The deregulation experiment

1

How the Deregulatory Meltdown affected telecom, and what can we

do now to fix it?

Lee L. SelwynEconomics and Technology, Inc.One Washington Mall, 15th FloorBoston, Massachusetts 02108

+1 (617) 598-2200

NASUCA Mid-Year MeetingJune 29, 2009 / Boston

Economics and Technology, Inc. / June 2009 2

The deregulation experiment

Across the US economy, the last eight years were dominated by a concerted effect to

elevate laissez-faire to new heights, and to

DEREGULATE FOR THE SAKE OF

DEREGULATION



• Antitrust

• Banking

• Securities

• Real estate lending

• Consumer protection

• Trade policy

• Environmental policy



• Antitrust enforcement was largely nonexistent– Under the rubric of enhancing America’s global

competitiveness, traded away domestic competition for increased market concentration and consolidation of market power

– Consolidations resulted in entities “too big to fail” – we put all of our eggs in one basket

– Catalyzed much of the current economic meltdown



• Banking and Finance– Lost sight of critical role of financial

institutions as economic drivers– Instead of financing and supporting

economic activity and growth, banking and financial sectors turned their attention to conjuring up derivative instruments that were essentially “side bets” on the outcome of economic events



• Residential real estate financing victimized the most vulnerable consumers– Absurdly easy credit drove up home prices and

created the real estate bubble– Loan originators had no “skin in the game,” no

incentive to properly vet prospective borrowers– Worked like a Ponzi scheme that was utterly

dependent upon prices continuing to rise– What the residential mortgage lenders did makes

Bernie Madoff’s scam (which also depended on a continuing bull market) look like chump change



• Consumer protections/safeguards ignored– Allowed consumers to run up huge credit

card and other debt (e.g., auto loans)– Once the economy began to sour, debt-

burdened consumers were forced to curtail consumption in a big way – mushrooming the scope and extent of the economic meltdown



• Trade policy– Blind focus on globalization led to the virtual

eradication of US manufacturing capacity across a broad range of industries

• George Perot’s “giant sucking sound”• Just try to buy “Made in USA” products … they’re pretty

hard to find• Loss of US manufacturing capacity/capability may be

largely irreversible

– Long-term impact on US economy• Trade deficit, growing dependence on foreign

manufacturing, escalating government and private debt, will all negatively affect US standard of living for generations



• Environmental policy (was there any?)– Allowed US automakers to take advantage of SUV

loophole in CAFE (Corporate Average Fuel Economy) standards, which pumped up demand for these vehicles, contributed to big 2008 jump in gas prices, and which in turn triggered the cratering of demand for SUVs and most other cars

– Failure to capture real environmental costs in product prices triggered grossly inefficient consumption

– Refusal to commit public sector funding for energy-efficient infrastructure investment – e.g., mass transit, high-speed rail



TELECOM DEREGULATION HAS PRODUCED COMPARABLY

NEGATIVE RESULTS


How we got towhere we are


SwitchNetwork

Local TollSwitch Network

Long Distance

Equipment Mfg.Company

Pre - Carterphone

Monopoly Franchise

Competition

Telco Owned - Closed

Telco Owned - Open

Non-Telco Owned

The Shrinking Natural Monopoly:The Shrinking Natural Monopoly:Pre-Carterphone (before 1970)Pre-Carterphone (before 1970)


SwitchNetwork

Local TollSwitch

Post - Divestiture

Monopoly Franchise

Competition


Telco Owned - Open

Non-Telco Owned

IXC

IXC

IXC

Equipment Mfg.

Company

Equipment Mfg.

Company

The Shrinking Natural Monopoly:The Shrinking Natural Monopoly:Pre-divestiture (before 1984)Pre-divestiture (before 1984)


SwitchNetwork

LocalAccess

Switch

Today

Competition


Telco Owned - Open

Non-Telco Owned

IXC

IXC

CAP

CAP

IXC

Monopoly Franchise

The Shrinking Natural Monopoly:The Shrinking Natural Monopoly:as envisioned by TA96as envisioned by TA96


SwitchNetwork

LocalAccess

Switch

Future

Competition


Telco Owned - Open

Non-Telco Owned

IXC

IXC

CLEC

CLEC

IXC

Monopoly Franchise

TelcoLong Distance

The Shrinking Natural Monopoly:The Shrinking Natural Monopoly:as envisioned by the Powell/Martin FCCas envisioned by the Powell/Martin FCC



• Lack of antitrust enforcement together with premature elimination of TA96 market-opening measures and competitive safeguards resulted in a “perfect storm,” assuring the demise of telecom competition– Mergers of incumbent carriers– Retail and wholesale price deregulation– Horizontal integration of “intermodal” competitors– Use of regulation to block and frustrate entry


SwitchNetwork


Long Distance

An Alternative Future

Monopoly Franchise

Competition


Telco Owned - Open

Non-Telco Owned

A Mass Market Cable/Telco duopolyA Mass Market Cable/Telco duopoly

SwitchNetwork


Long Distance


Monopoly Franchise

Competition


Telco Owned - Open

Non-Telco Owned

CableHead-end

Cable IPNetwork

CableCo - Closed

TerminatingILEC/CLEC


SwitchNetwork


Long Distance


Monopoly Franchise

Competition


Telco Owned - Open

Non-Telco Owned

Enterprise market: no real competitionEnterprise market: no real competition

ILEC

THE LOCALBOTTLENECK

ENDURES



Absent regulatory constraints on telecom carrier prices and earnings,

the now-deregulated incumbent carriers have escalated their prices

and have been able to pursue tactics that have operated to crush their

competition.


RBOC profits soar under deregulation

Escalating RBOC Interstate RORs

0%

10%

20%

30%

40%

50%

60%

1999 2000 2001 2002 2003 2004 2005 2006 2007

AT&T Qwest Verizon Total

FCC AuthorizedROR: 11.25%



Escalating RBOC Special Access RORs

0%

25%

50%

75%

100%

125%

150%

175%

200%

1999 2000 2001 2002 2003 2004 2005 2006 2007

AT&T Qwest Verizon Total




RBOC Total Interstate ILEC RORs for 2007

35%

53%

25%

33%

0%

10%

20%

30%

40%

50%

60%

The "New"at&t

Qwest Verizon RBOCAverage




RBOC Special Access RORs for 2007

138%

175%

62%

101%

0%20%40%60%80%

100%120%140%160%180%200%

The "New"at&t

Qwest Verizon RBOCAverage




RBOC “commitments” to invest in infrastructure and broadband – offered as a carrot to achieve

deregulation – turned out to have been empty promises


LEVEL OF REGULATION


RBOCs have disinvested in their core networks


The aftermath of telecom deregulation

• RBOCs abandoned many markets– After first convincing regulators that mergers would

produce increased efficiency and broad public benefits, Verizon has been off-loading its less profitable wireline markets onto undercapitalized and underqualified buyers

– Hawaii (former GTE) – filed for Chapter 11 in 2008– Northern New England – Fairpoint near collapse,

states providing bailout funds, service in meltdown– Pending sale of most of smaller former GTE territories

to Frontier – would nearly quadruple size of company


The rationale for deregulation

The Powell/Martin agenda was rationalized on the basis of

several repeatedly repeated – but factually vacant --

contentions



The incumbent telcos:• claimed that telecom services at all levels – local, long

distance, wireless, broadband – were all highly competitive• argued that incumbent telecom carriers should be treated

just like CLECs and cable companies – I.e., not subject to regulation

• promised to build out a national broadband infrastructure if they were left alone

• threatened to withhold their investment in and development of broadband service if forced to unbundle their networks

• convinced policymakers that if they did not build broadband, nobody else would.



The FCC’s big “come bet”

Competition will be here soon, so let’s deregulate now.

But the FCC’s premature deregulation actually worked to

derail nascent competition



• FCC deregulated for deregulation’s sake– Confused MEANS with ENDS

– No goal other than deregulation itself

– No benchmark for judging success

– No process for ex post evaluation of outcomes



• So as not to be confused by any facts, the FCC has actually worked to dismantle the means for making such assessments going forward– Blew off 2000 commitment to review

CALLS plan in 2005– Eliminated cost allocation rules– Eliminated ARMIS reporting– Frustrated state PUC efforts to maintain

these mechanisms



So what didtelecom deregulation

actually achieve?



• A legacy of failure– RBOC capital investment levels declined– Competitors exited the market or merged with

incumbent carriers, and the few that have survived have scaled back on their capital spending

– Market concentration has increased– Prices and earnings have soared

• And now the federal government is handing out stimulus money to construct broadband and wireless infrastructure that the deregulated telcos and cablecos failed to build


Looking forward,Fixing the problem


Fixing the problem

The American public has now experienced first-hand what can happen in the absence of

effective regulation.

The situation in telecom is no different from the rest of the US economy, but may be less visible

to the public and to policymakers

LET’S NOT WASTE THIS OPPORTUNITY TO REGAIN PUBLIC SUPPORT FOR TELECOM

REGULATION


Fixing the problem

• Identify and establish specific policy goals– Competition where economically feasible– Regulation where necessary – and to facilitate

development of competition (TA96 model)– Broadband infrastructure development and universal

broadband availability – may require reinvigoration of “natural monopoly” approach

– Where telecom is key input to other economic sectors, assure efficient and cost-based transfer prices either through competition or regulation


Fixing the problem

• Require functional if not full structural separation of wholesale and retail services– Bell System break-up demonstrated benefit of full

structural separation, but less draconian measures may still be viable

– Several European countries have adopted “functional separation” models – e.g., British Telecom’s “Openreach” wholesale entity

– Australia has embarked upon a government-funded broadband network (which will ultimately be privatized) providing open nondiscriminatory access to retail and other telecom carriers


Fixing the problem

UK Ofcom’s solution


Fixing the problem

• Retail price deregulation must be linked to continued availability of wholesale services at cost-based rates – or retail/wholesale functional separation.– Retailing of telecom represents as much as 40% of

total value added in final retail price– Competition at the retail level was fully contemplated

in TA96 and is not, as Bells claim, “phony” or “artificial” competition

– In some cases, Bell wholesale prices are higher than its retail rates – how can anyone compete with that?


Fixing the problem

• Reinvigorate regulatory institutions and mechanisms– Reinstate reporting and monitoring requirements

(e.g., ARMIS, state-level reporting)– Establish specific criteria for determining

effectiveness of regulatory model (e.g., earnings levels, price levels, market shares, penetration rates)

– Avoid “transition” arrangements that create regulatory uncertainty and that discourage entry and investment

– Establish and maintain schedule for periodic (e.g., triennial) reviews and corrective measures


Fixing the problem

• Identify and address (at a national level) specific issues and concerns. Examples:– RBOC earnings on wireline telecom services

are above overall RBOC corporate earnings, suggesting that these services are cross-subsidizing other (competitive) ventures (e.g., Verizon’s FiOS, AT&T’s uVerse)

– If wireless is a true intermodal competitor to wireline, the two lines of business should be made structurally separate


Fixing the problem

• Identify and address (at a national level) specific issues and concerns. More examples– Bundling of basic and optional services, and

of telephone and other services (e.g., wireless, video, Internet) has generally escalated consumer telecom costs

– Wireless E911 is still largely a fantasy -- households that “cut the cord” and abandon wireline service may not realize the risk


Fixing the problem

• The RBOCs have been particularly successful in convincing policymakers and the public that telecom is competitive and that regulation is not required

• NASUCA needs to better communicate the factual vacancy of these claims, and better explain the need for and public benefit of affirmative regulation and of consumer-oriented regulatory advocacy

The deregulation experiment

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