The cost of regulating special access: A 55 percent investment decrease

Often, an economist’s role in public policy is to explain obvious things that for some reason are being missed. This includes simple truths such as these: Only a monopoly can have monopoly power, regulations should not outlive their purpose, and pushing prices below commercial levels generally decreases investment. These economic lessons could assist the Federal Communications Commission (FCC) in the “special access” proceeding, in which the agency is being lobbied by resellers to extend existing price-cap regulations from TDM-based services (on copper connections) to IP-based services (on fiber connections). Those who support special access policies argue that because telecommunications firms and their customers are migrating from TDM-based to IP-based access technologies, the scope of the FCC’s special access rules need to follow suit. However, they ignore the fact that if the FCC extends these regulations to next-generation access technologies, it means that fewer buildings would be “lit” with fiber over the coming years.

The FCC’s special access policy reversal

In decisions spanning 2003 through 2007, the FCC appropriately decided that it should loosen regulation of prices on special access because the markets were changing rapidly and subject to competitive pressure. More specifically, the agency granted pricing flexibility on traditional special access lines and exempted from regulation circuits that use newer technologies or that are fiber-based. This was a reasonable way to address transitory market power and encourage technological process. Then, in 2012, the FCC signaled that it was interested in retrenching and expanding its special access regulations. More specifically, the FCC: (1) opened an investigation into special access pricing and included in this examination technologies such as Ethernet — services that had previously been exempted from regulation; and (2) launched a rulemaking on whether it was still appropriate to allow pricing flexibility. In August 2015, the FCC extended its wholesale unbundling obligations to fiber-based networks whenever a telco decommissions its copper-based facilities. This suggests the FCC won’t be bashful when it comes to extending its retail price regulations as well.

Monopoly regulation should be for monopolies

One troubling aspect of the FCC’s direction is its justification for regulation. Rather than looking for situations of enduring monopoly, which would make close regulation of prices appropriate, the FCC is looking for indications of market power. Close regulation of prices is designed to ensure that monopoly utilities provide infrastructure in a way that benefits their customers. The basic concern is that an unregulated monopoly would keep prices high by restricting output, which would limit service availability and drain value from the economy. In situations where markets are transitory and residual market power is a primary concern, a more liberal form of price-cap regulation may be appropriate, which is what the FCC adopted in 2003 through 2007. Rather than adhere to this well-established criteria for determining when and how to regulate prices, the FCC is simply looking for market power, which the agency is defining as situations where its statistical modeling indicates that prices during a single time period might appear unusually high relative to costs.

Regulations of transitory market power should at least be transitory

The belief that the mere existence of market power justifies price regulation is troubling. In a rapidly changing industry, a statistically high price-cost margin in the past does not mean that there is market power today. Nor does it mean that there will be market power in the future. In fact what could be happening is that a market is sending a price signal that it is ripe for new entry, either from additional firms or from new technologies. Clamping down on prices forestalls that new entry.

The consequences for investment

What would happen if the FCC extends its special access price regulations to next-generation networks? One certain outcome is that telecom companies will invest less in new technologies. The reason is straightforward: Price controls lower the profitability of new investments, so telecoms slow down their new technology adoption. Economist Hal Singer has estimated the impact of this scenario. Using the current fiber coverage of an incumbent telco in Charlotte as part of a geospatial cost model, in conjunction with estimated revenues for each building, Singer determined which unlit buildings would be lit by fiber in the absence of price regulation. Then he re-ran the model, this time lowering each unlit building’s expected revenue to account for price regulation. Over the coming years, 20 percent of Charlotte buildings would be lit by the incumbent telecom firm without regulation, but only 14 percent would be lit with regulation. Extrapolating this result to the nation, Singer concludes that new FCC price controls would decrease telco investment in fiber optics to buildings by 55 percent and that 67,300 fewer commercial buildings would have fiber optics. This would be a painful outcome for US businesses and an ironic consequence of regulations intended to benefit customers. Proponents of the regulations argue that CLECs will more than compensate for this decline by expanding their investments. Recall that CLECs buy special access and then compete with the telecom firms whose infrastructure they are using. If the CLECs get better prices from telecom companies, the argument goes, then they have an incentive to grow. This could happen, but there are some problems with this analysis. One is that retail prices for special access might decline when the prices that the telecom firms charge CLECs decrease. This would dampen the CLECs’ incentives to compete using their own facilities. If retail prices do not decline, then the more intense regulations on telecoms provide a disproportionate hit on telco profits. Such unbalanced effects on profits have actually led to declines in CLEC entry in the past. So where does this leave us? The FCC would do well to continue on its earlier path of liberal price flexibility for markets that may have some transitory market power. This actually encourages technology expansion and allows markets to grow and change according to their underlying economics. Unfortunately, it looks like the commission is headed down a different path.

The post The cost of regulating special access: A 55 percent investment decrease appeared first on Tech Policy Daily.