large business customers have constructed to serve their own facilities, compete with both access and toll service. $ ^{23} $

Three other competitive threats face traditional LEC's. First, cellular service, which initially was thought of as exploiting only the market for mobile telephone service, is increasingly showing the potential to provide direct competition with wireline local service. Second, the FCC's auction of PCS service, which is simply a cellular service using smaller cell sites, is a source of direct competition with wireline service. Finally, cable television networks, which currently pass 95 percent of American homes and are subscribed to by 60 percent of U.S. households, appear poised to enter the telephone market. The successful entry by cable television into this market in the U.K., the announcement by the Time Warner Cable Company of their intention to provide telephone service in the city of Rochester, New York, and the low cost at which entry apparently can take place, indicate that this is a highly credible threat.

These various sources of both existing and prospective competition pose an interesting challenge for telecommunications regulation, particularly at the state level. How should regulators manage the transition from a pervasively regulated to a more competitive telecommunications market? This challenge would be daunting enough if there were widespread consensus that the entire market was becoming competitive. Even in that case, the regulator would have to establish an appropriate pace and conditions for deregulation. Moreover, if there are to be competitive local exchange providers, continuing regulation will be necessary to assure effective and efficient interchange among these providers.

The situation is still more complicated because of the expectation that access and local exchange competition will proceed at different paces in various subsets of the telecommunications market. Competition is likely to come much more quickly in areas of high than in areas of low population density. Moreover, as already illustrated in existing toll markets, competition is likely to be far more aggressive for high than for low volume users of telephone service. The challenge to regulators is to devise a regulatory approach which permits competition to emerge where it is cost effective while continuing to provide price protection for consumers whose access is still limited to a single telecommunications carrier.

An additional challenge for regulators is to avoid what might be termed the “balkanization” of telecommunications markets. Currently, the only pervasively regulated telecommunications carriers are the LEC's, who in turn are subject to competition from less regulated carriers in portions of virtually all of their markets. If regulation of these carriers remains restrictive, they may lose the flexibility to compete effectively in those portions of their markets which are becoming competitive, and they may be reduced to being the carrier of last resort in markets which are untouched by competition. Such a development would, in all likelihood, produce a market of telecommunications haves and have-nots -- regulated but still expensive and