December 11, 2001
Dear
Sirs:
On December 4th, you
received a letter from eight economists offering a policy roadmap that they
believe would revitalize the country’s telecommunications sector and the
overall economy. While we agree
completely with these goals, we believe that the policy prescriptions proposed
in the letter would not accomplish these goals. We believe that the best way to restore the nation’s
telecommunications sector as an engine of technological and economic growth is
to continue and strengthen the pro-competitive policies that were adopted
overwhelmingly by Congress in the 1996 Telecommunications Act—not to dismantle
these policies as proposed by the authors of the December 4th
letter.
The December 4th
letter suggests that the principles of free-market economics dictate the
removal of the provisions of the Act that constrain the actions of the existing
dominant phone companies. Like the
signatories of the December 4th letter, we believe strongly in
relying on open markets to manage the allocation of resources. Because the Act is intended to promote such
free markets, it is a major step toward attainment of efficient advanced local
telecommunications services, and should not be undone.
The December 4th letter
argues:
1.
Growth
of the IT sector was crucial to the economic expansion of the late 1990s, and
its decline is a key element of the current slowdown.
2.
Current
Federal Communications Commission rules create substantial disincentives to
needed investment in the telecommunications infrastructure.
3.
Upgrades
of the telecommunications infrastructure are important for the IT sector
because they will allow it to create and market “next generation” products and
services that can only be made available over broadband connections.
4.
The
Administration should promote steps to eliminate disincentives to investment by
accelerating telecom deregulation as rapidly as possible.
Point 2
asserts that “regulations imposed by the Federal Communications Commission
impose substantial disincentives to investment in the telecommunications
infrastructure.” The only economic
principle that the letter adduces in support of this assertion is the claim
that if a firm is not permitted to capture the full fruit of its investments,
it will underinvest. But the Act does
not deprive the Bells of appropriate
returns on their investments—rather, it only permits new competitors to enter
local telecommunications markets and protects their investments from being
fully appropriated by the Bells.
Further, as is well documented in the literature of economics, monopolists
do not invest the full amounts required for economic efficiency when they are
provided with monopoly returns on their investments. In particular, a monopolist will resist investing in new
technology if its introduction will undercut the value of its existing
assets. Such is exactly the case in
broadband telecommunications. Because
the Bells remain monopolists over the last mile facilities that are critical to
all local telecommunications services, their embedded copper networks have huge
value. Over the years before the 1996
Act, the Bells kept their network modernization investments low, did not
undercut their current services and, thus, kept their profits high.
But upon
passage of the 1996 Act with its requirement that loops be unbundled, the Bells
began to face broadband competition from a host of new competitors—Covad,
Northpoint, Rhythms—who invested billions of dollars in the electronic
infrastructure that, once added to these loops, allows them to carry broadband
services. The Bells countered these and
other competitive pressures in two ways.
The first was to accelerate their own investments in similar
electronics, and the second was to resist providing unbundled broadband-capable
loops to competitors and to increase effectively the prices they charged for
these loops. This strategy succeeded in
thwarting the new competitors. Freed
from the threat of competition, the Bells once again cut their rates of
investment in new broadband facilities.
The unbundling
and pricing principles that the December 4th letter opposes are
designed to harness the power of competitive markets to create potent
incentives to invest in new generations of technology and services. The local networks of the Bells appear to be
natural monopolies in all but the densest areas. Thus, the Act properly envisages partial facilities-based
competition whereby entrants build services using Bell networks together with
their own complementary inputs. The key
feature of the Act in this respect is the requirement that the Bells lease
unbundled elements to competitors at cost-based rates─which include the
profit necessary to compensate the Bells appropriately for their
investments. This allows new
competitors to combine their own modern network electronic facilities with only
the minimum portions of the Bells’ networks they require in order to offer
broadband services to customers–and not be saddled with either unnecessary
purchases of extraneous Bell facilities or the payment of excessive lease fees.
Although
the December 4th letter characterizes these unbundling and pricing
regulations as the product of “the previous administration,” they are actually
well thought out precepts that are codified in the Act. Overwhelming majorities from both parties
supported the Act. The FCC that
developed the precise wording promulgating these precepts did so unanimously
and after careful study.
Point 4 of the December 4th
letter suggests that, if deregulation of the Bells is accelerated, incentives for
telecommunications investment will be enhanced. Without strict adherence to the pro-competitive precepts of the
Act, further deregulation of the Bells will not induce increased investments
from the Bells or from their competitors.
This is most obvious in the case of the competitors. Because of the natural monopoly character of
most local loops, unless these facilities can be leased by competitors on the
same economic terms as the Bells provide them for their own use, competitors
will have lessened incentives to invest in the electronic and other systems
that would permit them to offer broadband services to customers. But neither would further deregulation
induce any increments in investment from the Bells. As both history and economic theory have taught us, deregulating
a monopoly without genuine prospects of competition does not induce it to
deploy more infrastructure, only to exploit more severely the infrastructure
that it has already in place by limiting its use and raising its price. Furthermore, if, contrary to their business
instincts, the Bells really do intend to accelerate their broadband
infrastructure deployment should they be deregulated along the lines of H.R.
1542, the Bells would have offered build-out guarantees to secure this accelerated
deregulation. But they have not, and
H.R. 1542 imposes no such requirement.
That unbundling and
competitive pricing promote rather than discourage local telephone
infrastructure deployment has been noted worldwide. On October 29th, the OECD issued a report on The
Development of Broadband Access in OECD Countries in which it makes the
following observations. “Initiatives to
open the local loop are viewed by most OECD governments as being fundamental to
promoting a fast roll out of broadband services. … To date the major criticism
of unbundling or line sharing are that such policies allegedly discourage
investment in new infrastructure. No
evidence has been forwarded to substantiate such a claim.” (p. 15) “Policies such as unbundling local loops and
line sharing are key regulatory tools available to create the right incentives
for new investment in broadband access.
The evidence indicates that opening access networks, and network
elements, to competitive forces increases investment and the pace of development.”
(p. 4)
While the foregoing helps us
to understand the forces that have contributed to why both the Bells and new
entrants have reduced substantially their investment activities over the last
18 months, it also suggests the solution.
The most important thing that the Administration can do to reinvigorate
investment in advanced telecommunications networks and services is to improve
Bell compliance with the 1996 Act. When
entrants could rely on strict enforcement of the unbundling and pricing precepts
of the Act, they invested hugely in advanced telecommunications
infrastructures—and, facing this competitive challenge, so did the Bells. But as the Bells grew bolder in resisting
the Act’s provisions, as regulators slackened their commitment to its
enforcement, and as legislative threats to the Act such as H.R. 1542 loomed,
competitive investment understandably evaporated. When this occurred, the Bells also scaled back their own
investments in broadband. In contrast,
if the Administration were to send a clear signal that it intends to enforce
vigorously the pro-competitive features of the Act, we are confident that
renewed competitive investment will occur, and will be met by increased Bell
investment.
We all agree that it is
vital to restart the nation’s information economy. What we disagree on is the method. The signers of the December 4th letter rely on the
generosity of the Bells to undertake investments when their profit incentives
lead them to do the very opposite. In
contrast, we believe that the surest path to a robust and efficient
telecommunications infrastructure is reliance on markets that really are
competitive. We urge the Administration
to support competition over monopoly in our critical telecommunications
markets.
We appreciate the
opportunity to provide you with our views, and are happy to discuss or clarify
any of these important issues.
Respectfully,
|
William
J. Baumol Professor
of Economics New
York University* Professor
of Economics, Emeritus Princeton
University* |
|
|
Robert
E. Hall McNeil
Joint Professor of Economics and Senior Fellow of the Hoover Institution |
William Lehr Associate Director, Research Program on
Internet and Telecoms Convergence Massachusetts Institute of
Technology* |
|
John
W. Mayo Professor
or Economics, Business and Public Policy McDonough
School of Business Georgetown University* |
Janusz
A. Ordover Professor
of Economics New
York University* former
Deputy Assistant Attorney General for Economics, Antitrust Division, U.S.
Department of Justice* |
|
Frederick
R. Warren-Boulton MICRA,
Inc.* former
Deputy Assistant Attorney General for Economics, Antitrust Division, U.S.
Department of Justice* |
Robert
D. Willig Professor
of Economics and Public Affairs Princeton
University* former
Deputy Assistant Attorney General for Economics, Antitrust Division, |
|
|
cc: Hon.
Tom Daschle
Hon.
Trent Lott
Hon.
Dennis Hastert
Hon.
Richard Armey
Hon.
Richard Gephardt
Hon.
Michael Powell
Hon.
Kathleen Abernathy
Hon.
Michael Copps
Hon.
Kevin Martin