Opinion ID: 799751
Heading Depth: 1
Heading Rank: 1

Heading: The historic productivity component of the X-Factor

Text: 5 The X-Factor is aimed at capturing a portion of expected increases in carrier productivity, so that these improvements, as under competition, will result in lower prices for consumers. In the Matter of Policy and Rules Concerning Rates for Dominant Carriers, 3 FCC Rcd 3195, 3394 (1988). Apart from a consumer productivity dividend (CPD) described below, it is based on an assumption that historic productivity increases will be matched in the future. The agency resolved in the 1997 Order that the X-Factor (apart from the CPD) should be calculated as the sum of the difference in productivity growth and the difference in input price growth between the LECs and the economy as a whole. See 12 FCC Rcd at 16,680, p 95. It can thus be expressed as follows: X = ( % LEC TFP % TFP) + ( % U.S. input prices % LEC input prices), where TFP = total factor productivity. See 12 FCC Rcd at 16,785. 1 The formula may be more readily conceptualized as X = ( % LEC TFP - LEC input prices) ( % U.S. TFP % U.S. input prices). 6 Several parties submitted estimates of historical X-Factors. In a determination unchallenged here, the FCC accorded the greatest weight to its own estimates, although it also gave some weight to AT&T's estimates (we discuss this decision below). See 1997 Order, 12 FCC Rcd at 16,695, p 37. The estimates the FCC considered, and the averages of those estimates over specified periods, are the following: 7 Table 1 Year FCC AT&T 1986 -0.5% 0.2% 1987 5.0 4.1 1988 5.0 6.4 1989 7.9 8.8 1990 8.8 11.0 1991 5.8 6.0 1992 3.4 4.1 1993 4.7 6.0 1994 5.4 5.9 1995 6.8 9.4 Specified periods (averaged) 1986-95 5.2 6.2 1987-95 5.9 6.9 1988-95 6.0 7.2 1989-95 6.1 7.3 1990-95 5.8 7.1 1991-95 5.2 6.3 Range of Averages: 5.2-6.1 6.2-7.3 8 1997 Order, 12 FCC Rcd at 16,696, p 137. 9 The FCC consulted the moving averages to establish a range of reasonableness from 5.2% to 6.3% and then selected 6.0% as the historical (i.e., non-CPD) component of the X- Factor. See id. at 16,697, p 141. The LECs argue that the FCC did not give a rational explanation of that choice, and we agree. None of the reasons given for choosing 6.0% holds water. 10
11 First, in choosing a point within the range of reasonableness, the FCC determined that it was reasonable to place less weight on two lowest averages, the ones for 1986-95 and 1991-95. It said that the first, 1986-95, is heavily influenced by the improbably low 1986 estimate of-0.5 percent. Id. at 16,697, p 139. But the Commission gave no reason for condemning the 1986 estimate as improbable, and mere divergence from the other numbers does not justify such a conclusion. See Thomas H. Wonnacott & Ronald J. Wonnacott, Introductory Statistics for Business and Economics 497 (2d ed. 1977). The FCC invokes our cases upholding the elimination of outlying data points, but in them the agency explained why the outliers were unreliable or their use inappropriate. See Bell Atlantic Tel. Cos. v. FCC, 79 F.3d 1195, 1202 (D.C. Cir. 1996) (study indicated outlier erroneous); Association of Oil Pipe Lines v. FERC, 83 F.3d 1424, 1434 (D.C. Cir. 1996) (skewed data distribution required outlier elimination to avoid windfall profits to many oil pipelines). 12 As to the 1991-95 average, the Commission said it was the one most affected by the low 1992 estimate, which it in turn diagnosed as an artifact of a one-year jump in the measured productivity of the national economy as economic activity increased, rather than a change in the growth rate of LEC productivity or input prices. 1997 Order, 12 FCC Rcd at 16,697, p 139. This is mystifying. If the productivity component of the X-Factor is to reflect the difference between LEC and overall productivity growth, a proposition that is built into the Commission's formula, see 1997 Order, 12 FCC Rcd at 16,785, there seems no reason to slight a datum because its anomalous character stems from the unusual magnitude of the second term rather than of the first.
13 In justification of its choice of 6.0% the FCC also cites an upward trend in the X-Factor during the last years it surveyed. See 1997 Order, 12 FCC Rcd at 16,697, p 139 ([F]rom 1993 onward there has been an upward trend in the X-Factor); id. at p 141 ([T]here appears to be a strong upward trend in productivity growth from 1992 to 1995). 2 The FCC's reliance on the upward trend necessarily reflects the (unexplained) assumption that the trend will continue, at least in the immediate future. Explanation might be reasonably omitted if there were no obvious reason to doubt continuation of an observed trend. But two such reasons exist. 14 First, the trend appears to be part of a cyclical pattern. Although the X-Factor did increase steadily in the 1992-95 period, it also decreased from 1990 to 1992, after rising from 1986 to 1990. See Table 1, supra. Perhaps there was reason to believe that there would be no cyclical downturn during the expected life of this X-Factor determination, which was to be reviewed about two years after being made. See 1997 Order, 12 FCC Rcd at 16,707, p 166. But the FCC offered no such reason. 15 Second, the X-Factor is calculated as the sum of two components, neither of which followed a trend during the period in question. In fact, their year-to-year fluctuations swamped the trend increments: 16 Table 2 Year Difference between LEC & US changes Difference between LEC and in total factor productivity US changes in input prices 1992 0.21 3.21 1993 1.44 3.26 1994 3.69 1.71 1995 1.78 5.04 17 1997 Order, 12 FCC Rcd at 16,785. Where's the trend? As the underlying variables appear to be thrashing about wildly, the FCC's conclusion that the trend in the difference between the two had some predictive value requires explanation.
18 Finally, the LECs argue that in its treatment of AT&T's X-Factor estimates the FCC implicitly endorsed methodologies that it had earlier discredited. LEC Br. at 27. The FCC incorporated the aspects of AT&T's method that it deemed reasonable into its own method, see 1997 Order, 12 FCC Rcd at 16,658, p 33, and then gave independent weight to AT&T's X-Factor estimates in deciding to extend the range of reasonableness upward, see 1997 Order, 12 FCC Rcd at 16,697, p 140, and to select a value near the top of the range. Id. at p 141. We agree that both these uses of AT&T's estimates appear irrational; any differences between the FCC's and AT&T's estimates presumably resulted from elements of AT&T's analysis that the FCC specifically rejected. The FCC's argument that AT&T's estimates were help-ful because AT&T's methodology was similar, FCC Br. at 37, fails to overcome that logic. If there is an explanation--for example, conceivably the Commission gave some weight to AT&T's conclusions out of concern for the risk that it had erred in rejecting specific elements of AT&T's analysis--the FCC has failed to mention it. 19 The Commission having failed to state a coherent theory supporting its choice of 6.0%, we remand for further explanation. II. Consumer productivity dividend 20 The second component of the X-Factor is a consumer productivity dividend (CPD) of 0.5%. At the time of the 1990 order instituting price-cap regulation, the FCC expected ... that incentive regulation would result in greater productivity gains than rate of return regulation, Bell Atlantic, 79 F.3d at 1198, and instituted the CPD, as it said, to assure that the first benefits of price caps flow to customers in the form of reduced rates, In the Matter of Policy and Rules Concerning Rates for Dominant Carriers, 5 FCC Rcd 6786, 6799, p 100 (1990) (Price Cap Order). It retained the 0.5% CPD without specific explanation in a 1995 interim rule, Bell Atlantic, 79 F.3d at 1204, and retained it again in the current rule. See 1997 Order, 12 FCC Rcd at 16,690, p 123. 21 The LECs challenge the 0.5% CPD as based on an obsolete justification. The Commission's earlier data on historic productivity improvement derived from the rate-of-return era, so an adjustment to reflect the expected incentive effects of price caps was in order; but the post-1990 data presumably reflect those effects. 22 FCC counsel responds that the agency believes that an innovation in the current rule--the Commission's elimination of the sharing of profits exceeding certain benchmarks-will give the LECs still further productivity incentives, and that the FCC relied on that in retaining the CPD. Even if the agency relied on this justification (which the LECs dispute), it never explained retention of the old percentage, a retention that required some comparison of the current change with the initial one in terms of their likely impacts on productivity. Thus we must remand for an explanation of the Commission's choice of the amount--0.5%. 23 The LECs claim that the FCC did not rely on the expected effects of sharing elimination and that it gave no other reason justifying the retention of any CPD. We do not reach these arguments because the FCC will be able to give a clearer statement of its reasons in the remand on the amount and since the LECs do not dispute the argument FCC's counsel is presently making--that it is defensible to include a CPD corresponding to whatever productivity increase may be expected from the elimination of sharing.