Presentation to MAB
A.G. Edwards Financial Breakfast
April 21, 1998
Thank you, Mark, for those kind words of introduction, and thank you to A.G. Edwards for sponsoring the breakfast this morning.
The job of Wall Street investment analysts is to follow the performance of individual stocks. If you are looking for hot tips on individual stocks, I don't have any. Indeed, I studiously avoid in this job looking at individual stock performance. Picking winners and losers, or consciously influencing winners and losers is not my job.
But I do follow markets broadly, and, as an economist, I have strong views that excessive regulation harms businesses. I would like to caution you today about their potentially harmful effects of excessive regulation on broadcasters. I will describe changing market structures and market characteristics that have little rational basis for many of our broadcast rule, if a rational basis ever existed.
II. Market Structure
Economists look at economic activity in terms of markets. Markets have demand and supply characteristics, and are defined in terms of specific products or services, and in terms of geography.
FCC regulations span many markets. Let me describe six broad markets that are directly or indirectly affected by FCC regulation.
A. Creation of Intellectual Property. These are the writers, playwrights, songwriters, producers, directors, actors, and others who create original programming, books, and movies, and other forms of intellectual property. Intellectual property includes advertising . Broadcasters are creators of programming either through their own operations such as news, or through ownership interests in broader entertainment or information creation enterprises.
The vast majority of intellectual property creation, even creation limited to copyright works, goes on outside of the broadcast industry. Broadcasters have no market power in this market. FCC rules typically do not apply in this market.
B. Wholesale distribution, and management of intellectual property. Record labels, motion picture studios, book publishers, news agencies, cable MSOs, satellite broadcasters and others actively manage the wholesale distribution of intellectual property Including programming and advertising. Broadcast networks are also active in the wholesale distribution of intellectual property. Broadcasters have no market power in this market. FCC regulations typically do not apply in its market for wholesale intellectual property.
C. Retail distribution of intellectual property: Book stores, music stores, newspaper, daylight broadcasters, Internet companies, movie theatres, local cable operators, and others including local broadcasters, distribute intellectual property, including programming and advertising, directly to consumers. Terrestrial broadcasters are only a small portion of this market and they have no market power. Few FCC regulations apply to the distribution of intellectual property.
D. Wholesale information and communications transport anwholesale connections communications networks. The transport of information and communications and wholesale communications is heavily regulated by the FCC. Whether long-distance phone services, wireless services, satellite services, or others, the FCC regulates much of the transport communications. Broadcast networks have some interest in the transport of information, but they are a small part of the market, and have no market power.
E. Retail Distribution of Communications and Information Services. The FCC also regulates the retail distribution of information and particularly communications services. Local telephone companies, local cable operators, wireless carriers, and others, including local broadcasters, distribute information and communications services. Terrestrial broadcasters typically distribute audio and video programming, and commercial advertising both technologically, other forms of information would equally well be distributed. Broadcasters represent only a small portion of the market for the retail distribution of communications and information services.
F. Government property management. A final broad market is the management of government property, in this case, spectrum. Private and public groups demand access to the spectrum and the FCC has responsibilities to manage it efficiently. Broadcasters are active participants in the FCC's spectrum management, but they represent only a tiny share of the hundreds of thousands of FCC license holders, and have no market power.
V. Market Characteristics
All of these six markets have peculiar demand and supply characteristics. Many of these are worthy of extended discussions. But I will save those for another day. Today I would like to focus on three characteristics of these six markets that make FCC regulation difficult, particularly for the peculiar regulation of broadcasters.
A. Technological Change. All of these six broad markets are in the process of extraordinary technological change. Technology ten years ago was substantially different, and will doubtlessly be substantially different ten years from now. Regulations only directly affects supply or technology in a market. Devising sound regulations is difficult enough where technology is stagnant; it is truly problematic when technology is changing rapidly.
B. Fragmentation of markets. It is popular to speak of "market convergence." I personally believe the term is misleading. Two decades ago, many markets in which the FCC exerted regulation were characterized by atomistics firms providing one-or a small number of homogeneous products or services. Each of these products or services may have comprised a separate economic market, independent of the pricing behavior in other markets.
The term "convergence" conjures an image of markets merging into a single market with a single or small number of homogeneous products or services.
I do not believe that this form of market convergence is taking place. Rather, we are seeing an explosion in the number and complexity of goods and services available in the six markets described above. These markets are moving rapidly away from homogeneity. These markets are now characterized by a continuum of differentiated products. These markets consist of hundreds of smaller market segments or splinters, each of which has interrelated prices and service quality characteristics. There are many competitors in each of these market segments, and both consumers and suppliers can choose in which of the market segments they wish to participate. Consumers can substitute goods and services from one market to another.
The market fragmentation makes any form of regulation difficult, particularly for an agency such as the FCC, whose regulatory authority covers some, but not all, businesses and technologies in the market.
III. Regulation of the broadcast industry
The FCC regulates the broadcast industry more than most industries. The Commission uses two forms of legal authority to regulation: (1) specific statutory requirements for regulation; (2) optional regulatory authority at the discretion of the Commission.
Of the vast number of regulations on broadcasters, it turns out that the substantial majority is discretionary on the part of the Commission. That is, it would not be a violation of the law for the FCC to remove these regulations.
So, why do we have these regulations?
Not only are these regulations discretionary, but the statutory authority to impose then apply with equal force to hundreds of thousands of FCC license holders who are not broadcasters. The burden is upon the FCC first to rationalize why the discretionary regulation should be imposed on anyone, and second, why the discretionary rule should apply only to broadcasters. One might expect the FCC would have elaborate documentation on all such rules. One would be deeply disappointed.
Economists have a few rationales to justify some regulations. Let's see if the broadcast regulations meet these standards.
A. Competition. First, are there competitive concerns? As we have seen, broadcasters no longer occupy any market or market segments by themselves. All of these markets segments in which broadcasters can be found are relatively competitive. Lack of competition does not provide a basis for regulation in this instance.
B. Externalities. Externalities are actions by one party that affect the welfare of another party and for which no compensation is paid. Externalities are a common economic rationale for regulation, but not for broadcast regulation at the FCC.
C. Cost -Benefit Analysis. A third economic basis for regulation is a clear finding than benefits of a proposed regulation demonstrably exceed the costs. This is a common concept, but not one that has been applied to broadcast regulation at the FCC.
D. Intellectual Property Basis. Paradoxically, although most broadcaster activity is in the wholesale transport and retail distribution of information, these activities provide little of the basis for much of broadcast regulation. Instead, it is the activities related to intellectual property that provide for most of impetus of discretionary regulation.
The uniquely FCC concepts of "voices" is not one based on competition in a market for the distribution of information, but on the activities in the market for the creation, management and distribution of intellectual property. Yet intellectual property markets are some of the most competitive in the country.
V. Picking Winners and Losers
In every market and market segment in which broadcasters operate, they compete against non-broadcasters, firms that face substantially less regulation than broadcasters. Stated slightly
differently, in the six markets described above, not all businesses face the same regulations. Some face more; some face less.
Regulation raises the cost of doing business. If all firms in a market face the same regulations, there is not necessarily a competitive advantage or disadvantage resulting from the regulations. But where some firms face regulation and others do not, the competitive effect is predictable.
Differences in regulation are easily defended where the law requires differences in regulation. But in the case of broadcast regulation, most differences are not required. They are discretionary, and - whether intended or not - they have the effect of substantially influencing who will win and who will lose in the market.
The only rational conclusion is for the FCC to review its discretionary broadcast rules and determine which make sense and have benefits in excess of costs in view of rapidly changing, competitive, fragmented markets. The Commission is required by statute to conduct such a review of its ownership rules, but many more rules should be reviewed as well.