Like the hapless daycare provider to a hyperactive toddler, the FCC is grappling with the complexities of price regulation in telecommunications.  Under the 1996 Telecommunications Act, incumbent local phone companies (the ILECs) are under a mandate to share their networks with new entrants (competing local exchange carriers, or CLECs).  The perennial question is, if negotiations and arbitrations fail, at what price?  The FCC has found that its first answer, total elemental long run incremental cost (TELRIC-- a price based on the cost of a hypothetical, perfectly efficient future network), has raised some thorny problems, many of which are being revisited in the present TELRIC proceeding.  But perhaps the most interesting question of all has been neglected.  Why do so many negotiations and arbitrations between ILECs and CLECs fail?  Put another way, why has no wholesale market in local phone network access emerged?

 

Some might say that’s a stupid question.  Many (not all) CLECs are small, haven’t built their own networks yet, and start with a zero customer base.  In negotiations, then, another phone company has little to gain from dealing with them.  Unless and until bargaining positions are equalized, negotiations won’t get off the ground.

 

But that pat answer is way, way too simplistic.  First, the Telecom Act was supposed to offer the ILECs a nice carrot, access to long distance phone markets, if they granted access on reasonable terms.  Second, more significantly, negotiations between little-or-nothing-to-offer carriers and their larger competitors do succeed in some markets.  Internet peering and transit arrangements are a good example.  These are the deals that ensure that an email that starts out on one network (AT&T’s, say) can travel safely to another (Earthlink’s, say).  The Internet’s predecessor defense and academic networks started out under a general interconnection mandate. But voluntary negotiations set the terms.  A radical equalitarian might object to some arrangements (in general, big companies “peer” with each other mostly for free since the traffic loads balance out, little ones pay for “transit”), but it runs way more smoothly than the regulated telecom world.  

 

So a more sophisticated answer to the question of why the wholesale market in local phone network access is so slow to get off the ground is clearly necessary.  For a start, here are some plausible partial answers:

 

·        Maybe the Act’s “carrot” theory was just too late; with long distance revenues falling, entry into the long distance market just isn’t that enticing a prospect.  (The losers here?  Consumers who could have benefited from additional long distance competition).

 

·        Or maybe TELRIC, which both ILECs and CLECs know will be the default price if negotiations fail, is just so enticing to one side that good faith negotiations are impossible.

 

·        Maybe the fact that ILEC/CLEC arbitrations under the Telecom Act are not final but can be appealed to state regulators tempts one or both sides into gaming. Economist Pablo Spiller has urged that disputes between carriers be booted into final fast-track arbitration to avoid this (see his contribution to Regulators' Revenge and other articles). 

 

The problems that the FCC has raised in its TELRIC proceeding are important ones, and we wish the agency the best of luck in dealing with them.  But in the big picture, the most important thing is how to transition away from price controls to real markets.  And quickly—as with a toddler, by the time one gets the hang of things at square one, the toddler is a teenager.  The FCC was quick to grasp the advantages of long-run pricing (serious questions about its relevance to today’s investment incentives aside).  But can the agency, or Congress, offer a long-run regulatory policy?