Telecommunications

by John Haring
About the Author
Telecommunications matters economically for two reasons. First, it plays a role perhaps second only to brain power in the operation and rapidly expanding productivity of the modern “information-based” economy; indeed, it supplies a primary technical means for productively harnessing the information and knowledge spread among individual economic actors throughout the global economic order. Second, the evolution of telecommunications from a “natural monopoly” to a more competitively structured industry has raised many challenging economic issues, the analysis and resolution of which are important in their own right and relevant to other sectors of the economy as well.

There’s No “There” Anymore ... Only “Here”

Information and communications technology plays an increasingly important role in the wealth of nations. Adam Smith’s theory of economic growth emphasized the “division of labor” (i.e., productive specialization), and he argued that growth through the division of labor was limited by “the extent of the market.” Thus, he favored extension of markets overseas and expansion of trade as practical methods of extending market boundaries, and thereby the scope available for further division of labor. Improvements in maritime navigation and the development of the steam engine and rail transport were important because they increased the size of economically relevant markets, thereby fostering greater productive specialization. Increases in market size also encourage economies of scale and scope and more intense competition among buyers and sellers.

Just as improvements in transportation during the Industrial Revolution expanded the breadth of markets, so also recent improvements in the availability of information and the ability to communicate are expanding markets by making buyers and sellers aware of each other. High-quality transportation and communications sometimes make physical distance irrelevant: a buyer and seller may be thousands of miles apart but still figuratively “next door” (see spatial economics).

At the turn of the twenty-first century, the U.S. economy experienced a jump in productivity growth, with productivity increases about 0.2 to 0.4 percentage points above the long-term trend. While the causes of this productivity surge are still debated, many economists believe it is due to the spread of increasingly economical and powerful information movement and management technologies throughout the economy.

A Network of Networks

The fundamental economic reform that has altered telecommunications is the introduction of competition into what had previously been a closed monopoly. In the United States, governments monopolized and regulated private telephone companies; in most other countries, governments owned and operated a monopoly telephone network.

Privatization and deregulation (see Regulation) have produced substantial productivity increases, a proliferation of service offerings, and many service innovations. In the United Kingdom, for example, the British Post Office–run telephone company, prior to privatization, employed two to three times as many workers as were employed in the United States to maintain ten thousand access lines (a standard industry measure of productivity)—so there were huge gains to be reaped from privatization and deregulation simply by attaining productivity standards previously realized only by privately owned companies in the United States. Efficiency gains by U.S. telephone companies have also been quite substantial in the competitive era, although not as great as those experienced in many initially privatizing countries.

Before this revolution away from monopoly, governments typically sought to promote widespread (“universal”) telephone service by keeping long-distance rates high—sometimes as much as 100 percent above cost in the United States and even more in some foreign countries—and using, or, in the case of private phone companies, requiring the phone companies to use, the revenues from long distance to subsidize line rentals. To put this into perspective, imagine that the government decided that everyone should have a fine automobile and subsidized a BMW purchase for every household—and then paid for this largesse by imposing an additional two-dollars-per-gallon gasoline tax. Everyone has a nice car under this program, but most cannot afford to drive it long distances; likewise, virtually everyone had a phone, but long-distance calls were a luxury item for most consumers.

The artificially high-priced service, long distance, supplied an attractive target for competition, which is where the initial competitive forays in telecommunications occurred virtually everywhere. The subsidized service—local line rentals—offered a less attractive target, although wireless services provided a means to offer a competitive service without the need to duplicate the existing wireline carrier’s network of dedicated subscriber lines. U.S. regulators tried to have their cake and eat it too by attempting to promote competition for line rentals and related services at the same time they prevented the relevant service prices from rising to efficient levels. The result has been the proverbial “incomplete success” and a series of judicial reversals as the appeals courts have rejected the government’s program.

Counterproductive Regulation

One method governments in most countries have used to spur competition is to require that different networks “interconnect” and exchange traffic with one another. Network interconnection requirements enable subscribers to use different, competing networks to communicate with one another. If subscribers to a new network cannot communicate with subscribers to the incumbent’s network, and if most subscribers are on the incumbent’s network, entry may be difficult.

But such requirements can also hobble competition, depending on the specific terms and conditions of interconnection adopted. When a new network service is introduced, one way firms may compete is by connecting subscribers and offering the ability to communicate with a larger number of people than competing networks offer. An interconnection requirement that does not adequately reward productivity (completing calls and/or providing effective service) can reduce rivalry and the incentive to extend network coverage. Why build out if others have already done so and must share what they have built on generous terms? Government requirements to interconnect for terms that are too generous to the user can thus actually deter deployment of competing facilities.

Indeed, this has been the principal flaw in U.S. government policy. U.S. regulators went far beyond simple interconnection requirements and attempted to give would-be competitors access to the incumbent operators’ local network facilities and services on highly favorable terms. On the one hand, this encouraged many firms to try to compete with the incumbent network operators—indeed, so many that the market was effectively “spoiled” and most failed. On the other hand, the policy of low-priced access to the incumbent’s facilities and services discouraged investments in new network facilities, including upgrades in the incumbents’ own productive facilities. Why should a cable television system operator contemplating investment in a network upgrade that would allow telephone as well as cable services undertake such an investment when it might be undercut by competition from resale or repackaging of incumbent operator offerings at a huge discount? Or consider an incumbent telephone company that is considering deploying new “broadband” networks with huge information-carrying capacity; such a company could compete more effectively with the high-speed Internet and multichannel video services offered by cable system operators. But why would it do so if governmental “sharing” requirements make it effectively impossible to profit from such deployments?

The competitive revolution in telecommunications has placed substantial stress on the governmentally administered pricing structure. This pricing structure attempted to satisfy various political imperatives (notably, subsidized local service, especially to rural areas of the country) bearing little relation to economically efficient pricing. Such policies depend critically on closed markets; when markets are open, consumers can exercise “tax avoidance” strategies by turning to new, untaxed services. Voice-over-Internet-Protocol (VoIP) supplies a salient current example. VoIP supplies an increasingly effective substitute for telephony voice service, particularly for international long-distance calls whose prices in many instances remain wildly out of whack with relevant costs of production. VoIP permits users to complete telephone calls over the Internet without paying the taxes imposed on “plain old” telephone service. With widespread deployment of high-speed, broadband transmission capabilities, VoIP would supply an attractive substitute for conventional telephony and effectively doom the government’s system of administered prices.

Policymakers typically recognize this sustainability problem, but often try to “solve” it by extending taxation to new services rather than withdrawing it from old ones. Indeed, “reform” in this area has often resulted in increases rather than reductions in tax burdens. One such example is the “Gore tax,” named after former vice president Al Gore, that taxes users of various telecommunications services to subsidize installing computers in schools.

The Invisible Resource

While regulatory efforts to “create competition” through duplication or partial “socialization” of existing wireline networks have produced mixed results in the United States, “intermodal” competition, especially through development of wireless networks using the communications “carrying capacity” of the electromagnetic spectrum, has expanded tremendously. Here, too, it is difficult to credit the “visible hand” of government with a salutary influence. Jeffrey Rohlfs has conservatively estimated that the FCC’s more than decade-long delay in licensing cellular telecommunications cost the U.S. economy more than eighty-six billion dollars—an amount that approximates the magnitude of the government’s cost of the infamous savings and loan industry bailout (Rohlfs et al. 1991). Rohlfs’s estimate results from measuring what the economic value of cellular telephony turned out to be and evaluating the worth of realizing those benefits sooner rather than later. Using a less conservative valuation procedure, MIT economist Jerry Hausman (1997) has estimated that regulatory delays in licensing cellular systems and in approving Bell company offerings of voice messaging in the United States cost consumers as much as fifty-one billion dollars per year for each year of regulatory delay.

Economic arrangements for spectrum management in the United States are similar to those adopted elsewhere: the FCC defines, assigns, and polices spectrum resource rights. These rights have two important characteristics. First, the government usually determines the use(s) to which operating rights may be put with a high degree of specificity. For example, a license might authorize a radio broadcast service or a microwave service. Significantly, the rights holder is legally precluded from using the assigned rights to supply a different service from the one(s) specified, although that might well be technically feasible and more valuable. The FCC has in recent years begun to afford more flexibility in use of assigned rights: it allowed Nextel, for example, to use spectrum operating rights designated for supply of various work-group communications services to provide a wireless telephony offering.

Second, government defines rights primarily in terms of the inputs that may be used. For example, a radio broadcaster is licensed to transmit from a specific location and height with a specific type of transmitter with a specific amount of power for a specific number of hours per day. There is often an active market in rights so defined. Allowing licenses to be bought and sold leads to productive efficiencies by encouraging investment and facilitating rights acquisition by those who can use them most productively.

However, these licenses are sold within a system of spectrum governance that remains substantially one of “command and control” similar to that of the now-defunct Soviet economy. The central government defines the ends to which specific means can be deployed, and it “solves” the problem of “chaos in the airwaves” through close coordination and control of the inputs used to exploit the resource space. Its ability to adapt to changes in demands for spectrum outputs and technological capabilities is severely limited. The relevant government bureaucracies have little incentive to adapt, and, similarly, the legal processes and administrative procedures are fairly inflexible. Also, the specific methods of rights definition and enforcement that have been adopted are inflexible.

For more than forty years, economists have advocated “market-based” reforms of this regime, ideas the FCC itself has now begun to entertain as the resource has be-come more valuable and the government has begun selling it to the highest bidder. Rights might be “flexibly” defined, allowing a user to decide the uses to which they might be put. Just as a farmer can respond to perceived changes in prices and demands by altering the mix of crops produced, a spectrum owner might respond to changes in market conditions by altering the mix of outputs produced with given operating rights. Rights might also be subdivided and traded, so that “parts” as well as the “whole bundle” could be transferred through voluntary market exchanges.

Another suggested management innovation would designate some spectrum space for “unlicensed” usage. Instead of treating spectrum as if it were analogous to real estate, the idea would be to regard spectrum communications carrying capacity as more akin to roadways. Operating rights might be instantaneously assigned, as are rights-of-way on a highway, via various operating “etiquettes” or “protocols” and/or collection, using ingenious technical means, of usage tolls set to reflect instantaneous scarcity values.

The important advantage of these approaches is that they capitalize on “local” information about prevailing conditions of Supply and demand and do not rely on a distant central authority believing that action is warranted in particular local circumstances. Just as it is inefficient for an economic czar to decide how many acres, and which acres, should be devoted to growing beans, it is also inefficient for a central authority to decide how much spectrum, and which spectrum, to use for, say, FM radio or the specific use of a particular communication path at a particular instant.

Flexibility and free exchange depend on the ability to define rights in terms of transmission effects (i.e., interference) rather than, or in addition to, specification of the permissible inputs that may be used, as is largely the current practice. While this redefinition may be difficult to implement, the potential payoffs from allowing a free-market allocation of the radio spectrum would be even larger. Consider the potentially burgeoning markets for various wireless communications service applications, including high-speed wireless Internet access, “third-generation” wireless, “wi-fi,” and so on. Where will the spectrum “carrying capacity” to implement these applications be found? More effective husbanding of the “invisible” spectrum resource is one entirely plausible source of new supply. This is a case in which experimentation and implementation of test trials to gauge the market approach’s efficacy would likely be far more illuminating than a plethora of paper pleadings before the FCC. The FCC’s Spectrum Task Force has now arrived, in intellectual terms, where economists were forty years ago. As Mae West observed: “He who hesitates is a damned fool.”


About the Author

John Haring is a consulting economist based in Great Falls, Virginia. He was formerly chief economist of the Federal Communications Commission and chief of the commission’s Office of Plans and Policy.


Further Reading

Coase, Ronald. “The Federal Communications Commission.” Journal of Law and Economics (October 1959): 1–40.
Gordon, Robert J. “Does the ‘New Economy’ Measure Up to the Great Inventions of the Past?” Journal of Economic Perspectives (Fall 2000): 49–74.
Hausman, Jerry. “Value the Effect of Regulation on New Services in Telecommunications.” Brookings Papers on Economic Activity, Microeconomics. Washington, D.C.: Brookings Institution, 1997.
Jorgenson, Dale W. “Information Technology and the U.S. Economy.” American Economic Review (March 2001): 1–32.
Jorgenson, Dale W., and Devin Stiroh. “Raising the Speed Limit: Growth in the Information Age.” Brookings Papers on Economic Activity. Washington, D.C.: Brookings Institution, January 2000.
Kahn, Alfred E. Whom the Gods Would Destroy, or How Not to Deregulate. Washington, D.C.: AEI-Brookings Joint Center for Regulatory Studies, 2001.
Litan, Robert E., and Alice M. Rivlin. “Projecting the Economic Impact of the Internet.” American Economic Review, Papers and Proceedings (May 2001).
Oliner, Stephen, and Daniel Sichel. “The Resurgence of Growth in the Late 1990s: Is Information Technology the Story?” Journal of Economic Perspectives (Fall 2000): 3–22.
Rohlfs, Jeffrey, et al. The Cost of Cellular Delay. National Economic Research Associates, Inc., 1991.
U.S. Federal Communications Commission. FCC Spectrum Task Force Report. November 2002.

Return to top