[ Text Version | WordPerfect Version ]

Remarks of
Commissioner Susan Ness
Before the
Economic Strategy Conference
Washington, D.C.

March 3, 1998

"Why Investment Matters"
(as prepared for delivery)

Good morning.

Let me get started by telling you that I didn't pick the title for this speech. My remarks were billed as "Why Investment Matters."

As my 9-year-old son would say, "duh."

Why does investment matter? Well, if we want more and better telecommunications and information services to be available to business and residential customers, someone has to put up the money to develop and deploy them.

I used to be a banker. I lent money to a wide variety of communications entities -- rural telcos, long distance companies, cellular providers, broadcasters, cable television operators, and satellite systems. But you don't need someone with a Wharton MBA to tell you that investment matters.

We don't need to spend a long time discussing the importance of infrastructure, or innovation. You don't get either without investment.


So, if we can agree that investment matters, let's move on. Let's talk about what kind of investment is desirable, and what is the government's role in promoting desirable investment.

The Importance of Competition-driven Investment

Guess what? Government and industry long ago devised a regime that ensures plenty of investment. Create a monopoly, and give the monopolist a guaranteed rate of return that exceeds the real cost of capital.

Such a regime assuredly promotes investment. Attracting capital is never a problem. But it doesn't do much for innovation, or efficiency.

Thirty years ago, this nation began a grand experiment with a different approach. Prodded by the courts, the FCC began to allow the first seeds of competition to be sewn -- in long distance and in customer premises equipment.

Investors and entrepreneurs seized the opportunity. In the 1970's, the first seeds had sprouted and taken root, and competition had begun to take over. The FCC and the courts continued to make adjustments. Opportunities for competitive investment were expanded. New products and services began to flourish.

It's not my goal today to recount this history in any detail. Suffice it to say that there has been a long evolution of national telecommunications policy that has steadily increased opportunities for competition. And American consumers have reaped enormous benefits from this competition.

Throughout the course of the policy debates over the past twenty-plus years, there have been those who defended the status quo. Defenders have said that new policies of competition would be disruptive, lead to cream-skimming, threaten universal service, and jeopardize continued investment by the incumbents who have served this nation so well.

Passage of the Telecommunications Act of 1996 represents the ultimate repudiation of this view.

Signs of Healthy Investment

Congress, in passing the Act -- and the FCC, in implementing it -- have agreed on a vital point: the right question is NOT whether a policy promotes investment, but whether it promotes efficient investment, competitive investment.

That is what we have been trying to accomplish.

And although there have been bumps in the road and even some unexpected detours, we are now seeing the signs of healthy investment that Congress desired.

Let me mention a few examples:

And that's not all. This is just a small sampling of what's happening in the communications infrastructure in the United States.

At the same time we're seeing progress in the development of distribution technologies -- ADSL, HDSL, and "DSL-lite" for example -- and in the development of the services that ride atop these technologies.

The FCC tends to think in terms of developments at the physical layer, but we also need to take account of all the wondrous things that are happening, as my friend Dale Hatfield says, "up the protocol stack." That is, the growth of Internet content providers, and the accelerating progress of electronic commerce.

As you can tell, I'm delighted by all these developments. While it has become fashionable to complain that the Telecommunications Act has not yet brought about all the benefits that were contemplated, in fact we're off to a pretty good start -- all things considered.

What do I mean by those last few words? Well, for one thing, I think some of the expectations associated with the Telecomm Act were unrealistic. Not concerning what would happen, but how long it would take.

Telecommunications is an infrastructure business -- like railroads and highways and electricity. Building infrastructure takes time. Two years after the Interstate Highway Act, you couldn't drive 60 miles an hour from Portland, Oregon, to Portland, Maine. Why should progress in telecommunications occur any faster?

And by the way, we have an extra problem in telecommunications. The builders of the interstate highway system did not face entrenched monopolists that controlled the local access roads.

That's why I have been pleased that the financial markets are ready to supply not just capital -- but patient capital -- to some of the new entrants.

One CLEC chairman who had raised about a billion dollars told me that he had done so with the express understanding with his financiers that his company would lose money for at least four years. That gives him some time to get the infrastructure built out to where the target customers are.

Investment in Modes of Entry

To transform the local telephone marketplace from monopoly to competition takes time. Congress clearly hoped that new entrants would construct their own infrastructure, over time, using the cable plant, wireless local loop, or even partnerships with electric companies.

But Congress also sought to jumpstart competition by allowing strategies other than full-scale replication of the incumbents' networks for local market entry.

So Congress required incumbents to open their markets to competition through the vehicles of resale and unbundled network elements.

Resale has the virtue of being quick and easy -- or at least those are supposed to be its virtues. The incumbent's service is priced for resale by subtracting out the incumbent's avoided marketing expense.

Of course, the new entrant has its own marketing expense, so the profit potential is negligible. But this approach does -- or should -- give the new entrant a fast way to enter the local market and the customer an opportunity to obtain a bundle of services (such as local and long distance) by dealing with a single supplier.

Also the reseller does have some flexibility to offer different pricing packages and to target market segments that may be overlooked by larger players.

Under this approach, the incumbent maintains its full measure of profit. For the new entrant, this strategy will ordinarily make sense only as a transitional matter.

That's where UNEs come in -- or were supposed to.

The new law created an additional entry vehicle -- one that is considerably more novel. This one is called "unbundled network elements," or "UNEs." It allows new entrants to purchase the piece-parts of the incumbent's network. They can buy all of the pieces necessary to provide a service, or just those piece parts that the new entrant is not ready to supply on its own.

What's key here (besides the provisioning issues) is getting the pricing right. Wrong economic signals to a would-be competitor will deter it from constructing its own facilities.

The FCC spent a lot of time thinking about pricing issues when it wrote its local competition order in the summer of 1996. We listened hard to what the incumbents told us, and what the new entrants told us -- as well as to Wall Street and our own economists.

The statute said that UNEs should be priced on the basis of cost. Sending the right economic signal, every reputable economist told us, required that we interpret the term "cost" to mean forward-looking cost.

A new entrant confronting a build-or-buy decision should be making that decision based on its assessment of whether it is likely to be a more efficient provider -- not on the basis of how much undepreciated investment happens to be on the incumbent's books of account.

We also considered the question of whether the price for the UNEs should include a contribution to the incumbent's joint and common costs, and whether it should also include a risk-adjusted cost of capital.

We said "yes" on both points. Why? Because we wanted to send the right economic signals to new entrants and incumbents alike. We didn't want to deter facilities-based investment by the new entrants, or innovation by the incumbents.

Yet another issue was the question whether UNE prices should be geographically deaveraged. Generally speaking, it costs less to construct local loop facilities in urban areas, somewhat more to construct in suburban areas, and still more -- sometimes a lot more -- to construct in sparsely populated areas.

So long as telephone rates are set on the basis of averaged costs, allowing for UNE prices to be averaged as well would tend to artificially depress demand for UNEs in urban areas and stimulate it in rural areas, with distorting effects on investment decisions.

So we told the states that the rates they set in arbitrated interconnection agreements should be deaveraged.

We thought our role was to establish principles for construing the statute, leaving the specific setting of rates to the state public utility commissions, who are the ones most familiar with local market conditions and rate-setting. As most of you probably know, the Court of Appeals for the 8th Circuit decided that we had overstepped our authority in even establishing pricing principles.

The bad news is that, as a result of this decision, each of the state commissions is free to formulate its own notion of what the term "cost" means, subject to review in the 90-plus U.S. District Courts.

The good news is that, even before the Supreme Court agreed to review the 8th Circuit's decision, most of the states considered the same economic principles that we had. And, for the most part, they reached the same conclusion we did about the importance of sending correct economic signals.

Most states saw the potential harm to competition of discouraging efficient investment or encouraging inefficient investment.

There's a long road ahead, in the courts and in the state commissions, before final prices are set for interconnection, for UNEs, and for resold services. But there is a much higher awareness than in the past of the importance of addressing these issues in an economically rational manner.

Similar considerations apply in the case of universal service subsidies. Today, most subsidies are implicit; rates in high-cost areas are kept low because a variety of other services are priced well in excess of cost. That's not sustainable in a competitive marketplace.

One of the top priorities at the FCC and at the state commissions will be to devise a new system of support for high-cost areas, making the subsidies explicit, sustainable, predictable, and competitively neutral.

Once again, in devising this system, we will need to make sure it's calculated to send correct economic signals, and that it doesn't deter efficient investment. We want to stimulate investment that is justified by the business case, not by distortions of legacy regulation.

Minimizing Regulatory Risk

I want to take a moment now to acknowledge that one major deterrent to investment is risk. And one major risk confronted by investors in the telecommunications marketplace is regulatory uncertainty. As a former banker, I'm sensitive to this fact. I try to minimize the problem whenever possible.

Of course, there are numerous regulatory uncertainties that are beyond my power to control. Courts sometimes surprise us, as the 8th Circuit has more than once and a district judge in Texas did on New Year's Eve.

Congress, too, can change the rules of the game at any time, or place us in a position where we are compelled to change course. And, of course, it's their right to do so.

Changes in the composition of the Commission also can lead to changes in rulings, even where the underlying law, facts, and logic have not changed.

And, even in the absence of any of these factors, our reconsideration process may cause us to see things differently on the second go-round than we did on the first.

I can't tell you with confidence that anything the Commission has decided is a settled issue. I can tell you that I personally believe policymakers should avoid change for the sake of change.

I hope that my new colleagues will likewise recognize the desirability of maintaining as steady a course as possible, consistent with their right to question the wisdom of what has been done by their predecessors.

I think you can also count on us to prefer competition to regulation, and to back off from involvement in markets as competition emerges.

But it's important to note that Congress did not embrace the notion that the best way to encourage competition and investment was to eliminate all rules on everyone, before competition appears on the scene.

Unregulated monopoly, Congress recognized, is the worst of both worlds.

Investment in Education

I'd like to focus briefly on "Why Investment Matters" in another context -- investment in advanced communications for our schools and libraries.

Congress wisely enacted the Snowe-Rockefeller provisions of universal service, providing discounts on telecommunications services to schools and libraries. The cost of this program is borne by all telecommunications carriers -- many of which will enjoy greater demand for their services as a result of these provisions.

The costs of this program should be thought of as an investment -- a wise one. Why? Our next generation must have the tools to prepare them for global competition in the 21st century. A skilled labor force pays dividends 100 times over.

Moreover, our trading partners are making these very same investments in their students. We cannot risk our leadership in using Information Age tools to increase productivity and develop new services.

Some carriers are looking for the short term bottom line and are challenging the FCC's implementation of the Snowe-Rockefeller provisions in court. I think this is short-sighted.

Investment matters.

A Final Thought...

Finally, I want to say that I am well aware that investment comes from the marketplace, not from the government.

You put your dollars at risk. We want to encourage you to do so, so that this country can continue to lead the world in the quality of its communications infrastructure and services.

The role of government is not to pick winners or losers, but to make sure the doors of opportunity are open.

It shouldn't be the FCC that decides whether consumers will get HDSL or ADSL or DSL-lite. It shouldn't be an incumbent monopolist, either, who makes that decision.

The beauty of the Telecommunications Act is that it permits a variety of solutions to be tested in the marketplace, and may the best prevail. I am heartened by the emerging competition between the xDSL solutions offered by the telephone companies and the cable modem solutions offered by the cable companies.

I think this emerging rivalry bodes well for consumers in quenching their thirst for more bandwidth to go with the increasing speed of their PCs.

I believe you can count on the newly reconstituted FCC, and the state commissions, to create an environment that is conducive to competitive investment.

Let's all remember that it takes time for technology to mature, for demand to develop, and for technologies to be deployed. With that in mind, I think we can conclude that the Telecomm Act is beginning to produce the desired results.

And soon, the benefits of rampant local competition will be upon us. In the foreseeable future, my nine year old will get up from the dinner table to answer phone calls from telemarketers offering us an opportunity to switch our local telephone service.

Now that's progress! Duh!

Thank you.