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·- .; -·./ 
THE FCC, THE OCCs AND THE EXPLOITATION OF AFFECTION :J 

by 

John Haring ~ 

:J The views expressed are those of the author and should not be construed to 

reflect those of the Federal Communications commission or any other me1nber of 

its staff. 

~ Office of Plans and Policy, Federal Communications Commission, 

Washington, D.C. 20554. 

Protectionists are not 

fall into their laps. 

persistent expenditure 

favor their cause, and 

effective competition. 

prone to wait passively for overrestrictive rules to 

Rather, a central element in their strategy is 

of money and effort to change the rules in ways that 

resistance to any attempt to reduce impediments to 

William Baumel and 

Janusz ordover 

LIST OF REFERENCES 

Baumol, William and Janusz ordover, •use of Antitrust to subvert Competition,• 

Journal of Law and Economics (May 1985). 

Bork, Robert, The Anti trust Paradox ( 1978 l. 

Booz, Allen and Hamilton, Inc., "Prospects for Major Facilities-Baaed Other 

common carriers,• March 18, 1985. 

, "Testimony of M. SChwartz,• in U.S. v. AT&T, Defendant's 

----T-.h-i:-r-d=-s-ta_t_e_m_e-nt, of Contentions and Proof (March 1 0, 1980) • 

Brozen, Yale, "Antitrust Out of Hand," The Conference Board Record (1974). 

Business week (various numbers). 

Elzinga, Kenneth and William Breit, The Antitrust Penalties: A Study in Law 

- and Economics ( 1976) • 

Fortune Magazine, "The Coming Glut of Phone Lines," January 7, 1985. 

McKenzie, Richard and Gordon Tullock, The New WOrld of Economics (1975). 

Phillips, Almarin, "The Impossibility of Competition in Telecommunications: 

Public policy Gone Awry, • in Regulatory Reform and Public Utilities, 

Michael Crew ( ed.) ( 1982). 

Posner, Richard, Illinois Bell Telephone Company et. al. v. FCC, Nos. 84-1145, 

84-1382, 84-1475, slip opinion at 13 (7th Circuit, June 29, 1984). 

Schmidt, wilson, "Charitable EXploitation," Public Choice (Spring 1969). 

Wheat First Securities, "The Long Distance Telephone Business," 

February 20, 1985. 

Wieland, Bernhard, "Problems of Gradual Deregulation - What Can EUropean 

Authorities Learn from u.s. Telecommunications Policy? Deutsche 

Bundespost Diskussionsbeitrage zur Telekommunikationsforschung Nr. 9 

(August 1984). 

wolf, Charles, "A Theory of Nonmarket Failure: Framework for Implementation 

Analysis, Journal of Law and Economics (1976). 

Wolfe, Tom, "Mau-Mauing the Flak Catchers," in Radical Chic and Mau-Mauing the 

Flak Catchers (1970). 

I. Introduction 

The idea that protecting competitors protects consumers and competition 

is one that few disinterested members of the antitrust bar and even fewer 

economists would support. Competition is, in fact, highly antithetical to the 

interests of competitors in that it dissipates profits. Indeed, that is 

largely the point of competition. Claims by competitors that government 

action is necessary ''to promote competition" should thus be viewed with great 

skepticism and treated in the same manner as claims by competitors that a 

rival is pricing monopolistically • .)_/ Arguments for such action often simply 

amount to unsupported (and unsupportable) assertions that some form of 

cartelization is necessary to promote competition. 1f The way to promote 

.)_/ As Morris Adelman argued many years ago (see Yale Brazen, 1974), since 

truly monopolistic pricing benefits rival firms by providing profitable 

opportunities for expansion of output, allegations of monopoly pricing 

behavior by a firm's rivals should, in general, be taken as evidence that the 

accused is actually behaving competitively rather than monopolistically, That 

argument is particularly compelling when competitors' complaints stem from 

price cuts rather than price increases, competitors have a natural interest 

in tying the hands of those who compete for consumers' favors, On the same 

reasoning, government actions that competitors claim are required to promote 

competition are liable to be anticompetitive, particularly when their avowed 

purpose is to increase the profits of particular firms by distorting pricing 

and ~vestment decisions in an economically inefficient manner. 

2/ In general, cartelization refers to any activity designed to divide trade 

~ong rival sellers on a basis other than competition and voluntary 

exchange, Thus, for example, regulatory allocation of customers among 

competitors would clearly represent a cartelizing activity by the government 

and the antithesis of true competition. Regulatory pricing policies 

protecting competitors from price competition have the same cartelizing effect 

as direct allocation of customers by the government, such policies are 

predatory in effect, foreclosing markets to firms that regulation prevents 

from competing by price, As Circuit Judge Robert Bork (1978, p, 348) notes in 

his treatise on antitrust, crippling competition through the abuse of 

gover~nental processes "is a useful tactic against any size firm, regardless 

of relative reserves, for it may be worth the price of litigation to purchase 

delay ••• In such cases, successful predation does not require that the predator 

be able to impose larger costs on the victim, that the predator have greater 

reserves than the victim, or that the predator have better access to capital 

than the victim. No other technique of predation is able to escape all of 

these requirements, and that fact indicates both the danger and the 

probability of predation by misuse of governmental processes." 
-2-

competition is to allow competition, The idea that competition must be 

destroyed to save it is problematical to say the least.]_! 

Recently, GTE Corporation released a summary of a report it paid the 

Booz, Allen and Hamil ton consulting firm to prepare • .1J The report summary 

presents a forecast of how certain carriers will fare financially during the 

period 1985-1989. While Booz Allen draws no policy conclusions on the basis 

of its forecast, GTE concludes on the basis of the report's projections that 

"the prospects for effective competition in the long distance market are in 

severe jeopardy.• 2J Interestingly, the Booz Allen personnel who wrote the 

report specifically disavowed that conclusion under questioning by OPP 

staff. Their position was that their report was incapable of resolving 

questions about the prospects for effective competition. !if 

]_/ Competition is a process of discovery and adaptation, not a particular 

distribution of market shares, Any configuration of market shares may be 

consistent with effective. competition or noncompetitive performance. Where 

competitive processes are permitted to-c)perate, market shares are determined 

by competition. Where regulation is in effect, it determines market shares. 

Whether competition is "effective" depends primarily on the degree of resource 

mobility in the economy, It has little to do with the distribution of market 

shares prevailing at any point in time, particularly when shares are 

determined by regulation rather than competition. 

4/ "Prospects for Major Facilities-Based Other Common Carriers," March 18, 

1985. 

2J Statement of Edward c. Schmults, GTE senior vice President and General 

Counsel quoted in Telecommunications Reports, Volume Fifty-One, No. 12, 

March 25, 1985, p. 1, 

2J we note, however, that if the report meant what GTE says it means, that 

would be fully consistent with testimony the Booz Allen firm offered on AT&T'S 

behalf in us v. AT&T, In that case Booz Allen's position was that divestiture 

would impqse huge economic penalties and that telecommunications services 

would be far more efficiently provided by a single firm. See testimony of 

M, Schwartz, U.S. v. AT&T, Defendant's Third Statement of Contentions and 

Proof (March 10, 1980), If single-firm organization is more efficient, 

single-firm organization is clearly the result one would expect an effective 

competitive process to produce. Indeed, one measure of effective competition 

in that circumstance would be whether the competitive process resulted in 

survival of a single firm. It would certainly then be no surprise if, given 

natural monopoly elements, rival ventures were to prove unprofitable. 
-3-

The objectives of this paper are twofold: The first objective is to 

provide a brief critical commentary on the BOoz Allen report focusing mainly 

on its conceptual shortcomings, Since the actual report has not been released 

by GTE, we are unable to replicate and thereby verify BOoz Allen's analysis, 

That is, however, not as serious a matter as it would normally be given the 

report's essential economic irrelevance, consider that it is of little import 

whether a particular set of numbers is summed correctly if it is the wrong set 

of numbers and the required operation is not summation. 2J 

The second and more important objective of this paper is to provide an 

economic framework within which to analyze GTE's (and others') attempts to 

exploit the government's affection for competition, To this end, we first 

characterize "economically optimal" government intervention in the marketplace 

and then describe a number of circumstances under which nonoptimal 

intervention is likely to occur. An important potential source of 

governmental failure rests in the fallacious notion that deregulation can be 

permitted by regulators only when markets become, somehow measured, 

competitive, ~ That notion is fallacious because it characterizes 

competition as a static goal rather than a dynamic process, Competition is a 

means, not an end. Failure to draw and act on this important distinction 

2J on the other hand, if one were inclined to base policy on the report (as 

we are not), it would surely be foolhardy to do so without actually seeing it. 

8/ This is, of course, the position taken by most of the occs. Firms whose 

profitability can be enhanced by regulation are naturally loathe to see the 

source of their profit opportunities disappear, Indeed, they can be expected 

to proselytise for maintenance and expansion of inefficient regulatory 

policies that provide profit opportunities for unregulated firms. According 

to William Baumol and Janusz Ordover (1985, p. 258), "There is no doubt that 

potential and actual entrants (such as MCI) have a strong incentive to 

rigidify the price responses open to an incumbent who is confronted with newly 

emerging competition. It seems clear that the staunchest ad110cates of fullcost pricing have been firms anxious to hobble their disquietingly effective 

rivals." 
-4-

means that policymakers run the risk of creating a wholly artificial industry 

structure based on inefficient pricing and entry, ~ 

II. Booz Allen Analysis 

Booz Allen's financial forecasts are based on Booz Allen's judgments 

about what future demand for a particular subset of carriers will be. Given 

these assumptions about future demand, Booz Allen estimates the capital 

investment required to meet projected demand and then calculates rates of 

return on an annual basis for the next four years, assuming capital equipment 

is utilized at rates implied by the demand assumptions, lQ/ This exercise 

leads to the conclusion that certain OCCs will lose money over this period, 

Booz Allen claims to have based its analysis on assumptions that 

overstate likely profitability, Principal among these "conservative" 

assumptions is that the occs will capture all growth in the market over the 

time period covered by the study, How "conservative" this assumption is 

depends on the frame of reference. Assuming these carriers capture all growth 

in the market is equivalent to assuming that AT&T's quantities sold remain 

constant. Assuming no growth by AT&T is more conservative than assuming 

positive growth, On the other han:i, AT&T's historical quantities are by no 

means sacrosanct under competition. MCI claims it is the low cost supplier 

(others make the same claim for themselves), If that is so, what prevents it 

~ For " European view that that is precisely what is happening in the United. 

States, see Bernhard Wieland, "Problems of Gradual Deregulation - What can 

European Authorities Learn from u.s. Telecommunications Policy?" Deutsche 

Bundespost Diskussionsbeitrage zur Telekommunikationsforschung Nr. 9/August 

. 1984. 

lQ/ Booz Allen's techniques for estimating capital requirements are described 

in the vaguest terms in the report summary released by GTE. Their validity 

thus remains an open question. Note that a firm can substitute leased 

capacity for capital investment anci reduce its so-called "requirements." 
-5-

(the~) from taking more business away from AT&T? "No growth" is clearly not 

as conservative as "negative growth". 

Furthermore, the assumption that the occs capture all growth in the 

market is not necessarily a conservative assumption if the rate of growth of 

the market is itself understated, as it would appear to have been by Booz 

Allen, The future is unknowable in advance, but Booz Allen's demand growth 

assumption is less than the 10 percent that has usually been assumed for 

purposes of forecasting in this industry • ..!..!J Booz Allen casts projected OCC 

growth in terms of a compound annual growth rate (35 percent) that makes it 

sound as if the occs are growing by leaps and bounds (which, as a group, they 

apparently are), but that actually disguises an annual growth rate assumption 

significantly below that made by most analysts. Since projected demand 

affects both revenues and costs, .!.£/ Booz Allen's profitability forecasts 

would presumably look a little different and less favorable to the position 

GTE wants to espouse if a higher market growth rate were assumed. The same 

thing would be true if one of the OCCs dropped out of the market. An analysis 

of the sensitivity of Booz Allen's results to such an occurrence is 

conspicuous by its absence in the report summary. 

on the cost side Booz Allen (1985, p. IV-3) claims that if the occa 

achieved the rate of growth Booz Allen hypothesizes, they could be effective 

competitors with competitive unit costs by 1989. But this analysis assWDes 

that capital is a free good to the occs, that is, that its economic cost is 

zero. That it is legitimate to ignore the cost of capital in a relatively 

capital-intensive industry like the long-distance business is highly 

questionable. what Booz Allen has actually shown is just the opposite of what 

~/ Higher growth rates have also been forecast. For example, Business week 

(1/9/84) projects demand growth on the order of 14 percent per year. 

~ Per-unit costs are assumed to decline with increases in output. 
-6-

it claims-~the aces would clearly~ be competitive in 1989 if they were 

required to cover.capital costs in that year (which they are not). 

Under Booz Allen's assumptions, AT&T and the aces will have comparable 

costs in 1989, but AT&T will cover its costs, including costs of capital, 

while the aces will not. If a firm cannot cover its costs over the long run, 

it is not competitive, by definition. That the (n)th firm has costs 

comparable to the (n-l)th firm is of quite limited significance if the market 

is not big enough to support n firms. Moreover, Booz Allen's analysis 

actually suggests that AT&T's costs will, in fact, be lower than the aces• 

costs four years hence because economies of size are postulated. If the OCCs 

grow more slowly than projected, which Booz Allen suggests is likely (indeed, 

that is the basis for their claim of conservatism), AT&T's costs will be lower 

than Booz Allen projects and the aces' cost~ will be higher. 

Clearly, if all firms have the same access to productive technology and 

divide the market equally, all will have the same costs. But who cares? The 

purpose of regulation or competition is not to equalize costs, but to minimize 

them and thereby maximize consumer welfare. Regulatory policies that 

uneconomi£ally restrict the ability of individual firms to achieve cost 

savings will cause costs and prices to be higher than they need be and the 

market to be smaller than it could be. 

Since Booz Allen's forecasts deal only with the next four years, they 

really provide no information about the economic profitability of investments 

in the long-distance business. such investments are long lived and, as Booz 

Allen concedes, correct evaluation of them requires a calculation of the 

present value of the net revenues expected to be generated over the life of 

the assets. Booz Allen's results are thus perfectly consistent with continued 
-7-

investment in the business, since negative returns during the early years of an 

asset's life may be more than offset by positive returns in later years. W 

It is quite common for new entrants to incur losses initially, the 

losses in essence being used to purchase increased market share. W In BOOZ 

Allen's analysis, the OCCs end up with more than 40 percent of the market by 

1989. That gain in share may be well worth incurring losses even for a period 

of several years. on the other hand, it may not if long-term losses are also 

expected, but that simply says that such investments are uneconomic. It 

provides no basis for arguing that government should intervene to make such 

"'investments profitable. Indeed, it is likely that current government policies 

are the cause of declining profits. More of the same, as espoused by GTE, 

will simply make matters worse and even more difficult to remedy in the long 

run. 

While sensitive to the assumptions that underlie it, aooz Allen's 

conclusion about short-term profitability is in itself relatively 

uncontroversial. when increases in supply outstrip increases in demand by a 

wide margin, the natural economic consequence is a declining price. If the 

price ~eclines are steep enough, all carriers could end up losing money, at 

2.lf In this regard, it is significant that BOoz Allen never makes the claim 

that given present government policies GTE's profit maximizing alternative is 

to abandon its network. 

14/ In the computer industry, for example, Burroughs suffered losses for many 

years before becoming a profitable enterprise. In many "high tech" 

industries, huge investments are now being undertaken with no.prospects for 

any short-term payoffs. Consider gene splicing. 
-8-

least in -the short run, J2l Contrary to GTE's allegation that investment 

incentives are inadequate, current regulatory policies stimulate overentry, 

and the resultant excessive investment is one cause of low profits • .!!f 

A recent Wheat First securities Research Report 121 notes that the 

long-distance telephone business is already characterized by excess capacity, 

and that within the next four-to-five years the total capacity of the country 

could increase sixfold. During the same time frame, demand is forecast to 

increase at a rate of 10 percent per year, These forecasts together imply 

strong dewnward pressure on prices. The Yankee Group, a Boston research and 

consulting firm that follows the telecommunications industry, predicts a huge 

J2l Altecnatively, some firms may earn positive economic profits, but the 

industry's average profitability will be subnormal, Note that the assets of 

failing firms may be acquired and profitably operated by others. A failing 

competitor does not imply that competition is failing, To the contrary, it 

suggests that competition is working, These considerations are particularly 

relevant in considering the plight of GTE, which paid twice book value for 

Sprint, That the government should bail out incompetent management is, of 

course, highly questionable, particularly given the existence of substitute 

managemsnt capable of operating sunk capital at a profit. 

1§/ For example, in the lead article in the current issue of the Journal of 

Law and Economics ("Use of Antitrust to Subvert competition"), William Baumol 

and Janusz Ordover point out the inefficiencies that result from the use of 

fully allocated costs as constraints on the price responses of regulated 

firms, They (1985, p. 258) note that "insistence that such costs are the 

appropriate price floors invites socially inefficient entry that is elicited 

not by genuine cost advantages and productive efficiencies but by false 

profitability signals. • According to Baumol and ordover ( 1985, p. 255), "the 

evidence strongly supports the thesis that it [fully allocated cost]~ 

standard put forward almost exclusively by firms that were unlikely to compete 

successfUlly on the merits of their performance alone. They advocate their 

cost1ng approach as a device to limit the price-cutting opportunities of 

rivals rendered more efficient by economies of scale and scope, by superior 

management, or by other legitimate sources of superiority. This is surely 

attested to by the frequency of cases in which full distribution has been used 

to argue that some prices are unacceptably low, when the pricing behavior that 

should most be feared by guardians of the public interest in the presence of 

market power is overcharging, not underpricing." (emphasis added) 

121 "The Long Distance Telephone Business," February 20, 1985. 
• 

-9-

glut o-f long-distance capacity in the years ahead. ~ A recent Fortune 

magazine article, entitled "The Coming Glut of Phone Lines,• l2J predicts that 

the u.s. long-distance network will soon sextuple in size. In that same 

article, ex-chief executive of GTE Sprint, Dale Pilz, flatly contradicts his 

former employer's claims about inadequate investment incentives and the 

prospects for effective competition. He is quoted as saying that: 

If all the recently announced building programs are carried 

out, first thing you know we'll have· enough capacity to last 

this country forever. 

The article goes on to explain that Pilz does not believe that all the systeas 

will be built because competition will keep supply from outdistancing d-and. 20/ 

But that assumes that competition is permitted to operate. Continuation of 

traditional fully distributed cost tariffing policies would hinder and 

discourage price competition. Other FCC policies subsidize entry in various 

ways. 

III. Implications for Policy 

According to GTE, effective competition is in jeopardy because 

competitors (in particular, GTE) are allegedly not earning sufficient returns 

~ see Fortune (1/7/85). 

~/ In this regard, note the "nonfulfilling" nature of sooz Allen's so-called 

"forecasts." If profitability is so low as to render investment uneconomic, 

as GTE claims, actual profitability will, in the event, turn out to be greater 

precisely because less investment will have been undertaken. Booz Allen can 

only be right if investors ignore what GTE claims is BOoz Allen's message. 
-10-

to make additional investments in the business worthwhile. 111 Therefore, GTE 

advocates that the government take additional steps to increase profitability 

and thereby stimulate additional entry and so make the industry 

"competitive." The government, of course, cannot "make" the long-distance 

business competitive. whether competitive market forces can be relied upon to 

allocate resources efficiently in this market depends primarily on basic 

economic conditions of supply and demand, which the government can do little 

to alter. 

Government cartelization will not make the industry competitive--it 

will make the industry a cartel. In this regard, note that since the policies 

GTE espouses stop short of a bar on entry· (the sine qua non for effective 

cartelization and higher profits), they will not be successful even considered 

on their own terms. They will not increase profits. They will increase 

investment and further dissipate profits. If the profits of particular 

competitors are a concern of regulation, then nothing short of a bar on entry 

will help. An entry bar poses the issue of competition versus cartelization 

in stark relief. It is hard to claim you are promoting competition when you 

are so obviously destroying it. The only difference between the policies GTE 

espouses and a bar on entry is that the latter would be effective. Neither is 

consistent with competition. 

The real danger in the long-distance business is not inadequate 

investment, but excessive investment caused by inefficient government 

regulation. The solution is simple: get rid of the inefficient regulation 

which is causing excessive investment and let competition establish the 

efficient industry structure (i.e., the structure that minimizes 

111 MCI disputes this allegation. In a recently concluded damages trial, MCI 

sought to show that but for certain antitrust violations, it would be earning 

substantial profits. 
_,,_ 

costs/maximizes output). If an efficient industry structure is characterized 

by a small number of competitors, society might choose not to bestow on thoae 

competitors discretionary power to raise prices, W The point is to bave 

that decision based on accurate information about an efficient industry 

structure, not on the basis of an artificial industry structure that is the 

result of a regulatory rather than a competitive process. 

Professor Almarin Phillips (1982, p. 23) has observed that: 

Through regulation of one kind or another--legislation, 

injunctions, consent decrees, or regulatory edicts--the 

pricing and services of AT&T, the BOCs, and other 

non-Bell participants in the switched network can be 

arranged so that all are viable. That is, regulations 

can be formulated to preserve and protect an inefficient 

structure with many firms. Competition, nonetheless, is 

just the opposite of this. 

IV. What The Booz Allen Report Is Really About 

As the Booz Allen authors themselves concede, their analysis has ~ 

implications for evaluating competition in the long-distance business, What 

the Booz Allen report really involves is an attempt to exploit the u.s. 

goveihment's (and the citizens' it represents) affection for competition, 

To understand the nature of this antieampetitive, consumer-welfarereducing behavior, consider that government· intervention to provide 

competitive infrastructure in a post-divestiture environment is not a costless 

~/ Imperfections of regulation make it unclear whether consumers would be 

better off with imperfect competition or imperfect regulation. Many 

economists argue that consumers would be better off without explicit 

regulation of even the most highly concentrated industries. In general, the 

case for deregulation does not rest so much on the perfection of competition 

as on the huge costs of regulation. 
-12-

activity. 1lJ If the benefits sacrificed (i.e., the costs) exceed the 

benefits produced by marginal policy changes, such changes are clearly 

uneconomic. They hurt more than they help. 

There are a number of different failure modes one can conceive under 

which government will fail to execute an economically optimal effort to 

promote competition. 24/ Externalities--consequences that decisionmakers fail 

to take into account in making decisions--are a well known source of 

organizational failure that can account for failures of both the market and 

governmental variety. Just as the output of a polluting factory may be 

excessive if the cost of dirty air is neglected in deciding how much output to 

produce, government intervention will be excessive in circumstances where 

there are significant uninternalized costs of government policies. If the 

costs consumers are compelled to bear by government decisions are not 

• 

1lJ The successful operation of markets generally rests on a foundation or 

infrastructure of legal, economic and social institutions that facilitate 

productive activity and exchange. EXamples of providing competitive 

infrastructure in telecommunications include such activities as creation of a 

system of access charges and the establishment and enforcement of technical 

interface and interconnection standards. How well government carries out 

these activities has implications for both the viability and efficacy of 

competitive processes. For example, with respect to the viability of 

competitive processes, note that failure to implement a full-blown system of 

flat access charges hurts competition. Loading usage-insensitive costs into 

usage-sensitive prices constrains the size of the market and thereby limits 

the number of competitors that can operate economically. With respect to 

efficacy, note that competitive processes will produce perverse outcomes 

(i.e., outcomes that reduce consumer welfare) if artificial restraints are 

placed on or uneconomic inducements are offered to particular competitors. 

1if The idea of economically optimal or efficient promotion of competition is 

explained in Kenneth Elzinga and William Breit, The Antitrust Penalties: A 

Study in Law and Economics (Yale University Press, 1976). A taxonomy of 

governmental failure modes is given in Charles Wolf, "A Theory of Nonmarket 

Failure: Framework for Implementation Analysis, Journal of Law and Economics 

(1976). 
-13-

adequately accounted for by government decisionmakers, government policies 

will tend to inflict excessive costs (i.e., costs that are not worth the 

benefits) on consumers. 25/ 

While we think there are compelling reasons to believe that gover1111ent 

failures occur on this account, in the analysis which follows we shall assume 

that government decisionmakers accurately assess costs and benefits in 

deciding what to do. This assumption is analogous to assuming that 

externalities are not an issue in evaluating distortions in resource 

allocation that arise for reasons of monopoly. Here the posited failure mode 

is a governmental one analogous to the exercise of market power in econCl11ic 

markets. Fittingly, it involves a class of situations where strength lies in 

weakness. 

V. The Exploitation of Affection 26/ 

The basic premise underlying the exploitation of affection argument is 

that government decisionmakers have a personal stake in the success of the 

policies they pursue, in the instant setting policies designed to promote 

competition in the long-distance business. If competition in the sense of a 

self-policing industry structure proves workable, the policymaker who has 

sought that outcome will look good. If a self-policing industry structure is 

25/ In his recent decision sustaining the FCC's imposition of separate 

subsidiary requirements on the BOCs, Circuit Judge Richard Posner chides the 

Commi~sion for its failure to assess the economic costs of its policy 

adequately. 

~ our exposition of the exploitation of affection argument follows the 

treatment by Richard McKenzie and Gordon TUllock in their college textbook, 

The New world of Economics (1975), Chapter 6. A more formal elaboration is 

given in Wilson schmidt, "Charitable Exploitation,• Public Choice, (Spring 

1969). Perhaps the best (certainly the funniest) expression of the analysis 

has been provided by Tom wolfe, author of The Right Stuff, in his essay, "MauMauing the Flak Catchers." See Radical Chic and Mau-Mauing the Flak Catchers 

(1970). 
-14-

not via,ble, the same policymaker will look bad. 271 we assume that 

policymakers will have a downward-sloping demand curve for various policies 

designed to promote competition, that is, that they will be willing within 

limits (described by their demand curve) to incur costs to arrange conditions 

conducive to competition. Per the assumption described at the end of the last 

section, we further assume that this demand curve accurately reflects the 

benefits consumers would derive from different levels of promotional effort. 28/ 

Similarly, we assume that the costs of pursuing different policies more or 

less iRtensively are known (i.e., accurately measured). 

A rational, consumer-welfare maximizing decisionmaker will freely 

choose to extend his promotional efforts until the marginal benefits of doing 

so are equal to the marginal costs. And given that benefits and costs are 

accurately gauged, this level of effort will be optimal from an economic 

standpoint. Any different level of effort would imply opportunities to expand 

economic welfare by moving to the optimum effort. m 

In economic terms, the excess of total benefits over total costs of an 

activity is referred to as the "surplus value" of the activity. The 

exploLtation of affection involves the use of tactics designed to expropriate 

surplus value, that is, to transfer economic benefits from the public to 

private firms. 'ttlis expropriation is thus exactly analogous to the transfers 

27/ If competition were to prove nonviable in the long-distance business, the 

people responsible for breaking up the telephone system to promote competition 

would surely be accused of having committed a tremendously costly error. 

28/ we might alternatively speak of separate demand curves for different 

types of policy (viz., a demand for varying degrees of direct NTS cost 

assignment (access charges), a demand for separate subsidiary requirements of 

varying degrees of stringency, and so on). For simplicity of exposition, we 

cast the argument in terms of a single demand curve. 

29/ In areas where efforts do not go far enough, marginal benefits of going 

l[;irther exceed marginal costs so that greater efforts yield net benefits. In 

areas where efforts have gone too far, contraction yields net benefits. 
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that result from the exercise of monopoly power in economic markets. 

Exploitation of the government's affection for competition involves the use of 

extortion tactics to expropriate for individual competitors the benefits 

consumers might derive from policies promoting competition. 

The tactics for exploitation involve the use of all~or-nothing 

threats. Suppose an OCC canes to the FCC and makes the following threat: 

either you do X, where X stands for any policy change the Commission would not 

freely choose given its (accurate) knowledge of costs and benefits, or I will 

fail ii.e,, go out of business), Now it may be that this firm should fail 

" because it does not do a sa tis factory job of serving consumer demands compared 

to other firms (i.e,, is relatively inefficient), but if its failure makes it 

appear (or, for that matter, actually implies) that a self-policing industry 

structure is not viable, a policymaker with a stake in that outcome may well 

be susceptible to such an extortionate threat. He may thus be led to 

undertake actions that actually reduce consumer welfare and undermine 

achievement of regulatory goals, actions that would not be freely chosen 

absent the threat, actions that sacrifice the competitive process to prop up 

ineffective competitors. 

How successful attempts to exploit the government's affection for 

competition will be depends on a number of factors, including how closely 

identified policymakers are with particular policy outcomes, 30/ Where there 

are a number of competitors, a threat by any one to fail and thus threaten 

competition will presumably not be very compelling. However, it could be if 

reguiators attach importance to the survival of particular competitors and one 

of the chosen few threatens to fail. Moreover, as McKenzie and Tullock note, 

~ Again it is important to stress the difference between process and 

outcome, The competitive process is the only method capable of discovering 

whether competition in the sense of a self-policing industry structure is 

viable. 
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competitors may act collusively and threaten collectively to fail. In this 

regard, the fact that in the past "doom and gloom" communications to the FCC 

from the aces have been jointly undertaken is of striking analytical 

significance. In terms of GTE's Booz Allen campaign, a number of aces have 

chosen to associate themselves with the report's conclusions and GTE'S policy 

prescriptions. 

VI. conclusion 

_A firm does not have to possess a large market share to exercise 

economic power. The aces do not possess large market shares, but they can 

certainly exercise power by threatening to make government officials who have 

inflicted huge costs on consumers to promote competition look bad. They can 

do this by threatening to fail. A small market share and low profits can be 

assets in such an extortion campaign. They make the threat of failure more 

compelling and thus make it more likely that government officials will yield 

to extortion~te demands. And as is always the case with extortionists, giving 

in merely encourages additional blackmail attempts. 

_A correspondent in Business week magazine (3/25/85) recently wrote as 

follows: 

What we are now seeing is the market test of a stillunproven proposition: that one carrier's size and 

economies of scale do not preclude uncontrived 

competition in the long-distance telephone market. If 

the other carriers worry that they will, what are we, the 

public, to make of it all? we can be sure that the FCC 

and Justice have the power and that AT&T now has the will 

to keep a host of inefficient competitors in business, at 

higher costs to the public than under regulated 

monopoly. If that is all we gain, then the whole 

historic experi•nent in competition was mistaken.