing carriers, vibrant non-price competition (phone cards, frequent flyer miles, etc.) and, most importantly, sustained and demonstrable trends of declining prices and new products and services. [6] Given these market conditions, the Commission eventually decided to remove the asymmetrical regulation previously imposed on AT&T (realizing that the economic harms created by asymmetrical dominant carrier regulation outweighed the public interest benefits the dominant carrier regulation was originally intended to achieve [7] ) and, in fact, imposes only de minimis regulation on this market today. [8]

????? In contrast to the long-distance experience, the Commission is now faced with the task of promoting competition for residential telephone service in numerous local markets -- all of which are dominated by a monopoly incumbent. Moreover, potential entry is no longer limited to a discrete set of firms. Rather, under the 1996 Act, new entry may come ostensibly from a wide variety of sources, such as long distance companies, cable companies, fixed and mobile wireless providers, utilities, and supposedly even other incumbent local exchange carriers (?ILECs?), especially the largest of the ILECs, the Regional Bell Operating Companies or ?BOCs.? In addition, new entry does not have to be on a facilities-basis. Rather, under Section 251 of the 1996 Act, ILECs must make facilities available to competitors on either a total resale or unbundled network element (UNE) basis on a significantly discounted basis. Once certain pre-conditions are met from the ?Competitive Checklist? contained in Section 271 of the 1996 Act, then the BOCs will be permitted to enter the market for in-region long-distance and international service. In other words, a legislative quid pro quo -- if ?local? markets are ?open? for competition, then the ?reintegration? of the U.S. telephone market (the inapposite goal of the MFJ and the FCC?s Competitive Carrier paradigm) is perfectly acceptable.

????? Where the big economic rub comes into play is that the Competitive Checklist contained in Section 271 of the 1996 Act makes no reference to what level of market performance is necessary before BOC inter-LATA entry is in the public interest. Rather, the Checklist emphasizes only a minimum set of preconditions that can arguably be satisfied simply by de minimis entry via UNE and resale mentioned above. [9] What Congress did not understand (or deliberately ignored), however, is the economic reality that (as explained in more detail infra), it is far more difficult to enter into the local distribution market than it is to enter the long distance market and, therefore, immediate and significant new entry is unlikely to occur. [10] Thus, if entry for residential local service is already ?difficult? at best, it is important to ask whether the recent reconcentration trend (especially among incumbent LECs) has contributed positively or negatively towards facilitating (and, in particular, accelerating) new, facilities-based entry.

A.    Vertical Re-Integration

????? As a general economic matter, there is absolutely nothing wrong will vertical integration in and of itself. Vertical integration can allow a firm to realize many economies of scale and scope. [11] (Indeed, to the best of anyone?s knowledge, the United States appears to be the only country that currently has an artificial distinction between ?local? and ?long-distance? markets.) The competitive problems arise whenever the economic costs of vertical integration outweigh the efficiencies gained from such integration. Accordingly, if the ?re-integrated? structure of post-1996 Act telecommunications markets permit one or more firms to engage successfully in strategic, anticompetitive conduct against its rivals, then the consumers are unlikely to enjoy the purported benefits that politicians promised them prolifically they would receive.

????? First, it is very important to recognize that because entry is far easier into the long-distance market than it is into the local market, incumbents have a significant cost advantage over their rivals. In contrast to the local market, entry into the ?long-distance? is far less expensive. That is to say, the long distance network by design is a non-ubiquitous, facilities-concentrated, usage-based, mass-market network where high capital costs are spread among huge number of customers who in turn indirectly heavily subsidize the local loop. In contrast, the local loop by design is ubiquitous, more facilities-dispersed, generally fixed-cost, retail market where high cost rural areas a subsidized by urban and suburban areas and from long-distance access charges. [12]

????? ?Moreover, there is a huge differential in the capital cost involved in replicating the local loop verses the long-distance network. The local loop has roughly 6,200,000 km of all types of cable plant, while the long-distance industry has roughly 150,000 km of cable plant. This approximately amounts to a 41:1 kilometer differential. This differential magnifies if one considers the physical and regulatory costs of digging up America?s cities. Indeed, the total value of the local plant is roughly $270 billion while the total value of the long-distance plant is roughly $40 billion. These widely disparate costs result in a valuation differential of approximately 7:1. [13] Finally, even if a new entrant can raise sufficient capital, readers must also understand that because local residential rates are so heavily-subsidized, entry (even on a total resale basis at a discounted rate) is often so unprofitable as to make entry unlikely. [14]

????? Given the above, it will be quite expensive for new entrants to enter the market at ?two? (i.e., ?local? and ?long-distance?) levels. If an incumbent can use this structure to its strategic advantage, therefore, then an incumbent can further deter new entry. [15] For example, without competitive alternatives for ?local service,? ILECs will still control essential bottleneck facilities which they may use to deter entry into the ?bundled, vertically-integrated? market. Moreover, not only does the incumbent LEC have significant cost and access advantages (the economic ?yin and yang? of bottleneck facilities), but it also has significant other ?first mover? advantages over new entrants -- i.e., ILECs currently have virtually 100% of the residential traffic ?pre-reintegration,? and, as such, they have brand loyalty and an established local presence that other new entrants may not possess. If other potential entrants conclude that the risks associated with attempting to provide both long distance and create nascent ?local? competition is simply too great (i.e., uneconomical), then entry may not occur. [16] If entry does not occur or is delayed, then it is highly probable that an ILEC will be able to grab immediately a substantial -- if not an outright majority -- share of the ?bundled service? market before any of its rivals. [17] If this scenario comes to pass, however, then we may end up with the undesirable outcome of several regional markets (i.e., the ILECs? original service territory) characterized by a ?dominant firm/fringe? model for ?bundled? products (been there, done that), rather than the preferred outcome of a national market characterized by multiple vertically-integrated, facilities‑based carriers and a healthy competitive niche fringe which sustains a level of rivalry sufficient to make stringent regulation unnecessary. [18]

B.     Horizontal Re-Concentration

????? Just as with increased vertical integration, increased horizontal concentration is not necessarily reason for concern. Indeed, it is crucial to avoid resorting to the populist arguments that government intervention is appropriate merely because a particular company is too ?big? or makes ?too much money? because, under long-standing antitrust precedent, it is perfectly acceptable for a firm to gain market power by superior business acumen or even historical accident. [19] Market power, like all human endeavors, is really a question of degree. Accordingly, the appropriate inquiry should not focus on whether a particular firm has market power, but rather on whether the firm has the ability to exercise this market power successfully (i.e., raise prices or restrict output) and affect adversely market performance (i.e., consumer welfare). [20]

????? Accordingly, policy-makers should look to see if increased horizontal concentration will permit the merged firm to raise prices or restrict output and, in particular, erect or maintain barriers to new entry. In particular, while economies of scope can certainly have pro-competitive benefits, economies of scope can also create ability to engage in strategic anti-competitive conduct. That is to say, because of the significant costs of entry (especially for residential, local telephone competition), entry rarely occurs in ?waves of competition? on a large scale basis. Rather, entry usually occurs in ?pin point? attacks wherever the incumbent may be the most vulnerable. Yet, if the incumbent enjoys significant economies of scope, then it may attempt to allocate the defense costs of these attacks over a much wider customer base where competitive pressures may not be present -- i.e., the more captive customers an incumbent may have, the more the per unit share of defense costs will decrease. If there are enough customers to make the per unit/customer share sufficiently de minimis -- such that neither captive consumers nor regulators notice (or care about) this de minimis increase in price -- then the incumbent has used successfully its economies of scope to both successfully deter entry and evade regulation. [21]

????? The ability to engage in such strategic conduct is also exacerbated by the number of states a firm provides service in. That is to say, as the number of independent regulatory bodies increases, then the easier it may be for the regulated firm to play one state PUC off of another -- in other words, regulatory evasion. When this occurs, those captive ratepayers who live in rural or high cost areas where competitive entry may not be, to put it politely, immediate, may inadvertently end up paying against their own interests. [22]

III. Prognostications from the First Article

????? In the first edition of this article, I argued that because the 1996 Act?s naked goal is to create a vertically-integrated telecommunications market for bundled products and services, we probably should not spend an inordinate amount of time to analyze the current trend of reconcentration from a horizontal perspective. Why? Because from a strictly horizontal point of view, I then believed that if the Act?s interconnection provisions successfully eliminated barriers to entry for the local market, it was probably unlikely that horizontal concentration among LECs would permit any one firm to successfully raise prices or restrict output. Moreover, based on what we knew to date, it appeared that most BOCs never even really had any immediate intention of entering each others? service territories. [23] Rather, the new competitive entry was expected to come from an increasingly vertically-integrated fringe -- CLECs, CAPs, cellular, PCS, maybe cable, maybe utilities, and hopefully the Internet.

????? Instead, I argued that the key area to watch would be the re-vertical integration of the industry. On one hand, I argued that even if ?one-stop-shopping providers? dominated the market, I had little doubt that there would be a significant fringe of ?single-service? providers at each level to serve niche markets. On the other hand, however, I posited that the real question to ask is how many fully-integrated, facilities-based providers consumers will actually be able to choose from in any given market? I argued that the answer to this question would depend on how competition actually develops -- regionally or nationally.

????? That is to say, I argued that if a true national market for telecommunications services actually developed, then -- assuming no additional consolidation among the large carriers -- consumers should be able to choose a ?one-stop? telecommunications service provider from at least eight fully-integrated nationwide facilities-based providers -- i.e., the former five BOC providers and the three or four former major ?long-distance? providers -- plus be able to construct a package of ?ala carte? products and services from various niche providers. So long as competitive conditions exist (e.g., excess capacity, high own-price elasticity of demand, low barriers to entry, low switching costs), I believed that consumer welfare should probably be improved significantly.

????? Despite this rosy optimism, given the preliminary evidence available at the time of the first version of this paper, I nonetheless noticed uncomfortably that the current trend appeared to indicate that it was entirely possible that the telecommunications industry may eventually be characterized not by a single, national market, but instead by several distinct regional markets comprised of incumbent LECs? prior service territories. As mentioned above I believed that it was highly unlikely (but not impossible) that most fully-integrated BOCs will try to compete head-to-head in the near-term with other BOCs. Rather, they would probably try to focus on defending their core territories from new entrants by offering a wide variety of vertically-integrated bundled services and products. [24] If this occurred, I argued that these regional markets would probably be characterized by a dominant firm/fringe model and, in such a case, the Federal Communications Commission may find itself revisiting its original Competitive Carrier regulatory paradigm.

IV. Events of the Past Year

????? As mentioned above, the events of the last year (and, in particular, during the past two months) have been so remarkable that I am compelled to write a second edition of this paper far quicker than I ever expected. Indeed, despite the FCC?s various attempts to write ?pro-competitive rules? (the FCC refuses to acknowledge that because it is a regulatory body, it writes regulations that have both costs and benefits [25] ) to further the interests of ?competition, community and common sense,? [26] the empirical evidence unfortunately supports the conclusion that the FCC?s efforts to date have been a dismal failure. For example (just to highlight a few), the center-piece of the 1996 Act -- the interconnection rules under Section 251 -- have been completely eviscerated by the 8^th Circuit Court of Appeals. [27] Similarly, the safe-guards designed to mitigate an incumbent LEC?s ability to engage successfully in strategic anticompetitive conduct required by Section 272 of the 1996 Act are proving not to be worth the paper they are written on. [28] And, of course, the ultimate FCC-sponsored barrier to entry -- the surreptitious imposition of hidden costs to pay for the Administration?s pet political project of wiring the schools of America at the expense of overall consumer welfare. [29] Finally, in addition to the FCC?s ill-fated attempts to write ?pro-competitive? rules, the FCC?s various case-specific adjudications also deserve particular criticism -- especially those adjudications reviewing major industry mergers and acquisitions. As explained more fully below, these include the FCC?s gross mishandling of both the Bell Atlantic/NYNEX and BT/MCI mergers.

????? Give these developments, where does this leave us at the present moment? Certainly not in any condition that I would be bragging about. For example, because the growing amount of evidence indicates that the legal and economic merger analyses used, and the ?voluntary merger commitments? obtained by, the FCC in Bell Atlantic/NYNEX are not worth the paper they are written on, [30] coupled with the FCC?s almost complete ?capture? by ILECs (which is an open secret around Washington), [31] incumbent LECs now apparently have no fear (or, perhaps more accurately, the chutzpah) of asking regulators to approve a proposed merger between SBC and Ameritech -- a merger that, if approved, would give one company control over one third of the nation?s aggregate phone lines and near monopoly control over the residential local service for eleven states (including Texas, California and Illinois). [32]

????? Similarly, just as this paper is going to press, Bell Atlantic announced that it was now going to attempt to acquire GTE. This merger, if approved, would give create an ILEC that would control over 63 million access lines, have direct access to 33 million households in 38 states (along with 10.6 million wireless customers) and have revenues that will probably exceed easily $53 billion. [33]

????? To counter balance this increasing trend in mega-ILEC re-concentration, AT&T also announced just as this paper is going to press that it is acquiring TCI, the largest cable MSO in the United States. [34] While everyone is heralding this potential merger as the ?Great White Hope? that will finally bring consumers real competition for local telecommunications service and fulfil the promise of the 1996 Act, several points should be highlighted before we all get a bit too excited. As an initial matter, everybody needs to understand that despite the potential merger?s promises, scientists have yet to develop technology that allows firms to provide voice-over-coax cable (a) at the same cost and (b) with the same quality as the existing copper twisted pair (i.e., voice-over coax costs more and gives you less). [35] Moreover, even assuming arguendo that voice-over-coax is really a close substitute for the traditional twisted pair loop, there are several economic structural characteristics regarding both the telecommunications and cable markets that also may place a frost on the proposed merger?s bloom.

????? To wit, TCI (like all major cable MSOs) does not have a nation-wide contiguous footprint. Rather, its footprint is made up of multiple franchises in which it is the dominant (if not outright monopoly) provider. Second, given this status, TCI (again, just like the cable industry as a whole) has a less-than-stellar reputation for consumer satisfaction. [36] Third, given the ease of rent extraction from existing captive customers, the record is quite clear that cable MSOs have very little desire to overbuild into other dominant MSO providers? service territory (gee, just like the BOCs). [37] Thus, if you live in a non-TCI franchise area, don?t hold your breath waiting for this new AT&T low-cost broad-band access to the home; and, conversely, if you do live in a TCI franchise service area, don?t hold your breath waiting for any competition for multichannel video programming to come from AT&T. [38]

IV. The Political Response: The FCC?s ?Effectively Precluded? Merger Analysis.

????? This is not to say, however, that the FCC has not attempted to develop some kind of pseudo-analytical cover to convince both na?ve consumers and na?ve politicians on Capitol Hill that they are firmly out to protect and promote the public interest from increased industry reconcentration. In a speech narcissistically entitled Thinking About Why Some Communications Mergers are Unthinkable delivered at the Brookings Institution, former FCC Chairman Reed Hundt proudly announced his vision (or, more accurately, the revision) of how the FCC should analyze telecommunications industry mergers post-1996 Act -- i.e., the ?effectively precluded competitor? framework. [39] Yet, because, as Mr. Hundt?s title clearly implies, the EPC framework was designed, at bottom, to provide nothing more than political cover for the Commission?s then-anticipated (and pre-determined) dispositions of BT-MCI III (?thinkable? if ?neo-mercantile? trade objectives are achieved), [40] Bell Atlantic/NYNEX (?thinkable? if enough voluntary commitments are obtained), this ?framework? -- by its very purpose -- was forced to abandon any firm legal or economic analytical foundation when precedent or first principles conflicted with the pre-determined outcome. In doing so, the Commission unnecessarily subjected itself to claims of arbitrary and capricious decision-making -- especially when the Commission?s policy objectives could have been achieved equally using a more ?analytically honest? approach. [41]

????? What is even more disturbing, however, is the fact that the FCC has used successfully its EPC framework as political/analytical cover to extract sufficient ?voluntary? concessions or ?involuntary? conditions to ?buy off? opposing parties from contesting the case. I?m sorry, but ?regulatory shakedowns? should not be the centerpiece of the Commission?s litigation-avoidance strategy. At the end of the day, the Commission simply cannot use ?voluntary? commitments to make either economically (i.e., when the FCC?s own competitive analysis concludes that the merger should not be permitted to move forward) or politically (i.e., where trade concerns outweigh the economic evidence) ?unthinkable? mergers ?thinkable? at the expense of consumer welfare.

????? Accordingly, so long as the political hyperbole remains the centerpiece of the FCC?s merger analyses, therefore, then whenever the Commission does conduct an accurate economic analysis regarding the potential pro- and anticompetitive effects on industry re-concentration post-1996 Act, these important conclusions will simply be lost in the morass. This loss is quite sad, given the fact that the Commission truly had an opportunity to advance the analytical debate about the form of industry structure post-1996 Act. Moreover, as stated above, the Commission could have achieved its policy objectives just as easily and effectively -- and garnered the respect and admiration of the professional and academic communities in the process as well -- had the Commission adopted a more straight-forward analytical approach. This vacuum in analysis and leadership is even more acute today, given the plethora of recent impediments that have deterred the implementation of the goals of the 1996 Act -- i.e., substantial industry reconcentration, overturned interconnection rules, and a preliminary ruling that the salient pro-competitive provisions of the 1996 Act are unconstitutional. Accordingly, if the Commission is going to continue to apply its EPC framework on a generic industry-wide basis, then several key ?elements? of the EPC framework need to be refined and re-considered substantially to make the framework more legally and economically supportable in the future. [42]

A.    While the Commission?s ?Public Interest? Review is Certainly Broader than the Review Required Under the Antitrust Laws, the Commission?s Competitive Analysis May Not, However, ?Extend Beyond? Well-Accepted Economic First Principles

????? Under well-accepted precedent, because of the FCC?s unique and difficult responsibility to regulate the dynamic industries under its jurisdiction, courts generally hold that the Commission?s powers are significantly broader than those of the antitrust enforcement agencies, because they are ?entrusted with the responsibility to determine when and to what extent the public interest would be served by competition in the industry.? [43] Thus, for example, if an antitrust enforcement agency found that a joint venture might result in the loss of present static economic efficiencies, then this agency would probably be bound to attempt to enjoin the venture. In contrast, because of the Commission?s broader scope of review, the FCC may find it appropriate (and entirely lawful) to risk the potential for short-term static economic efficiencies in the hope of achieving much greater dynamic economic efficiencies in the long-run. [44] The ability to enjoy a broader perspective, however, does not mean that the FCC can ignore basic economic first principles.

????? As (now) Justice Stephen Breyer explained, despite the fact that economic regulation and antitrust approach analyze market performance from different perspectives -- i.e., economic regulation seeks to promote competitive rivalry directly ?through rules and regulations? while antitrust enforcement by the DOJ and FTC seeks to foster competitive rivalry ?indirectly by promoting and preserving a process that tends to bring them about? [45] -- both regimes should fulfill identical public-policy goals. These goals, according to Justice Breyer, are ?low and economically efficient prices, innovation, and efficient production methods. . . .? [46]

????? As such, those who argue that there is no relationship between antitrust and economic regulation completely miss the point. [47] Congress clearly intended this ?direct/indirect? dual regime approach, because there are often situations where certain market conditions or an individual firm?s conduct may not satisfy the requisite legal criteria to violate the antitrust laws, but nonetheless have a direct negative impact on market performance. These conditions are sometimes referred to as ?policy-relevant? barriers to entry -- i.e., those situations where government intervention may be warranted, because the economic costs of imposing remedial regulation will not exceed the existing economic costs created by the barrier if no government intervention occurs. [48] If a ?policy-relevant? barrier to entry is present, then regulatory intervention may be appropriate. [49] What Congress did not intend by this dual merger review process is wasteful redundancy of government and taxpayer resources. [50]

B.     The EPC Framework Tries to Perpetuate the Flawed Notion that the Commission May Use Regulatory Proceedings to ?Level the Playing Field? Among Competitors.?

????? Under its EPC merger framework, the FCC now holds that ?although the public interest includes consideration of the competition policies underlying the Sherman and Clayton Acts, the public interest standard necessarily subsumes and extends beyond the traditional parameters of review under the antitrust laws.? No longer will the Commission merely require applicants to demonstrate that their proposed merger would not ?substantially . . . lessen competition . . . [or] . . . tend to create a monopoly? -- i.e., maintain the competitive status quo. Now, the Commission requires applicants to demonstrate specifically that their proposed merger actually ?will enhance competition.? In the Commission?s view,

A merger will be pro-competitive if the harms to competition -- i.e., enhancing market power, slowing the decline of market power, or impairing this Commission?s ability properly to establish and enforce those rules necessary to establish and maintain the competition that will be a prerequisite to deregulation -- are outweighed by benefits that enhance competition. [51]

The Commission therefore held that under its new EPC approach,

consistent with the 1996 Act?s focus on competition and deregulation, it is incumbent upon applicants to prove that, on balance, the merger will enhance and promote, rather than eliminate or retard, competition. The competition and deregulation Congress sought to foster extends not just to traditional local telephone service, but to related interstate access services, to Commercial Mobile Radio Services (?CMRS?), and to interstate long distance services. [52]

The problem with this approach, however, is that it is black-letter law that an administrative agency may not subvert the public interest to leveling the playing field -- up or down -- among competitors. [53]

????? Hard to believe, but the Ninth Circuit recognized this basic principle nearly sixty years ago in Pacific Power & Light Co. v. FPC, 111 F.2d 1014, 1016 (9th Cir. 1940). There, the Ninth Circuit specifically rejected the Federal Power Commission?s (FERC?s predecessor) argument that an applicant?s burden to show that a particular proposal is consistent with the public interest ?requires something more than a showing of convenience to the applicant, and can reasonably be interpreted as indicating that the Congress intended that there be a showing that benefit to the public will result from the proposed merger of facilities before it should receive Commission approval.? In particular, the court rejected the FPC?s argument that it may deny a merger application if the parties cannot show that ?the consuming public will be benefited thereby.? According to the court, the ?phrase ?consistent with the public interest? does not connote a public benefit to be derived or suggest the idea of a promotion of the public interest. The thought conveyed is merely one of compatibility.? As such, the court concluded that it is ?enough if the applicants show that the proposed merger is compatible with the public interest. The Commission, as a condition of its approval, may not impose a more burdensome requirement in the way of proof than that prescribed by law.? [54]

C.     The EPC Framework Simply Provides the FCC with Another Opportunity to Engage in ?Regulatory Shakedowns? and/or ?Regulatory Greenmail? to Expand its Powers Improperly and ?Tax by Regulation.?

????? In its effort to ?enhance competition,? the FCC apparently has little shame in not so quietly hinting that, as a significant component of its EPC framework, it is

also possible, in certain circumstances, for prospective merger partners to make pro-competitive commitments, whose likely effect in enhancing competition in some or all relevant markets outweighs the likely harmful effects that are expected to occur by reason of the merger. In such a case, we might find it in the public interest, convenience and necessity to approve the merger. [55]

Of course, the Commission was quick to point out that it did ?not intend to suggest, however, that applicants, by offering pro-competitive commitments, will always be able to carry their burden of demonstrating that a proposed transaction is in the public interest.? To the contrary, the FCC explained that for

some potential mergers, the harm to competition may be so significant that it cannot be offset sufficiently by pro-competitive commitments or efficiencies. In such cases, we would not anticipate the applicants could carry their burden to show the transaction, even with commitments, is pro-competitive and therefore in the public interest. [56]

????? Unfortunately, these statements simply provide the public and industry with the improper yet distinct impression that a serious economic analysis is the last thing on the FCC?s agenda. This message -- express or implied -- is completely unacceptable. Because economic regulation has both costs and benefits, any condition imposed must have a direct nexus to a specific anticompetitive harm and, moreover, must be narrowly tailored to mitigate only that specific anticompetitive harm. In the FCC?s apparent view, however, the dicta cited above indicates that a nexus is irrelevant; rather, such language sends a clear message to the industry and public that the FCC will only entertain seriously a merger application unless the applicants are also prepared to accompany this application with a ?political? deal for the benefit of their competitors, [57] and reporting requirements designed to perpetuate the Commission?s regulatory oversight over the industry. [58] Moreover, this the impression of a regulatory ?shake down? is exacerbated by the fact that the FCC has yet to find any ?merger-related? efficiencies resulting from any of the mergers the FCC reviewed under its EPC framework. [59]

????? The SBC/Ameritech merger provides unfortunately the FCC with yet another opportunity to achieve indirectly what it cannot do directly at the expense of consumer welfare. To wit, readers should understand that prior to the announcement of the proposed SBC/Ameritech merger, SBC was one of the most vociferous -- and successful -- antagonists of the 1996 Act and the FCC?s attempts to implement this Act. It was one of the primary parties behind the effort to have the FCC?s interconnection rules overturned by the 8^th Circuit, and (if that wasn?t enough) hired hot-shot Harvard law professor Lawrence Tribe to argue (also successfully, at least as of the time of this writing) that the 1996 Act was unconstitutional to boot. Now, numerous industry observers are arguing rationally that the proposed SBC/Ameritech merger would be pro-competitive because the merger application ?gives the FCC the leverage to push hard on SBC to open its markets? and, if a deal can be reached, would be a ?major accomplishment for [current FCC Chairman Bill] Kennard? and the ?de-regulation of local services could move into high gear.? [60] ? Please. ?Regulatory Green-Mail? (i.e., we?ll let you reconcentrate if you promise to go away?) is no substitute for sound legal and economic analysis and should not -- under any circumstance -- be tolerated by the American public. [61]

D.    ?Protecting Competition by Protecting Competitors? does not Contribute Positively to Consumer Welfare.

????? In general, ?leveling the playing field? (a.k.a. a naked ?by protecting competitors, we protect competition? approach) -- especially by policies (and, more specifically, by ?voluntary? merger commitments) that rely heavily on promoting local residential competition through ?resale? -- does nothing to maximize consumer welfare, because any alleged competitive benefits consumers might perceive will be created neither by the addition of new capacity nor from competitive efficiencies as firms are forced to lower costs or innovate, but essentially from below-cost pricing and ?state? subsidies (i.e., artificially imposed costs ) -- especially as local residential rates are already subsidized heavily by other services. All that is accomplished, therefore, is a redistribution of wealth from one firm to another because, in the long-term, this policy provides neither any real incentives for new firms to enter on a true facilities basis nor any real incentives for incumbents to upgrade their networks. [62]

????? Moreover, the economic costs of maintaining this kind of ?artificial? competition are particularly expensive when the FCC uses heavily ?voluntary? commitments -- rather than serious legal and economic analysis -- to justify why a merger may be in the public interest, yet these commitments, either for exogenous or endogenous reasons, nonetheless fail to achieve their objectives. Because it is highly unlikely that any increase in ILEC concentration will contribute positively to the creation of a competitive local exchange market, consumers should not be the ones to pay for regulatory failure. [63] When this regulatory failure occurs, consumers, once again, get the short-end of the stick, and merely reinforces their notion that regulatory proceedings are politics first, based on economics last. [64]

????? Finally, the ad homonym defense of such policies that ?those who oppose ?leveling the playing field? must a fortiori be against competition? is specious at best. Let us be quite clear here: the naked ?protection of competitors? is not the analytical equivalent of attempting to promote tangible new entry (i.e., expanding capacity) into a market currently dominated by a monopoly incumbent by reducing barriers to entry, exogenous costs, etc. As the FCC?s former chief economist recently remarked:

Like most economists, I am uncomfortable with rules that forbid a firm from exploiting efficiencies just because its rivals cannot do likewise. Such handicapping, or leveling without regard for up or down, may make for a good game, but the game is only a metaphor. When firms are hamstrung, even in order to equalize them with other firms, consumers are liable to lose out. [65]

????? Indeed, there is a substantial analytical difference between the EPC framework?s attempt to ?enhance competition? (i.e., promote ?artificial entry? by ?voluntary? commitments) and what the Commission attempted to do over 15 years ago in its Competitive Carrier paradigm discussed supra. As stated above, while the FCC took great pains to remove regulatory barriers to entry and implemented policies designed to help new entrants, inter alia, to appear to consumers that they had a nation-wide, facilities-based presence until their networks could be completed, it is extremely important to realize that this ?appearance? was supposed to provide only a short-term mechanism to help nascent firms establish a market presence and not to establish a perpetual resale model (which was specifically considered and rejected).

E.      The EPC Framework Improperly Relies on ?Ephemeral Possibilities,? Not Real Probabilities.

????? The core of the FCC?s EPC merger framework is its near exclusive reliance on the identification of the firms that, in the FCC opinion and prognostication, are likely to be the ?most significant market participants based on an analysis of capabilities and incentives to compete effectively in each relevant market from the universe of actual and precluded competitors? -- in particular, those market participants that, in the Commission?s exclusive opinion, are likely to be at least as significant a competitive force as either of the merging parties. After the Commission has identified these significantly precluded firms, then the Commission attempts to ?forecast the probable future (absent the merger) as a base case by which to evaluate the merger? -- i.e., calculate HHIs based on the number of ?significantly precluded competitors? pre- and post-merger. There are two fundamental analytical problems with this approach, however.

????? The first analytical problem with such a framework is not that the FCC is attempting to forecast what the market may look like in the future with or without the merger. Indeed, it is wholly-appropriate ? indeed crucial ? for both antitrust enforcement agencies and administrative agencies (including the FCC) to view the market from both a static and a dynamic perspective. [66] Such an analysis cannot be undertaken in a vacuum, however; public policy officials must also have some policy goal of long-term market structure to make this dynamic approach worth-while. [67] The problem with the FCC?s EPC framework is that the Commission?s prognostication focuses improperly more on ?ephemeral possibilities? rather than true probabilities. [68] Indeed, there is a substantial analytical difference between improperly finding that future market conditions will adequately protect future consumers and properly analyzing the effect of imminent future competition on current market conditions. [69]

????? Specifically, rather than attempting to use the number of current and likely entrants to calculate supply and demand elasticities, the FCC, in its discretion, simply identifies the particular firms that, in its opinion, will be the most ?significant? competitors. Yet, by apparently relying on a firm?s brand name or professional reputation rather than its actual abilities, the FCC is essentially opining on which firms it believes will be successful, and which firms that it believes will not. (Indeed, assuming that you were the president of a start-up venture, one shudders to think how your investors and creditors would react when they hear that the FCC, out of nowhere, opines that you are not a ?significant? enough competitor.) The dangers of such a flimsy analysis can be found in the events immediately following the FCC?s disposition of the Bell Atlantic/NYNEX merger, where two of the FCC?s most significantly precluded competitors (AT&T & MCI) announced that they were delaying short-term entry into local residential because resale was not economically viable. [70]

????? Thus, the EPC framework simply turns the potential competition doctrine on its head. [71] Indeed, it is extremely difficult to discern exactly what specific competitive effects the FCC is actually looking for in its prognostication of future market structure, conduct and performance. For example, under the doctrine of ?actual potential competition,? it may be appropriate to enjoin a merger when one of the merging parties was actually about to enter the market, but for the merger. If this market is already highly concentrated and no other immediate and significant entry is likely, then the merger may be anticompetitive. When an economic analysis comes down to nothing more than cockroach-race betting, however, consumers are the ones to suffer. [72]

????? Yet, because the EPC framework focuses so heavily on subjective prognostication, it does not address squarely whether a ?significantly precluded competitor? designation automatically means that a firm has the ability to exert pressure on incumbents to innovate and lower price. Under the doctrine of ?perceived? potential competition (or, in non-merger situation, under contestable market theory), it is the contestable effect created by one or more new entrants ?waiting in the wings? that exerts downward pressure on incumbent firms to sua sponte lower prices or increase services in anticipation of the forthcoming competition. This type of downward pressure was a primary reason behind the FCC?s recent decisions to pre-empt state regulation of cellular rates, even though the cellular duopoly was still clearly very much in force.

????? In those cases, the FCC reasoned that pre-emption of intra-state cellular rates was warranted because the FCC found that, inter alia, although new PCS entrants had yet to roll-out service, their entry was likely and substantial in the short term because they had already committed the substantial sums necessary to win the FCC?s spectrum auction and, more significantly, that cellular incumbents were already taking steps (i.e., lowering prices and adopting new technologies) to respond to this imminent PCS competition. [73] As no party produced any specific evidence in either Bell Atlantic/NYNEX or BT/MCI that indicated whether the incumbent actually perceived that because entry by one or more ?significantly precluded competitors? would be significant and immediate (regardless of actual ability) that it should preemptively respond by lowering prices or introducing more services, however, the Commission apparently relied improperly more on ?ephemeral possibilities? rather than true probabilities in these situations.

????? The preceding discussion brings us to my second concern: the ?pavlovian? return to, and heavy reliance upon, the calculation of HHIs as either the primary indicator of current, or the primary prognosticator of future, market performance. It is very well accepted, both in antitrust jurisprudence and Commission precedent, that market shares are not, in and of themselves, an absolute indication that a market is performing poorly -- rather, a much broader inquiry must be conducted to examine demand and supply elasticities and, in particular, the presence (or lack) of barriers to entry. [74] Exclusive reliance on market shares is even more capricious, however: (a) where the predominant market share was the result of regulation [75] ; and especially (2), where the market boundaries (i.e., LATAs) were never intended to be definitive or (permanent) economic boundaries for purposes of measuring market power. [76] By arbitrarily constructing, and then heavily relying upon, the pool of significantly precluded competitors to calculate HHIs, the conclusions derived by the Commission are meaningless and, as such, may constitute arbitrary and capricious decision-making. [77]

F.      Gerrymandering Geographic Market Definitions is an Unacceptable Substitute for Thorough Economic Analysis.

????? As a general proposition, while it is crucial to identify first the correct product market when conducting a competitive analysis, defining the relevant ?geographic market? is not. By placing inappropriately too much priority on identifying initially the relevant geographic markets, gerrymandering geographic market definitions has now become nothing more than an intellectually lazy way to ensure that pre-determined outcomes can be achieved with a minimum amount of analytical effort. [78] For this reason, when the FCC promulgated its original Competitive Carrier paradigm, it refused specifically to first define the relevant markets or consider whether these markets were competitive and regulate them accordingly. Rather, the FCC examined certain characteristics of the participants in these markets and established two distinct sets of rules to regulate the firms which, based on the FCC?s assessment of these characteristics, had or lacked the ability and incentive to impede competition. [79] This analytical caveat is even more important to day.

????? Shortly after the 1996 Act was enacted, I warned that it is extremely important to avoid the use of overly narrow or broad market definitions when analyzing the structure of telecommunications markets, because the convergence of technologies makes ?traditional? telecommunications market definitions increasingly irrelevant. For example, it makes no sense to discuss a single ?cable? or similar technology market, when cable actually competes with broadcast television, direct broadcast satellite systems, MMDS systems, and the like. [80] Indeed, to argue that a telephone company has a monopoly over an ?open video system? (?OVS?) or a cable company has a monopoly over ?cable? programming in a relevant market, is like saying that Hostess has a monopoly over Wonder-Bread -- despite the fact that consumers view a variety of breads as acceptable substitutes. [81]

????? Similarly, as alluded to above, it is becoming increasingly questionable to define a homogeneous ?long-distance? or ?local? telephone market. Indeed, it makes little sense to consider separate ?long-distance? or ?local? markets with the imminent re-integration of the long-distance and local business as permitted by the new 1996 Act. See 47 U.S.C. ? 271. This distinction becomes even more obtuse now that companies are beginning to bundle additional telecommunications or information products and services into a single package, such as wireless service, paging, Internet access, video or even alarm monitoring. [82]

????? Accordingly, with this increasing convergence of telecommunications services and products into a variety of bundled offerings, the boundaries created by the MFJ increasingly reflect a dated economic picture of the market. When the MFJ was implemented, the various parties agreed to create ?local access and transport areas? or ?LATAs.? Although these lines were completely arbitrary, the LATAs were a convenient way to delineate the respective service areas of the BOCs. The creation of these boundaries under the MFJ therefore argued for three distinct economic markets: (1) local; (2) intra-LATA toll; and (3) inter-LATA or ?long-distance? service. However, while these boundaries may have made sense at the actual time of divestiture, it is important to realize that the LATA boundaries were never intended to be definitive (or permanent) economic boundaries for purposes of measuring market power. Accordingly, given the radical changes set in motion by the 1996 Act, continuing to use the MFJ approach will not be able to reflect accurately a market where firms offer ?one-stop shopping? for a variety of telecommunications services. [83]

????? For example, most consumers appear to take a more simplistic approach towards telephone service. To them, there is the local (fixed-charge) call (near) and the more expensive (per minutes of usage) long-distance toll call (far). In their minds, there is no significant difference between an intra-LATA toll call and an inter-LATA toll call -- they are both toll calls. Accordingly, the fact that consumers tend to view both toll calls as one product, rather than distinct services, argues against the automatic use of LATA boundaries as appropriate market definitions for antitrust or regulatory purposes. Similarly, the increasing use of wireless service also argues against the use of LATAs as appropriate market definitions. Wireless service, by definition, can extend beyond artificial LATA boundaries. Thus, if wireless service eventually replaces, or at minimum is viewed as a close substitute for, wired local service, then LATA lines again will not accurately reflect the actual economic boundaries of the market. [84]

????? Notwithstanding the above, the FCC decided to use LATAs as relevant economic geographic boundaries for purposes of analysis in its disposition of the Bell Atlantic/NYNEX merger. What is particularly incredulous, however, is that the FCC rationally believed that it could analyze a merger that would create a single firm with dominant control over the entire East Coast of America from Maine to Virginia (a footprint that -- according to Bell Atlantic Chairman Ray Smith?s own admission -- is worth ?$20 billion? alone [85] ) by defining exclusively the geographic market as LATA 132 -- i.e., the New York Metropolitan Area. [86] Accordingly, as a life-time resident of Washington, D.C., let me take this brief opportunity to thank personally the FCC for assuming that me and my neighbors -- along with the other good citizens of Washington, Boston and Philadelphia -- for looking out for our interests as well. [87]

????? Similarly, the fact that the FCC held that the relative market was limited to LATA 132 cannot substitute for its failure to examine -- much less even mention in a footnote -- the proposed merger?s effect on international IMTS traffic, especially as the merged entity would control five of the largest origination and termination markets for U.S. IMTS traffic (Boston, New York, Philadelphia, Baltimore and Washington). [88] Again, it was most disconcerting to see Ray Smith, smiling like the cat who just ate the canary, proclaim proudly on CNN the very night the FCC approved the merger that the merged company ?accounts for 50 percent of all the European international traffic? originating and terminating in the U.S. [89] Considering the sheer size of this number alone it would seem, therefore, that it would have been quite appropriate -- and indeed very important -- for the Commission to have considered these issues as part of its analysis. [90]

G.    Merger Review Should Focus on Whether a Transaction Will Permit the Merged Entity to Raise Prices or Restrict Output -- Not to Advance Improperly ?Neo-Mercantilist? Agendas.

????? As I explained in earlier writings, with the growing influence of the ?neo-competition? school, trade considerations are now increasingly becoming legitimate concerns in both antitrust and public interest economic analysis. [91] The problem with this approach, however, is that Adam Smith demonstrated powerfully over 200 years ago in his classic treatise The Wealth of Nations that whenever government attempts to coordinate the efforts of entrepreneurs, such policies almost invariably discourage economic growth and reduce economic well‑being. [92] ?Because Smith called this system ?mercantilism,? [93] I figured it was appropriate to describe current policies as ?neo-mercantilism.? [94] Indeed, after providing several examples of how trade concerns increasingly became an acceptable factor in antitrust and public interest lexicon, I questioned why not one proponent of the ?neo-competition? school had bothered to demonstrate what economic conditions have actually changed since Smith was alive that would merit a departure from his work. [95]

????? The FCC?s approach to foreign investment into U.S. telecommunications markets is no exception to this rule. [96] Indeed, contrast the FCC?s disposition of Bell Atlantic/NYNEX (i.e., attempting to make the uneconomically justifiable merger ?thinkable?) with the Commission?s disposition of the proposed (and subsequently aborted) merger between BT and MCI (i.e., attempting to make the politically unthinkable merger ?thinkable?). In that case, even though the record clearly revealed that the competitive conditions had improved dramatically since the time of BT?s original investment in MCI (including, among other things, the adoption of the February 1997 WTO Accord and the fact that the UK enjoyed effective competition for local loop facilities [97] ), the FCC decided to impose more regulation than it did in BT/MCI I in order to advance naked mercantile trade concerns. [98] Moreover, and certainly not least on the FCC?s collective mind, because the 8th Circuit Court of Appeals struck-down viscously the FCC?s much-hyped interconnection rules, [99] the FCC was under substantial political pressure to make it look like they were doing something to ?enhance competition.?

????? As such, the FCC in essence decided not to attack the potential anticompetitive harms resulting from the merger, but rather to attack the British government?s refusal to adopt a regulatory regime identical to one adopted in the United States, rather than any particular harm specifically created by the merger. To wit, even though the FCC conceded that BT faced increasing competition in this market [100] and that U.K. originating access services were subject to many of same regulatory constraints as those described for terminating access services (e.g., price caps and various license conditions regarding non-discriminatory behavior),

Other U.K. regulatory policies, however, undermine these constraints and allow BT to leverage its market power over originating access market [sic] into the markets for end-user services that depend on originating access (e.g., U.K. domestic and international services). [T]hese policies include the decision not to require BT to provide equal access to other long distance carriers, to provide unbundled local network elements to other carriers, and to resell local service at wholesale prices. Alternatives to BT?s local network may grow in time and eventually constrain BT?s control of originating access services, but they do not significantly do so at this time. In fact, the absence of equal access, unbundled local exchange network elements, and resale in the United Kingdom appears to create the conditions by which BT?s market power over U.K. domestic and international services will be perpetuated. [101]

????? Not to stop there, however, the FCC was equally as dismayed with the UK?s choice not to require incumbent LECs to provide unbundled local exchange network elements and resale as US ILECs are required to do under the Telecommunications Act of 1996. Once again, the UK Government disagreed that ?line-side? unbundling was necessary or appropriate in the United Kingdom because, in its view, the cost advantages of line-side unbundling would be small in the United Kingdom because prices are in line with costs, interconnection charges are to be based on long-run incremental costs, and access deficit charges have been abolished. The U.K. Government also claimed that making BT unbundle its local exchange network elements would be unlikely to promote local competition but would instead jeopardize the development of facilities-based local competition now underway. [102]

????? Accordingly, even though the WTO Agreement was signed over seven months prior to this order, because the FCC had yet to adopt final rules that implemented the WTO Basic Telecom Agreement, it stated that it was obligated to examine BT?s entry as a foreign carrier into the U.S. market under its ECO test. Because the Commission had previously found that BT did possess market power in its home market, but that the UK market nonetheless provided US carriers with effective competitive opportunities, the FCC decided to regulate the merged entity as a dominant carrier. [103]

????? Despite this fiery neo-mercantilist rhetoric, the FCC, after blasting another sovereign government, in the end decided to waive sua sponte the application of its then-current dominant carrier requirements to MCI pending the effective date of any new rules it might adopt in the Foreign Participation proceeding. [104] In the FCC?s opinion, not only would it be unduly burdensome (and therefore not in the public interest) but denying the merger could harm competition in the ?market for global seamless service.? Yet, even though this ?market? might have a very impressive-sounding name, it is extremely important for readers to understand exactly the characteristics of this so-called market the FCC is referring to. Basically, the purported ?market? for global seamless service is essentially nothing more than a sophisticated marketing ploy by large carriers of IMTS traffic to attract and retain the 2,000 largest users of IMTS products and services. As such, one must therefore ask why exactly is the FCC suddenly so concerned about protecting the largest business customers (who the FCC already found on numerous occasions to be quite capable of fending for themselves (see, e.g., Bell Atlantic/Nynex Merger Order), instead of the all other consumers? [105] Perhaps a good place for the FCC to start would be for it to fulfill the letter and spirit of the US?s own WTO regulatory commitments, rather than accuse other sovereign countries of regulatory failure when they have actually achieved tangible facilities-based competition.

????? The final epitaph to this regulatory passion play came just this week, when AT&T announced that it plans to enter a $10 billion joint venture with British Telecom that will, of course, ?enable BT and AT&T to deliver in a unique and powerful way the seamless global services [its] customers need and want.? [106] Given the record developed in the BT/MCI proceeding, this deal should go through for the same reasons the BT/MCI deal should have (but unfortunately did not) go through ? i.e., the U.S. firm is a non-dominant carrier (indeed, AT&T controls neither any bottleneck facilities (domestic or abroad) and has even sold its submarine cable repair division); there is effective and tangible local loop competition in the UK (a point that even the EC has stated this publicly); new under sea capacity continues to come on line (e.g. FLAG); and, of course, the near international commitment to adopt the WTO Regulatory Reference paper. What is particularly interesting/humorous about this proposed Joint Venture with BT, however, is that AT&T was one of the most vociferous opponents of the proposed BT/MCI deal, and was the primary motivating force behind the FCC?s decision to insert that fiery, neo-mercantilist rhetoric in the BT/MCI Order referenced above. Accordingly, while this merger does not appear to raise any competitive concerns and market conditions clearly have not changed dramatically over the past year, my only question to AT&T is: ?were you lying then, or are you lying now??

H.    By Focusing on ?Press Release Hyperbole,? the Commission Fails to Ask the Real Questions At Hand Regarding of How a Proposed Merger will Affect Long-Term Market Structure.

????? As stated above, what is perhaps the most disappointing about the FCC?s laudable attempts to bring increased vigor to its merger reviews is that any analytical improvements are simply lost in the morass of political, economic-type rhetoric. Indeed, while the purported rational for the construction of the EPC ?framework? was a need to create an analysis to help provide the Commission with a mechanism to manage the ?transition? from monopoly to competitive markets, the FCC consistently refuses to articulate specifically what exactly the underlying structure of this competitive market should be, even when Congress (in the domestic context), and the WTO (in the IMTS context), provided clear guidelines as to what kind of long-term market structure they wished to create. By failing to articulate a clear vision of long-term industry structure and performance (aside from apparently satisfying consumers? alleged desire for ?one-stop-shopping? from a few dominant, vertically-integrated firms and the wiring of the schools of America), therefore, this so-called ?transition period? to competition may be a very long time to endure. [107] If, however, the FCC had adopted a more analytically honest and straight-forward merger analysis, then the Commission?s underlying rationales -- and its policy concerns and objectives -- would have been far more persuasive.

????? To wit, the Commission stated that under the EPC doctrine:

In demonstrating that the merger will enhance competition, applicants carry the burden of showing that the proposed merger would not eliminate potentially significant sources of the competition that the Communications Act, particularly as amended by the Telecommunications Act of 1996, sought to create.? When facing a changing regulatory environment that reduces barriers to entry, firms that would otherwise compete directly may, as one possible strategic response, seek to cooperate through merger. [108]

This is an excellent point. The problem is that the FCC has never followed through with it.

????? Take for example the facts of Bell Atlantic/NYNEX. Low and behold, the Commission actually found documents showing that, among other things, Bell Atlantic ceased its planning to enter NYNEX territories during the pendency of merger discussions. Presented with such evidence, the Commission was then able to conclude that: (a) yes, Bell Atlantic did in fact plan to enter LATA 132 and other NYNEX territories; and therefore, (b) that Bell Atlantic would have been a competitor to NYNEX but for the proposed merger; and therefore (c) the proposed merger would a fortiori eliminate Bell Atlantic as a likely significant independent competitor in the market to provide local exchange and exchange access services, and bundled local exchange, exchange access and long distance services, to residential and smaller business customers particularly in, but certainly not limited to, LATA 132 and the New York metropolitan area (including northern New Jersey). [109] As this situation is a classic case of where the ?actual potential competition? doctrine would argue for disapproving a merger (e.g., very concentrated market, high barriers to entry, no other significant entry likely in short-term), there was nothing else for the Commission to say. The Commission, therefore, had no business attempting to prognosticate arbitrarily about the likelihood of success or failure of other market participants? business plans.

V.    Conclusion

????? The preceding analysis is not meant to suggest in any way that the Commission should not review major telecommunications industry transactions, or that when it does, it lacks a persuasive story to tell about how and why it should approach mergers post-1996 Act.? Quite to the contrary, given its broad and important responsibilities, there are actually numerous legitimate reasons very the FCC should play a significant role. Where the problem arises is that the FCC is guilty of simple regulatory failure.? Indeed, not only has the FCC failed to articulate, or convey, clearly this story to date, but that it has failed altogether to fulfill its public interest mandate under the Communications Act to protect and maximize overall consumer welfare. [110]

????? It is well-accepted (and indeed by now hopefully obvious) that telecommunications markets are characterized by rapid change and innovation and, as such, policy initiatives must undertake both a static and a dynamic analysis of current and likely market structure and performance. [111] Logically, therefore, in these situations, as any attempt of prognostication will be tricky at best, it would stand to reason that the most effective analytical approach would not be to ?guestimate? about future market conditions that are impossible to foresee accurately, but to focus specifically on those easily identifiable current structural conditions that will impact directly and substantially on future market structure, conduct and performance.

????? Like it or not, Congress (in the domestic context), and the WTO (in the IMTS context) each have provided clear guidelines as to what kind of long-term market structure the world wants to create; whether or not these structural parameters are actually capable of producing rivalrous competition, unfortunately, is a completely other matter and, moreover, is moot question at this point. [112] It is the FCC?s job, therefore, to attempt to promote the best market performance possible under these instructions -- no matter how economically or legally difficult this task may turn out to be. The problem, however, is that while the purported rationale for the construction of the EPC ?framework? was a need to create an analysis to help provide the Commission with a mechanism to manage the ?transition? from monopoly to competitive markets, the FCC consistently refuses to articulate specifically what the long-term structure of this ?competitive? market should be -- even when Congress (in the domestic context), and the WTO (in the IMTS context) provided clear guidelines as to what kind of long-term market structure they wished to create.

????? What I take from this experience is the growing belief that most people simply do not understand that ?competition? is just a form of conduct (in fact, the dictionary defines ?competition? as the ?act of competing?). Any evaluation of ?competition? is worthless, however, without an analysis of structure, because structure will determine conduct (i.e., whether firms can engage successfully in strategic, anticompetitive unilateral or coordinated conduct). [113] If this competition is rivalrous, then the market will produce good performance. When this performance is achieved, regulators are supposed to go home. Stated another way, different market structures induce different types of rivalrous conduct.? As such, unless the Commission articulates an explicit model of long-term industry organization within these parameters, it will be extremely difficult for the Commission to evaluate the success of its efforts to ?promote competition.? Only by spelling out specifically such a view can the Commission know when market performance is satisfactory enough to justify the eventual elimination of its regulatory intervention.

????? Accordingly, if we are truly serious about ?de-regulation,? then, using the 1996 Act?s and WTO?s instructional guideposts, the Commission needs to formulate, articulate and implement policy paradigms designed to establish, to the extent practicable, a market structure with a foundation conducive to competitive rivalry, under which firms will be unable to engage in strategic anticompetitive conduct -- even if they tried. [114] The FCC will preferably achieve this goal by developing and implementing pro-competitive policies; if it cannot, then it is required to approximate such performance by imposing price, conduct and structural regulation. Under any circumstance, however, what the Commission may not do is create, and perpetually rely upon, a hybrid of ?managed competition? -- i.e., regulation that ?mimics? competition. This is because

economic regulation is supposed to be a substitute for, and not a complement of, competitive rivalry. It is not, contrary to popular belief, ?because we can.? In other words, economic regulation is only appropriate where one or more firms are capable of successfully exercising market power (charging monopoly prices or restricting output) for a sustained period of time, and additional entry is unlikely. [115]

????? Yet, because the Commission relies so heavily on ?voluntary? commitments that benefit competitors in its EPC framework, it appears that the EPC framework is deliberately designed to create improperly such a hybrid market structure. In doing so, consumer welfare is not enhanced, only harmed. Rather, all the Commission achieves in reality with such a neo-competitive framework is giving those ?less-significantly precluded competitors? that are lower in the entrance queue an opportunity to ?butt-in? via enhanced resale commitments by the incumbents before they are really ready to enter on a facilities basis. As noted above, however, not only is it very expensive and wasteful to maintain such ?artificial? entry for a significant period of time, but that such artificial entry cannot, in the long-run, be sustained at all.

????? This is not to say that I have a per se hatred against resale, for I do not. What I do believe is that resale has its proper place, but using improperly resale as the permanent cornerstone for restructuring a major industrial sectors of our economy simply is not this place. For example, resale, when placed in proper context, is often a sign of a market with robust performance -- e.g., it prevents otherwise unused resources from going wasted, it places competitive pressure on facilities-based competitors from the fringe, and can provide consumer with non-price product differentiation as well. On the other hand, however, because a number of economic factors make a strict resale model simply unsustainable over a significant period of time, it is therefore highly doubtful that such an approach could contribute anything positive to overall consumer welfare. [116] To wit, from a public-policy point of view, so long as demand continues to increase, then there is really no such thing (just as being ?too rich? or ?too thin?) as having enough excess (i.e., elastic) capacity. This is because if capacity is in short supply (i.e., constrained), then the owner of the constrained facility will likely have the incentive to engage in some kind of strategic, anticompetitive conduct against other potential new entrants in order to protect its sunk investment. On the other hand, if supply is elastic (i.e., it is very easy to obtain capacity from other sources), then the owner of the facility will instead have the incentive to compete in order to ensure full utilization of its facilities. [117]

????? Accordingly, as I have argued elsewhere, because consumers consider, inter alia, cheap and reliable telephone and video service as an American birthright, if consumers perceive a sufficient diminution in quality or increase and price, then they will demand swift and demonstrable action. When the cacophony of consumer outrage becomes sufficiently loud (and it always does), then there is a distinct and strong possibility that Congress will instantaneously blame, and pressure heavily, the Commission. [118] Yet, because of the large sunk costs required for new entry, additional new capacity cannot come on line to relieve constrained facilities whenever politicians want them. These projects are both very time and capital intensive. Thus, without forward-looking policies designed to promote and encourage tangible, facilities-based entry, as demand expands and supply stays constant (or, in some cases, shifts in as outdated facilities go off line and are not replaced), consumers may very well experience an increase in price and a diminution in choices or quality of services, rather than the opposite result which they were originally promised and fully expect to realize.? When this happens, the lives of everyone involved with the process -- politicians, industry, and especially consumers -- become just a little bit more miserable. [119]

????? Yet, incredulous as it may seem, the uninitiated often still have a difficult time believing -- especially given the huge amount of ?pro-competitive? rhetorical promises made by politicians about their allegedly ?pro-consumer? policies -- that ?neo-competition? is actually the end goal. Well, believe it. The FCC has had two years to develop paradigms designed to promote and accelerate facilities-based entry and carry out their mandate to maximize consumer welfare. [120] Rather than focus appropriately on this task, however, the empirical evidence demonstrates that the FCC has been more interested -- not in maximizing overall consumer welfare -- in obtaining only the ?appearance? of competition (i.e., a ?trophy?) to divert public attention from their real goal -- implementing the Clinton/Gore Administration?s pet political agenda of wiring the schools of America via improper taxation by telecommunications regulation. [121] In my opinion, the fact that American consumers should pay for monopoly rents and decreased innovation with the sweat of their brows so that only the children of America can cross-over the bridge to the 21st Century -- adults may not cross this bridge because, like the initial group of the Children of Israel set free by Pharaoh from Egypt-land, they are not fully true believers in the master plan -- is obscene. [122]

????? If you think I am kidding about this ?neo-competition? approach, I am not. Take for example a recent ?regulatory Freudian-slip? uttered accidentally by the FCC?s new Chairman, Bill Kennard. This ?slip? was uttered recently while Mr. Kennard was speaking before a wireless industry trade association, where he was attempting to convey the point that competition and innovation can better the lives of people around the world. According to Mr. Kennard,

I want to start by telling you about somebody from the tiny village of Bora in Bangladesh. Her name is Noa Jahan Begum. And if you walked up to her house now, you?d see twenty or thirty ‑‑ or fifty ‑‑ people. They?re her customers. Some sit in her house, on chairs if they get there early enough. Others sit on the floor. The rest are lined up outside. And this goes on every day. Why? What?s happened to transform a woman who had no work nine months ago into an entrepreneurial success story? She got a loan from Gramin Bank ‑‑ and bought a cell phone. Noa Begum lives only 20 miles from Daka, the capital of Bangladesh. Still, most of her neighbors have never even seen a phone ‑‑ or a light bulb for that matter. To get a message to relatives in Daka they would walk. To call a relative, say, in New York City, they?d go to the city ‑‑ then wait days for a pay phone. Because to the rural poor, your technology has become a sure way to a better life. These new wireless phones give isolated people a link to the rest of the world. They help them in the most urgent ways. [123]

????? On its face, this is a very moving anecdote. While the concept that competition and innovation can better the lives of people around the world is certainly true, a close look at the preceding quote reveals that promoting competition and choice is not actually the true message that Mr. Kennard actually conveyed. Indeed, a careful look at the hypothetical reveals that Ms. Begum is clearly the exclusive monopolist for telephone service in the tiny village of Bora and, therefore, she clearly has the ability to charge consumers whatever she likes (as demonstrated by the throngs of people loitering around her house all day, hoping for a free chair). Ms. Begum gets rich, but the rest of the village continues to live in squalor. Of course, if Bangladesh had the current U.S. universal service system in place, then Ms. Begum would be able to both continue to receive monopoly rents and provide service at below-cost prices because she would receive substantial subsidies (i.e., expropriated) from consumers in Daka and from anyone who terminates an international call in Bangladesh originated from anywhere else in the world. [124]

????? Accordingly, rather than dedicating its efforts to achieving the ?appearance? of competition, the appropriate focus of the Commission?s efforts should be on both: (a) accelerating the decline of the entry-barrier slope over time -- i.e., reducing regulatory costs, effective enforcement, tangible things [125] ; and (b) ensuring that any increase in horizontal or vertical concentration does not delay or impede this process. The use of the word ?preclusion? means nothing without this broader context. Indeed, under the Commission?s current definition of ?preclusion? -- i.e., those firms that would have entered but for regulatory and other legal barriers -- anyone can be a precluded competitor. The key issue, therefore, is to turn the inquiry away from the who, and onto the how. If the Commission does everything in its power to reduce entry barriers, then the when will take of itself. So long as the FCC uses improperly the its merger review process to extract concessions to assuage political agendas, however, given the recent announcement of a possible merger between SBC and Ameritech, it tragically appears that the FCC?s standard of merger analysis is now tragically just reduced to nothing more than ?the bar is open.? [126]

Epilogue:

????? So, unlike last time, I do not have very good news to tell my mother. While I argued one year ago that even though many of the ingredients to the giant telecommunications omelet were already pre-determined, it was not too late to help influence positively the final recipe before the eggs finally set-up permanently. Indeed, I argued specifically in that article and elsewhere that that because market structure is they key to achieving sustained competitive rivalry, public policy officials needed to take careful and deliberate steps to ensure that the final omelet did not turn out to be so unappetizing that consumers only had dry toast and water on the menu. Tragically, given the huge amount of successful incumbent reconcentration and regulatory capture over the past year, all I have left to say to my mother now is just ?please pass the jelly.?