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Is regulation better than competition?

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Is regulation better than competition?

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Late last week the Federal Communications Commission voted along party lines to open a proceeding to “seek the best legal framework for broadband Internet access,” a process that could culminate in the imposition of stifling, telephone utility style regulations on America’s privately financed broadband networks pursuant to Title II of the 1934 Communications Act.
A statement by Commissioner Michael J. Copps explains in more detail than the rest why he thinks regulation is necessary for achieving this country’s “broadband hopes and dreams.”
The FCC has been deregulating communications services in response to increasing competition for years. Copps and others believe it is necessary to reverse course, although in his statement Copps doesn’t question the policy of deregulating a competitive market. He questions the facts, arguing that broadband is less competitive than it used to be. This is a misleading argument.


Copps is referring to the Telecom Bubble–the period between the enactment of the Telecommunications Act of 1996 and the crash which began in 2000, when FCC bureaucrats micromanaged the telecom sector. According to George Gilder,

The Telecom Act of 1996 was meant to “deregulate” America’s telecom infrastructure and technologies, the most dynamic sectors in the entire world economy. But after the usual lobbying and horse-trading, the Act turned into a million-word re-regulation of the industry. Regulatory actions by the FCC and the 51 state utility commissions greatly exacerbated the bad parts of the Act and distorted many of the good parts. As I predicted the day after it was enacted, the result was a carnival of lawyers, micro-mis-management by bureaucrats, price controls, the socialization of infrastructure, the screeching halt of innovation and investment in the “last-mile” local loop–and the Great Telecom and Technology Crash of 2000-2003.

Whether the broadband market is more or less competitive could be a significant issue when the FCC’s new regulatory policy is litigated in a federal appellate court. That’s because agencies like the FCC are required to make rational decisions.
A recent Supreme Court decision, FCC v. Fox Television Stations (2009) elaborates on this point. The case says, on the one hand, that when an agency reverses course, it doesn’t have to persuade an appellate court that the reasons for the new policy are better than the reasons for the old policy. It only has to show that the new policy is permissible under the statute, that there are good reasons for it, and that the agency believes it to be better.
However, the Court also said that a more detailed justification will be required

when, for example, [an agency’s] new policy rests upon factual findings that contradict those which underlay its prior policy; or when its prior policy has engendered serious reliance interests that must be taken into account. It would be arbitrary or capricious to ignore such matters. In such cases it is not that further justification is demanded by the mere fact of policy change; but that a reasoned explanation is needed for disregarding facts and circumstances that underlay or were engendered by the prior policy. (citation omitted.

According to Copps, the “changed circumstances” are the extent of competition in the market for broadband Internet access. Copps believes there is less competition now than 10 years ago.

[T]he independent Internet service providers like AOL and CompuServe were the names of the game. Since then, it is a few huge access providers that have become the only real broadband game in town. Resellers and competitive local telephone companies have been driven from the field, for the most part. And competition–that wonderful goal of the 1996 Telecommunications Act–reposes more in our hopes and dreams than it does on the bottom line of the monthly phone and cable bills we all get to pay. How can anyone fail to find “changed circumstances” in these revolutionary transformations?

Admittedly this sounds counter-intuitive, but although there were a lot of competitors, there wasn’t meaningful competition. It was artificial competition which was subsidized as a result of economically inefficient and unsustainable regulatory policies which seriously tilted the playing field in favor of new entrants.
AOL, CompuServe and other ISPs provided service over leased portions of the telecommunications networks belonging to AT&T, Verizon and other incumbent local exchange carriers at federally-guaranteed, below-cost prices.
Robert W. Crandall of the Brookings Institute has pointed out that the competitors

offered little in the way of innovation or new services. They were mainly interested in exploiting the arbitrage opportunities created through the regulation of wholesale and retail rates, and most of them failed with a vengeance when the telecom stock market bubble burst in 2000-02.

Crandall notes that the regulatory policies “simply transferred billions of dollars from incumbent telephone companies to fund marketing campaigns required to sell the same service under a different name.” He also points out that “competition has developed in ways totally unanticipated by regulators, namely through unregulated wireless providers and cable broadband platforms.”*
Supreme Court Justice Stephen G. Breyer made a similar observation in AT&T Corp. v. Iowa Utilities Bd. (1999). He pointed out in his dissenting opinion that

[A] sharing requirement may diminish the original owner’s incentive to keep up or to improve the property by depriving the owner of the fruits of value-creating investment, research, or labor …. [i]t is in the unshared, not in the shared, portions of the enterprise that meaningful competition would likely emerge. Rules that force firms to share every resource or element of a business would create, not competition, but pervasive regulation, for the regulators, not the marketplace, would set the relevant terms.

In the late 1990s, incumbent telecom providers were required share nearly every element of their business at below-cost prices, and hundreds of competitive local exchange carriers and/or Internet service providers were incorporated in an effort to get a piece of the action.
Alfred Kahn described the FCC’s regulatory policies of that period as “essentially a construct of perfect competition.” He noted that it was “in flat contradiction of the Schumpeterian preconditions of innovation–a truly startling deficiency, considering that the central purpose of the Telecommunications Act is to encourage the most rapid possible development of a modern telecommunications infrastructure.”**
The concept Kahn is referring to–perfect competition–is a rare occurrence in which many producers offer indistinguishable products that compete primarily on the basis of price alone and where no producer makes much money.
But perfect competition isn’t desirable in dynamic industries where innovation continues to yield improvements in products and services. That’s because innovation requires investment, and there is no private investment without profit.
The regulatory policies Copps is nostalgic for actually inhibited investment in broadband. According to Jeffrey Eisenach (2008), cable operators– who never had to lease out their facilities–invested more than $115 billion to upgrade their networks between 1996 and 2006, and overall investment in communications equipment in the U.S. rose by more than 40 percent since the FCC began exempting broadband infrastructures from sharing requirements.
FCC staff estimate that it could cost $350 billion to upgrade broadband connections to 110 million U.S. households to 100 megabits per second (mbps).
Regulatory policies which discourage private investment could mean that the government would have to finance network upgrades by adding to the national debt, which doesn’t seem likely at this point.
In an address to the Economic Club of Washington, Verizon Chairman & CEO Ivan Seidenberg said

Some of this will take public investment, but most can be done by the private sector, if we don’t impose so many rules and regulations that it becomes an uneconomic proposition.

That would be consistent with the direction Germany is heading

Chancellor Angela Merkel, addressing a business audience in Berlin today, said she told Obama in a phone call that cutting government debt is “absolutely important for us,” exposing a second point of contention ahead of the June 26-27 G-20 summit in Canada.
Reducing the budget deficit by 10 billion euros ($12 billion) per year “won’t put a brake on the world’s economic growth,” Merkel said, relating what she told Obama yesterday. Germans are more likely to spend money if they feel the government “is taking precautions” to ensure solid finances, she said.

Regulating the Internet plays well to the liberal Democratic base, who see the Web as a free propaganda tool. Do people believe what they are told? I happen to believe most people weigh the arguments and form their own conclusion.
Let’s not be content with an Internet that can merely compete with radio talk show hosts. Let’s let the Internet off the leash and see where it can go.
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* Crandall, Robert W. Competition and Chaos (Brookings Inst. 2005) at 157.
** Kahn, Alfred E. Whom the Gods Would Destroy, or How Not to Deregulate (AEI Press 2001) at 9-10.