Democracy & Technology Blog Is broadband “too important to leave to the marketplace”?

Title VI of the so-called American Recovery and Reinvestment Act of 2009 directed the Federal Communications Commission to submit a report to Congress containing a “national broadband plan.” Among other things, the statute specified that the plan should ensure that “all people of the United States have access to broadband capability.” It should also include a “detailed strategy for achieving affordability of such service and maximum utilization of broadband infrastructure and service by the public,” the statute said.
This process provided regulatory enthusiasts like Public Knowledge, Media Access Project, New America Foundation and U.S. PIRG an opportunity to advocate for government control of the broadband economy. In joint comments filed with the FCC, the groups called for the national broadband plan

to recognize that certain fundamental principles are too important to leave to the marketplace. * * * * a vibrant broadband network, placed at the center of our economy and our ability to communicate with one another, must follow in the footsteps of the Communications Act of 1934. This begins not with a discussion of competition, but a broad statement of the rights of all Americans to provide “all people of the United States” without discrimination access to “adequate facilities at reasonable charges.”

The 1934 Communications Act directed the FCC to make telephone service available all Americans. To this day, telephone service in many areas is subsidized by various intercarrier compensation arrangements (e.g., payments from long-distance to local phone companies), as well as explicit support from an exploding Universal Service Fund (USF) managed by the FCC. No one really knows for how much the carriers are required to pay each other, however, according to one estimate from 2008, it was up to $8 billion per year at that time. The USF spent $7.9 billion in 2010, of which $4.3 billion of the total went to support telecommunications services in high cost areas.
By 2005, the average percentage of households with telephone service (including cell phones) was only 94%. Is this a success story? Maybe we ought to ask, is broadband too important to leave to bureaucrats and politicians?
Consider that in only 10 years or so, broadband service providers have built terrestrial networks capable of serving 96% of U.S. households. And these networks continue to expand as technology continues to improve. FCC Commissioner Robert M. McDowell notes, for example, that “the number of unserved households dropped almost in half from 8.8 million to 4.6 million” between December 2008 and June 2010.
The FCC transmitted a report containing a plan to Congress on March 16, 2010 along with a two-page joint statement. Since there was no bipartisan support for the report itself, no formal vote was conducted for the purpose of ratifying it.
Congress assigned no legal significance to the plan itself. It is not entitled to any formal regulatory or legislative consideration, nor does it confer any jurisdiction for subsequent rulemaking. A “national broadband plan” just sounds impressive, perhaps.
In February of this year, the FCC issued a notice of proposed rulemaking (NPRM) proposing to create a new entitlement, i.e., a new Connect America Fund for subsidizing rural broadband. The FCC proposes to fund the CAF with savings it expects to realize from cutting telephone subsidies.
Although broadband is currently not “supported” by the FCC, broadband networks that have been built mostly with private capital presently serve all but 4% of the nation’s households. Broadband providers invested approximately $65 billion in private capital in 2010 alone.
In rural areas, as it happens some network components supported by government-mandated telephone subsidies can also be used to provide broadband, e.g., local loops and switching equipment. Other essential components of a broadband network — like trunking to an Internet point of presence — are not subsidized.
The NPRM contains several good ideas, but it’s centerpiece, unfortunately, is a blueprint for potentially permanent stimulus-addiction for broadband service providers in rural areas. On the positive side, the NPRM proposes to establish a competitive bidding process (also known as a reverse auction or a procurement auction) in which broadband providers would bid for the lowest amount of support they would require to provide service to unserved households utilizing the technology of their choice (including Voice-over-Internet Protocol and satellites). Alternatively, incumbent providers would be offered a right of first refusal for an ongoing amount of annual support based on what a cost model says that a hypothetically efficient provider would require to serve the market in question.
Roughly 35% of unserved households are in rural areas served by small telephone companies (providers with fewer than 100,000 lines) which currently receive telephone subsidies. The rest are located in the territories of large and midsize carriers, such as AT&T, CenturyLink, Fair Point, Frontier, Verizon and Windstream, which generally receive little if any telephone subsidies.
Most of these small carriers are under rate-of-return (ROR) regulation, meaning that they are legally entitled to recover their prudently-incurred investments plus a prescribed margin of 11.25%. Subsidies make up for whatever small carriers do not recover from their own customers. These carriers maximize their profit by maximizing their investment. ROR is controversial. It was “not designed to promote efficiency or innovation,” the broadband plan acknowledges. “[I]ndeed, when the FCC adopted price cap regulation in 1990 [for larger carriers], it recognized that ‘[ROR] does not provide sufficient incentives for broad innovations in the way firms do business.'”
Larger carriers, who generally receive no subsidies, are not entitled to recover their costs in the same way. The maximum prices they can charge their customers are capped. They maximize their profits by minimizing costs.
These conflicting incentives illuminate the contrary proposals that price cap and ROR carriers are advocating.
The large and midsize providers are proposing: (1) prohibit broadband subsidies in any census block in which at least one unsupported broadband competitor is already offering broadband service as of Jan. 1, 2012, (2) allow subsidies in unserved areas for any wireline or wireless technology that meets specified minimum bandwidth and service requirements, (3) subsidize broadband satellite service in the highest-cost areas, (4) determine the subsidies on the basis of a forward-looking cost model as opposed to a reverse auction and (5) terminate broadband subsidies after 10 years.
Meanwhile, the small providers oppose the distribution of subsidies

on any basis other than pursuant to the express statutory requirements of [47 USC �254(e) and �214(e)], and particularly any distributions to entities that are not telecommunications common carriers…

In other words, cable operators would be ineligible for broadband subsidies.
When Congress passed the Telecommunications Act of 1996, VoIP services did not even exist. And few predicted that wireless would soon become a mass market phenomenon. In a 1995 report to Congress, the FCC reported that there were only 25 million cellular subscribers, and that cellphone service was expensive. Commenting on the rates paid by consumers in 1995, the commission cited the following illustrative example.

Bell Atlantic offers a package with a low monthly fee ($14.99) and relatively modest per minute charges (thirty-five cents) for calls made in, and received from, a relatively small geographic area. However, calls outside the defined area are significantly more expensive (ninety-nine cents per minute).

The purpose of the 1996 law was to replace regulation and subsidies with competition wherever competitors were likely to enter the market. According to the conventional wisdom of the time, competition would continue to be based on traditional wireline technologies for the foreseeable future, and it would be confined mostly to urban areas. So small rural telephone companies were given a pass.
Fifteen years later, the 1996 act is even more outdated than the 1934 law was at age 64 in 1996, when there was still nothing that could take the place of a telephone.
For one thing, telephone subsidies are no longer necessary for voice service in most rural areas, since competitive VoIP and wireless services are widely available. Less than half of one percent of households are located in zip codes with zero providers of independent VoIP services. Nearly 92% of the population was covered by at least two mobile providers using 3G or 4G network technologies in July 2010 (4G buildouts are expecting to reach at least 94% of the U.S. population by 2013).
The independent VoIP and mobile wireless networks also deliver broadband. Most independent VoIP service providers do not receive subsidies, and it appears that wireless service providers increasingly do not need subsidies.
Although the areas served by VoIP and wireless providers continue to expand every year, small telecom companies in rural areas will continue to receive telephone subsidies anyway, because they are entitled by outdated law to recover their prudently-incurred investments. There is normally no guarantee of cost recovery in a competitive market, where private investment is inherently at risk. Write-offs are common, absent occasional government bailouts for friends and allies of politicians and bureaucrats.
Satellites are another big difference. The capacity of a single satellite was not very great in 1996, and satellite transmissions used to be unreliable during inclement weather. These technical limitations have been overcome, meaning that satellites could serve rural areas at substantially lower cost compared to terrestrial networks. The FCC staff has estimated that the cost of closing the entire broadband availability gap could be reduced by more than half if the 250,000 most expensive housing units (of the approximately 3 million unserved households) were served by satellite.
“Race to the Bottom”
Under the current statutory framework, telephone subsidies must be adequate to allow small providers to recover their actual costs, and the subsidy recipients want to apply the same model to broadband. Small providers are critical of every recommendation for limiting subsidies to more efficient levels. They justify their opposition to reverse auctions, for example, as follows:

Reverse auctions reward bidders who offer to provide service at the lowest cost. While ensuring efficiencies is a laudable goal, a “race to the bottom” neither serves notions of efficiency nor the statutory principles of universal service. In an attempt to win an auction and receive some high-cost support, rather than none at all, overzealous ad unscrupulous bidders may be motivated to submit bids that are far lower than what is actually needed to provide sustainable, affordable services for the long-term. (footnote omitted.)

The term “race to the bottom” is a pejorative for the free market. In the absence of enlightened regulation, according to this perspective, competition will aim for efficiency as opposed to subjective concepts of utopian social justice. Another school of thought holds that efficiency maximizes consumer welfare by furnishing products consumers want to buy at prices consumers are willing to pay, and that social engineers are unnecessary.
Although subsidy recipients acknowledge that there is, “without question a need to modify certain of the existing universal service mechanisms to enhance performance and improve sustainability,” they offer no significant alternatives.
The FCC, to its credit, has suggested the possibility that if small carriers serving rural areas continue to receive subsidies based on actual investment, it may be appropriate, at least, to cap the support, reconsider subsidy levels every five years, implement a more rigorous process for examining whether investment is “used and useful,” and/or re-examining the current 11.25 percent authorized rate of return. NPRM at 449.
The focus on making broadband subsidies more efficient than telephone subsidies is commendable. but the real question is whether subsidies for broadband are a good idea at all, since VoIP, wireless and satellite technologies are demolishing the assumption that the cost of deploying broadband facilities in rural areas is prohibitively expensive.
The FCC is attempting to unwind telephone subsidies (which is good) by creating a new entitlement for broadband, which theoretically could fully compensate small telecom providers in rural areas for the loss of their telephone subsidies while creating a new, future-oriented mission for the FCC.
This all sounds a bit like comprehensive health care reform, which was premised on the idea of eliminating inefficiecy and extending coverage. It proved easier to extend coverage than to eliminate inefficiency. It would be worse than the status quo if small telecom providers serving rural areas both retain their telephone subsidies and become entitled to broadband subsidies.
With no specific Congressional authorization and little more than a year before a much-anticipated presidential election, the creation of a new entitlement program should receive careful scrutiny. Once established, they are difficult to control as a political matter. Recipients become well-organized. They hire top-notch lobbying talent and contribute generously to the campaigns of favored political candidates. They punish their opponents. Their sole focus is to protect and extend their legal claim to other people’s money.
In the telecom world, we are witnessing an attempt to morph an imploding entitlement program designed for obsolescent wireline telephone service into a new entitlement program for broadband, even though private firms have managed to serve 96% of households mostly on the basis of private investment, and when technology is becoming more powerful every day.
So far, the argument is that we can cut telephone subsidies and utilize those savings to subsidize broadband. The real question is whether broadband requires subsidies at all, and whether an agency founded during the Great Depression of the 1930s to supervise cartels has any legitimate relevance in the Internet age.

Hance Haney

Director and Senior Fellow of the Technology & Democracy Project
Hance Haney served as Director and Senior Fellow of the Technology & Democracy Project at the Discovery Institute, in Washington, D.C. Haney spent ten years as an aide to former Senator Bob Packwood (OR), and advised him in his capacity as chairman of the Senate Communications Subcommittee during the deliberations leading to the Telecommunications Act of 1996. He subsequently held various positions with the United States Telecom Association and Qwest Communications. He earned a B.A. in history from Willamette University and a J.D. from Lewis and Clark Law School in Portland, Oregon.