CIAO DATE: 11/99

Competition, Innovation, and Investment in Telecommunications

Robert M. Entman, Rapporteur

Essay: David E. Gardner and Dale N. Hatfield

Communications and Society Program
The Twelfth Annual Aspen Institute
Conference on Telecommunications Policy
April 1998

The Aspen Institute

Table of Contents

1. Foreword

2. Competition, Innovation, and Investment in Telecommunications
   • Barriers to Investment
   • Regulatory Reform
   • Regulatory Treatment of New Investment by ILECs
   • Regulating Wholesale Pricing by ILECs
   • Regulating Retail Pricing by ILECs
   • Taxes and Rents on Telecommunications Imposed by Local Governments
   • Public Investment in Telecommunications Infrastructure
      

3. Conclusion

4. Appendices
   • An Essay on Competition, Innovation, and Investment in Telecommunications
        Dale N. Hatfield and David E. Gardner
   • Conference Participants

 

1.  Foreword

The Twelfth Annual Aspen Institute Conference on Telecommunications Policy was held August 10–14, 1997 in Aspen, Colorado, over a year after the passage of the Telecommunications Act of 1996. The thrust of the Act was to promote true and effective competition in and among telecommunications service providers. Congress envisioned a vigorous, expanding system of advanced comons service providers. Congress envisioned a vigorous, expanding system of advanced communications goods and services, an end to monopoly in telephone, cable, and other transmission and access industries, and a better civic society and economy as a result.

The sentiment of the nation as it evaluates implementation of the Act, however, is mixed. Significant progress in some areas thus far has been balanced by stalemate in others.

The topic of the 1997 Conference, “Competition, Innovation, and Investment in Telecommunications,” reflects one of the important areas for concern in the telecommunications community a year after the Act. Representatives of telecommunications carriers (local exchange, long distance, and wireless), cable industries, consumer, academic, and regulatory bodies at the federal, state, and local levels, representing a broad cross–section of interests, attitudes, philosophies and viewpoints, worked together over four days to define the difficult issues inherent in that topic and suggest practical resolution of these dilemmas.

The Conference began with a presentation by Dale Hatfield, then chief executive officer of the telecommunications consulting firm Hatfield Associates, who gave participants some background on the risks that competitive local exchange companies may see as they consider investment in the local exchange. (Hatfield’s presentation was based on a paper co–authored with David Gardner and reprinted in the Appendix of this report.) Participants then turned to a full agenda of questions concerning legitimate social goals and government regulations at the federal, state, and local levels which affect incentives to invest and, ultimately, the amount of competition that develops. Have government regulations created any unintended consequences for expanding competition? Are there changes to current regulations that would stimulate investment?

The answers to these questions have tremendous implications for the emerging networked society and the economy as a whole. Answers were often difficult and contentious. But that has become typical of these Aspen conferences, and in spite of their conflicting viewpoints, participants were able to define their differences and in some cases make constructive suggestions for improvement. Thus, in the following report, Professor Robert Entman, the rapporteur for the Conference, records some suggestions that reflect group consensus as well as some issues in which no consensus was reached, reflecting the diverse positions held within the telecommunications industry. While the report generally reflects the sense of the group, the statements made here should not be taken in any way as the views of any particular participant or participant’s employer unless noted otherwise.

Probably the area of greatest significance in the report — where a partial consensus emerged — is pricing. The group struggled at length over what many saw as a disincentive for incumbent local exchange carriers to invest in new technology if they must share that technology with competitors at wholesale prices. While participants generally agreed with the concept of a sunset to current wholesale pricing and unbundling requirements, they failed to reach consensus on a specific test for when that sunset should occur.

 

Acknowledgements

The Aspen Institute would like to commend conference participants for their openness, constructive attitudes, and willingness to grapple with the obtuse questions presented by the current regulatory milieu. A list of conference participants follows in the Appendix. We would also like to thank Robert Entman, our rapporteur for all twelve years of the Conference, for his excellent representation of the deliberations as well as his help in developing reading materials; our research associate, Susan Oberlander, for her help in developing the conference agenda and reading materials; and Elizabeth Golder, program coordinator, for her work on conference arrangements and this report.

Finally, but very significantly, we want to thank our Conference sponsors from competing organizations whose contributions made the Aspen Institute Conference on Telecommunications Policy and this report possible. They are Ameritech, AT&T, Bell Atlantic, Cablevision Systems, California Cable Television Association, Cox Enterprises, Intel, MCI, Nortel, NYNEX, Sprint Spectrum, TCG Teleport Communications Group, and U S West.

Charles M. Firestone
Director, Communications and Society Program
The Aspen Institute
April 1998

 

 

2.  Competition, Innovation, and Investment in Telecommunications

The Aspen Institute Conference On Telecommunications Policy met in August 1997 as an atmosphere of growing frustration enveloped the industry. ₁   More than a year after passage of the landmark Telecommunications Act of 1996, many observers believed little of its promise had been realized. Most significant, many felt, was the failure of local exchange telephone competition to take off. The central dilemma addressed by this year’s conference was how public policy might work better to stimulate efficient investment and vigorous competition in local exchange telecommunications.

Considering this core question in no way denigrates the importance of achieving the other objectives in the Act, or of investment and competition in other market sectors. But most conference participants appeared to agree that widespread penetration of facilities–based local exchange competition will be the sine qua non, a necessary if not sufficient indicator of success for the 1996 Act.

Beyond the general agreement on the key issue, however, lay a wealth of disputed diagnoses and variegated solutions. As we shall see, disputes arose over the meaning or measurement of such terms as facilities–based and competition. Nor was the agenda entirely consensual. Some participants felt the conference should have focused as much on competition in broadband services as competition in local exchange service. With the likely convergence of telecommunications networks toward a multimedia Internet, with cable television and telephone companies’ plans to challenge each other in broadband, these attendees argued for expanding the discussion.

This report documents the debates and the suggestions that emerged from this year’s energetic colloquy, with an emphasis on the local exchange market. Even more than usual, the report represents the rapporteur’s distillation and interpretation of a series of conversations and working group proposals far too intricate and lengthy to publish verbatim or even to summarize usefully. Given the complexities of this first post–Act year, and the many complaints and remedies that reverberated through the working group and plenary meetings, an interpretive essay will provide the most helpful information for those seeking the essence of our deliberations. Unless cited to a particular person, none of the comments herein should be taken as embodying the views or carrying the endorsement of any specific attendee at the conference.

 

Barriers to Investment

The agenda for the conference grew out of the perception that imperfections in the 1996 Act and other telecommunications policies, along with serious and even crippling problems with the regulatory process, have stifled efficient investment in the industry. Participants agreed with Dale Hatfield, who, at the time of the conference, was CEO of the consulting firm Hatfield associates, when he emphasized that simply increasing capital inflow or reaching some arbitrary absolute level of investment is not the goal. The idea is to encourage economically efficient investment, based on rational expectations for the evolution of a competitive market. Increased investment motivated by incorrect prices, for example, would hardly be desirable. On the other hand, if regulated prices or enduring artificial barriers to entry distort investment decisions, that most certainly is a matter for concern. Participants generally agreed that policy at federal, state, and local levels is having such effects. Some of the hindrances to efficient investment in some or all telecommunications market sectors mentioned are listed below. This is a list of contentions–most of the items would not be considered significant impediments by at least some participants.

• Carrier certification requirements that are costly, cumbersome, and time–consuming;
• Uncertainty over whether state or federal regulators’ jurisdiction applies;
• Difficulty of obtaining access to rights–of–way, buildings, and antenna sites;
• Uncertain regulatory status of the Internet;
• For incumbent local exchange carriers (ILECs), requirement of total–element long–run incremental cost (TELRIC) pricing, unbundling of service elements, and uncertainty over ability to recover embedded costs;
• Inefficient, regulation–set prices for ILECs at the retail level;
• Universal service obligations that could require ILECs to deploy any new service ubiquitously;
• Regulatory processes that create uncertainty and delay and use up resources in “gaming the process” that might otherwise be invested in telecommunications itself;
• Use of telecommunications, especially by local governments, as a source of tax revenues, and specifically, the imposition of rents or taxes by local governments that are unrelated to costs of using or maintaining rights–of–way;
• Regulatory commissions’ lack of a clearly defined mission in a changed and rapidly changing environment;
• The frequent need to deal with multiple, sometimes conflicting, regulatory and judicial jurisdictions; and
• Difficulties in enforcing policies that are meant to encourage equitable interconnection agreements between ILECs and competitive local exchange carriers (CLECs).

Admittedly, this enumeration reads something like a laundry list of company complaints about regulation in general. Perhaps the implication is that most of the frustrations that industry representatives cite can diminish firms’ incentives to invest, enter, and compete. The issues and potential solutions that generated the most interest and discussion were:

• Regulatory process reform;
• Regulatory treatment of ILECs’ entry into new areas outside of local exchange service;
• Regulation of wholesale and retail prices charged by ILECs, specifically, enforcement and potential phaseout of TELRIC pricing and unbundling requirements, and restructuring of retail rates;
• The nature, legitimacy, and proper level of taxes and rents on telecommunications that are imposed by local governments; and
• The potential for and desirability of public investment in telecommunications infrastructure.

The remainder of the report will concentrate on these areas.

 

Regulatory Reform

In two different working groups and the plenary sessions, a clear consensus emerged that the current regulatory process at all levels of government needs substantial, even radical, rethinking and reform. The fast pace of change in information and communication technology drives a constantly transforming series of potential new services, along with adaptations of existing ones. The contrast between the almost geometric rate of alteration in the technology and possible applications, and a regulatory process laden with opportunities for obstruction and delay, could hardly be more marked. The costs to the economy and to social welfare are surely enormous. In the words of Eli Noam, director of Columbia University’s Columbia Institute for Tele–Information, “The bottleneck isn’t the local loop anymore, it’s the policy process.”

A number of interesting suggestions emerged for unclogging the blockage. One that engendered no dissent was to eliminate the need for CLECs to obtain certification at the federal or state level. Instead, registration should be sufficient, which will avoid the delay and associated problems of the certification process. Beyond this relatively straightforward item, however, were more complicated, less readily agreed upon options, all designed to reduce the cost and delay inherent in state regulation:

• Speedily resolving carrier–to–carrier complaints, perhaps using special “quick look” methods for provisional resolution of disputes, with due process to follow;

• Similarly expedited resolution of consumer complaints;

• Modifying the roles of Public Utility Commissions (PUCs) to act more as legislative, policy–making bodies, rather than as case–by–case adjudicators. A corollary that received considerable support is to use administrative law judges to make specific rule–applying decisions, subject to PUC approval;

• Conducting more proceedings at PUCs via paper filings rather than oral hearings; and

• Based on the FCC’s unusually rapid production of rules to implement the 1996 Telecommunications Act, establishing clear deadlines and sunset provisions for appropriate PUC regulations.

The ultimate dream for some at the conference was a complete end to regulation, so that all these process reforms would become moot. Yet merely having new market entrants does not immediately eliminate the need for regulation. On the contrary, participants agreed, the burden on regulators in many respects has grown to the point that it merits the label “overload.” Eli Noam suggested developing a ten–year process for total deregulation, or as close to total as feasible. “We should,” he said, “be planning now how to eliminate regulation where possible and how to make regulation where needed as efficient as can be.” He observed that even ten years from now, significant numbers of consumers will not enjoy competitive carriers. Those conditions will necessitate some regulatory apparatus. Moreover, there will remain the big issue of whether a given service or carrier participates in a market sufficiently competitive to merit deregulation. Participants could not agree whether having just two firms vying in local exchange markets would constitute real competition. On the other hand, everyone concurred that having resale competition only would not create a genuine competitive market. Many assented to the possible need for asymmetric regulation in the future, with ILECs subject to more extensive oversight in some respects than CLECs. Then the question will return again to making that regulation as efficient as possible.

To reduce the scope of regulatory intervention, Noam and others suggested focusing on noncompetitive markets (such as some rural areas) in advance. As Joan Smith, commissioner on the Oregon Public Utilities Commission, observed, a critical goal for her state and others, as competition and advanced capabilities penetrate, will remain assuring that everyone, “all income groups, in rural areas and cities, 100 percent of the country,” has access. If this and other goals require some regulation, we should establish a forward–looking institutional process to determine, well before the time is upon us, ways of enhancing its efficiency.

 

Regulatory Treatment of New Investment by ILECs

The conference devoted substantial time to the way regulation affects investment by ILECs. Investment in innovative technologies and services by these dominant local carriers can obviously provide great benefits to society. but many participants voiced concern about ILECs leveraging their market power in the traditional local exchange market to the disadvantage of competitors and consumers alike. The same worry motivated many of the provisions in the 1996 Act, including the requirement that incumbents unbundle network elements and sell them at marginal cost to competitors. The next section of this report takes up the matter of pricing the unbundled elements. In this section the focus is on the scope of the unbundling and on other aspects of regulating the ILECs’ new market activities.

Henry Geller, communications fellow at The Markle Foundation, after analyzing the federal regulatory scheme’s impact on investment, proposed that a separation be enacted into policy between existing and new network components installed by the ILEC. He suggested that the unbundling requirements, which are embedded within Section 251(c) of the Act, should apply only to the existing network. To further Section 706, these requirements would not apply to future advanced telecommunications capabilities created by the ILEC.

How any demarcation of new from old network investment would work in practice generated substantial discussion. Geller suggested defining the existing network as of a certain date. Additions to facilities after that would not be made available to competitors under the Section 251 regime. As an example he cited asynchronous digital subscriber lines (ADSL), which will enable the ILEC to offer high-speed Internet access. In the current situation, he asserted, the incumbent has little incentive to bear the necessary cost to upgrade the network since it would immediately have to make the ADSL capacity available to competitors at regulated wholesale rates. For that very reason, CLECs may also have little incentive to invest in ADSL facilities, since they could procure the capacity from the incumbent without risking much capital. The Geller reform would augment the incentives of both sides to install ADSL capacity themselves. In Geller’s view, this reform would put into place win–win incentives for both ILECs and CLECs. Geller further argued that governments could implement this treatment of the ILEC without any new legislation.

Although nobody quarreled with the basic idea of improving incentives for new investment by the incumbent and competitive carriers, questions arose about possible drawbacks. Geller said the ILEC could separate its operation into two parts. One would provide local loop, remaining subject to Section 251. The other would be a separate, subsidiary CLEC using its own switches or other facilities to provide advanced services, such as video distribution or enhanced Internet connections. Regulators could treat an ILEC subsidiary engaged in broadband services as they would any other CLEC.

Jonathan Sallet, chief policy counsel for MCI, suggested applying to the ILECs’ activities a standard of market power. Geller maintained the ILEC has no market power in such areas as video distribution and high–speed Internet connection, where it will face competition from several competitors, especially cable. Dan Reingold, first vice president for global telecommunications research at Merrill Lynch, responded that if the incumbent carrier installs ADSL, it would indeed have market power wherever cable is not offering broadband, and that discouraging such entry by the incumbents would rob consumers of access to innovative technology and services. Robert Crandall, a senior fellow in economic studies at the Brookings Institution, sharpened the focus by suggesting an antitrust standard rather than market power, since the former means government will look for and prevent any use of the market power to impede competition. Endorsing this idea, Commissioner Steven Wallman of the Securities and Exchange Commission said, “If the incumbent local exchange carrier has clear market power we don’t want to prevent it from investing, just from using that power to advantage its new services.”

Larry Strickling, Ameritech’s vice president for public policy, seemed comfortable with this concept. He said that he could readily agree to policies that ensured ILECs would not discriminate in favor of their own CLEC affiliates or in favor of any particular technology that helps its affiliates. However, David Turetsky, vice president of law and regulatory policy at Teligent, asserted that this guarantee would not prevent the ILECs from deliberately allowing their older facilities to deteriorate, especially when wholesaling them to competitors. Even if there is no overt discrimination, the ILECs might put the bulk of their corporate energies and the best people into the new subsidiary. Strickling countered that the new entity would be buying loops from the incumbent, so the incumbent’s own CLEC would actually constitute an important source of demand for high–quality local loops. Unsatisfied, Turetsky pointed to the precedent of regional Bell operating companies discriminating against long–distance companies after the divestiture of AT&T, even when the Bell companies had no stake in the long–distance market themselves. Here their incentive to discriminate would be far greater since they would be serving direct competitors. Compounding problems with the idea, Ron Binz, president of the Competition Policy Institute, predicted that the old bugaboo of joint and common costs would rear its head in any scheme to operate a truly separate subsidiary. Charles Firestone, director of the Communications and Society Program at The Aspen Institute, suggested that regulators might alleviate concerns about degradation in the ILECs’ networks, and about discrimination against competitive carriers, by requiring ILECs’ subsidiary CLECs to buy their local access from their parents.

There were suggestions at the conference, some veiled and some quite direct, that it might be time to consider a “Divestiture II.” Such a policy must navigate between the Scylla of discouraging new investment by ILECs, the largest firms in the industry, and the Charybdis of allowing them to enter and perhaps either extinguish competition or severely limit its scope. In the divestiture scenario, the ILECs might be split into two independent firms, with one providing (what is likely to remain for the foreseeable future) the bottleneck local loops, and the second competing with other CLECs to offer advanced and traditional telecommunications services. Gail Garfield Schwartz, vice president for public policy and government affairs of TCG Teleport Communications Group, suggested explicitly that the ILECs might follow the lead of the smaller incumbent local carrier, SNET, of voluntarily splitting wholesale and retail operations. The goal would be for the ILECs’ retail services to operate on an equivalent footing with the CLECs. She predicted this would induce the ILECs not only to provide bottleneck facilities such as local loops in a nondiscriminatory fashion, but also to terminate all traffic without discrimination. She suggested that traffic termination might be the ultimate bottleneck function since eventually even local loops will be competitively supplied. Divestiture of the ILECs did not generate sufficiently careful attention at the conference to merit further discussion here.

 

Regulating Wholesale Pricing by ILECs

Ironically, given its stated goals, one of the 1996 Act’s major provisions was identified as creating a serious impediment to investment by the ILECs: requirements that they provide unbundled network elements (UNEs) and price them for resale at total–element long–run incremental cost (TELRIC pricing). Most participants agreed that the so–called UNE/TELRIC mandate discourages the incumbent from making large investments in the network. If they have to share the product of new investment with their competitors at prices that regulators may set at barely compensatory levels, why would ILECs take the risk? At the same time, in some participants’ view, knowing they can gain access at regulated prices to any new ILEC facilities gives CLECs less incentive to build their own. The latter point was more controversial. But as CLECs do build their own systems, there will be a smaller collection of bottleneck facilities and more reason to seek alternatives to the UNE/TELRIC regime. The two proposals that received the most attention were (1) to end TELRIC pricing on a phased basis that would vary from place to place depending upon certain criteria, and (2) to end it by a time–certain termination. Drawing heavily upon a proposal offered by Dan Reingold of Merrill Lynch, this section discusses the two alternatives.

Reingold suggested that TELRIC pricing be phased out, in effect allowing UNE prices to reach, over time, the level where they would help compensate the ILEC for historical costs. TELRIC pricing initially offers new entrants a kick–start, enabling them to offer local service to customers faster and at lower cost than by constructing their own facilities. In this sense, new entrants can use the TELRIC prices (which some believe average 50 percent below current aggregate retail rates) to offer price–competitive services and thereby build up local customer bases prior to and during construction of their own facilities. Establishing a transition plan would provide new entrants the certain knowledge that such discounts would not last, and thus stronger incentives for investing soon in new facilities. At the same time, knowing they would be freed of TELRIC requirements once certain conditions were met, ILECs would receive encouragement to invest more in upgrading local facilities to offer innovative new technologies and services.

Reingold proposed specifically that TELRIC pricing be phased out over three years, beginning from the date that the ILEC in a particular state received FCC approval to offer long–distance service to in–region customers, that is, the date they achieved approval under Section 271 of the 1996 Act. The Act charges the FCC generally to grant Section 271 approval when the incumbent carrier faces facilities–based competition in the local exchange market (defined by the Act as having a competitor that exclusively or predominantly uses its own facilities to deliver business and residential service). The trigger date of three years after Section 271 approval was proposed in order to accommodate the differing paces at which local competition would develop across different geographical areas of the United States.

Several participants felt a more finely tuned geographic standard should be used for deciding when and where to phase out the TELRIC prices. Absent a distinction between, say, urban and rural markets within a state, some feared that the latter might be left without competitive facilities or improved incentives for ILEC investment once the state’s urban areas became competitive. Moreover, David Turetsky of Teligent argued that Congress does not believe Section 271 approval is equivalent to effective competition, since the Act provides that for at least three years after such approval the ILEC must operate separate affiliates.

For this and other reasons, some participants felt that regulators should make even finer judgments about the competitiveness of specific network elements and customer categories (large versus small business versus residential) in particular places before eliminating the TELRIC rules. Among others, Bill Kennard, at the time general counsel of the FCC, Joel Lubin, regulatory vice president of AT&T, Gail Schwartz of TCG, and Larry Strickling of Ameritech seemed to find common ground in suggesting that the issue here as elsewhere is market power. All indicated regulators could find a workable standard for judging and containing an ILEC’s market power, lifting the TELRIC pricing rules only when competition sufficiently diminishes that power. Lubin suggested requiring that ILECs make new investments through a separate subsidiary that would have to act in a technology–neutral and competitor– neutral way. To minimize the incumbent’s ability to leverage any market power from its essential facility, Strickling said it might be appropriate to assess whether competitors have an alternative to the incumbent local exchange carrier. Thus TELRIC pricing for local switching might end before TELRIC pricing for local loops, since alternatives for the former likely will be available well before alternatives for the latter. Indeed, some note that switches are widely available for purchase from competitive suppliers right now, allowing a nearer–term phaseout of TELRIC pricing for local switching.

The notion of a switch phase–out was not specifically addressed or opposed, but this may well have been the consequence of the discussion moving to a more general plateau. Thus, several participants countered the above ideas, arguing that requiring regulators to make such fine judgments would likely deepen the morass of legal wrangling, political gamesmanship, and government gridlock, in effect postponing the incentives for years. In their view, state–wide termination of TELRIC pricing three years following fulfillment of the 1996 Act’s competitive checklist and facilities–based provider conditions serves as a reasonable compromise. In response, the other side maintained that analysis of competitiveness by place and service would work, and even if causing some delays would mark a major improvement over the current version of gridlock. Almost everyone seemed to agree that it would be both desirable and feasible to retain some kind of regulation to set wholesale prices at incremental costs for local loop transport and termination, the segment of the network least likely to see vigorous competition in the near future.

This last agreement extended to advocates of the other major proposal, which was to set a definite date to end UNE and wholesale pricing rules, with five years being the most commonly accepted time frame. Alternatively, Noam of Columbia Institute of Tele–Information suggested that rather than enforcing termination of TELRIC pricing, the policy might apply a sunset, which would allow policy makers to renew the TELRIC regime if officials felt competitive conditions warranted.

This second alternative aroused significant opposition. Most importantly, argued Sallet of MCI, a time–certain termination creates incentives for delay by the ILEC. The ILEC would know that by staving off competition for five years it could win big, gaining freedom from TELRIC rules while undermining competition in its local market. And the ILEC might still refrain from much new investment during those five years. Moreover, several participants suggested, whatever the effect on the ILEC’s incentives, TELRIC prices do not delay facilities investment by important new competitive carriers like fixed wireless and cable television. Lubin of AT&T asserted that these firms would not make investment decisions based on TELRIC rates but “on the basis of retail prices today.” Even if TELRIC prices are set at 50 percent of current retail revenue, such a discount does not provide the unfair bonanza to new entrants that some might believe, in Lubin’s view. Competitors have to bear high costs for marketing, customer acquisition, and customer care and service. And as Binz of the Competition Policy Institute argued, “a competitive carrier would be foolish to stake the future on permanent TELRIC pricing,” since it would assume the end of that regime at some point. Given Their view that TELRIC rules do not appreciably reduce incentives for investment by CLECs, these participants felt the benefits of time–certain termination of TELRIC pricing would not be worth the risk of ILECs exploiting the situation.

 

Regulating Retail Pricing by ILECs

Even if all the players could settle on a way to resolve the UNE/TELRIC pricing issue — and the conference gave little reason for optimism on that score — government officials still must confront the distortions from the implicit subsidies embedded within retail prices for local service. Many participants felt competitive entry for residential local service will occur slowly, if at all, in the absence of change in the structure of retail telephone rates. It was proposed and widely agreed that policy should strive to separate retail prices from subsidies, by making the latter explicit rather than burying them in pricing formulae.

Among the specific components of rate realignment suggested at the conference:

• Geographic deaveraging of rates within perhaps three broad density bands, encompassing urban, suburban, and rural. Given the finite amount available in the high–cost fund, this would enable targeting of subsidies to those in the highest cost areas.
• Bringing residential and business rates into closer calibration with each other and with the costs of service. Rate changes would be phased in over a defined time period.
• Making subsidies explicit and portable, so that consumers in high–cost areas could use them, after the introduction of competition, for the telecommunications services and carriers they wished.
• Providing rate flexibility to ILECs. In order to prevent predatory pricing but encourage competition, a floor for ILEC rates might be set by a formula that allows rates to go down to the equivalent of TELRIC plus any explicit subsidy.
• Finding methods to create more efficient price structures for high–usage lines, whether serving businesses or residences (e.g., for Internet access).

Often enunciated at this and other policy conferences and enshrined within the 1996 Act, these goals have long eluded policy makers sensitive to the political fallout. And certainly political realities and other considerations dictate protection of residential customers from rate shock. But this need not preclude all local rate increases. Conference dialogue suggested that proper political leadership and forthright explanation of the benefits from competition could enhance the political feasibility of raising local service rates. A persuasive case can be made that in numerous areas competition will soon yield lower prices and innovative services to compensate for many initial rate hikes. The public does increasingly appreciate the attractions of an information superhighway, of multichannel, multimedia services, and of diverse choices for local, wireless, and long distance. Preceding efforts to enact the rate reforms listed, officials from private and public sectors alike could organize a program of education for consumers about the benefits of advanced telecommunications and the need for regulatory reform to encourage investment. This program would emphasize that investors will take greater risk and invest more in competitive local facilities and alternative technologies if regulators allow competition to drive prices (both retail and wholesale) from current levels over time. However, rate payers should receive assurance that retail price levels will remain regulated as needed to protect consumers from market power exerted through control of bottleneck facilities.

 

Taxes and Rents on Telecommunications Imposed by Local Governments

The topic of charges assessed by local government upon telecommunications firms generated intense discussion, especially within the working group originally charged with the task of considering the impacts of local regulation on investment. The group contributed a detailed report of its deliberations. Many of its specific points were never discussed in plenary session, nor did the working group reach internal consensus. However, this section draws heavily upon elements of the working group’s draft. The working group did come close to consensus about whether locally imposed charges do in fact create barriers to investment, with almost all agreeing they do. The working group also agreed that local charges can be imposed in ways that distort investment in telecommunications. Some did argue that taxes and rents do not constitute a demonstrable burden on investment — witness the substantial continuing new facilities expenditures by cable firms and CLECs in many markets. All assented to the proposition that local charges should be competitively neutral and should not, for example, favor cable operators over incumbent telecommunications providers or favor incumbents over competitors where the different entities engage in the same activities.

The working group provided some much needed definitional clarification. It suggested that the term fees refers to charges imposed to recover government costs of providing a service or regulating an activity. To be considered a fee, revenues generated thereby can be used only to recover government costs. On the other hand, the term rents refers to charges imposed in exchange for the right to occupy public property. These charges reflect the value to industry users of property owned by local governments on behalf of local taxpayers. The term taxes then covers charges imposed without any necessary relationship to any service provided or privilege granted by the local government.

There seemed wide agreement within the working group and at the larger conference that state and local governments can and should be able to recover the actual costs imposed upon them by the operation of telecommunications facilities. Cost recovery comes by definition through imposition of local fees, where these charges are designed only to recoup incremental costs created by the installation of telecommunications facilities. Fees cover both short and long term costs related to maintenance of the public rights–of–way. As to taxes, the group agreed that telecommunications businesses should be taxed in a comparable manner and at comparable rates to other businesses. This means there should be no special taxes levied upon telecommunications entities that are not assessed upon other business firms.

Rents provoked the most contention. Consensus broke down along predictable lines. Representatives of the government perspective usually defended the right of municipalities to charge rents. Firestone of The Aspen Institute pointed out that cities actually have conflicting interests. On the one hand, they are often strapped financially and must maintain or expand revenue levels. Especially attractive are those sources like telecommunications rents that are typically far less politically visible and volatile than local sales, income, or property taxes. On the other hand, cities very much desire investment in their area’s telecommunications infrastructure and the concomitant benefits to their local economies and constituents. Proponents of the cities’ rights to charge rents argued that local taxpayers are entitled to receive a return on their investment when firms use the public streets to generate private profit. Moreover, they maintained, governments are not the only providers of rights–of–way. Using public rights–of–way reduces the transaction costs that would be involved in negotiating to obtain rights–of–way from multiple private property owners. And as Firestone suggested, local officials have a built–in reason to avoid excessive rental charges: angry constituents’ complaints if services available to other communities cannot be provided within their jurisdiction.

Most taking the firms’ vantage disputed the right or desirability of governments charging rents. They observed that rents discourage precisely the deployment of new telecommunications facilities and services that should be everyone’s goal. They also asserted that, as monopoly providers of access to streets, local governments can extract excess levels of payment.

Notwithstanding the wide gulf between these positions, most of the working group agreed that if rents are charged for the right to occupy public rights–of–way, comparable occupancies should be charged at comparable rates for all telecommunication providers, including cable television operators. The devilish details of implementing comparability received only brief attention. For example, “occupancy” can be ambiguous, say if a company changes from its initial menu of services or technologies to a new mix over time. Neither this element nor others were resolved. Working group members agreed that rents could be capped, though again unsurprisingly the level of the ceiling aroused debate. Some argued that Congress agreed in the Cable Act of 1984 on the fairness of cities charging 5 percent of gross revenues, a level legislators knew exceeded actual city costs. Others argued that rents should be capped at a much lower level, such as 1 or 2 percent of gross revenues.

Two additional important matters came up regarding inequality in rents which may discourage efficient investment. One is whether non–facilities–based carriers such as resellers and wireless should, in the interest of equity, be required to pay any rents that a government imposes. The other is how to deal with situations in which ILECs don’t pay rent while potential and actual CLECs do. On the first, there seemed general agreement that wireless providers should pay rents only to the extent they do use rights–of–way (for instance, in operating antennas). Resellers would more or less automatically pay rents embedded in the payments they make to the facilities–based carriers on whom they rely.

As for how to resolve apparent inequities between rents charged the ILECs and those charged other facility operators, the working group identified two alternatives for moving toward competitively neutral rental charges:

• Requiring local governments to provide access to rights–of–way free or at low cost to all providers; or,

• Requiring providers who benefit from low– or no–cost right–of–way access to increase compensation to levels commensurate with other providers.

The working group recognized that local governments and beneficiaries of low–cost access are likely to litigate disputes arising from either alternative for years. State law issues and constitutional claims may put these disputes beyond the reach of the FCC. As a result, the group suggested that a political compromise may be a more expeditious way to eliminate the inequities in rental charges which distort investment decisions.

Most of the group concurred that preempting local authority may not be the best way to resolve the problem of inequitable rents. Frank Fisher, a professor of public policy at the University of Texas at Austin, argued with particular force that municipalities’ control over this matter should not be breached, absent a showing that they have abused their authority. In his view, determining rents or taxes on local carriers should remain the province of local governments. On the other hand, some argued that cities have sometimes imposed unjustifiable charges. For example, Turetsky of Teligent said that some localities seek rents from his firm, even though its facilities are wireless and do not impact rights–of–way. The clash over local governments’ taxing authority spawned the idea of having industry representatives and local government groups meet to develop a mutually acceptable solution. Michael Guido, mayor of Dearborn, Michigan, and telecommunications committee chair for the U.S. Conference of Mayors, said that the discussions at the conference left him optimistic about achieving such an entente.

 

Public Investment in Telecommunications Infrastructure

A working group considered the idea of encouraging more direct government involvement in telecommunications investment, and this section relies upon their contribution. Little if any support was voiced for cities providing telecommunications facilities or services directly to citizens, but considerable backing arose for having cities more actively facilitate the development of advanced networks within their jurisdictions. The specific mechanism debated was making city–controlled or city–overseen ducts available to firms seeking to lay communications fiber or cable. The working group identified three alternatives, all to be employed at the time of major road construction or other projects that require digging up streets. One option would have cities install municipally–owned telecommunications ducts. Another would feature city–owned ducts and fiber. A third option would have cities contract with a private firm to install and operate telecommunications ducts.

The idea of encouraging any city involvement in duct ownership came under immediate attack. Sheila Mahony, senior vice president for communications and public affairs of Cablevision Systems, voiced her worry about cities forcing firms like hers to use the city–owned facilities, preventing companies from doing what they would prefer. Bruce Posey, vice president for federal relations of U S WEST, pointed out that telephony requires not just installing fiber or cable but also transformers and generators, a complication that might lead to regulatory delay. James Gattuso, vice president for policy development of Citizens for a Sound Economy, acknowledged that a single duct installation may be more efficient than expensively, disruptively, and repeatedly digging up streets. But he argued that such efficiencies could be harnessed with a duct operated entirely by a private company using private capital. Demand might even justify competing ducts. That option would be important in Eli Noam’s view. He saw the specter of monopoly in this proposal: a city controlling a single big duct would have incentives to overcharge for access, and it might develop a financial interest in prohibiting or obstructing wireless antennas that otherwise would reduce the value of the ducts. Several participants offered reassurance that city investment in ducts could work. Dale Hatfield recognized the potential drawbacks but observed, “What we have now is a mess anyway, so maybe this would at least represent an improvement.” Mayor Guido reminded all of how little it costs to put in conduits when a street is opened for sewer or water lines or road widening. In his view, consumers and communities waste valuable resources when they fail to seize the opportunities often presented by routine city construction projects. Making an inexpensive duct system available to new firms could so lower the cost of market entry as to provide a very powerful stimulant to facilities investment. James Ron Cross, vice president for regulatory policy at Nortel, revealed that his firm has been discussing these sorts of plans with several cities, and some municipalities are about to announce their own telecommunications network projects. These are innovative, creative proposals to stimulate competition and lower barriers to investment, he argued. The proposal for municipalities to get involved in owning or operating telecommunications infrastructure clearly perturbed many participants. Yet the basic concept of exploiting what is essentially a positive externality arising from city operation of roads and sewer and water lines just as clearly attracted many other attendees. Firestone noted that cities would not necessarily have to go it alone in such ventures. For example, municipalities could join with neighborhood or nonprofit groups in consortia to operate the duct systems. In the notion of joint ventures between local governments and private entities, whether for–profit firms or nonprofit groups, may lie a compromise that might reassure opponents while stimulating innovation and competition.

 

 

3.  Conclusions

Perhaps inevitably, given its broad purview, the conference stimulated an unusually wide range of ideas and controversy. This report covers only selected dimensions. One clear if unsurprising conclusion is that the Telecommunications Act of 1996 did not end or even appreciably reduce policy conflicts among key industry players. The stakes in the specifics of policy decisions remain high. Combine this with the political constraints imposed by clashing industry lobbyists and by fear of public opinion, add the unabated availability of the court system, and we have a recipe for persisting regulatory confusion and delay. The conference nonetheless pointed to a common theme: active leadership from government officials could provide some breakthroughs. Below are some key areas that could benefit from such leadership.

Almost everyone agreed on the need for regulatory process reform at the state level. Some suggested a special task force convened by the FCC in consultation with key associations of regulators and companies could produce ideas that could garner enough support to attain implementation.

Even though the issue of local taxes and rents on telecommunications firms generated heated disagreements, the cities’ interests in telecommunications development — not just in revenue maximization — opens a path toward compromise. Here too, based on discussions at the conference, it appears that an initiative by government actively to seek a mutually acceptable solution could pay off.

On the other hand, the stark conflict over enforcement and potential phaseout of TELRIC pricing and unbundling requirements seems, on the surface, less amenable to negotiated compromise. It appears that many participants fear what ILECs would do without the UNE/TELRIC mandate. By contrast, the ILECs are adamant that they will not aggressively invest in new facilities under that regime. This may be a place for courageous leadership from regulators who are willing to risk antagonizing essentially every major player by coming up with compromise that will have the virtue of moving things off dead center. Most participants appeared to agree that such a compromise is possible without new legislation by Congress. States and the FCC may have the authority to implement creative interpretations of the 1996 Act to allow a rational phaseout of TELRIC pricing that maximizes ILECs’ investment incentives while giving a reasonable window of protection for CLECs.

The conference made no real progress on the perennial problem of retail rate rebalancing. Virtually every policy analyst argues that subsidies should be generated and accounted for separately, outside of the retail price structure; that the subsidies should go only to those who need them to stay on the network; and that the spread between business and residential rates should shrink while that between urban and rural rates should grow. But most regulators and industry members believe the political opposition to this course is insurmountable. An academic observer might observe that the fear of constituent wrath in the wake of residential rate increases appears wildly exaggerated by all sides. Public reaction depends heavily on the framing of government actions. To take an example, localities and states regularly implement tax increases in the form of bond issues — tax hikes that the public voluntarily imposes on itself. People vote yes in bond referenda — and thus for tax increases — because of the context in which they are presented: we need schools, we need roads, we must prepare for the future. Yet the tax hikes required by bond issues typically dwarf any increase in phone rates likely to arise from rationalizing the retail price structure. If officials would frame the rate increases as a way of meeting future needs, they could minimize political opposition to rate increases. Recall the federal imposition of subscriber line charges in the mid–1980s. Reaction was intense but extremely short–lived, and it defies common sense to believe any members of Congress lost office because of it. There is almost certainly a lot more political space for change than most representatives of government and industry appear to think.

Without these sorts of initiatives, the dialogue at the conference supports a gloomy prediction of continued bickering, high investment in political and legal maneuvers, and delays in delivery on the promise of new telecommunications technologies and services. In the competitive global economy, that scenario truly serves nobody’s long–term interests.

 

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Endnotes

Note 1: Several participants have changed employment since the Conference was held. References to participants’ affiliations within the report are to positions held at the time of the Conference. See appendix for affiliations as of March 1998.  Back.