The Deregulatory Meltdown: Telecom Impact and Solutions

1. How the Deregulatory Meltdown affected telecom, and what can we do now to fix it?Lee L. SelwynEconomics and Technology, Inc.One Washington Mall, 15th FloorBoston, Massachusetts 02108+1 (617) 598-2200NASUCA Mid-Year MeetingJune 29, 2009 / Boston

2. The deregulation experiment Across the US economy, the last eight years were dominated by a concerted effect to elevate laissez-faire to new heights, and to DEREGULATE FOR THE SAKE OF DEREGULATION Economics and Technology, Inc. / June 2009

3. The deregulation experiment • Antitrust • Banking • Securities • Real estate lending • Consumer protection • Trade policy • Environmental policy Economics and Technology, Inc. / June 2009

4. The deregulation experiment • Antitrust enforcement was largely nonexistent • Under the rubric of enhancing America’s global competitiveness, traded away domestic competition for increased market concentration and consolidation of market power • Consolidations resulted in entities “too big to fail” – we put all of our eggs in one basket • Catalyzed much of the current economic meltdown Economics and Technology, Inc. / June 2009

5. The deregulation experiment • Banking and Finance • Lost sight of critical role of financial institutions as economic drivers • Instead of financing and supporting economic activity and growth, banking and financial sectors turned their attention to conjuring up derivative instruments that were essentially “side bets” on the outcome of economic events Economics and Technology, Inc. / June 2009

6. The deregulation experiment • Residential real estate financing victimized the most vulnerable consumers • Absurdly easy credit drove up home prices and created the real estate bubble • Loan originators had no “skin in the game,” no incentive to properly vet prospective borrowers • Worked like a Ponzi scheme that was utterly dependent upon prices continuing to rise • What the residential mortgage lenders did makes Bernie Madoff’s scam (which also depended on a continuing bull market) look like chump change Economics and Technology, Inc. / June 2009

7. The deregulation experiment • Consumer protections/safeguards ignored • Allowed consumers to run up huge credit card and other debt (e.g., auto loans) • Once the economy began to sour, debt-burdened consumers were forced to curtail consumption in a big way – mushrooming the scope and extent of the economic meltdown Economics and Technology, Inc. / June 2009

8. The deregulation experiment • Trade policy • Blind focus on globalization led to the virtual eradication of US manufacturing capacity across a broad range of industries • George Perot’s “giant sucking sound” • Just try to buy “Made in USA” products … they’re pretty hard to find • Loss of US manufacturing capacity/capability may be largely irreversible • Long-term impact on US economy • Trade deficit, growing dependence on foreign manufacturing, escalating government and private debt, will all negatively affect US standard of living for generations Economics and Technology, Inc. / June 2009

9. The deregulation experiment • Environmental policy (was there any?) • Allowed US automakers to take advantage of SUV loophole in CAFE (Corporate Average Fuel Economy) standards, which pumped up demand for these vehicles, contributed to big 2008 jump in gas prices, and which in turn triggered the cratering of demand for SUVs and most other cars • Failure to capture real environmental costs in product prices triggered grossly inefficient consumption • Refusal to commit public sector funding for energy-efficient infrastructure investment – e.g., mass transit, high-speed rail Economics and Technology, Inc. / June 2009

10. The deregulation experiment TELECOM DEREGULATION HAS PRODUCED COMPARABLY NEGATIVE RESULTS Economics and Technology, Inc. / June 2009

11. How we got to where we are Economics and Technology, Inc. / June 2009

12. The Shrinking Natural Monopoly:Pre-Carterphone (before 1970) Economics and Technology, Inc. / June 2009

13. The Shrinking Natural Monopoly:Pre-divestiture (before 1984) Economics and Technology, Inc. / June 2009

14. The Shrinking Natural Monopoly:as envisioned by TA96 Economics and Technology, Inc. / June 2009

15. The Shrinking Natural Monopoly:as envisioned by the Powell/Martin FCC Economics and Technology, Inc. / June 2009

16. The deregulation experiment • Lack of antitrust enforcement together with premature elimination of TA96 market-opening measures and competitive safeguards resulted in a “perfect storm,” assuring the demise of telecom competition • Mergers of incumbent carriers • Retail and wholesale price deregulation • Horizontal integration of “intermodal” competitors • Use of regulation to block and frustrate entry Economics and Technology, Inc. / June 2009

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20. A Mass Market Cable/Telco duopoly Cable IP Network Cable Head-end Terminating ILEC/CLEC CableCo - Closed Economics and Technology, Inc. / June 2009

21. Enterprise market: no real competition ILEC THE LOCAL BOTTLENECK ENDURES Economics and Technology, Inc. / June 2009

22. The deregulation experiment Absent regulatory constraints on telecom carrier prices and earnings, the now-deregulated incumbent carriers have escalated their prices and have been able to pursue tactics that have operated to crush their competition. Economics and Technology, Inc. / June 2009

23. RBOC profits soar under deregulation Escalating RBOC Interstate RORs FCC Authorized ROR: 11.25% Economics and Technology, Inc. / June 2009

24. RBOC profits soar under deregulation Escalating RBOC Special Access RORs FCC Authorized ROR: 11.25% Economics and Technology, Inc. / June 2009

25. RBOC profits soar under deregulation RBOC Total Interstate ILEC RORs for 2007 FCC Authorized ROR: 11.25% Economics and Technology, Inc. / June 2009

26. RBOC profits soar under deregulation RBOC Special Access RORs for 2007 FCC Authorized ROR: 11.25% Economics and Technology, Inc. / June 2009

27. The deregulation experiment RBOC “commitments” to invest in infrastructure and broadband – offered as a carrot to achieve deregulation – turned out to have been empty promises Economics and Technology, Inc. / June 2009

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29. LEVEL OF REGULATION Economics and Technology, Inc. / June 2009

30. RBOCs have disinvested in their core networks Economics and Technology, Inc. / June 2009

31. The aftermath of telecom deregulation • RBOCs abandoned many markets • After first convincing regulators that mergers would produce increased efficiency and broad public benefits, Verizon has been off-loading its less profitable wireline markets onto undercapitalized and underqualified buyers • Hawaii (former GTE) – filed for Chapter 11 in 2008 • Northern New England – Fairpoint near collapse, states providing bailout funds, service in meltdown • Pending sale of most of smaller former GTE territories to Frontier – would nearly quadruple size of company Economics and Technology, Inc. / June 2009

32. The rationale for deregulation The Powell/Martin agenda was rationalized on the basis of several repeatedly repeated – but factually vacant -- contentions Economics and Technology, Inc. / June 2009

33. The rationale for deregulation The incumbent telcos: • claimed that telecom services at all levels – local, long distance, wireless, broadband – were all highly competitive • argued that incumbent telecom carriers should be treated just like CLECs and cable companies – I.e., not subject to regulation • promised to build out a national broadband infrastructure if they were left alone • threatened to withhold their investment in and development of broadband service if forced to unbundle their networks • convinced policymakers that if they did not build broadband, nobody else would. Economics and Technology, Inc. / June 2009

34. The rationale for deregulation The FCC’s big “come bet” Competition will be here soon, so let’s deregulate now. But the FCC’s premature deregulation actually worked to derail nascent competition Economics and Technology, Inc. / June 2009

35. The aftermath of telecom deregulation • FCC deregulated for deregulation’s sake • Confused MEANS with ENDS • No goal other than deregulation itself • No benchmark for judging success • No process for ex post evaluation of outcomes Economics and Technology, Inc. / June 2009

36. The aftermath of telecom deregulation • So as not to be confused by any facts, the FCC has actually worked to dismantle the means for making such assessments going forward • Blew off 2000 commitment to review CALLS plan in 2005 • Eliminated cost allocation rules • Eliminated ARMIS reporting • Frustrated state PUC efforts to maintain these mechanisms Economics and Technology, Inc. / June 2009

37. The aftermath of telecom deregulation So what did telecom deregulation actually achieve? Economics and Technology, Inc. / June 2009

38. The aftermath of telecom deregulation • A legacy of failure • RBOC capital investment levels declined • Competitors exited the market or merged with incumbent carriers, and the few that have survived have scaled back on their capital spending • Market concentration has increased • Prices and earnings have soared • And now the federal government is handing out stimulus money to construct broadband and wireless infrastructure that the deregulated telcos and cablecos failed to build Economics and Technology, Inc. / June 2009

39. Looking forward, Fixing the problem Economics and Technology, Inc. / June 2009

40. Fixing the problem The American public has now experienced first-hand what can happen in the absence of effective regulation. The situation in telecom is no different from the rest of the US economy, but may be less visible to the public and to policymakers LET’S NOT WASTE THIS OPPORTUNITY TO REGAIN PUBLIC SUPPORT FOR TELECOM REGULATION Economics and Technology, Inc. / June 2009

41. Fixing the problem • Identify and establish specific policy goals • Competition where economically feasible • Regulation where necessary – and to facilitate development of competition (TA96 model) • Broadband infrastructure development and universal broadband availability – may require reinvigoration of “natural monopoly” approach • Where telecom is key input to other economic sectors, assure efficient and cost-based transfer prices either through competition or regulation Economics and Technology, Inc. / June 2009

42. Fixing the problem • Require functional if not full structural separation of wholesale and retail services • Bell System break-up demonstrated benefit of full structural separation, but less draconian measures may still be viable • Several European countries have adopted “functional separation” models – e.g., British Telecom’s “Openreach” wholesale entity • Australia has embarked upon a government-funded broadband network (which will ultimately be privatized) providing open nondiscriminatory access to retail and other telecom carriers Economics and Technology, Inc. / June 2009

43. Fixing the problem UK Ofcom’s solution Economics and Technology, Inc. / June 2009

44. Fixing the problem • Retail price deregulation must be linked to continued availability of wholesale services at cost-based rates – or retail/wholesale functional separation. • Retailing of telecom represents as much as 40% of total value added in final retail price • Competition at the retail level was fully contemplated in TA96 and is not, as Bells claim, “phony” or “artificial” competition • In some cases, Bell wholesale prices are higher than its retail rates – how can anyone compete with that? Economics and Technology, Inc. / June 2009

45. Fixing the problem • Reinvigorate regulatory institutions and mechanisms • Reinstate reporting and monitoring requirements (e.g., ARMIS, state-level reporting) • Establish specific criteria for determining effectiveness of regulatory model (e.g., earnings levels, price levels, market shares, penetration rates) • Avoid “transition” arrangements that create regulatory uncertainty and that discourage entry and investment • Establish and maintain schedule for periodic (e.g., triennial) reviews and corrective measures Economics and Technology, Inc. / June 2009

46. Fixing the problem • Identify and address (at a national level) specific issues and concerns. Examples: • RBOC earnings on wireline telecom services are above overall RBOC corporate earnings, suggesting that these services are cross-subsidizing other (competitive) ventures (e.g., Verizon’s FiOS, AT&T’s uVerse) • If wireless is a true intermodal competitor to wireline, the two lines of business should be made structurally separate Economics and Technology, Inc. / June 2009

47. Fixing the problem • Identify and address (at a national level) specific issues and concerns. More examples • Bundling of basic and optional services, and of telephone and other services (e.g., wireless, video, Internet) has generally escalated consumer telecom costs • Wireless E911 is still largely a fantasy -- households that “cut the cord” and abandon wireline service may not realize the risk Economics and Technology, Inc. / June 2009

48. Fixing the problem • The RBOCs have been particularly successful in convincing policymakers and the public that telecom is competitive and that regulation is not required • NASUCA needs to better communicate the factual vacancy of these claims, and better explain the need for and public benefit of affirmative regulation and of consumer-oriented regulatory advocacy Economics and Technology, Inc. / June 2009