Session Two:
Wireline Carriers--Regulation I:
Background and History of Regulation in the United States

Lecture Notes

The Nature of Regulation

You run into regulations every day. When you drive your automobile to work, you follow a set of regulations for driving—follow a speed limit, stay right except to pass and so forth. You have paid a tax for your tags, which you must have to drive your vehicle on the streets, and you have a driver’s license, which you obtained by initially passing a written and "behind the wheel" test. You have probably renewed your license by taking an eye test, or perhaps another written test. You enter a restaurant knowing, at least subconsciously, that the meat you will eat was inspected by the Department of Agriculture, its weight measured on a scale calibrated by the division of weights and measures, and in a kitchen conforming and inspected by the local department of health. Regulation permeates daily life.

Telecommunications, too, is largely regulated. While the Telecommunications Act of 1996 nominally creates a "free market" for telecommunications, in fact, telecom is still substantially regulated. This regulation, grounded in a century of practice and in longstanding theories of law, has substantial implications for everyone in the industry, whether in the public or private sectors. It will affect the decisions you make on a daily basis, because of its impact upon prices, options, suppliers, or availability of technology. At the same time, it will provide a more stable environment and help to prevent abuses, both in advance of and in consequence of the actions of companies within the industry.

There is a great deal of political debate over the value of regulation. Before one can sensibly participate in this debate, it is important to understand the rationale for regulation, the structures, agencies, and processes which are undergone, and the intended results.

The fundamental reason for regulation is to ensure fairness. Markets, as the more or less abstract and impersonal entities they are, cannot determine value. If you want a telephone, you must pay the going rate. If the supply of telephones is less than the demand, the price will likely go up. If the cost of doing business in, say, a rural area is greater than in an urban area, because there are fewer customers for each mile of (expensive) copper wire laid to provide the service, there is a natural tendency to want to charge more because of the higher cost associated with this group of customers.

Certain services may be more valuable only because they are cheaply available. For example, for many years, local residential phone service was priced about a third of the cost of providing the service. Charging substantially more for long distance service and then providing a cross subsidy for local residential service made up the deficit. The rationale was that having more people have access to phones was in the best interest of the public. The value of a given phone increased by the number of people it could be used to call. Long distance users were presumed to be primarily business users. Therefore, the long distance service—an "enhanced" service, was priced higher to pay for the local service by regulators who were trying to ensure that all customers had "affordable" local rates.

But one of the effects of such "cross subsidy" between long distance and local service was to distort, over time, the disparity in pricing which new technologies created. Over time, long distance costs became cheaper because of new means of transmission, while prices remained static in order to support lower local pricing. This conflict triggered a nearly two decade long debate in the Congress and in the regulatory bodies, to determine how best to proceed. We’ll get into the particulars of that debate, because of its impact on us today in the next few weeks. First, let’s look at the nature of regulation as it evolved in the U.S.

Why Regulate?

Fundamentally, regulations are adopted to protect the public. These regulations hare designed to help in a variety of circumstances. For example, the market may not be strong enough to prevent one competitor from holding enough market share to dictate prices to consumers. In such a case, the company may be said to have monopoly power. Regulation could be developed to prevent an abuse of such market power, perhaps by setting rates, or at least by limiting them.

Regulation could be used, as in the example above, to provide a cross subsidy. Using a high margin service to support a high cost service is not unusual, in the public interest. With phones having become a necessity, there are other social goals to be met by regulation as well. For example, ensuring that all, including the poor and the elderly living on fixed income, have access to a basic phone service, has been one of the tenets of "Lifeline" legislation and regulation.

Regulation also can ensure the quality of service is maintained to a specific standard, that the concerns of safety are met, and that there is no adverse impact on the environment. And it does so, because the government is the counterweight to market pressures.

There are several types of regulation. First, the government may prohibit certain actions, like price fixing, pollution, or "slamming." This type of regulation is called "proscriptive", because it is designed to identify and prohibit certain behaviors.

The second type is a more positive construct and is known as "prescriptive." In this method of regulation, the regulated entity is told what it should or must do. Rates may be set, scarce resources allocated, standards set, are permission given to conduct a wide range of activities.

There are alternatives to regulation, many of which also constrain behavior or action. Competition, for example, is a method of economic constraint, without government’s direct involvement. The computer industry, at least to date, is a good example of a totally free market industry.

Antitrust law is another. Under antitrust principles, companies may not "restrain trade." In this construct, size alone does not create a problem. What creates the problem is using power in a way that limits consumer choice or restrains competitors’ fields of action.

An example of this is the antitrust case brought against AT&T in 1947 and again in 1976 or the current case against Microsoft. In the first case, AT&T was charged with unlawfully leveraging its monopoly in local exchange service to unfairly act in equipment and long distance markets. Microsoft has been accused of unlawfully leveraging its monopoly in operating systems to disadvantage its competitors in providing browsers, though the outcome of this case has yet to be decided.

Finally, the government may intervene to provide for the common good by preempting the private sector. For a long time, the Postal Service was a government-run monopoly in the U.S. In most other countries, the telephone and telegraph systems were also provided by government monopoly. The theory underlying this sort of nationalization of services may be because of a scarcity of resources or, for example, as part of the national defense. In the early 80’s the defense department saw maintaining the corporate integrity of the Bell System as an essential to national defense in the event of nuclear war.

Conversely, there are safeguards to ensure that regulatory actions follow a clear process to protect both the public and providers against arbitrary or rash rulings. Procedural rules, for example, require that regulators follow the Administrative Procedures Act. They must provide advance notice of their proposed actions, hold public hearings, meet in the open (in front of public and press), and make reasonably justifiable decisions. Further, they must follow the "due process of law" standards. Finally, they are accountable through judicial review. That is, the courts may oversee what the regulators are doing.

The more specific goals of regulation are to produce efficiency by limiting providers to prudent costs and investments, maintaining low prices for consumers, curbing abuses of monopoly or dominant firms. In addition, regulation meets certain social goals, such as nondiscrimination, consumer protection, and targeting of populations in need. Even in the "free market" tenets of the Telecommunications Act of 1996, there remain priorities for telecommunications development. Education and libraries, for example, are identified as priorities for investment and for government funding under this so-called "deregulation" act.

 

Competition, monopoly, and antitrust

Let’s conclude this discussion by discussing the nature of "competition", "monopoly" and "antitrust", and by reviewing the legal underpinnings for regulation in the U.S.

Markets in which there are many buyers and sellers characterize competition. Each transaction in the marketplace has a relatively small bearing upon the overall market and each transaction is a small component of overall market volume. Products differ, and consumers may choose the characteristics of the products they want from among a wide range of suppliers. Consumers or purchasers need a high degree of information to make choices. They may use product specifications, price, and other criteria to make their market choice. Choosing one supplier over another does not disadvantage them.

In a "monopoly" environment, choice is substantially reduced. There are fewer choices of suppliers, of products or services, and of criteria for choosing products. Think about the pre-competitive days when the only telephone choice was a black rotary dial. Bell provided a "breakthrough" when it introduced the "Princess" Touchtone phone in pastel blue or white. Now compare that with today’s choices.

Associated with monopoly services are higher prices, often incented and stimulated by the regulatory process itself. The monopoly supplier has no incentive to reduce costs in order to cut prices. In addition, there is a net transfer of income from consumer to supplier, much like a tax.

Some industries are arguably "natural" monopolies. Because of economies of scale, the tremendous cost associated with entering, developing or maintaining the industry, and its need, a writ is granted to a firm to provide the service. Telecommunications followed this model until the early 80’s.

Regulatory Theories

Underlying all forms of regulation is a series of legal theories. You’ll read it in detail in the Pierce and Gellhorn text. The three key concepts which effect telecommunications are represented by the terms "affected with the public interest," "substantive due process," and "legislation supported by facts." The first concept, "public interest" was an early concept that held telecommunications was in the public interest because of the value and utility of the medium. The second concept, of "substantive due process" is largely out of favor now. It held that regulation should be a regular process to monitor and oversee the operations of the monopoly provider. Finally, the concept of "legislation supported by facts" has become the modern method of regulating. In this approach, the presumption is that regulation will be minimal unless there are clear evidences of abuse. At that point, legislators and regulators will review the facts, and, if necessary, intervene.

Authority to conduct such regulation stems from the U.S. Constitution, as well as from the specific laws enacted to implement it. The key constructs are the Commerce Clause, Due Process, state’s rights, and equal protection of the laws.

In the next Session, we will see how these concepts have historically applied to telecommunications.

||  Contact Dr. Cohen  || Back to Lesson Guide  ||
||  Library Services  ||  Graduate School HomePage  ||  E-Mail Directory  ||
||  Back toTycho Login  ||
© 1999-2000 University of Maryland University College.