Like a sprint through molasses, the battle over implementation of the6 1996 Telecommunications Act continued this week as the Supreme Court heard arguments in Verizon v. FCC.  This case, largely unreported in the major media, has major implications for the future of the telecommunications industry.  It also shows the pitfalls of government attempts to create competition through regulation.

At issue are the rates incumbent local telephone companies charge competitors for access to their existing networks.  Under the Telecommunications Act, local telcos were required to let competitors use certain parts of their networks, such as switches, in order to jumpstart competition.  But the terms and prices of this access were left ambiguous, for state and federal regulators to decide.

After considerable regulatory scuffling, the FCC came up with a method for setting rates called “Total Element Long-Run Incremental Cost,” or TELRIC.  Rather than depend upon historical “book” value of the assets deployed, the idea was to figure out what the cost of an up-to-date, efficiently run, network should be, and let telephone companies charge only that amount.  The net effect was to reduce charges by about half from their book-value-based level.

The system looks fine on a blackboard.  After all, in a competitive market, firms are limited by such “forward-looking” costs.  If you rent out an apartment, for instance, it doesn’t matter how much you paid for the building; the current realities of the marketplace sets the rent.

But in telecom there was no competitive market.  Instead, regulators set about creating a hypothetical “efficient” telephone system, making decisions about the best technologies, the proper functionalities, and the ideal configurations of assets.  It was the ultimate regulatory conceit, a belief that if you got enough engineers and economists in the room you could replicate the results of a competitive marketplace.  (Not too subtly, Alfred Kahn has dubbed this blank-slate approach “TELRIC-BS”).

Moreover, by attempting to reproduce the results of a competitive market, regulators sabotaged the chance that one will ever be created.  After all, if a new company can lease parts of the existing network at the costs of hypothetical perfectly efficient competitors, why would it ever build facilities of its own, with all the messy risk that these might turn out to be less than perfect? And why would an incumbent invest in new facilities that it must then lease out at a perfection-based rate?

Difficulties in implementing TELRIC, magnified by endless litigation, have mitigated the adverse effects to date.  Moreover, the recent telecom stock meltdown has hurt prospects for all new ventures, TELRIC-based or not.  But when the economy does pick up again, TELRIC will remain a presence, discouraging investment in new facilities.

The telcos’ challenge to the rules is based on a number of grounds, including a claim that TELRIC constitutes an unconstitutional taking of private property.  The claim has some merit – even regulated utilities have property rights.  The Supreme Court, however, may be reluctant to step too far into this briar patch, not wanting to drown in a sea of regulatory accounting issues.

In the end, the Court may simply affirm what the appeals court said in this case last summer, throwing out (on statutory, not constitutional grounds) the current version of TELRIC as too hypothetical, but stopping short of requiring use of historical costs.

That would throw the whole issue back to the FCC for another round of rulemaking, yet again prolonging this regulatory soap opera.  Strangely enough, however, if the resulting uncertainty encourages potential competitors to build their own networks rather than rely on mandated access to the current system, this could be good news for consumers.