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Regulation: “Phone Bill Too High? Blame the FCC”

Continuing with my effort to archive at Cafe Hayek as many as possible of my writings, I paste below the fold the full text of my review, which appeared in the Winter 1997 issue of Regulation, of Paul MacAvoy’s 1996 book, The Failure of Antitrust and Regulation to Establish Competition in Long-Distance Telephone Services.

Phone Bill Too High? Blame the FCC

The Failure of Antitrust and Regulation to Establish
Competition in Long-Distance Telephone Services

by Paul W. MacAvoy
(MIT Press and AEI Press, 1996) 314 pp.

Reviewed by Donald J. Boudreaux

True or false: since the Justice Department forced AT&T to divest its regional operating companies in 1984, competition among long-distance telephone carriers has intensified.

Most Americans would likely answer “true”—just as I would have answered before reading Paul MacAvoy’s The Failure of Antitrust and Regulation to Establish Competition in Long-Distance Telephone Services. After all, before 1984 we were never entertained by the likes of Candace Bergen, Dick Cavett, Whitney Houston, and NFL stars hawking long-distance services. More important, since 1984 prices of long-distance calls have dropped on average by 50 percent. With prices down, usage up, and with the electronic and print media teeming with pleas by AT&T, MCI, and Sprint for long-distance subscribers, who could doubt that the market for long-distance telephone carriage is hotly competitive?

Not only does Yale economist Paul MacAvoy doubt the conventional wisdom about increased competition in long-distance telephone services, he marshals striking evidence showing that wisdom is mistaken. Long-distance carriers have not been released from the protective bosom of government regulators, principally the Federal Communications Commission, and thus are not obliged to attract customers with the most cost-effective deals possible. MacAvoy explains that, rather than competition developing in the aftermath of the divestiture, tacit collusion developed among the three large incumbent providers of long-distance services. Collusion occurred principally because of the methods the commission used to regulate tariff rates and because the court (of Judge Harold Greene) forestalled the entry of other potentially competitive carriers.

So what accounts for the substantial drop in prices since 1984? Answer: “Regulation, not competition, is to be ‘credited.’” However, rates would have fallen further if not for regulations. Specifically, long-distance carriers no longer must subsidize local telephone service. More notable, access charges—that is, prices paid by long-distance carriers for access to local lines—have fallen. MacAvoy approvingly quotes Alfred Kahn’s conclusion that the access-charge reductions mandated by the FCC “produced enormous net economic benefits, but it was they, and not competition itself, that caused prices to decline and demand to grow more rapidly than it would otherwise have done.”

At the heart of MacAvoy’s study is his careful and impressive analysis of the trend of long-distance prices relative to the incremental costs of providing long-distance services. If the divestiture had really unleashed greater competition, those price-cost margins would have decreased. Instead, the price-cost margins increased. MacAvoy calculated the post-divestiture sizes and trends of those margins for a wide variety of long-distance services. The facts overwhelm: without exception, since divestiture the price-cost margins on all long-distance services have increased. That is to say, prices paid by long-distance callers have fallen much less than the costs of supplying long-distance connections.

Few readers of Regulation will be surprised to learn that competition’s bête noir is government—in this case, the FCC with the blessing of the Congress and the courts. It is also no surprise to learn that AT&T, MCI, and Sprint encourage this regulator-orchestrated cartel. There is no doubt that the fall in consumer prices, made possible by the substantial reduction in long-distance carriers’ costs, has helped mask the transfer of wealth from consumers to carriers.

MacAvoy’s case for regulators-as-cartelizers is strengthened by his explanation of the FCC’s adroit schemes for keeping competition bottled up. For example, unlike rate changes by MCI and Sprint, AT&T’s proposed rate changes cannot be implemented within twenty-four hours. Instead, the FCC requires AT&T’s pricing proposals to be delayed at least two weeks, which allows other carriers to respond before the tariffs take effect. According to MacAvoy, “This process precluded any competitive gain for AT&T from an own-price-reduction initiative. The what and when in the tariffs of the largest carrier established discipline in the price-change practice of all three large carriers.” Why cut prices if your rivals are guaranteed to beat you to the punch? And when AT&T does propose significant rate reductions for certain services, MCI and Sprint are not above whining to the FCC and, when the FCC is insufficiently responsive to their gripes, to the courts.

Judge Greene’s court and the Antitrust Division of the Justice Department pour salt into consumer wounds. According to MacAvoy, the Baby Bell operating companies (BOCs) would vigorously compete for long-distance customers and, hence, disrupt the current pattern of coordinated price-setting between the three large interexchange carriers. But the law effectively prohibits BOCs from entering that market. MacAvoy ably explains the foolishness of the antitrust concerns used to rationalize keeping that market off-limits to potential entrants.

Regrettably, the ballyhooed Telecommunications Act of 1996 does little to liberate consumers from rentseekers’ clutches. Despite rhetoric to the contrary, the act erects a labyrinth of rules, a “checklist” to be navigated before any BOC can supply long-distance service. Regulators must prevent BOC entry into long-distance markets until the regulators conclude that there will be no injury to competition. MacAvoy writes:

What has resulted is a regulatory rendition of Waiting for Godot. The great wait for competition in long-distance telephone services now has to be focused on competition being realized first in local telephone services. Such a prolonged process is an unnecessary burden on consumers and a charade. Consumers lose because the entry of BOCs into long-distance markets has a low probability of causing competitive harm and a high probability of producing lower prices. The checklist is a charade because complying is sufficiently complicated to require years of litigation before the FCC and state public utilities commissions. The ultimate explanation for such a process must be based on the incentives facing those agencies—if the Baby Bells could meet checklist requirements quickly, or if there were no requirements, the regulators would put themselves out of business.

MacAvoy is justifiably pessimistic about the prospects for any BOC to clear the regulatory barriers in time to compete against the incumbent long-distance suppliers.

MacAvoy’s case that regulators create substantial rents for long-distance carriers is convincing. So why the barrage of long-distance commercials given that completely successful cartels have little need to advertise for customers? It seems fair to say that the advertisements cascading today over American airwaves are much like the toasters that banks gave away before the repeal of Regulation Q (the maximum interest rate banks lawfully could pay on deposits)—they represent a diversion of competitive efforts away from price cutting into promotion. Current promotions show the potential among long-distance carriers to compete in ways that consumers would prefer—that is, by cutting prices—if only regulators would stand aside. I wonder how much of the difference between long-distance suppliers’ prices and incremental costs is spent on advertising and how much of that would be better spent on price reductions.

Read MacAvoy’s book for at least two reasons: first, to rid yourself of the notion that long-distance supply is now competitive; and second, to learn just how crafty and self-righteous regulators and rentseekers can be as they pilfer wealth from unsuspecting consumers.

Donald J. Boudreaux is an associate professor of law and economics at Clemson University and a research scholar at the Competitive Enterprise Institute.

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