NATIONAL ASSOCIATION OF REGULATORY UTILITY COMMISSIONERS
February 25, 1997
(As prepared for delivery)
Access Reform and Universal Service: Into the Thick Of It
Everyone in the communications field is still excited about the extraordinary achievement of Charlene Barshefsky, our extraordinary Trade Representative, on February 15. That's the day she okayed an agreement on telecommunications services under the auspices of the World Trade Organization. More than 70 countries were parties to this agreement creating major benefits for American consumers and extraordinary opportunities for U.S. businesses.
Everyone involved with the WTO agreement owes many thanks to NARUC and the state pioneers that laid the foundation for the bold deregulation of the Telecommunication Act of 1996, the "gold standard" for countries around the world. You should take pride in the fact that your leadership and courage was instrumental in placing the United States in the vanguard of the policy, economic, and social changes that will be driven by this monumental agreement. Of course, being a leader means everyone else is watching you -- and now more than ever the world is watching us to see if we really can produce competitive communications markets, while simultaneously protecting consumers and ensuring universal service.
In the United States, the Act requires us domestically to do exactly what the WTO agreement requires countries internationally to do: Bring interconnection and access charges down to cost, cut out all implicit subsidies, and ensure universal service is collected and distributed in a competitively neutral fashion. We all are aware that the FCC interconnection order and the actions by 35 states to adopt their own pricing methodologies were the first part of a trilogy (interconnection, access reform, and universal service) that needs to be written both at the federal and state level. No one can really judge whether the trilogy has a happy ending until it's finished.
So now we're really into the thick of it as we try to polish off the federal part of the trilogy in the next few weeks. I don't mind telling you we're laboring; we're overwhelmed by the input (75 thousand pages of comments were filed on universal service and three feet of comments were filed on access, and we've spent hundreds of person hours in meetings with interested parties) and despite the effort, we're still not clear on what to do.
I'm here to plead for all the help you can give us. We respectfully request help of three kinds:
Let's start with the three purposes of the new Act. These are the same purposes that various states used in starting reform before Congress passed its law; you will find them familiar.
The acronym is PDU, which at this point stands for Pretty Darn Ugly when it comes to the actual process of implementation.
But the goals are crucial.
Pro-competition means, among other things, that we need rules, not the absence of rules, to create incentives for competition. This is true--at least in the near term--because incumbents benefit from already having ubiquitous networks in the ground, the services of which they can price, and indeed, are typically by states obliged to price, in such a way that deters broad competitive entry. Without specific, enforceable rules that let new entrants bypass or share the existing essential facilities of local networks, there is simply no chance that Americans will have a choice in local phone service. The creeping pace of competition a year after the law was passed stands as obvious overwhelming testimony to this fact.
Pro-competition also means we want to promote all competitors and competitive strategies, even-handedly and indifferently, as opposed to following the United Kingdom model and promoting specifically and unevenly alternative infrastructure development by the cable industry, or a single facilities-based long distance carrier like Mercury.
Our choice of being pro-competition instead of any being pro- any specific competitor is why we at the state and federal level are supposed to guarantee all three of the basic rights of new entrants under the Act: buying at wholesale, leasing elements, and interconnecting from new facilities. Effective enforcement of all three rights is necessary to expedite the entry of new competitors into the local exchange and access markets.
Our vigilance in enforcing these rights is essential because the scope of the challenge facing new entrants is quite broad. In every single existing service territory the market is dominated by one company--the historic monopolist. For example, in its service areas in Michigan, Ameritech takes about two-thirds of the consumer dollars spent on wireline communications, including fax, long distance, local, and so forth. GTE's impressive results in long distance--capturing almost a million customers in 12 months--show that as incumbents get into long distance, there is a real prospect that the incumbent LECs' share of total telecommunications revenues will go up as opposed to down, at least during the early phases of the new law's implementation. Indeed, it could be a decade before we see the more widely distributed market shares that typically characterize robust competition. Just look at what happened in long distance: in the 13 years since the break-up of AT&T, this formerly dominant long distance carrier was only dropped a little below 60 percent share of the total long distance market.
Being pro-competition also means that none of us in this room is going out of business any time soon. We will all have to be enforcers of competition for some long time to come to keep our commitment to the right mission for the country.
So that was "P", pro-competition. What about the "D" in PDU, "deregulation"?
Being for deregulation means that while we have created three different avenues for new entrants, we should be most eager to see infrastructure competition. Infrastructure competition will permit us to stop regulating prices. In the short run, the best way to ensure infrastructure competition is to permit new entrants to share the existing network, via leasing elements or buying services at wholesale. This is the way new competitors can win customers before building facilities, instead of being forced to the much higher risk strategy of building facilities first and hoping that the customers will come later.
Over the longer term, the need for infrastructure competition also explains why we should think hard about the effects of our rules on innovation. We want to be sure that both incumbents and newcomers are able to innovate without being discouraged by our rules. We are similarly inclined to be careful about the effects of our rules on investment in the network. Both of these issues will be explicitly addressed in our upcoming proceeding on innovation. I'm pushing for an Innovation Notice in April.
Finally, the "U": universal service.
Being for universal service means we recognize that a modern communications infrastructure available to absolutely all Americans is essential for the economic growth and social well being of our country. So that's why it is the law of the land that we should connect every rural town, every classroom, every library, every health clinic, every native american community, every farm and ranch to a modern, affordable communications system --that's the information super highway.
In fact, although industry reports that $23 billion in subsidies flow every year from urban, long distance calling and business users to rural, local calling, and residential users, we have an astonishingly poor record of service to many parts of our country, particularly low income groups, minority groups and children in classrooms. I suspect that we could do a whole lot better for a whole lot less subsidy money. In fact, I suspect that some portion of the subsidy implicit in the current structure underwrites the delivery of local service at below cost to people who don't know they get subsidies and who, if they did know, wouldn't think it was fair. Moreover, to a degree the current subsidy system props up retail pricing schemes that could only exist in a monopoly environment and which are unsustainable in the face of real competition.
This suggests that, if we are to implement the Congress's directive of moving from implicit to explicit subsidies, fixed costs must be recovered by a fixed charge.
So we have three goals: PDU: pro-competition, deregulation, and universal service. And as everyone here has experienced in hundreds or thousands of hours of hearings and decision-making, implementing these goals causes changes in the status quo and these changes require us all to strike difficult balances. A state could deregulate right away; but if that meant no retail price regulation for basic dialtone we would see prices soar to unaffordable in many places and universal service wouldn't be achieved. We could have stopped after our August Interconnection order and never gotten to universal service, but then today 's subsidy-rich access charges for high volume users would be competed away and the overall telephone network would be under-funded. Or, we could make universal service our sole goal, but then the necessary steps to create incentives for competition couldn't be taken.
We have to consider all three objectives at once and make policy choices about how to balance the conflicts in the transition to a more deregulated world.
It is conceded by all that a large portion of access charges subsidize low toll volume, high cost residential users. As a consequence, the "value" of providing service is artificially concentrated, which deters broad competitive entry and overly incentives entry targeted at high toll volume customers.
We've now rejected this artifice of the monopoly paradigm, as have nearly 70 other countries as part of the recently signed WTO agreement. So now we're all together in the "thick of reform".
However, while we're in the same room and in the same pickle, we're jurisdictionally separated. Thomas Jefferson was a great American visionary, but I find it hard to believe that his theory of states' rights contemplated the age of digital communications. Bits don't know about state lines and modern communications systems don't respect what Justice Frankfurter called "our federalism." Nevertheless, here we are together, 50 states and a federal government, dealing with regional/national/global network of networks, sharing the privilege of trying to figure out the right thing to do.
The interconnection experience taught me at least two things: (a) avoid jurisdictional litigation because the states so far have beaten us bad in the 8th circuit, and (b) when we're not suing each other, it looks to me like we find ready agreement on substance. So rather than committing to a civil war of jurisdictional contest, I am asking that we join hands on the substance and make similar decisions, similar arguments in court, similar commitments to universal service and access reform, as most of us have, in effect, so far, on interconnection policy.
So how does this actually translate into something concrete?
An Approach to Access Charge Reform
Beginning with access, I think that our target is clear: over time lowering traffic sensitive interstate access charges to forward looking cost and restructuring the cost recovery such that prices charged reflect the way in which costs are incurred by LECs. That's what would happen in a competitive market and thus we should seek to emulate this result in the absence of such competition. Where and when the market for a particular access service is workably competitive, access prices should be set by the market, not by government. The big question in access reform is not our target, but how -- and how fast -- we get there.
According to some LECs, interstate per minute access is just under 3 cents today and forward looking economic cost ranges from .4 to about 1.2 cents. This means that access is priced somewhere between 250-700 percent too high. This inefficient pricing discourages broad entry by new entrants (because revenues are concentrated in high volume users) and deters usage of long distance (because it is priced artificially high).
To get from where we are today to where we would like to be, the Joint Board thought we should move some traffic sensitive charges to flat rate charges imposed on IXCs by the LECs. We're calling this the flat and equitable rate charge, or FERC...why not let some other agency have some recognition.
This FERC is plainly the subject of state and federal consensus, as stated by the Joint Board, and should be implemented as part of our access reform proceeding.
But we still have to decide how much usage-based charges should be reduced on what we call Day One, the effective date for the changes in our access reform order, and how long we should take to phase in the rest of the reduction required to get to forward looking cost. Plainly, as the usage charges go down, the FERC will have to be phased in. But how closely should these two processes be tied together? Should the transition processes be on the same track or would staggering them in some way be better?
Nor is it obvious that the FERC ought to be imposed equally on all access lines. There is some rationale for imposing the new FERC more quickly or to a greater degree on multiline businesses and residential second lines than on single line residences. This technique would be beneficial for low volume toll users and yet still would broaden the distribution of revenues and hence encouraging wide competitive entry.
In terms of rate levels, we may wish to have different approaches for originating and terminating access charges. There seems to be broad consensus among economists that originating access rates will experience significantly more market pressure than terminating access. This idea is fairly intuitive: the calling party chooses the originating carrier but doesn't select the terminating carrier. Thus, we suspect that the better method favors smaller initial reductions and a more market-based approach for originating access, and more significant initial reductions and a more prescriptive approach on terminating access.
The combined effect of the changes I'm discussing here today is to take a significant step toward getting access charges to cost immediately, with the bulk of additional reductions coming later, over time. There's also sound economic reasoning behind this phased approach: a significant but partial step in reducing usage-based access charges to TELRIC has disproportionately large positive effects.
As to future access reductions, it will be critical to set in motion a predictable process in our order that will reduce access to forward looking economic cost within a reasonable time period. Of course, the market may drive change faster or give us new information over time.
On the topic of universal service, many members of the Joint Board supported a combined interstate and intrastate fund. There's a very strong legal argument that we have the jurisdictional authority to do so. However, I'm very shy about precipitating another jurisdictional war in civil court.
I agree with the Joint Board, a combined fund is clearly the superior policy option. After all, customers don't ask for any communications services labelled "interstate" or "intrastate". In a competitive setting, marketing departments would just laugh at such a distinction or ignore it. Similarly, new entrants will not necessarily adopt such product categories; they're purely a product of federalism.
In the world of divided funding for high cost support, both the effective collection/levy rates and the basis of assessment could also vary between the federal and state jurisdictions. Thus, carriers may have artificial regulatory incentives to classify their revenues as inter- or intrastate, or otherwise to minimize their universal service contribution burden. In the long term, I would submit that a fund divided against itself cannot stand.
Some have suggested an opt-in approach might alleviate the jurisdictional problem and thus avoid the economic distortions. I suspect, however, that the states that don't need much support would choose not to opt in, and without them, the plan may not be workable.
We also have to decide other fundamental questions about high cost support that continue to challenge us. The cost models have only just now arrived at the FCC and are still undergoing revisions by the parties, turning them into moving targets for assessment by FCC staff, state joint board members (who are supposed to weigh in by March 1st) and other commenters. Just running one of the models took 40 hours! Maybe that's because the numbers grew so much. In any event, I am increasingly concerned whether a workable, reliable model will emerge in time for our decision on May 8.
These and other complexities that we are grappling with may warrant a phased approach to our decision on high cost support. Of course, whatever we do, we would need to guarantee that the needs of rural telcos are continuously met. As well, support for schools and libraries, rural health care and low income users must be guaranteed on the date our universal service rules are issued.
The Historic Cost Issue
As we observed in the Access NPRM, we also intend to address the question of LEC recovery of historic costs. We recognize that there may be some costs that the incumbent LECs should rightfully be able to recover, but which will be difficult to recover in a competitive market. This is a classic problem of transitioning from monopoly-based regulation to a competitive market. Some of these costs may represent under-depreciated assets or investment.
I do not believe, however, that we should begin the inquiry into the historic cost issue with the supposition that the LEC is necessarily guaranteed as a matter of law a complete certainty of recovering all such investment. Takings is certainly one of our concerns here, but we must not forget "givings". Let me mention three: first, giving the LECs cellular licenses worth billions; second, giving LECs yellow pages publishing opportunities (also worth billions); and third giving LECs the opportunity to enter long distance, where they can leverage their regulated local asset.
Like high cost support, historic cost recovery is a difficult analytical task and in our Order, we may wish to provide guidance for a joint Federal-State effort, akin to the Joint Board process, to address this question.
Some Closing Thoughts
In closing, let me touch on briefly the question of Bell entry into long distance and the role that states play in that process. As I stressed to you last July, each state's knowledge of local conditions and experience in resolving factual disputes enables it to play the vital role of fact-finder in the 271 process. States should become like to special masters in court proceedings: the states make findings of fact on the disputed issues relating to the opening of the relevant BOC's local network, and we can, if we choose, rely on those findings of fact.
A credible state fact-finding process, in which opponents have ample opportunity to challenge directly Bell company claims of network opening, will be useful to a Bell in carrying its burden of proof before the FCC on any disputed facts. The quality of the record compiled by each state commission may be more important than the vote that commission casts.
I know that the state commissions are all working overtime to fulfill their important role in the 271 process and I would personally like to thank Ken McClure, Cheryl Parrino and Joan Smith for the excellent letter they wrote last month on the subject. The three commissioners highlighted the need for states to meet our Day 20 comment deadline in order for their opinions to be accorded due weight by the FCC and the Department of Justice, and they stressed the importance of states completing their analysis of a Bell Operating Company's compliance with the Section 271 requirements prior to the date that the company files its application with the FCC. I could not agree more, and I commend them for their leadership on this topic.
As I look back on the last year, I'm exhilarated by our common achievements and left daunted by the fact that so much remains to be done. Consider that the way forward relies on our joint efforts. If we were an orchestra, we've only just now finished the overture. Access and universal service are the final two movements. As the lights flash and the audience takes their seats after the intermission, let's all remember that no matter how brilliantly any one of us individually plays, the performance will only succeed if we follow the score together.