Regulatory Institutions | Concluding Remarks

The received paradigm for telecommunications regulation is being called into question. The traditional oversight of telecommunications operators by national regulatory agencies (NRAs) no longer seems appropriate. Examples of timely questions about the structure and the scope of regulatory institutions include these: Should telecommunications regulators be specializing in that industry, or should we opt for multisector regulators as in Australia? How much regulation should be conducted at the federal level and how much at the national or state level? Should we give up regulation and, as in New Zealand, rely on competition policy?

The economics literature does not provide a systematic analysis of these important questions, which lie beyond the scope of this book. We content ourselves with a mention of the general issues and with a discussion of some of the trade-offs involved. We start by listing some factors that have led to the current concern about the adequacy of existing structures. We then discuss potential institutional reforms of the regulatory structure, and we conclude with a discussion of the possible substitution of competition policy for regulation.

1 Unsettling Factors: Innovation, Convergence, Proliferation of Operators, and Globalization

The traditional paradigm for utility regulation rests on the regulation of a well-defined set of services offered by a well-identified operator (or small group of operators) in a well-circumscribed geographical area. Recent evolution in telecommunications has shattered each of these foundations:
  • Innovation: While plain old telephone services (the POTS) such as local, long-distance, and international calls remain important sources of revenue for the operators, new services (the PANS) keep gaining prominence. Furthermore, marketing innovations change the pricing structure of POTS. As was discussed in chapters 24, neither price-cap regulation nor older regulatory approaches are at ease with either rapid technological progress or complex nonlinear pricing and discriminatory tariffs.
  • Convergence: It is commonplace to note that the telecommunications, broadcasting, and computer industries are coming together. Fundamentally, audio, video, voice, and Internet data are digital bits, ones and zeros. Internet service providers are starting to offer broadcasting and IP telephony. Broadcasters are entering Internet provision and offer telecommunications services. Telecommunications operators offer Internet access and services and want to enter the video-on-demand and cable markets. Convergence means that new players from formerly distinct industries have entered telecommunications: electronic publishers, broadcasters, Internet service providers, content creators, software companies, hardware companies, . . . The new players are either unregulated (as in the case of information technology) or else regulated by different regulatory bodies (as for broadcasting). This fact raises issues of licensing, standards, level playing field with traditional operators, and coherency of the overall regulatory approach
  • Proliferation of operators: Similar issues are raised by the entry into telecommunications of utilities and franchisees overseen by other regulatory bodies. Recently, water companies, cable operators, railroads, power companies, and highway franchisees have provided infrastructures to telecommunications entrants or have become operators themselves. The multiplicity of regulators raises issues of regulatory competition, cross-subsidization, and commitment.
  • Globalization: It becomes more and more obvious that the "right" geographical boundary for telecommunications regulation is unlikely to coincide with political boundaries. While some markets, such as international fixed and mobile telephony and global corporate services, have long been understood to be international in nature, the trend is accelerating; for example, Internet services truly represent worldwide markets. Yet, much power still resides at the "local" level (member states in the European Union due to the subsidiarity principle; states in the United States, although the FCC has substantial control rights). A fortiori, there is no worldwide regulatory body. The imperfect overlap between the operators' geographical coverage and their regulators' geographical jurisdiction raises issues of regulatory externalities as well as competency and regulatory arbitrage (or forum shopping in which operators seek the most lenient treatment).


2 The Structure of Regulatory Institutions: Theoretical Considerations

We content ourselves here with a mention of a few theoretical contributions to serve as a guide for the interested reader. We do not go into the arguments in any detail; nor do we assess their relevance for the forthcoming telecommunications environment.

2.1 One versus Several Regulators

Were regulators well-informed and benevolent, their number would not matter much. Regulators would always coordinate to achieve what's best for society. In practice, though, regulators, like other economic agents, are self-interested. They, like anybody, must be provided with incentives to become (economic and technological) experts, to think hard about specific regulatory issues, and to shun putting their career concerns or the stakes of their favored interest groups or causes first.

The presence of multiple regulators raises a concern about the coordination of their decisions. Several recent theoretical approaches, though, have stressed some benefits obtained by splitting the regulatory tasks among several regulators. The first motivation is benchmarking. Regulatory policies in different states in the United States or different member states in the European Union are often compared. From a theoretical perspective, provided that the information acquired by the regulators in their activities is correlated or that the performances on the tasks they oversee are correlated, having several regulators enables a form of yardstick competition among the regulators. This benchmarking is effective if regulators do not collude. Second, having specific industry regulators enhances their technological expertise, although it may facilitate their colluding with the industry. Third, splitting regulatory tasks may inhibit capture by the industry. Fourth, the provision of incentives within government agencies is often facilitated by focused missions and by the creation of advocates.

Last, we should note that, all along, we have assumed away subsidies from outside the telecommunications industry. While realistic, this is not an obvious assumption. Theoretical finance has always stressed the benefits from a broad "tax base" that permits spreading the distortionary burden of tax finance. In this book, we have assumed, for example, that the fixed costs associated with local loop provision must be financed through markups on various telecommunications services, but not on non-telecommunications-related goods and services; that is, we have artificially constrained the number of commodities that can be "taxed" by the telecommunications industry. While this approach seems reasonable, it can be vindicated only by a theory of political institution design relating incentive considerations and the separation of powers.

2.2 Federal versus State Regulation

The centralization of regulation at the federal level would appear to be the leading contender for institutional design because it eliminates competition between and externalities across regulatory bodies. As for the broader issue of the optimal number of regulators, though, things are more complicated. The arguments cited in the previous subsection apply with appropriate reinterpretations. For example, decentralization may give control rights to more accountable bodies. Or, adapting to decentralization an argument made by in favor of privatization, decentralizing information-collecting rights may create an information barrier and prevent nonbenevolent federal politicians from unduly interfering with business; relatedly, decentralization is sometimes justified by the lack of commitment at the federal level.

2.3 Competition Policy versus Regulation

In view of the difficulties involved in regulating the new telecommunications environment the old-fashioned way, one may rationally consider substituting competition policy for regulation. Indeed, there are some signals in the Anglo-Saxon world that point in this direction. The Merger and Monopoly Commission in the United Kingdom and the Department of Justice and the courts in the United States have intervened in the telecommunications industry in order to promote competition. And the New Zealand telecommunications regulatory agency has been abrogated altogether, leaving the regulatory task to competition policy. Another signal of the growing influence of competition policy is provided by recent Internet cases, which involve a worldwide market without any regulator.

Let us say right away that there are many forms of regulation as well as various approaches to antitrust enforcement, making it difficult to provide a clean comparison of "antitrust" and "regulation." Furthermore, there are alternative techniques of (what we will label generically) "industry oversight." For example, compulsory arbitration in which the parties must defer to a designated arbitrator if they fail to come to an agreement is sometimes proposed as a way of regulating interconnection.

While they differ in several respects, the premises of antitrust and regulation are roughly the same. Industry oversight aims at promoting economic efficiency. Regulatory agencies, although not competition officials, are often further instructed to perform redistributive functions across consumers and across geographical areas, although there is some debate as to whether such redistribution should be performed through the regulation of the telecommunications industry rather than by other means. In contrast, competition policy is a priori not meant to perform redistributive functions, which are left to other government agencies; therefore, cross-subsidies are often more transparent under a competition policy regime.

Another point of convergence between antitrust and regulation is that they strike the same rocks: lack of information about costs, demands, and competitive pressure; capture by interest groups; limited commitment ability.
A third point of convergence is that both use an advocacy process. The enlistment of advocates helps reduce the informational handicap faced by the industry overseer.

Let us now come to a couple of lines of departure between competition policy and regulation:
  • Procedures and control rights: By and large, regulatory agencies have wider control rights than competition agencies and courts. Competition policy assesses the lawfulness of conduct. In contrast, regulatory agencies engage in detailed regulation of wholesale and retail prices, profit sharing, and investments, and impose lines-of-business restrictions.
    Furthermore, courts are subject to stronger consistency requirements than regulatory agencies. They must refer to the decisions of other courts and apply criteria that are uniform across industries.
    To be certain, regulatory discretion is limited by procedural requirements, by statutory limits on the ability to commit in the long term, by safeguards against regulatory takings, by legal constraints on the mode of regulation (e.g., price cap, rate of return, nondiscriminatory, and cost-based regulation of access), and by the parties' possible resort to courts among other things. But, as a first approximation, it is fair to say that regulatory agencies have more extensive powers than antitrust enforcers.

  • Timing of oversight: By and large, competition policy operates ex post (after the fact), with the exception of merger control (in this sense, a merger task force bears strong resemblance to a regulatory agency). Conversely, regulators operate ex ante by defining the prices of utilities or the rules for the industry, with the exception of the ex post disallowance-of-investments process. The judicial process is a lengthy one, while the regulatory process can (must) be more expedient.
    The difference in timing (ex post versus ex ante) has a couple of implications. First, the players in the telecommunications industry perhaps face more uncertainty under competition policy (this effect may be offset by the larger discretion enjoyed by regulatory agencies, as discussed earlier), since, under regulation, the uncertainty is partly resolved before operators take their private decisions. Second, antitrust enforcement benefits from the late accrual of information. That is, what constitutes acceptable conduct may become clearer after the fact.
    Perhaps the implication of all this is that the decision rights endowed upon regulatory agencies and antitrust enforcers have a different nature. Regulators define ex ante a set of feasible moves for operators. Antitrust enforcers, in contrast, check ex post that anticompetitive moves in the feasible set were not selected.

  • Information intensiveness and continued relationship: Regulators often have expertise superior to that of their antitrust counterparts, although the use of specialized courts and antitrust officials tends to reduce the informational wedge between the two. This wedge has three origins: Regulatory oversight is industry specific; antitrust enforcement is not. Regulators have long-term relationships with regulated firms; antitrust enforcers (Judge Greene notwithstanding) do not. Last, regulators have larger professional staffs as well as continued procedures of data collection.
    The relative shortage of data available to antitrust enforcers implies that they are usually more at ease with cases based on qualitative evidence (price discrimination, price fixing, vertical restraints, . . . ) than those based on quantitative evidence (predation, tacit collusion, access pricing, . . . ). In contrast, regulators are more at ease with quantitative evidence, which they often use to set very detailed regulations, as in the case of cost-based pricing rules.
    There are costs of being too well-informed, though. Too much information about profitability, for example, coupled with limited commitment power, aggravates the ratchet effect (which, recall, ex post penalizes operators who have proved efficient or have invested). Furthermore, to the extent that expertise is partly associated with the existence of a long-term relationship between the regulator and the industry, expertise may also be correlated with a higher risk of capture by the industry.

  • Political independence: Although many regulatory agencies are in principle independent of the political power, they probably are less so than courts. In effect, politicians exert some influence on the so-called independent agencies through the appropriation process and through nominations. The costs and benefits of agency independence transcend the telecommunications industry (for example, they have been much discussed in the context of central bank independence) and are well known. The cost of independence is a certain lack of accountability. Its benefits are that regulators are less concerned about the electoral impact of their decisions and therefore less biased in favor of domestic firms or powerful interest groups, and, to the extent that they include fewer political appointees, their staff may be more professional.
    Our view is that in the context of network industries, independence (of regulatory agencies or courts) is a virtue. Regulatory decisions in the telecommunications industry are usually very technical for an outsider, and their economic impact is unlikely to be understood by the public. For such industries, the political accountability mechanism is unlikely to operate well.

3.1 Toward the Demise of Regulation?

We have stressed a number of shortcomings of the regulatory framework in the new telecommunications environment. Our brief overview of the comparison between antitrust and regulation is insufficient to conclude that antitrust should substitute for regulation, even though we feel that competition policy should be given a more prominent role in the overall process.

Consider a key issue treated in this book: interconnection policy. Reaching good decisions in the matter requires (1) a sophisticated understanding of the economics of network interconnection, (2) technological expertise, and (3) some or a lot of cost and demand information (depending on the approach). Unsurprisingly, traditional antitrust enforcement has been ill at ease with the few access-pricing cases it confronted, despite a well-established practice of dealing with essential-facility cases.

Besides, antitrust enforcement and regulation need not be incompatible, even though their coexistence may jeopardize the coherency of the oversight institution. Several cases can be made for their complementarity: reduction in the scope for capture, creation of more focused missions through the separation of tasks, and reduction in the incentives for "cover-ups" through a separation of ex ante (regulation) and ex post (antitrust) decisions between two unrelated players (regulatory agency and antitrust enforcers).
In fine, what matters most is not the labels one gives to industry overseers, but rather their attributes: expertise, information, independence from politics and industry, commitment ability, and overall organization of the oversight process. We leave a more detailed investigation of the industry oversight process for future research.