Local Telephone Competition: Unbundling the FCC’s Rules

Published January 1, 2004

Rules that force firms to share every resource or element of a business would create, not competition, but pervasive regulation, for the regulators, not the marketplace, would set the relevant terms.

Justice Stephen Breyer
AT&T v. Iowa Utilities Board

To the average consumer, the debate over new rules governing competition for local telephone service probably seems obscure and impenetrable–filled with technical jargon and acronyms. Yet the consequences of this decision may determine not just the future of competition in this market, but prospects for new technology and for the U.S. economy as a whole.

At its core, the issue presents a stark choice between two very different visions of competitive markets. The first–embodied in the current Clinton-era rules–relies on regulations to require incumbent providers to share parts of their network with potential competitors. The second approach would encourage the development of competing networks with a minimum of regulation. Despite loud protests by many firms that now benefit from the current, regulation-based policies, the second path offers consumers better prospects for real choice and greater availability of advanced telecommunications services.

The current rules actually could hinder competition. The availability of UNEs from incumbent carriers at low regulated prices distorts the “make vs. buy” trade-off for competitors, making it more likely that they will lease vital equipment rather than make the expensive–and risky–investment necessary to develop their own facilities.

The rules also can discourage investment by incumbent providers. Quantifying the effects is difficult, but a recent study conducted by the Cambridge Strategic Management Group (CSMG) and commissioned by Corning, Inc., concluded that UNE rules have reduced the availability of high-speed fiber optics. The authors of the study calculate that while 5 percent of homes would have a fiber connection by 2013, 31 percent would have one if UNE rules did not interfere. Overall incumbent investment, CSMG calculates, would be some $39 billion less than it would be without the rules.

The harm caused by the current rules, however, goes well beyond competition for traditional telephone service connections. The greatest danger may be to the development of tomorrow’s high-speed Internet connections. The potential impact of broadband technologies is huge. By speeding up the rate at which users can transmit information, a host of new applications and services, ranging from high-definition video to Internet-assisted medical care, become practical.

Aside from the qualitative consumer benefits involved, many observers see broadband as a critical catalyst for reviving the Internet economy, and perhaps the U.S. economy as a whole. The numbers could be large. One study estimated that the total potential benefits to the economy from universal diffusion of broadband service could be nearly $400 billion.

Broadband service is growing rapidly. An estimated 15 million Americans subscribe to some form of broadband. Cable firms are the leader in broadband service with 9.4 million subscribers, and LECs are a distant second with 5.4 million. Yet there are reasons for concern. One is that the relatively inexpensive places to deploy broadband are becoming harder to find, making future growth more difficult. Another is that today’s version of broadband is only a start; the real benefits of broadband may come when speeds hit much higher levels.

Finally, there are competitive concerns. Although broadband promises to be a competitive service, with multiple facilities-based rivals already in the market, the networks (particularly the telephone networks) are not yet able to offer broadband everywhere. As a result, many consumers today can get broadband from only one source–typically, their local cable companies.

Building a broadband network is expensive. Deploying current technology nationwide and upgrading to higher-speed systems could demand investment in the hundreds of billions of dollars. Yet, for DSL service by telephone companies, much of the resulting infrastructure will be subject to the same unbundling rules that apply to traditional telephone service. The result is discouraged investment. In fact, because the potential harm from such rules increases with the riskiness of investment and complexity of the technology, the disincentive to broadband may be even greater than to traditional telephone service.

Consistent with the remand order from the D.C. Circuit Court of Appeals, the FCC must significantly rewrite its rules on the unbundling of network elements. Unlike last time, however, these changes should not just tinker at the margins. Major change is needed not just to satisfy the courts, but also to provide competitive, advanced telecommunications services to American consumers.

James L. Gattuso ([email protected]) is research fellow in regulatory policy in the Thomas A. Roe Institute for Economic Policy Studies at The Heritage Foundation.