Regulators Must Send the Right Signals

Published February 1, 2005

Telecommunications has been referred to as the central nervous system of the American economy. There is almost no aspect of today’s economic activity that can occur without it.

Only a few years ago, telephone and computer networks were separate wires. Video could be viewed only on a TV set. Because this was a limited and structured system, federal and state policymakers imposed stringent regulation on the few companies that delivered narrowly defined services.

Over the past several years, however, a technological revolution has occurred in which communications have converged and all the formerly separate technologies (wireline, wireless, cable, and satellite) can now deliver voice, data, and video. As a result of that revolution, each technology now competes against every other technology to provide the whole gamut of services.

These fundamental changes present policymakers with a golden opportunity to reform telecommunications rules by substituting market forces for regulation. A new report commissioned by the U.S. Chamber of Commerce describes the internal contradictions in the existing regulations and recommends an exit strategy. Recommended reforms, which require regulatory or legislative action at the state or federal level, fall into two categories: ending policies that discriminate among networks and ending price distortions in telecommunications markets.

Ending Policies that Favor One Network over Another

Phase out wholesale access based on theoretical costs in favor of the basic price-setting mechanism now used for total service resale.

Current pricing is based on what a company might charge if operated at a theoretically ideal level of efficiency. This approach sets a low wholesale price that encourages new entrants to use existing company networks rather than build their own facilities. This approach has the perverse effect of discouraging existing companies from upgrading their own networks through new investment. Why upgrade if government regulations require you to lease to a competitor at a price that is lower than the cost of investment?

Instituting this proposed change would send the right signal to new entrants to build rather than lease network facilities. It also would tell existing companies they should bring new communications technologies to the market because they could earn a reasonable profit on their investment. This proposal would end the reliance on highly controversial theoretical pricing mechanisms and, instead, would set prices based on actual pricing data.

Expeditiously allocate at least 438 MHz of additional prime radio spectrum for flexible use by competitive wireless licensees.

Currently, U.S. spectrum policy has created an artificial scarcity of airwaves. Allocating more bandwidth would make wireless telecom service an effective third competitor with DSL and cable. Competition would drive down the prices of all three services and would create billions of dollars in consumer savings. The extra bandwidth would fuel substantial growth of mobile phone voice networks and would give homes and businesses the ability to receive high-speed telecommunications services at lower prices. It also would make U.S. businesses far more productive.

Declare cable modems and DSL services to be information services, which are not subject to common carrier regulatory obligations, and pre-empt state regulation of these services under the guise of “open access.”

Cable modem service has been tentatively treated as an information service, and this approach has helped the service become more widely used by businesses and homes. But uncertainty about the regulatory status of cable modem and DSL services has made investors jittery about investing in these technologies for fear of being subject to telecommunications regulation that would undercut profitability. Policymakers should end the uncertainty over broadband by permanently abandoning efforts to regulate the technology.

Extend to all voice over Internet Protocol (VoIP) service the FCC declaration of Internet-only VoIP as “information services” not subject to regulation and pre-empt Internet phone service from state regulation, specifically leaving the quality of service unregulated.

State regulators have expressed interest in licensing and regulating VoIP providers in the same way they now regulate telephone companies. Internet services are provided regionally, nationally, and globally. Consequently, having different state regulations, taxes, and fees on VoIP services would be highly disruptive. The worst-case scenario would be to have 50 different state regulations.

That scenario can be avoided, and uniformity achieved, through federal pre-emption of state rules, thereby ensuring that VoIP can prosper and provide its many benefits as a genuine competitor to traditional wireline service.

Ending Price Distortions

Raise funds for universal service in a competitively neutral manner.

U.S. social policy dictates that telecommunications service is a critical link to society that every citizen should enjoy. Current universal service subsidies, however, favor traditional telephone service at the expense of newer technologies, and today’s universal service policy is fundamentally hostile to competitive telecommunications markets.

The U.S. Chamber report therefore recommends a change in the way funds are collected and distributed. Currently, long-distance, urban, and business telephone users are generally billed above cost, while local, residential, and rural users are often subsidized. These pricing distinctions are complex and create market distortions. The report recommends non-distortionary approaches–for instance, drawing universal service subsidies from general tax revenues or assessing a fixed monthly fee for each telephone number–to achieve a fairer and more efficient market.

Distribute universal service funds via consumer vouchers, not with payments to telephone companies, to allow competition among suppliers and choices for customers.

Under the current universal service funding system, government subsidizes high-cost telephone companies, as opposed to compensating phone users in high-cost areas. Some firms that qualify for subsidies are favored over others. This has two negative effects. First, it reduces incentives for suppliers to be efficient because their losses are made up by taxes. Second, it prevents consumers in areas that qualify for universal service subsidies from receiving the most advanced technologies, such as wireless and VoIP.

Under the proposed voucher system, consumers could choose to apply the subsidies to whatever telecommunications services best meet their needs, whether they be traditional wireline, wireless, or newer broadband services.

Sending the Right Signal

At this juncture, the United States must choose: It can allow regulatory uncertainty to literally deaden its central nervous system, or it can escape the regulatory quagmire and allow market forces and technological innovation to create the world’s most advanced and efficient telecommunications system.

If it chooses the right path, it will reap astonishing gains. It will create greater economic activity. Consumers will enjoy an abundance of services. Individuals and organizations will have available to them products and services that were unimaginable only a few years ago.

This article is adapted from Sending the Right Signals: Promoting Competition Through Telecommunications Reform, an independent report commissioned by the U.S. Chamber of Commerce and released in October 2004. The report was researched and written by Thomas Hazlett ([email protected]) of the Manhattan Institute, Coleman Bazelon ([email protected]) of Analysis Group, John Rutledge ([email protected]) of Rutledge Capital Research, and Deborah Allen Hewitt ([email protected]) of the College of William and Mary. The full report is available online at and