When in Doubt, Regulate…

Posted By George Ford On June 6, 2012 @ 3:04 PM In Broadband Credibility Gap,Federal Communications Commission,Investment,Law and Economics,Regulation,Special Access | Comments Disabled

In 1999, the FCC began to grant incumbent LECs pricing flexibility on special access services in some Metropolitan Statistical Areas (“MSAs”) when specific evidence of competitive alternatives were proven to be present.  Ever since, whether or not the Commission was justified in following the path toward deregulation of special access services has been disputed.  A proceeding initiated in 2002 on the topic of special access pricing flexibility remains open today.

Recent press reports indicate [1] that FCC Chairman Julius Genachowski is now circulating a proposal that would transform the way the FCC regulates such high capacity services.  Among other things, this agency’s review of the regulatory paradigm includes an expanded data collection effort.  Consistent with our findings in The Need For Better Analysis of High Capacity Services [2] (published as 28 John Marshal Journal of Computer and Information Law 343), the agency apparently has concluded that the evidence available today does not support a renewed regulatory effort.

While I welcome the agency’s efforts to collect better data, these press reports also raise some serious concerns about how the agency may approach the problem.

First, an official spokesman for the agency stated that the regulator would “eliminate regulations where evidence of competition exists.”  However, as we showed in a paper entitled Market Definition and the Economic Effects of Special Access Price Regulation [3], if the Commission continues to adhere to a geographic market that is “location specific,” which is consistent also with the position of those calling for renewed regulation of the services, then price regulation reduces economic welfare in all instances.  Admittedly, this is a seemingly odd result to the layman.  But, basic economics shows that even with monopoly supply, regulation offers no improvement in economic welfare when the geographic market is location specific because the buyer is likewise a monopolist.  The effect of regulation in such settings is mostly to transfer profits from seller to buyer, but every $1 of transfer costs more than $1 to society, so price regulation of special access services in location-specific markets unambiguously reduces welfare.  Obviously, the question of market definition will be critical in determining the path forward on regulating special access services; in fact, far more critical than the extent of competition.

Our paper also reveals, as do numerous other economic analyses of regulation, that deregulation should not depend solely on whether competition exists.  As the case law and the FCC’s own precedent have long-recognized, price regulation is not an “exact science.”  Indeed, not only is the rate-setting process itself complicated, but the regulator’s deliberation is complicated by interested parties who inevitably seek to use the regulatory process to effectuate a transfer of wealth from one industry segment to another.  Regulation, then, is imperfect, just as markets are sometimes imperfect.  The relevant question, therefore, is which maximizes social welfare—unregulated or regulated markets?  In some cases, regulation will flunk a cost-benefit test even under monopoly.  Our paper reveals one case, but the shortcomings of regulation apply in nearly all circumstances.

Second, the same spokesman noted that since the “existing framework is broken,” the agency plans to “temporarily suspend consideration of pricing flexibility petitions pending development of a new framework.”  I suppose some may feel this suspension is sensible, but my concern is that the choice reveals a bias.  That is, the Commission has decided that in the presence of concerns about the effectiveness of its own regulatory rules, its proper response is to suspend deregulation and, in turn, embrace regulation.  As an initial matter, the 1996 Act was supposed “to promote competition and reduce regulation”—it was not to extend regulation.  If the agency does not like its own regulatory policies, then its bias should be to eliminate regulation rather than put deregulation in abeyance.

Moreover, the agency’s decision to suspend deregulation and extend regulation sends a clear signal to the firms doing the vast majority of the investment in broadband infrastructure that they can expect a more regulatory and not-less regulatory bent to policy making.  As we demonstrated in our Broadband Credibility Gap [4] paper, we can therefore expect the FCC’s approach on special access to reduce the broadband providers’ investment incentives.  So, while the Chairman consistently says he wants more investment, the FCC consistently adopts policies that discourage firms from making those investments.

It will be interesting to see how the agency’s renewed efforts on special access regulation and deregulation will play out.  Certainly, data collection could be improved.  But, it is not clear to me that the agency is ready to interpret good data with impartiality.  Instead, it appears to me, at least at this point, that the agency is entering this proceeding with a clear bias toward the expanded use of price regulation.

 


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[1] Recent press reports indicate: http://www.pcworld.com/businesscenter/article/256947/fcc_looks_to_regulate_middlemile_connections.html

[2] The Need For Better Analysis of High Capacity Services: https://www.phoenix-center.org/JCILSpecialAccess.pdf

[3] Market Definition and the Economic Effects of Special Access Price Regulation: https://www.phoenix-center.org/pcpp/PCPP37Final.pdf

[4] Broadband Credibility Gap: http://commlaw.cua.edu/res/docs/articles/v19/19-1/06-v19-1-REVISED-FordSpiwakStern-Final.pdf

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