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"Transition From Regulation to Competition"

Comments of

Harold Furchtgott-Roth

Commissioner, Federal Communications Commission

Before the

Wisconsin Public Utility Institute

Madison, Wisconsin

January 19, 2000

It is a great pleasure to be here in Madison. Many states are named after great Americans, but none greater than Madison. The author of the Constitution was a great believer in government, in the proper role of government, in limited government. He also understood, perhaps better than anyone else of his time or any time since, the delicate balance between state and federal governments.

How fortunate for the people of Wisconsin to have a state capital named Madison.

Wisconsin has produced more than its fair share of civic-minded public leaders, people who cared passionately not just about government, but about good government. I understand that the Wisconsin Public Utility Institute holds Bob La Follette as such an example, and with good reason.

And how fortunate for the people of Wisconsin to have been ably served for many years by Cheryl Perrino. She served as chair of the Wisconsin Public Utility Commission; chair of the prestigious national trade association for regulators known as the National Association of Regulatory Utility Commissioners; and now, her most difficult challenge yet, President of the Universal Service Administrative Corporation. It is an impossible task managing new programs and old; collecting, accounting for, and disbursing, billions of dollars annually. It is an enormous challenge, but--as I have often said--if any one can do it, Cheryl Perrino can.

Measuring regulation and competition

The topic of today's talk, "Transition from Regulation to Competition" suggests a one-dimensional characteristic, such as temperature, that varies by degree from hot to cold. For temperature, there is a thermometer, with a simple scale, to measure heat and coldness. It turns out, hot and cold are easy to define relative to one another - they are opposites. One is the absence of the other.

Regulation and competition are neither one-dimensional, nor are they opposites. Competition refers to the state of a market, particularly how businesses behave in a market. Regulation refers to how government interferes with the market.

Absent government intervention, markets may be competitive, monopolistic, or anywhere in between. With government intervention, markets may take on any characteristic, although I believe the likelihood of competition is diminished by substantial government intervention.

Consequently, I see nor causality, no necessary and sufficient conditions in any direction between competition and regulation.

Role of government

Then why do we speak of a "transition to competition?"

Because in the case of utility regulation for most of the 20th Century, regulation meant monopoly regulation, competition was outlawed, what is the role of the government in competition?

In the narrowest sense, government addresses law-and-order issues such as:

Enforcement of contracts

Protection of property

Non interference

Provision of a stable currency

Provision of a national defense.

The government has other roles that go beyond law enforcement. These may include limited interventions when there is clear and compelling evidence of

Externalities or

High administrative and transactional costs

These may provide a basis for clear and defensible government intervention. For example, at the FCC, we recently had a matter involving spectrum licensing where there would be high administrative and transactional costs present in market contracts absent government licensing.

One could conceive of pure property right to spectrum without public records. But like real estate and intellectual property, there is public government role in licensing and deeding where they are more efficient.

In telecommunications, there is also a clear government role in enforcing contracts, whether between and among carriers or between consumers and carriers.

Efficiency and distribution regulation

The issues above are what I might call "efficiency regulation." Such regulation neither creates nor precludes competition. Some purists, who think "regulation" an evil word, would not call these law-and-order issues regulation at all.

The role of government is not merely efficiency, but distributional as well. Government is concerned about outcomes, concerns about equity.

Thus there is a government role, according to many, in wealth, service offerings, quality of service, pricing, and other factors in a market.

These are important issues but it is here that government starts to get into trouble. Equity regulation can have profound effects upon competition, often not good effects.

Paradoxically, most of the failings of 20th century regulations were not based on what I would call "equity regulation", but rather on a misapplication of "efficiency regulation."

Although there were always equity trappings of helping one group or another, the core of 20th century utility regulation was premised on the notion of natural monopoly, that certain types of industries always face declining average cost curves and could thus be served most efficiently by a single provider. Both to protect and to restrain the monopolist, all sorts of regulations were imposed.

The notion of single providers, natural monopolists, is at best dated, at worst demonstrably false. Remove the assumption of natural monopoly, and much of 20th century regulation begins to unravel.

What replaces 20th century regulation? Is it no regulation? Is it competition?

Let me see if I can give some insights with my views of competition. Let me briefly discuss two particular issues:

Mergers and acquisition;

And universal service.

Mergers and acquisitions raise important issues for efficiency regulation, but these are antitrust issues, not telecommunications policy issues. Antitrust principles are extremely important for competition, but they are related to telecommunications regulation only to the extent that telecommunications regulation is based on natural monopoly concepts. To the extent that telecommunications regulation does not rely on theories of monopoly, it is unclear what is uniquely telecommunications policy related to the review of mergers and acquisitions.

Under the Telecommunications Act of 1996, the FCC has no clear role in the review of mergers of acquisitions, other than under the Clayton Act which is never invoked. Paradoxically the FCC continues to review mergers, not under explicit statutory authority, but under its license transfer authority. I am uncomfortable with this exaggerated interpretation of legal authority.

I believe in letting professionals handle issues. That is precisely the role of the Department of Justice and the Federal Trade Commission, the professional antitrust arms of the federal government. These agencies have explicit legal authority to review mergers and acquisitions, and they have the professional staffs to do them competently, as they demonstrate continuously.

In contrast, the FCC has neither the explicit authority nor the expertise. Our indirect process, without written rules, has become a back-door, closed-room deal process. One need only look at the license transfer situation for SBC and Ameritech.

2. In contrast, universal service is not an area of efficiency regulation but one of equity regulation. The Telecommunications Act of 1996 requires universal service in high cost areas. Absent FCC regulation, this program might not exist. There are counter examples - Fed Express, gasoline and food essentials - are provided in high-cost areas even without federal intervention. But universal service need not hinder competition, and an appropriately structured program would not.

Competition is the ultimate market structure. It is both efficient and equitable. The proper role of regulation, in addition to following the law as it is written, is not to harm or to preclude competition.

What is competition?

I will summarize competition with seven characteristics. Others may have been chosen, and some of these deleted. My main emphasis here is not an exhaustive and comprehensive definition, but rather a definition that helps illustrate what, if anything, a government regulatory agency has to contribute.

A. Unrestricted entry

The first characteristic is unrestricted entry to sell the good or service. If you want to sell electricity or telephone service in Madison, those markets are competitive only if no one prohibits such selling.

Many people confuse "unrestricted" entry with "free" or "costly" entry. Entry may be costly, but as long as everyone faces roughly the same costs of entry, including those already in the market; and these costs are not in some sense "unnatural," this condition is met.

For the economists in the audience, I don't want to get in a protracted debate now about sunk costs. Let me focus instead on the "unnatural" costs of entry. Just a few years ago, it was unlawful to offer competitive phone service in Wisconsin under any circumstances, and that may still be the case for some selected other services. The cost of entry was what I might call unnaturally high. Entry might lead to government confiscation of assets, perhaps even jail time. Hardly what I would call a competitive market.

In a market heavily influenced by organized crime, entry might also be discouraged or allowed only with certain payments to a local mobster. Hardly competition.

Unrestricted entry must also be voluntary entry. If I want to offer telephone service in Madison, but a government official who has the power to stop me insists that I have permission to serve Madison only if I agree to serve Milwaukee as well, I have no unrestricted entry into either city. In a truly competitive market, someone else will enter if I don't, and the proper role of government is not to restrict entry or even condition it.

Ultimately, only government officials and mobsters can impose what I would characterize as "unnatural" barriers to entering a market. Some people confuse the two. But when government restricts entry, or force entry, or conditions, it - willingly or not - is engaged in a corrupt practice of picking winners and losers in a market, the net effect of which may be indistinguishable from that of the gangster.

B. Unrestricted Exit

The second characteristic of a competition is unrestricted exit. Michael Jordan may be the greatest, most competitive basketball player ever. When he chose to retire, no government law, regulation or underworld gangsters stood in the way and forced him to continue to play. Every year, millions of Americans choose to retire, most in occupation for less glamorous than professional basketball. No one stands in the way.

Suppose, however, I wanted once I had begun, to stop offering telecommunications services in Madison. If I were a new entrant, no one would stand in the way. But if I were SBC, now that is a different matter.

In a perfectly competitive market, entry and exit are fluid, and those who exits are replaced by others in the market or by new entrants.

The proper role of government is not to interfere with this process either by limiting, conditioning, or prohibiting exit from markets. To do so is, once again, no different from picking winners and losers in a market, a corrupt form of practice little different from a mobster not wanting one of his paying customers to go out of business.

C. Market determination of available goods and services

In a competitive environment, markets, not government laws or officials, determine which goods and services are available. In a competitive market, if the people of Madison want a call-forwarding feature on their phones, and it is technological feasible, it will magically be available. In a market governed by excessive regulation not competition, the magic may take years of regulatory review to allow the service.

The American public was forced to wait decades for wireless telephone service and cable video services entirely as the result of regulatory delays. Under competition, these delays could never have occurred.

When government officials, not markets force pick the goods and services that will be available in a market, consumers always lose. Some goods and serving will be delayed or not offered at all. Others, with insufficient market demand to warrant being offered, can be sustained in a market only by taxing consumers, directly or indirectly. Picking goods and services in a market corrupts the regulatory process into a game of winners and losers. Competitive markets cannot sustain such intervention.

D. Market determination of quality

In a competitive market, the quality and characteristics of goods and services are determined by the power of supply and demand. In an overregulated market, these decisions are made by government administrators after protracted deliberations. Consumers wind up paying more than they wish for some services whose service quality is set too high, and do little for other goods and services whose quality is set too low.

E. Market-determined prices

Prices are the central form of information in a competitive market. When bid up, prices help encourage entry. When bid down, prices encourage exit. But, when prices are set by REGULATION, entry and exit conditions are confused and corrupted. Prices set too high encourage over investment and entry. Prices set too low discourage investment and entry.

F. Market Determined Quantities

Under competition, markets determine how much is supplied for each good and services in each market. Under excessive government regulation, government officials do. Prices and quality of service adjust to make up the difference.

Much of economics is a recognition that transactions in competitive markets can be summarized with three elements: Prices, quantities, and quality characteristics. An old theorem is economics holds that if, you try to restrict any one of these elements, the other two will respond accordingly in a manner that the net result is harmful to both businesses and consumers.

Restrictions on two of the three elements lead to substantially reaction in the third element, and have potentially more serious economic consequences.

According to the economic theorems, it is impossible to restrict all three elements at once. The economists who propound the last part of this theory have obviously never visited the FCC.

G. Protection of Information Insurance, Intellectual Property and Related markets.

Competitive markets are usually based on free and competitive operation of supporting activities such as information, insurance, and intellectual property. Local mobsters have a stake in some of these markets and do not want competition there. When government officials intervene in these activities they threaten all related markets.

There you have my views of competition.

Will regulation take us there?


My hope is "regulation won't stand in the way."