Since the Great Depression, the telecom* industry has been subject to comprehensive regulation, with the Federal Communications Commission (FCC) in charge of interstate services and state public utility commissions overseeing intrastate services. This regulatory regime sufficed in the days of copper wires and mechanical switches but is anachronistic in an era of fiber optics, routers, cell phones, and Internet “teleputers.”
Today, telephone companies compete with wireless phone and cable companies using Voice over Internet Protocol (VoIP) to deliver phone service. “Cable’s digital phone service is now available to over 97 million U.S. homes and more than 13.5 million homes are now subscribing, with that number growing by more than one million per quarter in recent quarters” (NCTA 2009). Comcast had 5.6 million voice customers in August 2008, making it the fourth-largest landline phone provider behind AT&T, Verizon and Qwest (Fernandez 2008).
Wireline phone companies also face significant competition from cell phones. There were 163.2 million wirelines and 238.2 million cell phones in service at the end of June 2007 (FCC March 2008), and a growing number of cell phone customers are “wireless-only” or “mostly wireless.” More than one-third of the nation’s households fell into one of these two categories in 2007 (Blumberg and Luke 2008).
Cell phones will become more reliable and less costly in the future and they are beginning to feature television, location services based on global positioning systems, and Internet access. Wireless providers already have 35 million broadband subscribers (more than either the cable or phone companies), even though wireless broadband services are currently slow compared to DSL and cable modem services (FCC March 2008).
Cell phone companies and others are gearing up to add more speed. For example, a consortium that includes Google, Intel, Comcast, Time Warner, Clearwire, and Sprint Nextel plans to build a wireless broadband network based on WiMAX technology that will rival DSL and cable modem services in speed and is much cheaper to deploy than DSL, cable modem service, or the 3G networks Verizon Wireless and AT&T are deploying. The consortium is determined to beat Verizon and AT&T to the market. Meanwhile, AT&T reported its 3G network, currently rated the fastest, would be available in 350 leading U.S. markets by the end of 2008 (AT&T 2008).
Even the largest firms are not immune to competition. AT&T lost 1.2 million landlines nationwide in the first quarter of 2008 (Cheng and Lavallee 2008) and more than 1.5 million more in the second quarter (AP 2008). One industry analyst estimates that Verizon and AT&T are losing residential phone lines at a rate of about 10 percent per year (Savitz 2008). Another analyst projects that by 2012 the market share of incumbent telephone companies will have dwindled to 51 percent, with potent competition from a variety of innovators using VoIP (SNL Kagan 2008).
The traditional rationale for utility regulation–that telephone and cable services are natural monopolies–is gone. Continued utility regulation–except as may be necessary for ensuring interconnectivity and number portability–is unnecessary and distorts competition in ways that harm consumers. So far, few states have faced up to this challenge.
The question is frequently asked whether it is necessary to remove all regulation, or whether consumers would benefit more from a combination of regulation and competition. The answer is that competition and regulation are incompatible. As Robert W. Crandall of the Brookings Institution pointed out:
The economic lesson from the history of regulation is that regulation and competition are a bad emulsion. Once the conditions for competition exist, it is best for regulators to abandon the field altogether. This is particularly true in a sector that is undergoing rapid technological change and therefore requires new entry and new capital. The politics of regulation favor maintaining the status quo, not triggering creative destruction (Crandall 2005, p. 166).
Distinguished economist and former federal regulator Alfred Kahn agrees:
The [telecommunications] industry is obviously no longer a natural monopoly, and wherever there is effective competition–typically and most powerfully, between competing platforms, landline telephony, cable and wireless–regulation of the historical variety is both unnecessary and likely to be anti-competitive … (Kahn 2007).
Congress didn’t act to deregulate the railroads until 1979, after President Jimmy Carter stated in a message to Congress that deregulation was necessary to avert an industry crisis. Without regulatory reform, telephone companies could face the same predicament, since current telephone regulation is modeled after former railroad regulation (Huber et al. 1999, pp. 214-220). Among other things, the regime forces the regulated entities to set some prices below cost (for example, residential and rural services)–forcing them to operate at a loss and discouraging competitive entry that would produce more choices for consumers; and set other prices well above cost–creating magnets for competition and eroding subsidies to support the services priced below cost. Eventually the system implodes.
Regulatory reform of wireline phone service is lagging behind wireless and cable, both of which were largely deregulated at the federal level during the Clinton administration when they faced much less actual competition than phone companies do now. Preemption of state regulation of wireless services in 1993 coincided with the auctioning of additional spectrum, because Congress assumed competitors would materialize. The elimination of cable rate regulation in 1996 occurred while cable operators still retained 91 percent of all subscribers, because Congress saw that new entrants such as direct broadcast satellite service providers were attracting many customers.
A few states, in particular Indiana, have taken the lead in regulatory reform. In March 2006, Indiana Gov. Mitch Daniels signed into law measures eliminating hidden subsidies in intrastate access charges, ending tariff filing requirements, permitting pricing flexibility, taking away from the state utility commission jurisdiction to regulate competitive services, streamlining provider-of-last-resort regulation, and assigning responsibility for consumer protection and broadband deployment to other state agencies.
These reforms may seem radical to anyone who remembers the days when incumbent phone companies were monopolies. But the monopoly era is over. The reforms enacted in Indiana are an appropriate and necessary response to the surge of competition that has transformed the telecommunications industry.
This booklet describes the beneficial results of what Indiana and other innovation leaders have done and how other states can follow their lead to reap the rewards of new investment in telecommunications services.
* By “telecom” we mean technologies and services used to communicate information, including data, text, pictures, voice, and video, over long distances. Telephone, cable television, and Internet access are the three major components of the telecom industry.