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Dear Prof

    stLiberal Rules for a 21 Century

    Communications World:

    The U.S. Experience with Convergence

    Thomas W. Hazlett

    Professor of Law & Economics

    George Mason University, USA


The obsolescence of traditional Postal Telephone and Telegraph (PTT) monopolies has forced

    liberalization in the telecommunications sector. This transition challenges policy makers with two

    visions of convergence, however, one implying the emergence of a new monopoly where diverse

    applications are provided via a single high-capacity network, the other implying the growth of

    diverse networks that encroach upon rivals. The former generally implies mandatory network

    sharing regulations; the latter is associated with deregulation. The selection of these distinct policy

    paths can now be informed by experience. Ironically, U.S. competition in fixed-line phone service

    succeeded only after the sharing mandates of 1996-2004, designed to facilitate competitive entry,

    were over-turned by federal courts.. Residential broadband markets yield further data suggesting

    that deployments accelerate when open access requirements are eliminated. These experiments in

    liberalization can inform and advance pro-consumer, technology-friendly policies in


Liberal Rules for Telecoms page 2 Thomas W. Hazlett

    1. Convergence and the Transition to Competition

The devolution of the separate telecommunications silos of the 1970s is now a familiar story. As early as

    1987, Peter Huber‟s masterful “Geodesic Network”[1] framed the policy debate as one of adjustment to

    convergence, removing artificial barriers that kept potentially rival networks quarantined in monopolistic

    fiefdoms. Even then, a generation ago, the picture on the horizon was coming into focus: local voice access,

    long distance transport, multi-channel video, and data were not productively supplied under “regulatory apartheid[2].

What was a “vision” then is a reality today. Liberalization in telecoms has swept the globe; the PTT

    monopolies of the 1980s are now largely museum exhibits. But the ways in which communications

    markets have been opened differ across regimes. This can be said to reflect rival assumptions as to the full

    meaning of the term “convergence.”

The “Convergence A” view is that the maturation of communications networks has produced a natural

    competitive rivalry in the marketplace. What U.S. regulators called the “two wire to the home” policy in

    the 1980s one owned by the local telephone carrier, the other by the cable TV operator spontaneously combusts. Given modern technologies and new business plans, head-to-head network rivalry emerges.

    The phone wire expands to carry video; the cable wire expands to carry voice. What were two monopolies

    in distinct product markets merges into a market with overlapping networks battling for market share in

    either. Integration into broadband richens the rivalry and brings customers “triple play” (voice, video, data) options. The addition of wireless carriers extends the competitive continuum.

In this view of things, the role of the government is to unleash the market, eliminating barriers to naturally 1rivalrous behavior.

    In the “Convergence B” framework, existing networks do not expand onto rivals‟ turf (Perhaps this owes, 2in part, to the stunting of their initial growth due to economic or regulatory constraints.) And now the day of the competitive entrant has passed, precisely because the “convergence” implies economies of scale:

    services that once required their own delivery platform are now efficiently supplied via facilities supplying

    a vector of services. Rival platforms are now replaced by a communications network with abundant

    capacity to provide triple plays. Of course, organizing all communications within a single firm has costs as

    well as benefits; the loss in market rivalry is typically met by regulatory interventions that seek to offset

    some of these social costs. The resulting markets may be deemed “open,” in the sense that non-network application providers utilize the underlying facilities on “reasonable terms and conditions,” but basic network infrastructure is supplied on the regulated monopoly model. Convergence B delivers us not to

    competitive networks but to the PTT model whence we came.

This paper does not undertake the task of global comparison, an important and ongoing element in 3discerning the optimal policy path. It sets its sights on more specific target, describing the policy path in

     1 These include such competitive impediments as local government video franchises that deter telephone

    carriers from entering cable TV markets. See Hazlett 2007, Cable TV Franchises as Barriers to

    Competition, 12 VIRGINIA JOURNAL OF LAW & TECHNOLOGY 2. It also includes liberalization of spectrum

    policy, providing more bandwidth for operators to expand services (e.g., into high-speed data) and to adopt

    innovative technologies. See Hazlett 2008, Optimal Abolition of FCC Spectrum Allocation, JOURNAL OF ECONOMIC PERSPECTIVES (Winter). 2 In some countries, cable TV networks have been deterred by regulatory barriers. In others, cable TV has

    not developed throughout the market due to the presence of abundant broadcast TV channels (e.g., Italy) or

    the relatively high costs of constructions (e.g., the U.K.). 3 For contrasting analyses, see, e.g., OECD 2001, The Development of Broadband Access in OECD

    Countries, Working Party on Telecommunications and Information Services Policies (Paris: Organization

    for Economic Co-operation and Development; Oct. 29). And National Research Council 2002, Broadband: Bringing Home the Bits, Committee on Broadband Last Mile Technology, Computer Science and

Liberal Rules for Telecoms page 3 Thomas W. Hazlett

    the United States where the “A” view has come to dominate – not exactly by strategic vision or formal consensus but by the rough-and-tumble reality of policies tried, failed, and then reformulated.

    The short story and a summary of the paper‟s main points – goes like this. The 1996 Telecommunications Act laid out a policy reform on the vision of “Convergence A,” but with a

    schizophrenic twist: the transition to competitive networks would be managed by a mandatory network

    sharing regime. This was a temporary expedient to assist the development of new networks, not a long-run

    “B” view of convergence as leading to dominant platforms with sufficient capacity to efficiently re-monopolize the market.

The transitional regime, however, proved administratively complex and economically disappointing. It

    encouraged extreme contentiousness in the drafting of network access (wholesale) pricing rules, and

    deterred network development by both incumbents and entrants. It collapsed in mid-2004, overturned by

    courts as violating the instructions in the 1996 Act to facilitate the construction of competitive systems.

    But the demise of regime did not prove a set-back to competition in the marketplace. Inter-modal

    competition is today supplying the competitive constraints that the network sharing regime, effectively

    ended just four years ago, could not.

Cable television systems having made local phone service available to under 15% of U.S. households in

    2003, the product of seven years of investment since being awarded the right to supply voice services in the

    1996 Act today pass over 85% of U.S. households. Broadband competition between cable operators and

    telephone carriers has also accelerated since FCC deregulation of DSL networks in the first quarter of 2003;

    DSL subscribership was about 60% higher at year-end 2006 than it would have been under the pre-

    deregulation growth rate. These marked gains in competitiveness are buttressed by trends in wireless

    phone markets. Yet, by standards used to determine “effective competition” in other communications

    markets, local phone services are today “effectively competitive” even disregarding mobile telephony as a

    substitute product. The recent market trends, highly successful in realizing the stated goals of the 1996

    Telecommunications Act, appear at best unrelated to the “policy-induced” rivalry supported via network sharing mandates. Indeed, the data suggest that the sharing mandates designed to provide

    “stepping stones” to rivalrous communications networks deterred such deployments.

In sum, the U.S. experience offers lessons from policy experiments suggesting that convergence can deliver

    market outcomes advancing consumer welfare. By an iterative process, the U.S. has discovered much st Century telecoms. This may be of interest about how to craft, and how not to craft, liberal policies for 21to policy makers elsewhere as a case study revealing how the Schumpeterian forces now shaking the

    communications sector can most effectively be channeled.

    2.Fixed Line Telephone Competition: the U.S. Experience

The central economic concern of the 1996 Telecommunications Act was the promotion of competition in

    local telephone service. This was to be accomplished with a two-pronged policy attack. First, the Act 4eliminated entry barriers to new entrants in local telecommunications markets. Previously, state and local franchising laws had created legal prohibitions explicitly or implicitly limited competitive entry. Second,

    to assist entrants who might emerge, the Act required that incumbent telephone companies:

     5(a) interconnect with entrants‟ networks 6(b) provide customer connections, at wholesale prices, to new rivals to resell at retail prices 7(c) provide “unbundled” pieces of their network to alternative providers

Telecommunications Board, Division on Engineering and Physical Sciences, National Research Council

    (Washington, D.C.: National Academy Press). 4 47 U.S.C. ?253(a). 5 47 U.S.C. ?251(c)(2). 6 47 U.S.C. ?251(c)(4). 7 47 U.S.C. ?251(c)(3).

Liberal Rules for Telecoms page 4 Thomas W. Hazlett

The basic interconnection obligation was not controversial. However, the mandates requiring incumbents

    to share their networks proved highly contentious. In the use of “resale” or “UNEs” (unbundled network

    elements), rates charged and terms of wholesale access were regulated by state regulatory commissions

    under guidelines crafted by the Federal Communications Commission. These rules imposed a TELRIC

    (Total Element Long-Run Incremental Cost) determination of wholesale network access pricing that sought

    to approximate the costs of a new, efficiently-sized, state-of-the-art network. This tended to under-

    compensate investors for the risks of technological changes [3], placing zero value on the options extinguished when capital was sunk to create infrastructure[4].

According to later decisions by U.S. courts, the regime tilted decidedly in favor of low access prices and

    generous terms for competitive entrants leasing incumbents‟ networks. This, in turn, was found to bias the

    “rent v. buy” decisions faced by such entrants, and to depress the incentives of incumbents to fend off

    emerging rivals by investing in new, upgraded facilities. Federal courts found that this undermined the

    plainly stated goals of the 1996 Act in promoting the creation of competitive telecommunications networks.

    Mandates to share existing infrastructure as a “stepping stone” to facilities-based competition [5] were

    called for in the Act, but this cause-and-effect sequence was undermined by an unbalanced approach that

    sought only to promote resale of incumbents‟ services. As the D.C. Circuit Court of Appeals wrote, in overturning the network sharing rules, the Commission‟s “entire argument about expanding competition and investment boils down to the Commission‟s expression of its belief that in this area more unbundling is 8 better.” 9A March 2004 appellate court decision effectively ended this regime and the two major telephone carriers

    reselling incumbents resale services, AT&T and MCI, were soon (in 2005) acquired by local exchange

    carriers, SBC and Verizon. The experiment in “policy-induced competition” [6] was over, and by

    consensus a failure [7]. There was no stepping stone to facilities-based competition, but a stifling of

    investment in new network facilities by both entrants and incumbents [5]. While about 32 million lines

    (out of about 180 million total fixed connections, or about 18% market share) were provided by

    competitive entrants in June 2004, the resale model appeared to be crowding out entry via “competitor-

    owned” networks, including (most importantly) those provided by cable TV operators. Unbundled 10Network Element-Platform (UNE-P) lines grew, on net, from under a million in Dec. 1999 to nearly 16 million in June 2004; cable CLEC lines grew much less (to under 4 million) in June 2004, and had virtually

    no growth in the 2002-2004 period when UNE-P wholesale rates were declining and UNE-P lines were

    growing most rapidly. See Fig. 1.

     8 United States Telecom Association v. FCC, 290 F.3d 415. (D.C. Cir. 2002). 9 United States Telecom Association v. FCC, 359 F.3d 554 (D.C. Cir. 2004). Uncertainty about whether the decision would be appealed to the U.S. Supreme Court delayed a resolution of the policy even alter the

    March 2004 verdict. In June 2004, however, both the FCC and the Bush Administration announced that

    they had decided not to ask the highest court to overturn the decision and the policy was essentially settled.