Are
America's telephone networks privately owned or do they belong to
the government? The question seems an odd one. From the time of
Alexander Graham Bell, the vast majority of U.S. telephone
companies have been privately owned. Yet in the current debate over
telephone regulation, some people propose that telephone network
assets belong to the public because captive ratepayers funded them
under a system of monopoly regulation.
This
startling argument is deeply flawed. Today's telecommunication
networks were not built by the government, but by private investors
with private capital. Far from being a legacy of the regulatory
past, today's networks are overwhelmingly the product of new
investment made long after legal monopolies and guaranteed rates of
return were abolished. Indeed, data from Standard & Poor's show
that investors have replaced the entire capital structure of U.S.
telecoms almost twice over since passage of the Telecommunications
Act of 1996.
History, Rules, and Regulations
The
current debate about telecommunications regulation concerns FCC
rules that require incumbent telephone companies (known as
"incumbent local exchange carriers," or "ILECs") to lease elements of their
networks--such as transport lines and switches--to potential
challengers. On March 2 of this year, the D.C. Circuit Court of
Appeals struck down a significant portion of these rules,
essentially finding that the FCC had not sufficiently shown them to
be "necessary" for competition to continue.
Proponents of forced leasing argue that
such regulation is in fact necessary to spur competition in
telecommunications. Without access to key parts of the existing
network, they claim, rivals could not hope to compete against
ILECs. They overlook, however, the fact that ILECs have no economic
"bottleneck" control over many elements that are subject to FCC
leasing rules. Many ILEC competitors, for example, own and operate
their own switches. More broadly, new technologies, such as
wireless and Internet telephony, are providing substantial
competition to ILECs without burdensome federal rules. Instead of
fostering such competition, the FCC's forced leasing rules undercut
it by encouraging new entrants to lease network capacity, rather
than building their own. Unsurprisingly, network-sharing
requirements also discourage ILECs from investing in new capacity
that would have to put at the disposal of their competitors.
Recently, supporters of forced leasing
have come up with a new argument: that ILECs are not the real
owners of their networks because the networks were constructed when
telephone service was a legally protected monopoly. Boston
University economist Laurence Kotlikoff is a proponent of this
reasoning:
The local phone system is not only a
public good, as defined by economists, it's also a public good as
in who paid for it--the definition understood by everyday folk.
Whether the regional Bell companies and their lobbyists want to
hear this or not, the local phone system is not their property. It
belongs to the public, having been built over the last century at
enormous public expense. True, the federal government never
directly paid for the phone system. Instead, it licensed a single
company--the Bell Telephone System --to construct this network by
charging the public phone rates far above the actual marginal costs
of transmitting calls and guaranteeing the Bells an essentially
risk-free return [Italics in original].
Legally, there is absolutely no basis for
Kotlikoff's assertion that the network is not the ILEC's property.
While this statement is undoubtedly rhetorical, such a casual
dismissal of property rights--the basis of the U.S. legal
system--is dubious and unsettling.
Kotlikoff's history is flawed, too. First,
he misstates the nature of the monopoly/regulation trade-off under
which the Bell System (and other, independent phone companies)
operated for much of the twentieth century. It is true, as
Kotlikoff recounts, that telephone companies were given legal
monopolies, and that they were allowed to charge rates above
"marginal" costs: After all, the marginal cost of a single phone
call is essentially zero. However, this does not mean that firms
were free to reap monopoly profits because regulators limited
overall prices so as to ensure telephone companies earned only a
set rate of return. As a result, phone company stocks were widely
viewed as essentially risk-free, but low-yield investments.
This
system has now been largely abandoned. Most regulators eliminated
rate-of-return regulation in the 1980s and 1990s. It was replaced
with a mix of price caps and rate freezes. While imperfect, this
new system eliminated telephone companies' guaranteed returns and
exposed them to economic risk. Telephone companies were still
required to charge set prices, but their profits (or losses) could
vary by performance.
Second, another critical change overlooked
by Kotlikoff was the abolition of legally protected telephone
monopolies, which began in many states as early as the 1980s. The
Telecommunications Act of 1996 eliminated all remaining statutory
monopolies in telecommunications: States could no longer grant
exclusive rights to any provider.
Since that time, telephone companies have
had to compete for voice and data service customers. Roughly 15
percent of wired lines are now provided by competitive carriers,
although only about a quarter of these use their own network
facilities. The ILECs, however, face greater competitive challenges
from wireless and Internet telephony. According to one survey, 20
percent of Americans consider their wireless phone to be their
primary connection. In broadband Internet service, the ILECs are
not even the market leader: Cable television firms hold two-thirds
of the market. Whatever their histories, ILECs no longer enjoy
government protection and monopoly power, and haven't since at
least 1996.
So How Much?
The
timeline above gives us a basis to address Kotlikoff's point: Is
the current network an asset created and given to the ILECs in the
days of monopoly regulation? The answer is no for the simple reason
that, for the most part, yesterday's network no longer exists.
Advances in telecommunications technology, from fiber-optic lines
to digital switches, made much of that old network obsolete, and
telecom companies have invested to replace it.
To
determine the size of these investments and how much of the old
network still remains, we studied financial data from the largest
ILECs (BellSouth, SBC,
Verizon, and Qwest). The Standard & Poor's Compustat database
includes financial data from over 10,000 U.S. publicly traded
companies, including one statistic that is an excellent measure for
this study: cash used to
increase "property, plant, and equipment" (PP&E). This number
represents a company's annual investments in tangible fixed
property, such as land, buildings, and mechanical equipment.
Two
basic measures of PP&E are reported: "gross" and "net." Gross
PP&E represents the actual cost of a company's tangible fixed
property, while net PP&E represents the cost of that property
after depreciation. In other words, net PP&E reflects the cost
of the company's outstanding capital less the portion that has been
"used up." Of course, net PP&E is only an approximation of the
"true" economic usefulness that remains, but it is probably the
best available measure of a company's productive physical
infrastructure.
To
determine how much ILECs spent on their networks between 1996 and
2002, we compared the cash that they invested in PP&E during
those years with both their net and gross 1996 PP&E. (See Table 1.) At the
end of 1996, the ILECs' gross PP&E stood at more than $307
billion, and their net PP&E stood at nearly $135 billion. From
1996 through 2002, the ILECs invested nearly $236 billion in new
capital.
With
their 1996 gross PP&E as a baseline, the ILECs' spent enough to
replace over three-quarters of their existing stock of fixed
property (about 77 percent). And with their 1996 net PP&E as a
baseline, the ILECs spent more than enough to replace their stock
of fixed capital nearly twice over. In fact, the capital
expenditures made by these ILECs--just four companies--amount to
nearly 3 percent of all such corporate expenditures in the United
States from 1996 to 2002.
Conclusion
Far
from being a gift from an age long past, today's ILEC networks are
overwhelmingly the product of recent private investment.
Critically, maintaining and upgrading these networks depends upon a
continuation of that private investment. Declaring the networks to
be "public property" would not only be legally and historically
wrong, but also economically dangerous.
Likewise, the FCC's access rules--while
not asserting government ownership over networks--discourage ILECs
from further investment in new network technologies and capacity.
Instead of increasing government's control of telecommunications
networks, the FCC should reduce mandates that discourage such
investment. For that reason and others, the D.C. Circuit Court of
Appeals' decision to overturn the FCC's leasing rules was a step in
the right direction. Rather than appeal the court's ruling,
policymakers should accept it and set telecommunications on a more
market-oriented, and investment-friendly, path.
James L. Gattuso is Research Fellow in
Regulatory Policy in the Thomas A. Roe Institute for Economic
Policy Studies, and Norbert Michel, Ph.D., is
a Policy Analyst in the Center For Data Analysis at The Heritage
Foundation.