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.
Justice Stephen Breyer, AT&T v. Iowa
Federal Communications Commission (FCC) is expected to vote this
week on new rules governing competition for local telephone
service. To the average consumer, the debate on this issue probably
seems obscure and impenetrable--filled with technical jargon and
acronyms. Yet the consequences of this decision may determine not
just the future of competition in this market, but prospects for
new technology and for the U.S. economy as a whole.
its core, the issue presents a stark choice between two very
different visions of competitive markets. The first--embodied in
the current Clinton-era rules--relies on regulations to require
incumbent providers to share parts of their network with potential
competitors. The second approach would encourage the development of
competing networks with a minimum of regulation. Despite loud
protests by many firms that now benefit from the current,
regulation-based policies, the second path offers consumers better
prospects for real choice and greater availability of advanced
Specifically, the FCC should rewrite its
rules so as to limit mandated unbundling to those network elements
that are true bottlenecks. In addition, new investment in
infrastructure for high-speed services should not be subject to
regulation. Finally, the commission should ensure that state and
local regulators do not nullify its decisions by imposing
additional regulation on U.S. telecom markets.
roots of the current debate go back seven years to the
Telecommunications Act of 1996. One of the goals of that
legislation was to open local telephone service to competition,
much as had been done in the long-distance telephone market in the
1970s and 1980s. As a first step, the legislation stripped local
telephone companies, known as local exchange carriers (LECs), of
their legal monopoly on telephone service, overturning state rules
that made it illegal to compete with an incumbent LEC. But it went
farther: providing for rules requiring LECs to make parts of their
networks available to potential competitors.
basic idea behind this "unbundling" requirement was deceptively
simple: While many firms would be able to compete with the formerly
monopoly LECs in many or most aspects of their business, the LECs
still controlled a number of key network elements that could not be
economically duplicated and without which a competitor could not
1996 act left to the FCC the job of defining which of these network
elements would be subject to unbundling. It required, however, that
the commission consider whether access to an element was
"necessary" to a competitor and whether its absence would "impair"
the competitor's ability to compete.
Taking an expansive view of its authority,
the FCC in late 1996 adopted extremely inclusive rules specifying a
large and detailed set of unbundled network elements (UNEs). The
UNE list included everything from wires to individual users and
switching equipment to directory assistance and telephone
operators. It also permitted competitors to lease what is known as
the UNE-platform (UNE-P)--basically the entire LEC network--as if
it were one element.
LECs cried foul, appealed the decision in court, and won. In a 1999
decision, the U.S. Supreme Court struck down these rules, rebuking
the FCC for ignoring the "necessary" and "impair" wording in the
Later that year, the FCC issued revised
rules on unbundling. Except for a few minor changes, including the
elimination of operators and directory service from the list, these
new rules looked remarkably like the old rules. The issue went back
to the courts, and in May of last year, the rules were once again
struck down. In a strongly worded decision, the D.C. Circuit Court
of Appeals found that the commission had again failed to consider
meaningfully the "necessary" and "impair" language. Instead,
the FCC in effect merely looked at whether mandating access to a
particular part of the network would help competitors--in violation
of both statutory language and economic common sense. The court
also criticized the FCC for defining elements nationally, with no
examination of the economics of each local market.
FCC, under the chairmanship of Bush Administration appointee
Michael Powell, is now set to take another bite at this apple, with
a third version of the unbundling rules expected soon. The decision
is a critical one, and the issue is complex.
public debate on the topic, however, has too often been
oversimplified. As framed by many, the choice for the FCC is simply
competition or monopoly, with any lessening of the current
unbundling rules portrayed as a deathblow to competition. This
storyline is a tempting one, nicely fitting a classic black
hat-white hat scenario of spunky small competitors versus
reality, however, is much different. Competition in local phone
service, far from being threatened, is in fact quite healthy, and
for reasons that have little to do with the FCC's unbundling rules.
Revisions of the rules, in fact, could actually increase real
competition. The most critical impact of the commission's decision,
meanwhile, may have less to do with competition in old-fashioned
telephone service than with the development of advanced new
technologies and services.
THE STATE OF LOCAL COMPETITION
the first few years after passage of the 1996 Telecommunications
Act, a large number of challengers to incumbent LECs entered the
marketplace. In 1999, some 300 competitive local exchange carriers
(CLECs), with a total capitalization of some $86 billion, were
operating in the United States. The next few years, however,
brought a wave of bankruptcies and liquidations. Today, only 80-100
survive, with a total capitalization of some $4 billion. The biggest
names in the industry, including Covad, NorthPoint, Teligent, and
Winstar, have filed for bankruptcy protection.
Given these numbers, one might think that
local phone competition is on the rocks, with the incumbent
carriers holding a steady grip on their monopoly position. In fact,
the opposite is true: Despite massive consolidation, competitors
hold more of the local phone service market than ever before.
According to a report just released by the FCC, as of June 2002,
CLECs held 21.6 million--11.4 percent--of all telephone access
That is a 10 percent increase over the beginning of 2002 and the
highest CLEC share ever.
total CLEC share varies quite a bit state by state. While quite
small in many states, they serve a quarter of all telephone lines
in New York state and a sixth in Michigan.
These numbers, however, tell only part of
the story. Most notably, they do not include competition from
cellular phone and other mobile wireless providers. Once purely a
supplementary telephone service and too expensive to use regularly,
wireless phones, because of their price and functionality, are
becoming a viable substitute for wireline phones. The number of
subscribers is vast--some 129 million, a figure approaching the 189
million wireline lines in service. And while only about 6.5
million Americans rely exclusively on their wireless phones, with
no wireline subscription, some 18 percent now consider their
wireless phone to be their primary phone line. Most important, even for
consumers who do not currently rely on wireless, it serves as a
vital check on the market power of wireline incumbents.
Ironically, cellular's competitive success
story was not contemplated by the 1996 Telecommunications Act,
which barely references mobile wireless services at all, and the
service has rarely figured in subsequent efforts by regulators to
foster local competition. Instead, after the assignment of spectrum
to wireless providers, Washington largely left them alone. In other
words, despite the years of squabbling over how to create
competition, the biggest success has come from the marketplace, not
from regulatory policymaking.
Significantly, wireless firms provide
service largely using their own infrastructure, generally without
leasing network elements from incumbent LECs, but the same cannot be said
of more traditional competitors to the incumbent LECs. While CLECs
serve 21.6 million lines, only 29 percent use their own local
Close to half of these are cable companies offering telephone
service through their coaxial cable lines. Of the remainder, most
use loops obtained through UNE regulations, while 20 percent of the
total are merely "resold" lines, with little infrastructure owned
by the competitive provider itself.
is the Achilles' heel of local telephone competition today. When
competitors are merely leasing facilities owned by others, they
provide less of a real choice for consumers. The nameplate may be
different, but ultimately, to the extent they lease their product
from the incumbent provider, they offer the same old product to the
consumer. As Justice Breyer wrote in AT&T v. Iowa Utilities
Board, "A totally unbundled world...is a world in which competitors
would have little, if anything, to compete about." The local
competition challenge for policymakers, therefore, is not to
increase the total number of brand names from which they can
choose, but to maximize the number of facilities-based telecom
providers offering them service.
PROBLEMS WITH CURRENT RULES
this in mind, it appears that the concerns of critics are
misplaced: The current comprehensive unbundling rules are not only
unnecessary, but could actually be hindering the development of
more real (i.e., facilities-based) competition. Perhaps more
important, beyond their effect on local telephone competition, the
rules actually could be hindering progress in other
markets--particularly broadband telecommunications--with far more
serious consequences for consumers and the U.S. economy.
Last year's D.C. Circuit Court of Appeals opinion, written
by Judge Stephen Williams, was based on an economically sensible
reading of the text of the 1996 act: The FCC was required to
consider whether forced access to each element was "necessary" to
competition and whether the unavailability of an element would
"impair" the ability of a potential competitor to provide service.
The terms, the court wrote, cannot mean only that it would be more
expensive or more difficult for a firm to compete if it did not get
access to an element.
a reading would be grossly overbroad. Firms in almost any
industry--even fully competitive ones--might find it cheaper and
easier to use their rival's assets than to build their own. Anyone
who starts up a burger stand, for instance, would likely find it
cheaper to lease Burger King's kitchens. With thousands of
restaurants, Burger King's costs are probably lower, and the
competitor would benefit from that. That does not mean, however,
that forced access is necessary to achieve competition in the
Congress, the court reasoned, must have
meant a tougher test--especially in a supposedly deregulatory
statute. The obvious situation is one in which economies of scale
are so strong that it would not make sense to duplicate the asset.
A classic example is a bridge over a river: The bridge is
essential, but two bridges may be economically unsupportable. The
owner of the bridge would then have what is known as a bottleneck
facility and, under traditional antitrust regulation, could be
compelled to share it. While the court did not
explicitly require the FCC to apply the same rules used under
antitrust regulation, it was clear that simply reducing a
competitor's cost is not enough to require forced unbundling.
Harm to Local
Beyond being unnecessary, the current rules actually could
hinder competition. The availability of UNEs from incumbent
carriers at low regulated prices distorts the "make v. buy"
trade-off for competitors, making it more likely that they will
lease vital equipment rather than make the expensive--and
risky--investment necessary to develop their own facilities.
rules also can discourage investment by incumbent providers.
Quantifying the effects is difficult, but a recent study conducted
by the Cambridge Strategic Management Group (CSMG) and commissioned
by Corning, Inc., concluded that UNE rules have reduced the
availability of high-speed fiber optics. The authors of the study
calculate that while 5 percent of homes would have a fiber
connection by 2013, 31 percent would have one if UNE rules did not
interfere. Overall incumbent investment, CSMG calculates, would be
some $39 billion less than it would be without the rules.
The harm caused by the current rules, however, goes well
beyond competition for traditional telephone service connections.
The greatest danger may be to the development of tomorrow's
high-speed Internet connections.
High-speed, or broadband,
telecommunications allows users to receive and send information
over the Internet at many times the speed of a standard telephone
connection. Broadband service can be delivered in a variety of
different ways, including cable modem service through cable TV
networks, digital subscriber line (DSL) service through telephone
networks, or several wireless and
potential impact of broadband technologies is huge. By speeding up
the rate at which users can transmit information, a host of new
applications and services, ranging from high-definition video to
Internet-assisted medical care, become practical.
Aside from the qualitative consumer
benefits involved, many observers see broadband as a critical
catalyst for reviving the Internet economy, and perhaps the U.S.
economy as a whole. The numbers could be large. One study estimated
that the total potential benefits to the economy from universal
diffusion of broadband service could be nearly $400 billion.
Broadband service is growing rapidly. An
estimated 15 million Americans subscribe to some form of broadband.
Cable firms are the leader in broadband service with 9.4 million
subscribers, and LECs are a distant second with 5.4 million. Yet there
are reasons for concern. One is that the relatively inexpensive
places to deploy broadband are becoming harder to find, making
future growth more difficult. Another is that today's version of
broadband is only a start; the real benefits of broadband may come
when speeds hit much higher levels.
Finally, there are competitive concerns.
Although broadband promises to be a competitive service, with
multiple facilities-based rivals already in the market, the
networks (particularly the telephone networks) are not yet able to
offer broadband everywhere. As a result, many consumers today can
get broadband from only one source--typically, their local cable
Building a broadband network is expensive.
Deploying current technology nationwide and upgrading to
higher-speed systems could demand investment in the hundreds of
billions of dollars. Yet, for DSL service by telephone companies,
much of the resulting infrastructure will be subject to the same
unbundling rules that apply to traditional telephone service. The
result is discouraged investment. In fact, because the potential
harm from such rules increases with the riskiness of investment and
complexity of the technology, the disincentive to broadband may be
even greater than to traditional telephone service.
WHAT THE FCC SHOULD DO
Consistent with the last year's remand
order from the D.C. Circuit Court of Appeals, the FCC must
significantly rewrite its rules on the unbundling of network
elements. Unlike last time, however, these changes should not just
tinker at the margins. Major change is needed not just to satisfy
the courts, but also to provide competitive, advanced
telecommunications services to American consumers.
Crafting this new set of rules will not be
easy. Given the complexity of the technology and the markets
involved, the FCC will have to contend with a multiplicity of
In determining which network elements should remain subject to
unbundling, it should adopt a rule similar to the "essential
facilities" doctrine used by the courts in antitrust cases. Under
this test, only those elements that are true economic bottlenecks
for which sustainable duplicate facilities are not economically
feasible would be subject to forced access. While the D.C. Circuit
Court did not specifically require this, Judge Williams hinted
strongly that it would be appropriate.
Under such a rule, many current network
elements, including switching and inter-office transport, would
likely be crossed off the regulatory list. Much of the local loop
infrastructure probably would still be classified as a bottleneck,
although that could vary by geographic market. The all-inclusive
UNE-P would also be eliminated, as least as currently
investment in infrastructure for high-speed and other advanced
services also should not be subject to regulation. Not only is the
disincentive effect particularly strong for such investment,
but--because of the wide availability of cable modem service--the
LECs also have no monopoly power, making regulation unnecessary.
While the Telecommunications Act does not specifically cite
consideration of such factors, they can be considered because of
the FCC's general authority under the act to "forbear" from
subjecting providers to regulation it finds not to be in the public
is likewise important that the FCC ensure that state or local
regulators do not nullify its decisions by imposing their own
unbundling requirements on carriers. To a large extent,
telecommunications today is inherently interstate in nature. Rules
imposed in one jurisdiction can interfere with national efforts to
create competitive and advanced telecom networks. The FCC's rules,
however, need not exclude the states entirely from decision-making.
They could play a role, for instance, in evaluating specific market
conditions in local areas to determine whether bottleneck
FCC's upcoming decision is a complex one, but the principles that
need to be followed are clear. All parties agree on the benefits of
competition and advanced services. At issue is whether policymakers
will continue to pursue those goals through highly prescriptive
regulations and mandates, or whether they will reduce regulation
and foster marketplace incentives. The better choice, both for
consumers and for the economy, is the second path.
Gattuso is Research Fellow in Regulatory Policy in the
Thomas A. Roe Institute for Economic Policy Studies at The Heritage