Deregulation vs. Reregulation of Telecommunications: A Clash of Regulatory Paradigms

I. Introduction II. Mandating Access to Telecommunications A. First Generation Access: Mandating Access to Local Telephone Systems and Vertical Structural Separation 1. The Inevitability of Rate Regulation 2. The Inability to Realize Efficiencies of Vertical Integration B. Second Generation Access: Local Loop Unbundling 1. Administrative Difficulties 2. The Impact on Investment Incentives C. Third Generation Access: The Ladder of Investment III. The Deregulatory Alternative A. The Emergence of Competition B. Impact on Investment Incentives IV. Deciding Between Regulation and Deregulation V. Conclusion I. Introduction U.S. telecommunications policy has reached a crossroads. During the 1980s and 1990s, regulations focused primarily on mandating access to the portions of the local telephone network that still represented a natural monopoly, a policy epitomized by the two great landmarks of modern telecommunications policy: the breakup of AT&T (1) and the Telecommunications Act of 1996. (2) The basic policy approach was eventually extended to broadband networks as well (3) and has been widely emulated by other countries. (4) At the prompting of the courts, (5) the Federal Communications Commission (FCC) began to retreat from this policy during the 2000s in favor of a more deregulatory course. In response to the growing levels of competition, the FCC took steps toward eliminating mandatory access requirements on both telephone and broadband networks. (6) Once the 2005 Brand X decision effectively signaled the Supreme Court's accession to this deregulatory trend, (7) the FCC eliminated all access requirements on telephone and broadband systems alike. (8) The inauguration of a new administration has caused policymakers to consider once again whether to begin mandating access to broadband networks, as evinced by the continuing controversy surrounding the policy initiative known as network neutrality. (9) This Article reviews the arguments on both sides of this debate. Part II examines the case for regulation, focusing on the rationales and critiques surrounding three separate regulatory approaches: mandating access to local telephone networks, local loop unbundling, and promoting the ladder of investment. Part III lays out the case for deregulation. Part IV sets out the tradeoffs implicit in the choice between these two regulatory strategies. II. Mandating Access to Telecommunications This Part traces the origins of the policy of mandating access to telecommunications networks. The move to regulation takes place in three distinct phases. The first is mandating access to local telephone networks, exemplified by the regime imposed in the aftermath of the breakup of AT&T. The second is local loop unbundling, epitomized by the unbundled network element provisions of the Telecommunications Act of 1996. The third is a theory developed in Europe known as "the ladder of investment." A. First Generation Access: Mandating Access to Local Telephone Systems and Vertical Structural Separation Since at least the days of John Stuart Mill, one of the central problems usually seen as justifying rate regulation is natural monopoly. (10) Natural monopoly occurs when a single firm can serve the entire market more cheaply than can two firms, a condition known as "subadditivity." (11) A sufficient condition for subadditivity is the existence of scale economies throughout the entire range of production, such as occurs when fixed costs are very high. These scale economies permit the firm with the largest volume to face the lowest costs, which in turn permits that firm to underprice all of its rivals. The resulting transfer of sales volume to the market-leading firm causes its cost and price advantage to widen still farther until it is the only firm remaining in the industry. Thus large scale economies can cause markets that begin with multiple producers to inevitably collapse into monopoly. …