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> **Federal Communications Commission**

**International Bureau**

**445 12th Street, SW**

**Washington, DC 20554**

# 

# 

**International Bureau**

**Working Paper Series**

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  2              The Limits of Economic Regulation: The U.S. Experience

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June 2004

Peyton L. Wynns

The FCC International Bureau\'s Working Paper Series presents staff
analysis and research in various states. These papers are intended to
stimulate discussion and critical comment within the FCC, as well as
outside the agency, on issues in international communications policy.
Titles may include preliminary work and reports on work in progress, as
well as completed research. The analyses and conclusions in the Working
Paper Series are those of the authors and do not necessarily reflect the
views of other members of the International Bureau, other Commission
staff, or the Commission itself. Given the preliminary character of some
titles, it is advisable to check with author before quoting or
referencing these Working Papers in other publications. This document is
available on the FCC\'s World Wide Web site at http://www.fcc.gov/ib/.

***The Limits of Economic Regulation:***

***The U.S. Experience***[^1]

**Peyton L. Wynns**[^2]

Federal Communications Commission

International Bureau

Washington, DC 20554

June 2004

IB Working Paper No. 2

We are often so overwhelmed with our immediate workload that we fail to
look more widely to see what might be learned from other jurisdictions
and other industries. This review summarizes some of our experience in
the United States over many years in hopes that others might avoid at
least a few of our mistakes.

It focuses on the industries I have worked on most closely---airlines,
railroads, trucks, and telephones, all of which are described as
"network industries." It concentrates on long-term trends rather than
the implementation 1996 Telecommunications Act.

In the United States, the Interstate Commerce Commission was established
and railroads were brought under economic regulation in 1887 to protect
shippers---especially farmers---from monopoly power.[^3] A half a
century later---during the great depression of the 1930's---numerous
agencies were created for the regulation of a wide variety of other
firms, including those engaged in finance, energy, and transportation.
This wave of regulation reflected a belief that free markets were not
working well rather than a concern about market power.

Over a long period of time, it became apparent that applying economic
regulation was much more difficult than commonly supposed and the
consequences were often unexpected. The regulatory process turned out to
suppress innovation and productivity. The economic performance of
regulated sectors was often worse than that of unregulated areas---even
where the unregulated firms had some degree of market or monopoly power.

During the 1960's, students of regulation became increasingly
critical.[^4] By the 1970's, the counter-revolution was well underway,
first by the regulatory agencies themselves and then later ratified and
extended by legislative actions. Legislation abolished both the Civil
Aeronautics Board, which had regulated airlines, and the Interstate
Commerce Commission, which had regulated the truck and rail industries.
The initial waves of telecommunications deregulation were also
accomplished under existing law by the FCC, often at the prodding of the
courts. Major legislation was not passed until 1996.

Despite the vast differences among the various industries, the language
contained in the 1887 rail legislation was largely copied---in many
cases word for word---and applied to trucking, airlines and
telecommunications. Thus, the legal requirements set forth by Congress
regarding entry, exit, and pricing were almost identical in all four
industries. Although different agencies have experimented with different
procedures, several common themes run through our experience. I will
first give a very abbreviated summary of the experience of each industry
and then draw together what, to me, seem common themes.

THE INDUSTRIES BEFORE AND AFTER

AIRLINES:

Airlines were the first major industry deregulated and by far the most
studied and best documented. Air service had barely begun when the Civil
Aeronautics Board (CAB or Board) was created by the *Civil Aeronautics
Act of 1938*.

Airlines already in operation when the Board was established received
operating authority from the Board. After World War II, those carriers
were standardized on larger aircraft and abandoned smaller towns. The
Board then permitted a number of smaller firms to enter the industry as
"feeder airlines." But aside from these smaller carriers intended to
feed the major airlines, the board never permitted a major new carrier
to enter the industry and compete in providing scheduled service.

Despite the fact that new firms were not allowed to enter the industry,
more than one airline served most major routes. Where existing carriers
sought to serve new routes, complex and lengthy trial type proceedings
evolved, usually requiring years to complete.[^5]

Airlines found it easy to reduce service on unprofitable routes. They
were usually able to abandon towns entirely. For firms wanting to exit
the industry, the Board always approved a merger with a stronger carrier
interested in acquiring the route authority held by the failing
firm.[^6]

As carriers competed on major routes, industry profitability was
generally below what the regulators regarded as a healthy level. Failing
in other efforts to raise profitability, the Board eventually decided to
fix prices by specifying the exact fare to be charged in each market.
The airlines nevertheless continued to compete by stressing food and
other amenities but especially by scheduling additional flights.[^7] The
result was a "ratchet effect" as more capacity led to lower than desired
earnings, causing the regulator to raise fares, causing still more
capacity to be added, necessitating still more fare increases.[^8] The
ultimate effect was an airline system with high fares; plenty of
capacity; frequent flights at prime times; and primarily serving
business travelers and the wealthy. Those who flew found spacious
seating, free meals, and gracious service. But few could afford to fly.

Two types of operators were not covered by CAB regulation. First, the
CAB did not have jurisdiction over firms that restricted their
operations to a single state. Airlines flying only in California and
only in Texas began to provide high frequency, low-cost air service. The
intrastate carriers packed more seats in each plane and filled those
seats by charging dramatically lower prices. By carrying twice as many
people on each flight, they could charge fares that were only half as
much as fares charged by regulated carriers.

Second, firms that restricted their operations only to small planes had
been exempted from regulation by the Board itself, which did not want to
bother with regulating crop dusters, flight schools, air taxis and other
small commercial operators. Under this exemption, small "commuter
airlines" sprang up, often replacing the former "feeders" and small
communities became increasingly dependent on such service.[^9]

By the mid-1970's a vast amount of economic research cast doubt on the
efficacy of CAB regulation,[^10] as did the success of intrastate
carriers and commuter airlines and the Board's continued refusal to
license applicants who promised to provide low fare service.

By the late 1970's the Board itself was opening entry and permitting
pricing flexibility. With the airlines beginning to believe they
continued to have the burdens of regulation but not the benefits, the
industry split and the largest airline, United, joined the calls for
deregulation. In 1978, Congress passed the *Airline Deregulation Act*.
The Civil Aeronautics Board was phased out and a few of the Board's
former functions were transferred to the Department of
Transportation.[^11]

Today, airline pricing is completely deregulated and airlines can exit
as freely as they can enter. If a city will be left without any air
service, and if that service is deemed essential, the government
provides subsidies to arrange continued service by other carriers.[^12]

The results have been well documented by a considerable body of
research. Average prices fell dramatically, traffic surged, and the
airlines moved to hub-and-spoke operations.[^13] Some business travelers
experienced less convenient flights and higher fares but hub-and-spoke
operations resulted in more flights and more nonstop flights. The vast
majority of non-business travelers and even most business travelers paid
lower fares and service to small communities ceased to deteriorate.
Airline deregulation has pretty much been an unambiguous success for
airline passengers and the annual benefits are generally reckoned to
exceed \$20 billion.[^14]

Some, of course, complain that air travel has changed from a pleasurable
adventure to a cattle car experience for the masses. Periodically an
entrepreneur starts a new airline modeled after the old system---high
prices for spacious elegant service. The new firms promptly go broke as
people continue to purchase lower priced services rather than the more
elegant new offering.

RAILROADS

The railroads were the first major industry regulated[^15] and, after 80
years of regulation, the nation's railroads were in deplorable
condition. Railroads were unable to stem major losses from passenger
service; not permitted to discontinue such service; unable to abandon
lightly used branch lines; often not permitted to raise prices for
"captive shippers;"[^16] and the industry had been losing market share
to trucks and barges since World War II.

The physical plant was in such bad repair, that "standing derailments"
began to occur---where stationary trains simply toppled over. By then,
farmers no longer used the railroads for anything but grain because
shipments moved so slowly that other produce rotted long before
delivery.

The rail crisis was brought to a head by the threatened cessation of
rail operations in the northeastern United States as all the major
railroads in the Northeast and Midwest had gone bankrupt. Congress
created a public corporation in 1970 to take over passenger service
(Amtrak).[^17] More legislation was required in 1973 to take over
freight operations in the northeast by establishing another new
corporation, Conrail.[^18] More billions of dollars were required in
1976 and the funding was accompanied by granting the railroads minor
regulatory relief.[^19] Finally, in desperation, amid continued losses
for both Conrail and other railroads, Congress responded with sweeping
regulatory changes in 1980 by passing the *Staggers Rail Act*.

The *Staggers Act* was by no means total deregulation: although carriers
were given much more pricing flexibility and allowed to enter contracts
with shippers, limits were placed on the amounts that could be charged
captive shippers. Carriers were allowed to abandon trackage but shippers
were given the right to purchase and continue operating the tracks.
Given the financial condition of the industry and the amount of deferred
maintenance, many prices were expected to rise substantially. Most of
the debate on the legislation focused on how much railroads would be
allowed to raise prices.

For the railroads, the *Staggers Act* was a success from the start.
Earnings improved rapidly and productivity soared as railroads became
vastly more efficient as a result of mergers, crew reductions,
abandonment of lightly used lines, more intermodal operations (such as
containers carried partway by rail and partway by truck or ship),
reductions in the number of empty cars, reductions in empty backhauls,
contractual agreements with shippers, and a surprising amount of new
investment. The efficiency of the rails has increased to such an extent
that, today, five times as many ton-miles are moved per employee as in
1980.

Until the *Staggers Act*, the railroads were able to offer services only
under tariffs. Contracts between railroads and shippers were illegal.
The introduction of individual contracts yielded benefits for both
railroads and shippers. Both invested in more efficient equipment and
about 80% of tonnage now moves under contract. Agricultural produce even
returned as railroads began to offer guaranteed on-time delivery in good
condition.

Many prices rose initially, but many fell, and some were unchanged. By
1988, however, deregulation had lowered rates significantly for almost
all commodities.[^20] Average rates went down substantially even as
earnings rose. Estimates of the direct savings to rail shippers from
lower rates are enormous, estimated to be \$32 billion annually in
1999.[^21] Some captive shippers did, of course, pay higher rates but
these were far more than offset by lower rates for the vast majority of
shippers, improvements in service times and the value of shipper's time
saved. Some concern remains to this day about captive shippers but,
given the overall declines in rates and the improved health of the
industry, that is not a major issue.

As the results of the Staggers Act became viewed as an unambiguous
success, the ICC was abolished in 1995 and replaced by the Surface
Transportation Board, an agency with much more limited functions.[^22]
The government even managed to sell Conrail to the private sector in
1997 although the government continues to finance large annual losses on
passenger service by Amtrak.

TRUCKING

Trucking was brought under the jurisdiction of the ICC by the *Motor
Carrier Act of 1935*.[^23] Later legislation, in 1948, gave the trucking
industry antitrust immunity to collectively set rates.[^24]

In terms of revenues, trucking is vastly larger and more important than
all other modes of transportation combined.[^25] The trucking industry
includes more than 300,000 firms and an amazing variety of firms.[^26]
Some specialize in small shipments; some deal only in full loads; and
some specialize in particular types of hauling (e.g. household goods or
petroleum products). Some provide package express and some focus on
local delivery. There are also a large number of firms that carry their
own goods (private carriage) and several hundred thousand "owner
operators" who use their tractors to haul trailers for others. Some
segments of the industry were never subject to ICC regulation at all,
primarily intrastate operators and haulers of unprocessed agricultural
products.

As with the airlines, the regulators sought to ensure a financially
healthy competition by very restrictive entry practices. New firms had
to demonstrate that their service would be successful and not harm
existing operators. The "operating rights" held by those firms that had
established operations before the advent of regulation attained large
values. The ICC left ratemaking to industry rate cartels called "rate
bureaus" and regulated prices were high as were industry wage levels and
the profits of at least some of the companies. For regulated truckers,
exit was much easier than for railroads: where truckers discovered
service unprofitable, they simply cut back service and ultimately
disappeared.

Trucking was usually understood by economists and other academics to be
an industry that would naturally support a very large number of small
competitors and where economic regulation was not necessary. The
trucking industry, however, made the usual arguments against
deregulation such as loss of service to small towns and rural areas and
suggested the likely inability of firms to finance the networks of
terminals necessary for less than truckload operations.

Critics of regulation pointed to high prices; circuitous routings; an
unnecessarily large number of empty backhauls; the increasing use of
private carriage; the high value of operating rights;[^27] unusually
high wage levels;[^28] differentials between similar agricultural
products that were exempt or non-exempt depending on their degree of
processing;[^29] experiences where commodities had shifted from
regulated to unregulated status;[^30] and international
comparisons.[^31] Academic research concentrated on comparisons of the
types described above. Broader research on the overall effects of
trucking regulation was limited because the necessary statistical data
was scarce.

The regulatory status of the industry was jealously guarded by both the
industry and its labor force. Both provided far stronger opposition to
deregulation than did the airlines or railroads. Trucking regulation was
first liberalized in a series of small steps by the ICC. In 1980,
Congress first passed legislation aimed at a small segment of the
industry where consumer complaints were particularly numerous, and then
passed more general legislation later that same year.[^32] The *Motor
Carrier Reform Act* liberalized entry but allowed the truckers to keep
their rate cartels. Although the rate cartels were allowed to remain,
their power to set high rates evaporated with freer entry. The value of
operating rights collapsed as thousands of small new firms surged into
the industry.

There have been relatively few attempts to make comprehensive
assessments of the effects of trucking deregulation. This is due, in
large part, to the scarcity of data with which to make quantitative
assessments. Nevertheless, there is general agreement that there have
been great productivity gains along with a great deal of turmoil as many
incumbents went bankrupt and were replaced with lower cost operators.
Some research found improved service to small towns and some estimated
that most of the gains had come from goods shipped in less than
truckload lots and improvements in private carriage.[^33]

TELEPHONE SERVICE

From the telephone industry's inception, the local telephone companies
owned by AT&T refused to allow any customer equipment to be connected to
their networks unless that equipment was produced and owned by AT&T.
Similarly, AT&T refused to connect with other long distance carriers.
The regulators accepted these refusals and, as a result, AT&T, which
owned most of the major local telephone companies, also monopolized both
the production of equipment and the provision of long distance service
for most of the 20^th^ century.

During the last quarter of the 20^th^ century, the integrated monopoly
came unglued. A series of court decisions and FCC actions opened the
equipment market which is now completely deregulated and highly
competitive.[^34] New companies were permitted to offer long distance
telecommunications and AT&T's operating companies were required to
connect with them. Pricing requirements for long distance carriers were
gradually eliminated, first for smaller firms and later for AT&T.[^35]
In local service, where monopolization of the local loop remains a
concern, pricing regulation generally shifted from rate-of-return
regulation to price-cap regulation.

In telecommunications, as in transportation, the changes that have
accompanied the transition toward more competition have been stunning.
Cellular services have become ubiquitous. Like such services in much of
the rest of the world, mobile services were never subject to traditional
economic regulation. The Internet, which also remains unregulated,
continues to increase its reach and importance. Long distance prices
have declined to such an extent that, for many consumers purchasing
bundled services, the costs of additional calling is essentially zero.
The deregulation of terminal equipment is perhaps worth a little
discussion only because it is so commonplace that we often forget all
about it.

For nearly one hundred years, only equipment provided by the telephone
company could be connected to the network and only telephone company
personnel could install, fix or move phones. This was a terribly
inefficient system where a service call was needed for every
installation and to fix any problem, no matter how small.

More fundamentally, however, the monopolization of terminal equipment
precluded any innovation by outsiders. Most households had only a
single, solid black rotary phone produced by the monopolist---exactly
the solution a state owned utility might have selected. After consumers
became free to attach their own equipment to the telephone system, a
virtual explosion of new equipment and services resulted.

Facsimile machines, which were rare despite the fact that the technology
was even older than the telephone, became common. So did answering
machines---previously rare despite the fact that voice-recording devices
were patented as early as 1903.

And of even greater importance is the connection of a vast number of
personal computers to the telephone system. I think we can all imagine
how limited personal computers might be if all equipment and all
software had to be invented, designed, and manufactured by the telephone
company. The Internet would be nonexistent.

Our enthusiasm for citing the virtues of our telecommunications system
and the success of the FCC in fostering its successes should be tempered
by the realization that mobile service and the Internet may be
successful precisely because they were never subject to economic
regulation\--and the realization that success in long distance and
terminal equipment came at the insistence of the courts rather than the
FCC.

COMMON THEMES:

Several themes run through the common experience of the ICC, the CAB,
and the FCC. Here are those I draw from my experience.

[Regulators are not the problem]{.underline}. At all three agencies,
political appointees have generally been able, honest, energetic, and
well intentioned. The staffs have been well trained and diligent. I
stress this because the first reaction to calls for regulatory reform
was often "we must need better regulators." Any failures of regulation
should not be taken as a criticism of the regulators any more than the
poor performance of centrally planned economies should be blamed on the
ineptness of planners. Where the results of regulation have not been
desirable, the problems are with the nature of regulation itself rather
than the regulators.

[Much of traditional economic regulation is now in
disrepute.]{.underline}

[Entry]{.underline}. Entry controls limit competition within an industry
at great cost and little benefit. Limiting entry to ensure a healthy
industry is an inherent contradiction.[^36] Limiting entry to allow
incumbent firms to earn profits to generate cross subsidies has been
consistently unsuccessful. In fact, it is hard for me to visualize any
situation where some benefit to the public arises from keeping a
legitimate firm from serving customers who want to purchase its
services.

[Exit]{.underline}. Exit controls are usually viewed as a way of
protecting customers from the withdrawal of services they depend on.
Sometimes exit controls are an attempt to continue perpetuating cross
subsidies. Experience varied from agency to agency, but never with happy
results.[^37] And exit barriers can unintentionally serve as substantial
entry barriers.[^38]

[Pricing]{.underline}. Price regulation is the most difficult and
frustrating aspect of regulation. In all of our regulated industries,
pricing became so complex that tariff schedules could be understood only
by specialists.[^39] Tariffs often benefited primarily the companies
that filed them.[^40]

The ICC held lengthy proceedings on how to regulate rates without
satisfactory resolution and often held up rates to protect
competitors;[^41] the CAB's attempt to practice "scientific regulation"
led the Board to prescribe exactly the same fare in all markets of equal
length; the FCC's Telpak proceeding dragged on twenty years and helped
AT&T fend off entry in the long distance market.[^42] The FCC's latest
pricing prescription\--TELRIC\-- remains debated by economists and under
challenge in the court system.[^43] Thus, while all of the regulatory
agencies devoted major efforts to establishing pricing rules, it remains
unclear whether we were ever able to accomplish more than a very rough
justice.

Prices that are either too high or too low are not only inefficient but
can have unexpected consequences: Consider the U.S. experience of
overpricing long distance calls to encourage universal service only to
later learn that the practice actually reduced subscribership.[^44] It
does not matter whether the troublesome prices are set directly by the
regulator or filed in accordance with rules specified by the regulator.
I can only conclude that the fewer prices we regulate and the more we
recognize that we are unlikely to prescribe the correct prices, the less
damage we are likely to do.

[The retention of "non-economic' regulation]{.underline}. In general,
regulation of other matters such as safety, sanitation, financial
reporting, antitrust, environmental protection, and consumer protection,
has not fallen into the same disrepute as economic regulation. These
sorts of regulatory activities have generally not been eliminated and
represent useful work for regulatory agencies.

[Productivity]{.underline}. In all of the industries discussed above,
deregulation has resulted in enormous productivity improvements. Reviews
of the results by economists of the transportation industries find
annual benefits of the size mentioned earlier---for example, \$30
billion annually in the railroads. Those who look at logistics in a
broader sense find far larger savings---usually about three times the
savings related only to transportation.[^45]

[Inability to foresee the future]{.underline}. During debates over
airline deregulation, no one predicted the development of hub and spoke
systems. The decline in rail rates was not foreseen. No one imagined
most freight would soon be carried under contracts. No one foresaw the
huge savings from reducing inventory costs or realized that deregulation
would be a necessary precursor. No one visualized the Internet or the
proliferation of personal computers, and other equipment connected to
the telephone network. The ability of markets to respond to evolving
needs faster than regulators is one of their strengths.

[Regulation's inevitable need for additional controls]{.underline}.
Where a firm or industry does not want to do what the regulator wants,
simply controlling one facet of industry behavior will not be sufficient
to accomplish the regulator's goals. The CAB sought to limit the amount
of competition by restricting entry. When this did not result in the
level of profitability the Board thought necessary, the Board specified
fares to prevent price competition. When the airlines then competed by
increasing the level of service and amenities, the Board then began
ruling on such matters as meals and movies and began a proceeding to
specify seat width and legroom.

[Regulatory processes are slow]{.underline}. At least in the United
States, no agency has been able to avoid cases that have dragged on year
after year after year. Consequently, regulation is less appropriate for
a dynamic, rapidly changing, industry than a static one.

[Regulation probably cannot be technologically neutral]{.underline}. The
unfortunate result of attempting to be neutral is that the regulation of
the old technology is often applied to the new technology. As people
began to use the local telephone network to connect personal computers
to Internet service providers (ISPs), telephone companies argued that
such calls were similar to calls using the same local loops to reach
long distance carriers. Because long distance voice calls generated
per-minute payments from long distance carriers, local companies argued
ISPs should pay similar charges. These charges, if applied in an attempt
to achieve equal regulatory treatment for both ISPs and long distance
carriers, would have doubled the costs of Internet service. Equal
regulatory treatment in the name of technological neutrality would have
almost certainly nipped the development of the Internet in the bud.
Thus, while regulated companies often make a persuasive case against
"asymmetric" regulation, I am convinced that it is often only such
loopholes that let new ways of doing business develop.

[Regulation slows new business strategies]{.underline}. Although the
adverse impact on technology is widely understood, regulation also
impedes new ways of doing business. At the CAB, an application by
Federal Express to provide a package delivery service was set aside as
staff resources were devoted instead to dealing with matters affecting
"real airlines." At the ICC, United Parcel Service struggled for years
to acquire the operating authority that would allow it to provide a
nationwide delivery service. The ICC stifled piggyback operations[^46]
by applying both truck regulation and rail regulation. Hushaphone and
Carterphone (applications seeking to connect non-AT&T supplied equipment
to the telephone network) and MCI's initial application to provide
shared private line microwave service between St. Louis and Chicago all
required years and years to struggle through the regulatory process.
Each of these examples was a new way of doing business. None depended on
new technology.

[Dependency on regulation]{.underline}. Each of the regulated industries
became dependent on regulation, often used it to their own purposes, and
often opposed deregulation.[^47] And the regulators begin to depend on
the industries and are sometimes described as being captured by the
industries they regulate.[^48]

[Transition costs can be high]{.underline}. For many regulated firms and
their employees, the move from regulation to deregulation was not a
happy one. Many airlines and trucking firms went bankrupt and were
replaced by more efficient competitors. Many employees of these
regulated firms, who had enjoyed high wages and inefficient employment
practices, often found wages reduced or employment terminated. Only
among local telephone companies and railroads, where existing carriers
had "bottleneck" facilities or "captive" customers, did the incumbent
firms generally do well.

[Regulatory accomplishments]{.underline}. Regulators have been able to
crudely limit monopoly earnings.[^49] Regulators have managed to outlaw
restrictions on resale, thereby allowing arbitrageurs to eliminate some
monopoly rents.[^50] In some cases, a regulator can prevent a firm with
monopoly power from extending that power to other lines of business or
prevent unreasonable restrictions of interconnection. Thus, we have now
outlawed the tying of telephone equipment to service\--although some
would argue that it should not have taken a hundred years to prevent.

[Comparative hearings do not work; auctions do]{.underline}. Comparative
hearings were once used by the CAB to award new airline routes and by
the FCC to award licenses to use the spectrum. Such hearings involve a
comparison of competing applications and decision on which applicant is
best qualified to receive the award. Typically presided over by an
administrative law judge, each applicant presented evidence on why it
was the "best." The proceedings often dragged on for years; the outcomes
of such "beauty contests" were inherently subjective; and the awards
sometimes suspected of political influence.

At the FCC, it was clear the agency would never be able to complete
enough of the proceedings to establish a competitive cellular industry.
We next tried lotteries---which worked but drew so many applicants that
structural engineers had to be called in to make sure the building would
not collapse under the paper. Finally, we moved to auctions. Auctions
work. They not only raised large sums of money, but cellular service
growth accelerated and prices fell dramatically as having multiple
vendors rather than just two in each market increased competition.

[The failure of cross subsidies]{.underline}. Regulators have been
generally unsuccessful in compelling the use of cross subsidies to
accomplish whatever goals are desired by the regulators. Firms that have
managed to acquire earnings from whatever source are naturally reluctant
to fritter those earnings on whatever the regulator might wish. The best
a regulator can expect to accomplish is lousy service churlishly
provided.

[Direct subsidies work]{.underline}. The CAB's efforts to improve the
financial health of the airline industry failed to prevent the
abandonment of some 200 small towns. Direct payments to replacement
carriers have eliminated such abandonment at a relatively small
cost.[^51] The FCC's Lifeline and Link-Up programs, provide direct
assistance to poor households, and have a small but statistically
significant impact on subscribership levels. In contrast, the impacts on
subscribership of the much larger, "high cost support mechanisms" are
unknown.[^52]

[Regulation has not helped service to small towns]{.underline}. In both
trucking and airlines, regulated carriers tended to grow and concentrate
on larger markets, leaving small town service to others. Service to
small towns was often provided by private carriage, small aircraft, or
other operators exempted from regulation. Small communities ceased
losing air service after deregulation (assisted in part by the new
Essential Air Service Program) and service levels improved. After
deregulation, truck service to small towns stayed constant or
improved[^53] and relatively little rail service was lost despite
widespread abandonment by major railroads.[^54]

SUGGESTIONS FOR ANY NEW REGULATORY REGIME:

It may be presumptuous, given our experience with economic regulation,
to make suggestions to others. Thus, my list of suggestions is short.

1\. [Flexibility]{.underline}. Because legislation, at least in the
United States, tends to have a relatively long life, regulators need the
flexibility of abstaining from applying the law where it makes no sense.
In the absence of such flexibility, regulators have to require firms to
do things that they know makes no sense, and are harmful to both the
industry being regulated and their customers. The CAB used its exemption
authority to avoid wasting resources trying to make flight schools and
crop dusters follow the provisions applied to airlines. ICC used their
exemption authority to allow specialized carriers to move fragile
computer equipment. The FCC used its "forbearance" authority to relieve
small carriers of tariff requirements.

2\. [Information]{.underline}. A great deal of information can be
collected by a government regulatory body in a manner that places little
burden on either the industry or the government. There are good reasons
for a government agency to devote resources to doing so: Information has
many of the characteristics of a "public good;" and, at least in the
United States, few other organizations are capable of producing
consistent information over a lengthy period of time.

We live in what has been called the information economy. If this is an
overstatement, it is at least true that information is the oil that
lubricates modern economies. Information allows better investment
decisions, lowers the likelihood of wrong decisions, and thus lowers
barriers to entry. For consumers, better information allows more
informed choices. Information is also a great prophylactic---keeping
corporate management and regulators on their toes.[^55]

3\. [Alternatives to traditional entry and exit regulation]{.underline}.
In addition to their other benefits, contracts can protect against the
consequences of unexpected service termination. Notice requirements can
protect customers from the shock of sudden termination. Insurance
requirements can protect customers from harm or compensate them if it
occurs. Where "bottleneck" facilities exist, the opportunity for
customers to purchase abandoned facilities offers a measure of
protection with little burden on the carrier. In situations where
deposits or advance payments are involved, firms may be required to
place funds in escrow or purchase a bond against default. All of these
approaches move toward achieving legitimate goals of protecting
consumers from unscrupulous firms and sudden service termination without
generally restricting either licensing or exit and without placing great
burdens on carriers.

4\. [Benchmarks]{.underline}. It seems a good idea to always leave some
sectors unregulated to serve as benchmarks. Except for the fact that a
major sector of the trucking industry was deregulated---agricultural
products---we might have never recognized how inefficient and in need of
reform the remainder of the industry was. Similarly, but for the
existence of intrastate airlines in Texas and California, we might never
have gotten around to deregulating the airlines.

5\. [Independence]{.underline}. In the United States, there has
historically been an effort to provide regulators some measure of
independence from political pressures and the industries they
regulate.[^56] It also seems useful to separate regulators from
responsibilities to promote industries they supervise.[^57] The
rationale for this separation is that regulators who are faced with
prospect of being blamed for industry failures do not necessarily
perform well---and may focus on promoting a financially healthy industry
rather than an efficient one.

6\. [Transparency and impartiality]{.underline}. Just as regulators
should be independent of undue political pressure, they should be free
of the suspicion that they can be easily corrupted or unduly influenced
by those they regulate. In the U.S., a two-pronged approach has
generally worked: First, rules of conduct prohibit or severely limit
such things as bribes, gifts, and entertainment. Second, administrative
procedures generally require openness. When undertaking the development
of new rules or regulations, the usual sequence is to announce the
possible rules, seek public comment on those proposed rules, give all
interested parties a chance to provide a second round of reply comments,
announce the final regulations, offer the opportunity for
reconsideration, then, finally, provide an opportunity for review by the
courts.[^58]

7\. [Auctions and direct subsidies]{.underline}. Having proved
themselves superior to their alternatives, at least in the U.S., these
measures are worthy of serious consideration.

\* \* \* \* \*

In closing let me add two final notes of caution. First, I stress again,
the views presented here are merely my own impressions of the themes
running through a broad history across several industries. Second, the
initiators of regulation (Legislators) should keep in mind that they
cannot imagine what regulators will actually do or how individual firms
or even whole industries will react. What the law says is not
necessarily what the regulators do. Recall that the statutory language
on entry, exit, and pricing for airlines, trucks, railroads, and
communications is not just similar---but many provisions are word for
word identical. Each administrative agency developed its own procedures,
practices and interpretations and regulatory environment. All this is
simply to say that agencies, like children, are often not what the
parent imagined.

Gerald W. Brock, *[The Telecommunications Industry: Dynamics of Market
Structure]{.underline}*, Harvard University Press, 1981.

Robert V. Delaney and Rosalyn Wilson, "State of Logistics Report."
Annual. Most recently, June 2, 2003. <http://www.cassinfo.com/bob.html>.

Department of Transportation, Office of Aviation and International
Affairs, *[Study of Air Service to Small Communities:
1978-1995]{.underline}*, May 1996.

Federal Communications Commission, Joint Board Monitoring Reports on
Universal Service, available at
[www.fcc.gov/wcb/iatd/monitor](http://www.fcc.gov/wcb/iatd/monitor).

Robert E. Gallamore, "Regulation and Innovation: Lessons from the
American Railroad Industry," in Gomez-Ibanez, Tye, and Winston, 1999,
pp. 493-529.

Jose A. Gomez-Ibanez, William B. Tye, and Clifford Winston, editors,
*[Essays in Transpiration Economics and Policy]{.underline}*, Brookings,
1999.

Curtis Grimm and Clifford Winston, "Competition in the Deregulated
Railroad Industry: Sources, Effects, and Policy Issues," in Peltzman and
Winston, 2000, pp. 41-72.

Jerry Hausman, Timothy Tardiff and Alexander Belinfante, "The Effects of
the Breakup of AT&T on Telephone Penetration in the United States," in
the [AEA Papers and Proceedings]{.underline}, May 1993, pp 178-184

Alfred E. Kahn, *[The Economics of Regulation: Principles and
Institutions]{.underline}*, MIT Press, 1988 edition.

James C. Miller and George Douglas, *[Economic Regulation of Domestic
Air Transport: Theory and Policy]{.underline}*, 1974.

Steven A. Morrison and Clifford Winston, "The Remaining Role for
Government Policy in the Deregulated Airline Industry," in Peltzman and
Winston, 2000, pp. 1-40.

Steven A. Morrison and Clifford Winston, "Regulatory Reform of U.S.
Intercity Transportation," in Gomez-Ibanez, Tye, and Winston, 1999, pp.
469-492.

Sam Peltzman and Clifford Winston, editors, *[Deregulation of Network
Industries: What's Next?]{.underline}* AEI-Brookings Joint Center for
Regulatory Studies, Washington, D.C., 2000.

Surface Transportation Board, Office of Economic, Environmental
Analysis, and Administration, Rail *[Rates Continue Multi-Year
Decline]{.underline}*, December 2000. Available at
[www.stb.dot.gov](http://www.stb.dot.gov/).

W. Kip Viscusi, John M. Vernon, and Joseph E. Harrington, Jr.
*[Economics of Regulation and Antitrust]{.underline}*, third edition,
MIT Press, 2000.

Leonard W. Weiss and Michael W. Klass, editors, *[Regulatory Reform:
What Actually Happened]{.underline}*, Little, Brown and Company, 1986.

Wesley W. Wilson, \"Market-Specific Effects of Rail Deregulation,"
Journal *[of Industrial Economics]{.underline},* 42 (March 1994): 1-22.

Clifford Winston, Thomas M. Corsi, Curtis M. Grimm, and Carol Evans,
*[The Economic Effects of Surface Freight Deregulation]{.underline}*,
Brookings, 1990.

Bradley S. Wimmer and Gregory L. Rosston, "Winners and Losers from the
Universal Service Subsidy Battle, draft available at
[www.stanford.edu/\~grosston](http://www.stanford.edu/~grosston).

[^1]: This paper is based on a presentation at a Conference on
    "Designing Russia's Telecommunications Regulatory Reforms: Theory
    and International Experience," Sponsored by the Centre for Economic
    and Financial Research, Moscow, 28 June 2003.

[^2]: At the time this paper was presented, I was a Senior Economist in
    the Strategic Analysis and Negotiations Division, International
    Bureau, Federal Communications Commission. Douglas Webbink, Gale
    Cohen, and Mark Uretsky and numerous others have provided helpful
    comments during the preparation of this paper. Nevertheless, the
    analyses and conclusions in the working paper are those of the
    author and do not necessarily reflect the views of other members of
    the International Bureau, other Commission staff, or the Commission
    itself. I can be reached at <Peyton.wynns@yahoo.com>.

[^3]: An alternative view is that the act was encouraged by the
    railroads to reduce the number of price wars either to prevent
    "destructive competition" or to limit cheating on collusive pricing.

[^4]: Numerous critical studies of transportation regulation were
    published by academics including John Meyer, Ann Friedlaender, and
    Richard Caves. Both the Department of Transportation and the
    Department of Justice called for less regulation and began to
    participate in rule-making proceedings held by the regulatory
    agencies. By 1970, the annual report of the President's Council of
    Economic Advisors called for deregulation.

[^5]: These proceedings required such time and effort that regulatory
    attorneys captured a major share of the prospective gains from route
    awards and it was no coincidence that some of the most vociferous
    critics of proposed deregulation were Washington attorneys.
    Ironically, many of these attorneys migrated into the practice of
    telecommunications law following airline deregulation.

[^6]: The Board took pride in the fact that no secured lender had ever
    lost money in the industry.

[^7]: The Board had no statutory authority over scheduling or equipment
    selection and therefore could not control capacity.

[^8]: The Civil Aeronautics Board believed itself to be the "best" of
    the regulatory agencies and prided itself on "scientific
    regulation." What the regulators actually attempted to do was to
    establish a reasonable rate of return for an average airline
    operating with average efficiency. They erred in choosing a rate of
    return that was too high.

[^9]: See DOT, [Air Service To Small Communities]{.underline}, 1978. The
    limitation on aircraft size led to obvious inefficiencies. For
    example, Federal Express, unable to obtain operating permission from
    the CAB, began flying multiple small aircraft "wing tip to wing tip"
    where a single larger aircraft would have been far more efficient.

[^10]: See for example, Miller and Douglas, 1974.

[^11]: Primarily, licensing, which now focuses on operational fitness,
    as well as consumer complaints, international negotiations, and
    statistical reporting.

[^12]: The Essential Air Service Program was established by the Airline
    Deregulation Act as a guarantee that small communities would not be
    harmed by deregulation.

[^13]: By connecting multiple flights at a central point, airlines can
    provide service between a large number of city-pairs with a
    relatively small number of flights.

[^14]: For a recent summary, see Morrison and Winston, 2000.

[^15]: The Act to Regulate Interstate Commerce in 1887 (usually referred
    to as the Interstate Commerce Act) established the Interstate
    Commerce Commission and first brought railroads under federal
    regulation. The Hepburn Act in 1906 and the Transportation Act of
    1920 increased the ICC's authority.

[^16]: The term "captive" usually refers to shippers using rail but not
    having access to a second railroad or to water transportation. In
    such situations railroads are thought most likely to have market
    power.

[^17]: The Rail Passenger Service Act of 1970.

[^18]: The Regional Rail Reorganization Act of 1973 (3R).

[^19]: Railroad Revitalization and Regulatory Reform Act of 1976 (4R).

[^20]: Wilson, 1994, at pp 2-3. Earlier studies had yielded differing
    results about average price changes resulting, in part, from changes
    in the mix of traffic. Viscusi, 2000, provides an excellent recap of
    some of the early studies and differing conclusions at pp 537-543.

[^21]: This estimate was based on waybills: by repricing shipments made
    in 1999 at what they would have cost in 1984. The STB staff
    concluded that revenues moving the same traffic at 1984 rates would
    have cost \$70 billion, compared with actual 1999 revenues of \$38
    billion, a savings of 45%. See, Surface Transportation Board, 2000.

[^22]: The Interstate Commerce Commission Termination Act of 1995.

[^23]: Technically, both trucks and intercity buses are "motor carriers"
    and both were brought under the jurisdiction of the ICC by the Motor
    Carrier Act of 1935. Somewhat different regulations evolved and
    Congress ultimately passed separate legislation terminating the
    regulation of intercity buses, the Bus Regulatory Reform Act of
    1982. Scheduled intercity bus service, however, was a small and
    declining industry that has been little studied. I follow the common
    practice of simply ignoring it.

[^24]: The Reed-Bullwinkle Act actually applied to railroads as well but
    collective rate setting seemed far more important in the trucking
    industry. The rate cartels were called "rate bureaus."

[^25]: Delaney puts 2002 business expenditures on intercity trucking at
    \$300 billion; local trucking at \$162 billion; railroads \$37
    billion; water \$37 billion; oil pipelines \$9 billion; air freight
    and forwarders at \$38 billion; totaling transportation expenditures
    of \$573 billion. For reference total GDP is estimated to be about
    \$10.5 trillion. See Delaney, 2003. As rail, barges, and pipelines
    specialize in bulk commodities, ton mileage figures are very
    different. The railroads carry about 40% of the nation's intercity
    ton-miles; trucks 28%; barges 14%; pipelines 18%; and air carriers
    less than 1/2%. The ton-mile data are from the Association of
    American Railroads for 1996 as cited in Viscusi, 2000, at p 531.

[^26]: The largest firm, UPS, has about 10% of intercity revenues. No
    other firm has even 1%.

[^27]: Usually regarded by economists as capitalized economic rents.

[^28]: In the 1970's unionized workers in the trucking industry were
    paid a premium of perhaps 50% over wages of comparable workers in
    manufacturing industries.

[^29]: Raw manure versus dried manure was a favorite example.

[^30]: Transport prices dropped, for example, when frozen chicken was
    reclassified as an exempt commodity rather than a regulated item.

[^31]: For example, comparisons showing higher rates in heavily
    regulated countries such as West Germany than in less regulated
    countries such as Belgium and the Netherlands.

[^32]: The Household Goods Transportation Act of 1980 and the Motor
    Carrier Act of 1980.

[^33]: Winston, et al., 1990 p 28.

[^34]: The first significant court decision beginning to crack open the
    equipment market --the "Hushaphone" case---was handed down in 1956
    but significant restrictions and limitations on connecting customer
    owned equipment to the telephone network were not eliminated until
    the early 1980's.

[^35]: AT&T complained bitterly about "asymmetric" regulation but was
    regarded as a dominant carrier domestically until 1995 and
    internationally a year later.

[^36]: It would be hard to find economists who think that predatory
    pricing is a reasonable worry.

[^37]: For railroads exit was historically difficult. Attempts to
    abandon lines resulted in administrative proceedings where shippers
    described their potential hardships compared with the minor
    improvement to a railroad's health that might be achieved from the
    abandonment of their particular line. In trucking, exit was
    generally easy---as truckers simply reduced service levels and
    ultimately disappeared. For airlines, the Board usually found it was
    better to allow an airline to abandon service to a city simply to
    get the complaining over with (complaints both from the airline
    about its losses and from the city about lousy service). In
    telecommunications, exit has not yet been a major issue as firms
    without market power have been allowed to exit and firms with market
    power have not sought to exit.

[^38]: Firms will be reluctant to enter markets, or experiment with new
    services, if failure may result in an ongoing string of losses.

[^39]: In the freight transportation industries, "rate sharks" appeared.
    For carriers, rate sharks scrutinized invoices to identify errors so
    that customers could be re-billed at higher rates. For customers,
    they examined bills\--sometime the very same set of invoices\--so
    that refunds for overcharges could be demanded.

[^40]: Thus, when the FCC told smaller long distance carriers that they
    no longer had to file tariffs, they kept right on filing. When the
    Commission told carriers not to file tariffs, they went to court
    arguing that that the Commission's action was illegal and that they
    should keep filing tariffs.

[^41]: For an extensive discussion of ICC's rate regulation, see Alfred
    E. Kahn's classic [Economics of Regulation]{.underline}, especially
    chapter 6 in volume I.

[^42]: See Gerald W. Brock, 1981, pp. 198-210. Antitrust and court
    challenges to AT&T's continued monopolization of the long distance
    market were delayed while the matter was being considered and
    reconsidered at length by the FCC.

[^43]: TELRIC is shorthand for "Total Element Long Run Incremental
    Costs."

[^44]: It turned out that many of those without telephone service had
    been disconnected for non-payment of long distance bills. As long
    distance rates fell, poor families no longer found themselves so
    likely to incur large bills and lose telephone service. Rate
    rebalancing, which involved raising monthly local charges and
    slashing long distance prices, actually raised subscribership among
    poor households. See Hausman and others, 1993.

[^45]: Delaney has argued that, in the 1970's, business transportation
    was of poor quality and increasingly unreliable. The only real
    growth was in private trucking operated by manufacturing and
    distributing firms to haul their own products. Only after
    deregulation was it possible to merge materials management and
    physical distribution into integrated systems such as the
    "just-in-time" and other fast cycle manufacturing procedures that
    have spread widely throughout the American economy. Both
    transportation costs and other logistics costs were rising until
    1980 when logistics totaled about 16% of GDP. These were split about
    equally between transportation and other inventory expenses
    (primarily obsolescence, warehousing, interest, and insurance). By
    2002, measured in such terms, inventory costs had fallen by
    two-thirds and transportation costs by a quarter. Total logistics
    costs had fallen from 16% of GDP to 9%. Given a GDP exceeding \$10
    trillion, the logistics savings total several hundred billions of
    dollars annually. See, the annual reports by Delaney. Annual [State
    of Logistics Report]{.underline},
    <http://www.cassinfo.com/bob.html>[.]{.underline}

[^46]: Piggyback operations refer to goods in containers pulled part way
    by trucks and carried part way on rail flatcars.

[^47]: Both truck firms and labor opposed trucking deregulation. The
    airlines generally opposed deregulation and the largest, United,
    endorsed deregulation only after the CAB had opened entry and
    permitted price competition. AT&T supported regulation until
    competitors entered the industry, then changed its stance. The
    railroads endorsed deregulation only after their economic condition
    became critical. Some have suggested that the railroads changed
    their stance only after they came to believe that the ICC was
    favoring trucks, barge operators, and shippers at their expense.

[^48]: There are actually several different views and a considerable
    literature on whether agencies are captured by the industries or
    whether individuals within the regulatory agencies use the regulated
    industries for their own gain. But in one form or another, the
    criticism lingers on. For example, Congressman John Dingell, the
    Senior Democrat on the Commerce Committee in the US House of
    Representatives, reportedly described the FCC as being "so enamored
    with some of the industries it is assigned to regulate that it has
    become unable to act as the aggressive consumer advocate that is so
    needed at this time." As quoted in [Communications
    Daily]{.underline}, Tuesday, June 13, 2003.

[^49]: Historically, this was most commonly done through regulating a
    firm's "rate of return" which, in turn, has a variety of other
    problems. Recently, at least in telecommunications, we have
    attempted to apply "price caps" as an alternative.

[^50]: An opportunity to buy and resell offers arbitrageurs the
    opportunity to prevent a monopolist from fully exploiting its power.

[^51]: The Essential Air Service Program has been criticized for high
    costs per passenger, but the subsidies are transparent, and at about
    \$100 million per year, are very small in relation to any possible
    system wide subsidy.

[^52]: The "high cost" programs provide funds to small local telephone
    companies with higher than average costs. Economists might suspect
    that any program designed to assist monopolists on a "cost plus"
    basis will not be enormously effective. The programs are a legacy of
    AT&T's practice of sharing revenues from overpriced toll services
    with the rest of the industry. Expenditures on high cost programs
    now total \$3 Billion annually. For program costs, see FCC, Joint
    Board Monitoring Reports, section 1. The high cost programs have
    been criticized by economists (for example, Wimmer and Rosston) but
    remain enormously popular with representatives of rural states.

[^53]: Winston et all 1990 p. 40.

[^54]: Ibid. Short line railroads picked up some of the lines and in
    some cases government subsidies assisted.

[^55]: It is no accident that the airlines were far more studied and
    better understood than the other transportation industries. The CAB
    did a magnificent job of collecting information from carriers, and
    making that available to the public. In contrast, the ICC devoted
    less attention to similar information on surface transportation and
    the industries were less well understood. AT&T carefully guarded and
    controlled similar information so long as it monopolized the
    telephone industry. I believe telecommunications deregulation would
    have occurred far sooner had we more fully understood the cost of
    the old regulatory regime.

[^56]: At the federal level, this was traditionally done by legislative
    requirements specifying that the members appointed to a regulatory
    board not all be chosen from a single party; that appointments be
    made for fixed terms; and that appointees could be dismissed only
    for bad conduct and not for regulatory decisions; requiring that
    appointments expire on different dates so that not all members of a
    regulatory body would come up for reappointment when a new political
    party took power; and placing the agency outside the executive
    branch.

[^57]: Thus, the building of airports and task of promoting aviation was
    placed in the Federal Aviation Administration rather than the CAB.
    Similarly, the task of subsidizing rural telephone companies was
    traditionally left to the Department of Agriculture. The universal
    services provisions of the 1996 Telecommunications Act are a
    departure from this tradition.

[^58]: An unfortunate byproduct of these administrative procedures to
    guard against corrupting influences is, of course, that is causes
    the regulatory process to work very slowly.