The Cato Institute
UNE-P and the Future of Telecom "Competition"
by Adam Thierer
WASHINGTON -- On Feb. 8, the Telecommunications Act of 1996 turns 7 years old. Few will be celebrating the occasion. The telecom industry lies in shambles. While job creation, new investment, and increased entry followed the passage of the act, recent years have witnessed a stark reversal of fortune for companies, consumers and investors alike as the market has tanked with a vengeance.
Job cuts have been severe, once mighty stocks are trading for a tiny fraction of where they previously stood, debt loads are ballooning, bankruptcies are everywhere, and industry investment has plummeted.
What gives? Has the Telecom Act been a failure?
It depends on whom you ask, of course. Some companies and policymakers argue that the only problem with the act is that it has not been given enough time to work, or that regulators have not gone far enough in enforcing the act's "pro-competitive" provisions.
Another crowd argues that the act has been overzealously interpreted by the Federal Communications Commission, so much so that it has been the primary cause of the industry's recent woes.
These intellectual combatants have clashed in Congress, the courts, the states and before the FCC. While no lobbyists have fallen in battle, forests of trees must have, given the voluminous paperwork trail that accompanies this melee. The number of pages in the FCC Record alone has tripled in the wake of the act, according to Greg Sidak of the American Enterprise Institute. A virtual avalanche of filings accompanies this circus no matter what town or venue it's visiting.
The latest battle in this protracted war of words and paper is currently taking place at the FCC as both sides eagerly await a decision from the FCC in its Unbundled Network Element Triennial Review. This proceeding is reevaluating the unbundled network element platform, known as the UNE-P, that incumbent local exchange carriers, known as ILECs or Baby Bells, must provide to competitive local exchange carriers, or CLECs at regulated rates.
And according to supporters of the UNE-P regime, nothing less than the entire future of telecom industry competition is at stake with this decision. They may be right, but for all the wrong reasons.
Under the Telecom Act, Congress granted the FCC a generous degree of latitude in terms of how to interpret the interconnection, open access, and unbundling provisions of the Telecom Act. Consequently, under the leadership of Chairman Reed Hundt, the FCC embarked on a grandiose experiment in re-ordering the affairs of the telecom sector.
Hundt saw himself as an almost messianic figure sent to save the industry from the Bells, so much so that in his 2000 book, "You Say You Want a Revolution," Hundt candidly noted that, "Congress had not been mindful of Senator McCain's repeated warnings against transferring power to me. (T)he Telecommunications Act of 1996 made me, at least for a limited time ... one of the most powerful persons in the communications revolution."
Indeed it did, and during Hundt's reign at the FCC, the agency aggressively crafted the implementing regulations in such a way as to maximize short-term CLEC entry by guaranteeing them cheap access to virtually every element of the Bells' networks. Hundt's managed competition vision for the telecom sector could be filed under the "burn the village in order to save it" theory of political philosophy.
In several chapters of his book, Hundt boasts about commission efforts to deliberately handicap the Bells and advantage rivals. Considerations of future innovation and investment took a backseat to the short-term goal of rapidly increasing the number of new entrants into the market. While Hundt's regulatory house of cards did foster short-term entry, these new rivals largely built "networks out of paper" in the words of Manhattan Institute scholar Peter Huber.
They deployed few actual new facilities and instead focused on lobbying the FCC for the broadest possible package of UNEs at the lowest price possible. Regulatory arbitrage replaced genuine marketplace competition. Counting noses (new entrants) became more important than counting networks. And as for the future, well, that was another day. Hundt's crew had taken Keynes' famous quip about us all being dead in the long run a little too seriously.
The fatal conceit underlying this UNE-P regime and the forced access regulatory ethos in general is that it presumes that new products, systems, or technologies will be produced by companies regardless of the regulatory environment or legal incentives in place. UNE-P proponents repeatedly ignore the risk-reward relationship in a capitalist society and its importance for long-term economic investment and innovation.
One need not be versed in the works of Schumpeter or Hayek to understand what AT&T Chairman and Chief Executive Officer Michael Armstrong eloquently summed up in a 1998 speech: "No company will invest billions of dollars to become a facilities-based broadband service provider if competitors who have not invested a penny of capital nor taken an ounce of risk can come along and get a free ride on the investments and risks of others."
Worse yet, UNE-P supporters conveniently sidestep the question of what happens if things turn sour. We know what open access supporters will say if incumbents spend billions deploying a ubiquitous and successful new network: Open it up to "competitors" and let everyone share that new system equally.
But what if those networks that the incumbents threw billions at prove to be a bust? Will the so-called competitors help foot the bill then? Unlikely, but that's really what the UNE-P regime is all about: privatizing the risks and socializing the rewards, to paraphrase technology guru George Gilder.
At a minimum, therefore, it should be relatively uncontroversial for the FCC to rule that investment in new technologies and services will be exempted from the infrastructure-sharing provisions. That's the easy part. The more difficult issue is what to do about the older copper loops, switches and support systems that are currently shared at below-cost rates. CLECs claim they cannot survive without them, and yet one wonders whether they should if they cannot provide at least some of their own facilities.
Moreover, switching can be competitively supplied; many CLECs already install their own switches in many regions. And high-capacity loops (typically fiber) or inter-office transport lines don't need to be shared. There's a lot of fiber in the ground in most regions the CLECs serve today; they can negotiate access at a good rate. And operations support systems (operator and director assistance services or databases, for example) never belonged on the list to begin with. They should be removed promptly from the sharing regime.
Local loops ("last mile" copper lines) are the only element of the local telephone infrastructure where the CLECs can make a credible case that reproduction costs are prohibitively expensive. Ignoring wireless competition and the fact that some cable companies are serving some customers today, the short-term reality is that most citizens only have one phone line.
Of course, largely ignored in this debate is the question of whether or not some of these CLECs might have more seriously considered investing in new last mile facilities to homes and businesses if not for the generous FCC unbundling rules. True, it would have been capital intensive and required many agreements and alliances to deploy last mile facilities, but the sharing rules essentially gave the rivals an excuse for not even trying it to begin with.
For that reason, the FCC needs to consider a sunset plan for even these sharing provisions. The gradual march of technological progress will likely solve this problem for policymakers as wireless options proliferate and carriers gradually deploy more fiber. It would make sense, therefore, to place a firm cutoff on all sharing rules, including local loops, after a gradual phase out. Set a date -- perhaps Feb. 8, 2006 -- and close the book on this misguided experiment with micro-managing telecom markets.
(Adam Thierer is the director of telecommunications studies at the Cato Institute.)
Bush's budget will make him the biggest spender in decades
WASHINGTON -- Cato Institute Director of Fiscal Policy Chris Edwards released the following statement in response to President Bush's fiscal 2004 budget:
"The Bush administration's fiscal 2004 budget shows an admirable reform spirit in its pro-growth tax cut proposals, support for private Social Security accounts, and government management initiatives such as competitive sourcing. But the administration has failed to tackle the serious overspending problem in the discretionary budget.
"Indeed, based on his first three budgets, President Bush is the biggest spending president in decades. For fiscal year 2004, discretionary outlays will rise 3.5 percent, which follows increases of 7.8 percent in fiscal 2003 and 13.1 percent in fiscal 2002. Non-defense discretionary outlays will rise 3.2 percent in fiscal 2004 following increases of 7.9 percent in fiscal 2003 and 12.3 percent in fiscal 2002.
"Rather than spending increases, the return to deficits and the coming cost explosion in elderly entitlement programs means that discretionary spending should be immediately frozen and major cuts identified. The administration has backed large increases in the defense budget -- from $306 billion in fiscal 2001 to $390 billion in fiscal 2004. Yet it has not offset those increases with an aggressive plan to reform non-defense spending by major program terminations, privatization, and moving functions such as education back to the states.
"The following budget data highlight the continuing overspending problem in the federal government:
-- The biggest spending administration in decades. With Bush's budget plan for fiscal 2004, real non-defense discretionary outlays will rise 18.0 percent in his first three years in office (fiscal 2002 through fiscal 2004). That growth far exceeds the first three years of any recent presidential term, including Ronald Reagan's first term (-13.5 percent), Reagan's second term (-3.2 percent), George H. Bush's term (11.6 percent), Bill Clinton's first term (-0.7 percent), and Clinton's second term (8.2 percent). When Reagan came to office and pursued a large defense build-up, he essentially froze non-defense discretionary outlays, which were $150 billion in fiscal 981 and just $151 billion three years later in fiscal 1984 (in current dollars).
-- A spending freeze would eliminate the deficit. The fiscal 2004 budget would increase discretionary outlays from $791 billion in fiscal 2003 to $926 billion by fiscal 2008. If, instead, discretionary outlays were frozen at the fiscal 2003 level, the deficit would plunge to just $55 billion by fiscal 2008. The budget could be balanced even more quickly with reforms to cut rapidly growing entitlement costs. If total outlays were frozen at the fiscal 2003 level, the budget would essentially be balanced in just two years (by fiscal 2005).
-- Spending increases dwarf proposed tax cuts. The administration proposes to increase total federal outlays by $89 billion in fiscal 2004, $114 billion in fiscal 2005, and more than $100 billion each year thereafter. As spending increases accumulate, annual outlays are expected to be $571 billion greater in fiscal 2008 than in fiscal 2003. By contrast, the tax cuts in the administration's growth package have a tiny effect on future budgets. By fiscal 2008, the Bush growth package tax cuts would reduce federal revenues by just $50 billion annually in fiscal 2008.
-- Only two of 21 major departments and agencies are cut. Only two of the 21 major federal departments -- Justice and Labor -- would receive an actual cut in discretionary budget authority in fiscal 2004. While most departments receive small increases this year, many have had substantial growth in recent years. For example, the Department of Education budget has jumped from $40.1 billion in fiscal 2001 to $53.1 billion in fiscal 2004. During the same period, the Health and Human Services budget increased from $54.2 billion to $66.2 billion, State and International Assistance from $20.4 billion to $27.4 billion, and Veterans Affairs from $22.4 billion to $28.1 billion.
-- Almost $400 billion for state and local governments. State officials are demanding a federal government bailout to make up for their poor fiscal management. Yet the budget shows that total federal grants-in-aid to state and local governments increased from $285 billion in fiscal 2000 to $384 billion in fiscal 2003. The administration has resisted as large a bailout as states want, but grants are still expected to rise to $399 billion in fiscal 2004.
-- Bush vs. Clinton for fiscal 2004. When former President Clinton introduced his fiscal 2000 budget, he proposed that non-defense discretionary spending for fiscal 2004 should be $335 billion, as shown in Figure 1. President Bush is now proposing that non-defense discretionary outlays rise to $429 billion in fiscal 2004, or almost $100 billion greater than Clinton's original plan.
"The sad fact is that the administration and Congress do not adhere to out-year budget plans, as they always spend far more than originally proposed. Unless the Bush administration pursues major program cuts and terminations, its 2.3 percent proposed annual average growth in non-defense discretionary outlays (fiscal 2004 through fiscal 2008) is very optimistic."
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