Inside The Telecom Policy Cartel -- A Case Study

by publius

Writing from YearlyKos’ FCC panel, Yglesias sees visions of progressive telecom reform:

This is, in my view, one of the aspects of the netroots that gets most overlooked in the media coverage I tend to see. This nexus of issues is an area where until very recently the conversation was entirely dominated by interested corporations. There was no equivalent to labor unions or environmental groups to anything else in civil society to [weigh] in. And now there is!

This is an important point. As public choice theory predicts, the regulatory and legislative agenda has indeed been dominated by the big organized interests with money at stake. There’s nothing wrong with that per se, but it’s a one-sided battle. There’s not really an organized, well-funded interest group that can balance the Madisonian equation. Even the net neutrality debate, for instance, initially flared up because big content companies had an interest in it.

Thus, the fundamental problem is not that the telecom lobby is . . . evil [Dr. Evil voice], but that it’s overwhelmingly better funded and organized. Indeed, DC boasts a veritable army of smart but hackish think-tank professors and analysts who feed policymakers with favorable studies. These studies, in turn, are cited to justify favorable legislation or regulation. Some studies are legit. Many aren’t. The problem, though, is a lack of think-tank funded economists and analysts to examine these papers critically. (That’s why CAP and New America are so promising.).

Today, I want to explain in some detail how this game works by looking at a recent (and short) paper (pdf) released by Scott Wallsten of the Progress and Freedom Foundation (PFF). It’s a stunningly misleading paper designed to justify continued deregulation in an important part of the telecom market (special access). For your reference, Wallsten is an old AEI guy, and PFF is funded by the big boys. Again, there’s nothing necessarily wrong with that, it’s just something that should be understood going in.

Before I dive into the details (and it gets wonky), here’s the quick summary. (1) The FCC opened (or "refreshed") an important proceeding that could result in regulations that would hurt the Bell companies. (2) Wallsten’s Bell-subsidized paper appears a few weeks before comments are due arguing for the position the Bells will take. (3) All the Bells in their FCC comments will undoubtedly cite this paper as evidence that deregulation in this sector has worked great. (4) The FCC will use these citations to justify inaction or continued deregulation. This is how the game works. There’s nothing necessarily wrong with it, but if the paper is wrong, it needs to be critiqued. At the very least, it needs to be critically examined. Sometimes the FCC does the wrong thing not because it’s corrupt, but because only one side of the debate is providing any information. (Same problem in Congress).

As I said, this will get complicated but I’ll do my best to keep it simple. The issue -- “special access” -- is incredibly important and, after the jump, I’ll explain why Wallsten’s hackish paper is so seriously flawed.

When you pick up the phone (or use DSL), you use the old public phone network. And like the roads outside your house, the network has been around for many decades. Many businesses, however, don’t sign up for phone and Internet service on these older lines. They purchase “special” lines that serve only them. This is called “special access” (or “dedicated access”). For instance, when a business in downtown Manhattan wants Internets or phone, it won’t use the old system. It will request a new special line that connects the business directly to the broader network. It’s sort of like building a “special” off-ramp from the interstate that secures better access to a shopping mall, rather than relying on old single-lane roads.

Unlike residential broadband, special access is almost exclusively provided by incumbent phone companies (particularly the Bells – Verizon, AT&T and Qwest). Cable and wireless have yet to enter this market in a significant way. One reason is because of the “last-mile” barriers to entry that we see in the net neutrality debate. When someone wants a new “special access” line (usually high-speed capacity), the phone company can just adjust the electronics of existing lines or slap a new line over top. These phone companies already have facilities, rights of way, etc. They don’t have to dig up anything. They don’t need regulatory approval.

Bottom line – the big phone companies have a potential chokehold over these bottleneck “special access” facilities, more so than in the traditional residential broadband market (the latter being the heart of the net neutrality debate).

Here’s why you should care. Wireless service (including all wireless broadband) in America depends on special access. It is a necessary input. For practical purposes, you can consider each wireless tower or facility that you use every day as being its own business that requires “special access” lines to connect to the larger network (again, imagine off-ramps and the interstate highway system). Special access lines connect wireless infrastructure to the larger national and global network.

Thus, if they jack up special access prices, the incumbent phone companies can chase wireless rivals out of the market, and can prevent competitive wireless broadband from emerging. For instance, one reason that MCI and AT&T merged with Verizon and SBC (the latter now being AT&T) is that MCI and AT&T couldn’t afford special access rates following a controversial 2004 court decision. (That’s a whole different story but I’ll spare you).

This is why Cingular (AT&T Wireless) and Verizon Wireless have such enormous advantages over companies like Sprint and T-Mobile (to say nothing of smaller, more regional carriers). The former are affiliated with incumbent phone companies that provide special access and, more critically, own the special access facilities.

To understand how this works, go back to the Gilded Age. One tool Rockefeller used (if I recall) to drive out competition was to collude with the railroads. Oil competitors couldn’t use the railroad lines, or at least paid more to do so. That’s an extreme example, but the point is that the competitive services (the oil) depends upon using transport bottleneck facilities (the railroads) to compete. The Bells in a sense own the railroads (or at least own a bottleneck segment) and could use that control to affect telecom (i.e., oil) competition. It’s all very similar to the net neutrality debate.

Ok – so far, so good? Let’s charge on. Special access was deregulated around 1999 (deregulation was phased in). Wireless carriers and other customers have (they claim) been squeezed so hard by price increases that they want it re-regulated. The FCC has responded by inviting comments due later this month. The Bells obviously don’t want this to happen. Thus, they need to show that deregulation worked well. Enter Scott Wallsten.

I really should be writing a longer paper on this (anyone at New America or CAP still reading?), but I’ll try to be as brief as possible with the understanding that I could and probably should go into more detail. But anyway, the gist of Wallsten’s argument is that special access investment (i.e., investment in new lines, etc.) has increased following deregulation. The implication is that deregulation spurred capital investment -- the exact same argument people use to criticize net neutrality. Here’s his nifty chart:

Looks pretty convincing right? If I were an overworked FCC or Congressional staffer with no evidence to the contrary, I might be convinced. Deregulation worked. But when you dig a little deeper, you’ll see why Wallsten’s argument is grossly misleading if not flatly dishonest. There are several independent reasons:

First, the FCC changed its methodology in 2000 because the number of special access lines was being underreported. As the FCC explained in 2003 (DA 03-4070):

Prior to ARMIS reporting year 2000, some carriers were under-reporting their special access lines by reporting special access circuits terminating at multiple customer premises as a single special access line, rather than as multiple special access lines. . . . As a result, Verizon's special access lines [in this region] increased substantially between year 1999 ARMIS reports and year 2000 ARMIS. reports.

Nary a peep of the FCC’s methodology change in Wallsten’s paper.

Second, the key move Wallsten makes is by treating the FCC’s number of lines as a “proxy for investment.” The FCC, however, counts special access lines in a unique way. It equates greater capacity with an increased raw number of lines.

For instance, one line with 64 kbps capacity is counted as one line, while a single “DS-3" line (a much higher-capacity line) is counted as 672 separate lines. The bottom, um, line here is that improved technology (i.e., improved capacity) gives a potentially misleading view of the numbers. The Bells haven’t gone out and built this many new lines. Improving existing ones (again, sometimes simply readjusting electronics) can result in many more new “lines” under current FCC methodology. Wallsten generically notes this methodology in a footnote but doesn’t really deal with it other than to say it "complicates the data issue."

Third, the demand for Internets went up sharply in the late 90s. (Special access is generally for high-speed access). I don’t really understand the economic model he uses at the end (and he claims to control for demand, so maybe this is a non-issue). But still, the big chart above doesn’t control for demand. It gives the misleading impression that deregulation -- rather than skyrocketing demand -- led to sharply-increased numbers of lines. It’s the whole correlation vs. causation point. Who knows, maybe Monica Lewinsky led to increased investment.

But fourth, even if I’m wrong on everything else, the real killer is that the data establishes exactly nothing. The criticisms surrounding special access don’t relate to the raw number of lines, but to the percentage of those lines controlled by the incumbent phone companies. It’s the market power that matters. Even if you quadruple the number of “lines” after 1999, it doesn’t really matter if there’s no competition. The question isn’t just “did output go up?" It's “is the output lower than it would or should otherwise be in a more competitive market.” As my law and econ professor always said, it’s the “as compared to what” problem.

To be fair, Wallsten does mention that it’s hard to draw strong conclusions because we don’t have similar information for special access competitors (they aren’t regulated in this way, so they don’t submit reports). So he notes this caveat. But that said, the clear conclusion of the report (and his rhetoric) is that deregulation was a good thing that led to massive increases in investment. And that’s how it will be used in the Bells’ comments. In fact, it will be the footnote supporting an even stronger and less nuanced statement in the comments filed at the FCC. Already, the PFF website boldly announces "Analysis Suggests Deregulation of Special Access Has Had Positive Effects on Investment."

And so that’s how the game is played. In this instance, companies like Sprint and T-Mobile might fight back and point out the flaws. But many times, papers like this go unchallenged. And to be honest, a real economist could probably provide an even better critique. But that’s where the gap is. And that’s where the netroots -- as Yglesias noted -- might step up and fill it.

Comments

[OCSteve]

Man, this stuff makes my head hurt. Once again – you’re doing an awesome job covering it. Kudos.

One question – when might a monopoly actually be a good thing? This may wrap around to the discussion the other day on private vs. government control of what you could call national infrastructure…

I had no problem with “Ma Bell”. For the youngsters out there, not only have I used a rotary dial phone, but when I was growing up we actually had a “party line” (not as much fun as it may sound). We were pretty poor, and there were times when other utilities were shut off due to lack of payment, but never our phone service. Basic service in my lifetime has always been pretty cheap. Considering what you get and what it takes to deliver it, it may be one of the best bargains available.

I never saw much benefit from breaking up AT&T. I tried the new guys – Sprint, MCI, etc. and found out that they all suck. I always ended up back with the big guy. I’m a diehard Verizon customer today and you couldn’t pay me to switch. I get unlimited land line, wireless, and DSL for less a month than I spend on cigarettes and it is 100% reliable.

Some of this stuff almost seems like “affirmative action” for wanna-be Telco companies. I honestly don’t get it. If one company can provide cheap reliable service for the whole country, why should the government intervene? Honest question – I understand of course why a monopoly can be bad, but in the case of AT&T I never saw them being bad. I’m not sure I can think of another private company that did so much for national infrastructure. And even as the poor as we ever were, we had a piece of that.

[cw]

Thanks for the update. I'm now retired but no so long ago I was a network geek and your posts bring back memories - fond or sometimes not.

One comment. In built-up areas, we found it wasn't that unusual to find other providers. There's other right-of-ways under the streets and i.e. cable companies can also provide high-speed access, especially for Internet access. Still your general point is correct.

I generally think deregulation has been a good thing, but the fly in the ointment has always been the "last mile". I've generally thought that because this last mile has been legally controlled, enforced by the government, that the government ought to regulate its use.

[publius]

cw - exactly. i'm certainly prefer deregulation over regulation. my gripe however is that we should focus more carefully b/c different parts of the network call for different solutions. imposing some "foundational" regulation such as net neutrality or special access allows dereg to happen elsewhere.

OCSteve -- it's a very good question adn it was debated for a very long time. and that was exactly the argument of the old Ma Bell. In return for the monopoly, they provide cheap (subsdized) basic service. i guess the point is that the old Ma Bell stifled innovation. for instance, without carterfone, there may not be things like faxes and PCs. also, the phone companies didn't develop DSL (even though they had it on the shelf ready) until cable entered the internet market. but anyway, these are all key questions that smarter people than i have debated for a long time

[publius]

cw - one other point. even in the built up areas, you're right that there are competitive fiber rings, etc. BUT BUT BUT, often even these facilities need special access facilities for the last "mile".

when the bells asked for deregulation on a number of fronts, they said exactly what you said (different things built up by competitors). the problem is that they didn't go all the way. you just need to control one link in the chain.

also, if you want to get really wonky about it, the old MCI and AT&T were large national competitive providers of special access. the market is now much more consolidated given that these companies have been acquired by the incumbents (Verizon and SBC/AT&T)

[cw]

often even these facilities need special access facilities for the last "mile"

Very true. But the "other guys" were pretty clever about finding conduits into buildings. Sometimes too clever. I can't remember many of the details, but as an example I recall one deal that involved the city water department.

To answer the obvious question, the pipes did burst one day. That in itself didn't hurt the fiber, but the repair action certainly did. Fiber is no match for guys named Bubba armed with cutting torches.

And as long as you have line-of-sight to someone's pop, you can always try wireless and worry about birds and bandwidth.
Still, your original point is valid for probably 90% of the situations.

We pretty much gave up trying to circumvent the phone company, unless we needed redundant facilities and they couldn't provide them.

[Bernard Yomtov]

Wallsten breaks out channel termination deregulation from dedicated transport/special access deregulation. Only the latter show significant results in his very shaky regression. I'm not sure what this means, but I think it's not good for his argument.

On the one hand, I'd like to read this paper more carefully, but OTOH I don't want to. That probably puts me in the same position as a lot of the staffers of various sorts who deal with this stuff.

[publius]

yeah, that stuff is unfortunately greek to me. it doesn't surprise me though. someone probably came to him and told him to do somethign to help with special access and he threw together this crap.

if he got called out publicly more often, it would help. for one, he would know he couldn't do this type of crap

[Catsy]

There was actually a very lively and interesting discussion about this on Redstate recently, in Sen. Durbin's thread. My personal opinion is that the telco and cable infrastructure needs to be nationalized, with the most rudimentary, basic phone and internet service being a subsidized government service. Anything beyond that bare minimum would be provided by service providers, who would lease the rights to provide services over this infrastructure, the way everyone else currently pays the telco and cable monopolies extortionate amounts to provide services.

It's a solution with its own problems, and it's guaranteed to make most of the free market religionists howl the S-word. But it's about the only way I see to lower the barrier to enter the internet and telephone services market in such a way that meaningful competition can occur. Whoever owns the local infrastructure has an unbreakable choke-hold over the local market, and that's bad for consumers in every part of the country.

[OCSteve]

Catsy: It's a solution with its own problems, and it's guaranteed to make most of the free market religionists howl the S-word.

Ooookay… I’ll step up.

Damned socialists…

;)

[Catsy]

Damned socialists

*grin* I still reject the premise that that's a bad word. I don't have any particular ideological attachment to socialism, capitalism, or any other system. I think most systems have good ideas, and some of these ideas work better than others. We've had a lot of well-earned success with free market capitalism, but it's not without its problems either. Some of those problems are ameliorated by a healthy contribution of concepts commonly considered "socialist"--along with many other sorts--to the mix in the right places.

Anyway, I know you were yanking my chain, so soapbox off. ;)

[Jack Robles]

OCSteve - "One question – when might a monopoly actually be a good thing?"
Certainly prior to Reagon, and possibly even up to W, I would have said that if one can maintain a monopoly without violating anti-trust law, then the monopoly is probably not a horrible thing.* With W's assertion that only price fixing cases (i.e. cases of collusion, not monopoly) are going to be tried, that goes a bit out the window.
But lets pretend that we have a properly functioning anti-trust regulation. The simple theory of anti-trust, as I understand it, divides behavior into two different categories based upon intention. If one were to take an action which increases one's profits while holding his rivals behavior constant, then any anti-competitive results of this action are hard to critisize. For example, in a market with fierce price competition, a low cost firm may end up charging such a low price that nobody else can compete. That's okay. They achieved their monopoly because of lower costs, or (as put forth in the Standard Oil case) because of competition on the merits. On the other hand, a particular action may actually be bad for a firm (perhaps simply from being costly) but may benefits the firm by changing a rival firm's: actions, costs, quality. This is not competition on the merits.
Viewed simply, competition on the merits should generally make the world a better place. In the above example it reduced the costs of production. However, the second type of behavior is simply bad for society. For example, makig a rival's product worse hurts those who consume that product. However, it has a more insiduous effect. If a firm needs to engage in this type of behavior, then it is a fairly safe assumption that they would not be able to maintain their market position if they were not to engage in this behavior and instead were to compete purely on the merits of their goods and cost structure. Consequently, consumers may actually be recieving lower quality and higher cost goods than if other firms were not being detered from entry (or expansion.)Worse, from a dynamic point of view, with this deterence present, there is a smaller return for innovation in this market, and consequently less innotation.
It used to be that anti-monopoly cases were decided on, more or less, the above distinction between types of behavior. If a firm achieved and maintained a monopoly by competition on the merits, then that was okay. If a monopoly were achieved or maintained by the use of the second type of behavior, or by behavior which was simply illegal, then the monopoly itself was illegal. Of course, we can't see intentions, so instead incentives were examinend, and arguments were presented based upon the intentions which were implied by the incentives.
Regarding ATT, they were clearly involved in the second type of actions. For example, long distance services need to hook up with the local service hubs. ATT instructed their employees to make the MCI connections poor, so that noise would be added over these long distance lines.
As regards the quality provided, I think that ATT realized from the getgo that their cost structure prevented them from competing via price. Instead, they have tried to maintain a reputation for quality. But personally, I think that the level of quality that they provide is a response to competition. I too am old enough to remember Ma Bell, and I don't recal especially good service prior to the break up.
*Of course, I ignore something quite relevent to the current discussion. In particular, there is an argument that if a particular good requires an expensive network, then it might be best to not duplicate this network needlessly. Hence, we might wish the network provider to act as a monopolist. However, we probably want to regulate him. More to the point, much of the above argument continues to apply. If someone else can duplicate the network and enter the market profitably, then that means that prices are too high, and we certainly don't want to allow the incumbent to deter entry via something other than competition on the merits. Also if we are not going to regulate the firm, and there are not really srong arguments for why vertical integration is a good thing, then we should not allow the natural monopoly in the network to be extended into other markets. In particular, just because it might make sence not to have duplicate land lines all over the place, does not mean that we should allow the firms owning those line to prevent other firms from providing cellular service. There might be an argument for why, from an efficiency point of view, we want to allow vertical integration between land line providers and cellular providers. However, I have not heard it. Since the anti-competitive consequences are pretty clear, it seems incumbent on the land line providers to put forth a convincing counter argument.

[Bernard Yomtov]

ATT instructed their employees to make the MCI connections poor, so that noise would be added over these long distance lines.

ATT also argued that other companies' equipment was unreliable, and might damage the entire ATT network if connected. The Carterfone case dealt with this issue.

The natural monopoly Jack Robles discusses in his last paragraph is really not "merit-based" so much as "technology based." It comes up in a situation where each customer the monopolist adds costs less than the last one, usually because there is already a huge network in place. This makes it impossible for a competitor to enter the market. The usual example is utilities of various sorts, which of course were historically subject to price regulation.