Federal Communications Commission 

 International Bureau 

 445 12th Street, SW 

 Washington, DC 20554

International Bureau 

 Working Paper Series 

2 The Limits of Economic 

Regulation: The U.S. Experience

June 2004

Peyton L. Wynns 
1

 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/. 
2

The Limits of Economic Regulation: 

The U.S. Experience1

Peyton L. Wynns2

Federal Communications Commission 

International Bureau 

Washington, DC 20554 

June 2004 

IB Working Paper No. 2 

 

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

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 

 

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. 
4

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 

 

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. 
5

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

 

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, 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.

10See 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. 
6

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 regulated15 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. 

 

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. 

14For 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. 
7

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 

 

17The Rail Passenger Service Act of 1970. 

18 The Regional Rail Reorganization Act of 1973 (3R). 

19Railroad Revitalization and Regulatory Reform Act of 1976 (4R). 20Wilson, 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. 
8

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 

 

21This 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. 

23Technically, 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. 
9

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 

 

26The largest firm, UPS, has about 10% of intercity revenues. No other firm has even 

1%.

27Usually regarded by economists as capitalized economic rents. 

28In the 1970’s unionized workers in the trucking industry were paid a premium of 

perhaps 50% over wages of comparable workers in manufacturing industries. 

29Raw manure versus dried manure was a favorite example. 

30Transport prices dropped, for example, when frozen chicken was reclassified as an 

exempt commodity rather than a regulated item. 

31For example, comparisons showing higher rates in heavily regulated countries such as 

West Germany than in less regulated countries such as Belgium and the Netherlands. 
10

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 20th century. 

During the last quarter of the 20th 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 

 

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.
11

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. 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 
12

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.

Entry. 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. 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. 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 

 

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. 

39In 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. 
13

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. 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. 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

 

41 For an extensive discussion of ICC’s rate regulation, see Alfred E. Kahn’s classic 

Economics of Regulation, 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.”

44It 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 
14

Inability to foresee the future. 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. 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. 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. 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 

 

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, 

http://www.cassinfo.com/bob.html.
15

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. 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 

operations46 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. 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. 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. 

 

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, Tuesday, June 13, 2003. 
16

Regulatory accomplishments. 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. 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. 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. 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 

 

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. 
17

impacts on subscribership of the much larger, “high cost support mechanisms” are 

unknown.52

 

Regulation has not helped service to small towns. 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 

improved53 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. 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. 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. 

 

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.
18

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. 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. 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. 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 

 

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 
19

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. 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. 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. 

 

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. 
20

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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, May 1996. 

Federal Communications Commission, Joint Board Monitoring Reports on Universal 

Service, available at www.fcc.gov/wcb/iatd/monitor. 

Robert E. Gallamore, “Regulation and Innovation: Lessons from the American Railroad 

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Jose A. Gomez-Ibanez, William B. Tye, and Clifford Winston, editors, Essays in 

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Steven A. Morrison and Clifford Winston, “The Remaining Role for Government Policy 

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www.stb.dot.gov.
21

 

W. Kip Viscusi, John M. Vernon, and Joseph E. Harrington, Jr. Economics of Regulation 

and Antitrust, third edition, MIT Press, 2000. 

 

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Service Subsidy Battle, draft available at www.stanford.edu/~grosston.