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    MILLER - Is Public Utility Concept Obsolete

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    LNIVERSITY 98 RQ CERSIN Bess Press ‘JourNaLs DIVISION ‘The Board of Regents of the University of Wisconsin System Is the Public Utility Concept Obsolete? Author(s): Edythe 5. Miller Source: Land Economics, Vol. 71, No. 3, Social Control of Private Power: The Past and Future of Public Utility Regulation (Aug., 1999), pp. 273-285 Published by: University of Wisconsin Press Stable URL: htip:/ivww jstor org/stablel3 146346 ‘Accessed: 08/06/2013 01:45 ‘Your use of the JSTOR archive indicates your acceptance ofthe Terms & Conditions of Use, available at utp//www jstororp/page/info/about/policies/terms jsp JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact support@jstor or. The Board of Regents of the University of Wisconsin System and University of Wisconsin Press are collaborating with JSTOR to digitize, preserve and extend access to Land Economics. ‘Ties coment dowatedes front 143.10.(54.1 Sat, Ju 201301 45.14 AM "Ait apt JSTOR Terms ad Is the Public Utility Concept Obsolete? Edythe S, Miller ABSTRACT. Public utility regulation is a uniquely ‘American structural innovation, and has evoked ‘ambivalence on the part of the public, and more particularly the economics profession, over the years ‘Almost from the time of its inception, diverse voices have sounded its death knell. While many of the arty critics of regulation, irrespective of philosophic bens, recognized that inherent structural conditions preclude the emergence of competition, contempo- rary critics urge that regulation be eliminated and replaced with competition or a competitive surro- ‘gate. The paper examines the opposing viewpoints ‘and current proposals for “regulatory reform” within the context of contemporary structural conditions. GEL L9) L. INTRODUCTION It often is noted that economics is highly metaphorical. Of the many metaphors cher- ished there may be none more powerful and enduring than that of “the invisible hand.” Attachment to this ideal, however, should not be permitted to obscure market reali- ties. Under certain conditions market forces are inadequate to protect against abuse; that is, structural patterns deprive the “invisible hand” of its ability to ensure optimal out- comes. The public utility concept and adminis- trative organization originated primarily in the United States to provide the social con- trol necessary to prevent abuse of private market power by firms providing essential services. Recognition of this potential for abuse today seems blunted. Indeed, adher- ence to the metaphor of the invisible hand may be stronger at present than at any time during the last sixty years. The economics profession consistently has manifested an ideological bias toward free markets. In the past, however, some diversity of thought was tolerated. Many ‘economists questioned unconditional adher- ence to noninterventionist positions, includ- ing members of the institutionalist school who played central roles in the development of a theory of public interest regulation (Trebing 1994, 200-10). The discipline to- day, in contrast, exacts ideological conform- ity. The contemporary academic literature is almost single-minded in its endorsement of laissez-faire. ‘The message of the academicians is echoed in virtually every public policy forum —judicial, congressional, even regulatory. Deregulation and decentralization are equated with competition, irrespective of market conditions. For example, the 1982 resolution of the antitrust suit against AT&T, divesting the local operating compa- nies, was widely heralded as “pro-competi- tive” because it was deintegrating in effect. Recent energy legislation is hailed because it is deregulatory and therefore perceived as, competitive. The price cap decisions of the Federal Communications Commission (FCC) and many state commissions are viewed as advancing competition because they eliminate or erode traditional rate-of- retum (ROR) regulation and provide for price “flexibility.” A recent California “wheeling” decision increasing direct access in electricity markets is proclaimed “a cru- cial step . . . to wider deregulation of the industry” and therefore to the achievement of “direct competition” (Pasztor and Kansas 1994, A13). In each of these cases the changed status is extolled irrespective of the relative market strength of affected parties. Yet market flaws remain; they have not, as if by some stroke of these magical pens, been dissipated. ‘The public utility concept is not obsolete. It is not obsolete because, despite the pre- vailing ideology, not all markets are effec- ‘The author is unaffiliated. Her most recent affilia- tion was with the Colorado Public Utilities Commis- sion, where she served as commissioner and chair- ‘woman. She is a past president of the Association for Evolutionary Economics, and was a recipient of the Distinguished Member Award of the Transportation and Public Utilities Group of the American Economic Association. Land Economics * August 1995 + 71 (3): 273-85 28 Land Economics tively or contestably competitive. Specific structural conditions preclude the emer- gence of competition, make an empty threat of potential competition, and thwart the op- eration of automatic market mechanisms. Market barriers prevent the entry that gives ;ning to the premise of competition. De- the continued viability of the public utility concept, however, its application cur- rently is at risk. II BARRIERS TO ENTRY IN PUBLIC UTILITY MARKETS ‘Among the barriers that impede the de- velopment of competition in public utility markets are the following: The industries are characterized by high threshold levels of investment, mandated at a minimum by the necessity 10 connect and/or interconnect all customers. They thus also will have as dis- tinguishing features the existence of sub- stantial sunk costs and a high fixed to vari- able cost ratio. The assets of public utilities, moreover, typically are substantially non- fungible. Incumbent providers have control ‘over essential bottleneck facilities, and uniquely are granted the power of eminent domain. jes typically serve a number ‘kets, with differing demand ies. Thus, for some part of the com- modity o service in question, demand will be highly price inelastic; that is, there will exist a high element of necessity in demand. In addition, the requirement that networks be constructed in advance of demand al- most ensures the existence of economies of scale, when demand is properly forecasted. Public utilities also are distinguished by the substantial utilization of joint assets. The use of joint assets for the production and distribution of multiple services ensures that joint costs comprise a significant pro- portion of total costs, and is a source of significant economies of scope. That is, in- vestment in joint assets permits the develop- ‘ment and distribution of multiple services at lower cost than if each service were re- quired to expend its stand-alone cost to construct for itself a self-contained means of operation. Moreover, the fact that net- ‘The content demanded mt 10310154 1 om Sat 8 21 Augast 1995 works essentially entail a large number of segments contributes to network economies of flow; the larger the number of segments included as part of a network, the greater the flow of traffic to all segments (Selwyn 1994, 22-24). ‘Additional impediments to the establish- ment of competition in the current indus- trial environment include the presence of significant excess capacity, a common char- acteristic of public utilities if only because facilities typically are constructed in ad- vance of demand. However, excess capacity in these industries may be more of a factor currently than in the past. For example, in telecommunications structural change has resulted in the installation of redundant networks by the various facilities-based car- riers. In the electric industry, a major thrust of the Energy Policy Act of 1992 is the creation of multiple sources of supply and the opening of the transmission network to the various supply sources. Public utility industries also are distin- guished by essential interdependencies, luding the requirement to coordinate across markets. As with other impediments to en- try, the need for coordination in these mar- kets is mot a new phenomenon; it has ex- isted historically. Conspicuous examples include interconnection in telecommu tions, interlining in transportation, and power pooling in the electric industry. How- ever, coordination requirements also appear to have increased in the current environ- ‘ment. For example, the authorization in the Energy Policy Act’ for the Federal Energy Regulatory Commission (FERC) to require mandatory wheeling is all but certain to increase the need for coordination as trans- mission increases. Public utility industries also historically have been characterized by the presence of t externalities. The individuals di- rectly involved do not bear all the costs or realize all the benefits of transactions. Un- der such circumstances, strictly private mar- ket considerations will not bring about op- timal results. Often recognized examples include: in telecommunications, the benefit of the service to all consumers is enhanced by the interconnectivity of the network; in ‘Ai ae spt STOR Terms ad Contam 7103) clectricity, the service is degraded by the simultaneous production of pollution asa by-product of the primary commodity. An additional factor inhibiting the establ ment of competition in public utility m kets is customer inertia and loyalty to cumbent providers and established brands. Conditions such as these, in varying combi- nations, generate or constitute significant barriers. It is important to recognize that these are structural, rather than merely legally imposed, barriers to entry and exit. Tt is demonstrably evident that public utility networks typically exhibit such char- acteristics. It is irrefutable that public utili- ties require high minimum threshold levels of investment because of the need to inter- connect consumers and the common prac- tice of constructing in advance of demand. Public utilities also are distinguished by a substantial reliance upon joint and common assets that yield important economies of joint service and product development. ‘These structural conditions also, however, give these entities significant strategic ma- neuverability that permits market domi- nance. For example, the fact that consumption in public utility markets is highly concen- trated gives firms the ability to segment markets and differentially price, favoring consumers with higher price elasticities of demand over relatively demand-inelastic consumers. Moreover, supplier vulnerability to the exercise of monopsony power (includ- ing the threat of bypass) enables high-use customers to extract price reductions and to achieve network improvements that advan- tage these influential groups. Indeed, monopsony power appears to be a driving force behind many developments in public utility markets today. For example, in gas markets, it appears to be the motive force behind current steps to “unbundle” transport and marketing functions and thus enhance the ability of industrial customers to secure low-cost sources of supply. In elec- tric markets, it seems to be a driving force behind steps to substitute price negotiation for price regulation, thus effectively achiev- ing a system of selective discounting, and behind decisions to permit high-use con- Miller: Public Utility Concept 25 sumers to pick and choose amongst sources of supply. This, in itself, gives to favoved classes of consumers the ability to abandon —or to threaten to abandon—the system, and to leave fixed and sunk system costs the responsibility of low-volume consumess, bo do not have this option. In telecommunications markets, sony power appears a primary factor behind many modernization programs. Moreover low-usage customers may be allocated a dis- proportionately high share of the cosis of network development. This occurs because irrespective of technical specifications for delivery of particular services, these assets nevertheless are jointly used to distribute the various services. ‘The stage thus is set for the implementa- tion of practices of market segmentation. cross-subsidization, and price discrimination that are self-sustaining and ensure market dominance and high profits. It should be noted that the existence of incentives such as these and the potential for their abuse ir public utility markets consistently has beer recognized in the institutional public utility literature. The existence of economies of scale im- plies that it is necessary for companies ‘te achieve a high minimum efficient market share (MEMS) to reach the minimum eff cient scale (MES) of operation. If the MEMS is more than SO percent of the market, onky one firm will have the ability to survive. I is more than one-third, the market will no: support more than two firms. This require- ment gives to incumbent providers an. im portant—what, in fact, may be an insur mountable—advantage over challengers Recent research indicates that many telecommunications markets presenthy are characterized by high MEMS (e.g... Setwon and Hatfield 1994). If competition is to sur vive, however, the MEMS must be low. Un der conditions involving a high MEMS, mar kets will, at best, be oligopolistic . It is important to emphasize the essentia! interrelationship and interdependence of these characteristics. It is evident that the existence of structural impediments pre vents the development of competition even in the absence of legal barriers. Structural 26 Land Economics imperfections make possible specific pat- tems of behavior that, in turn, exacerbate structural flaws and conditions of market concentration, The patterns of dominance that emerge constitute the interplay of the combined and interactive effects of interre- lated and interdependent strands of struc- ture, behavior, and performance The issue of the continued viability of the public utility concept will be explored fur- ther primarily in reference to telecommuni- cations, which provides vivid illustration of many of these conditions. IL THE CURRENT TELECOMMUNICATIONS ENVIRONMENT The contemporary telecommunications era may be viewed as having begun with the reorganization of the industry set forth in the 1982 Consent Decree and related orders that concluded the U.S. Department of Justice antitrust suit against AT&T. It is useful to delineate three trends—what may indeed be defining trends—of the cur- rent telecommunications era: diversification, modernization, and consolidation and con- centration. Diversification To begin with, the 1982 Consent decree freed AT&T from a prior agreement that had limited its activities to regulated com- munications. Among the more important additional provisions of the settlement was the divestiture by AT&T of its 22 operating companies. It is important to note that the companies were not to be divested as inde- pendent entities, but as parts of seven regional holding companies (RHCs). In an attempt to prevent the abuse of the monopoly bottleneck power acquired from AT&T, the RHCs were subjected to certain line-of-business (LOB) restraints. Specifi- cally, the RHCs were prohibited from pro- viding long distance service, engaging in the manufacture of equipment, or in the gener- ation or transmission of information ser- upon RHC investment in unrelated enter- August 1995 prises. In a related action, the Cable Act of 1984 prohibited the offering of video service by telephone companies through lines in their service areas. In short order, many of these restrictions were relaxed, Limitations placed upon investments in un- related endeavors and prohibitions in re- gard to information services were elimi- nated. The restrictions incorporated in the Cable Act also were substantially eased. Implicit in what was included and, more specifically, in what was omitted from the category of LOB restrictions, was that the RHCs were now permitted to offer through subsidiaries related and unrelated services that previously they had been required to offer only as part of their regulated opera- tions, or had not been permitted to offer at all. It also is important to note that the subsidiaries formed to offer such services generally were organized as unregulated subsidiaries of the parent holding company, rather than of the local exchange company (LEC). Initial diversification activities of the RHCs included activities that had been the province of the regulated LECs; for exam- ple, ownership of the profitable yellow pages and cellular operations were’ transferred from operating companies to parent holding companies. Domestically, the RHCs moved aggressively into a wide assortment of un- regulated activities, ranging from real estate to computer services to cable TV. They also moved forcefully into foreign markets, indi vidually and jointly acquiring and installing cellular and cable networks, purchasing large equity blocks in public telephone compa- nies, and engaging in myriad enterprises in geographic areas that spanned the globe. AT&T also moved assertively, diversifying into both domestic and foreign markets. That the process has not been solely a one- way international flow is demonstrated by British Telecom’s purchase of a 20 percent share of MCI. The magnitude and costs of these activi- ties raise a host of concerns about their consequences, most particularly in regard to the future of basic telephone service. The post-divestiture era ushered in an unprece- dented mixed mode of monopolistic-com- 7103) petitive, regulated-unregulated enterprise coexisting under one roof. The RHC sub- sidiaries formed after divestiture to provide nonutility service initially were required to be organized as operations that were fully separated from the LECs. While the ability of the initial separation requirements to protect against cross-subsidization is not undisputed, at the least the separation rec- ognized this as a possibility and attempted to prevent indemnification of the risky nonutility operations of the RHCs by basic telephone service. The separation requirements for the monopoly and competitive activities of these companies subsequently were relaxed. Sig- nificant questions of risk and burden shift- ing, present even when separation is re~ quired, are magnified with the easing of requirements. Deepening these concems, recent research reveals that a preponder- ance of the capitalization of RHC nonutility ventures derive from Bell LEC operations, which account for by far the major part of the assets, revenues, and carnings of the RHCs. The research finds a general pattern of diversion of funds away from the regu- lated to the nonregulated activities of the RHCs and, moreover, that most of the nonutility operations of the RHCs are ci- ther showing a loss, or generating very small returns. Indeed, it is found that in almost every instance these unrelated activities are substantially underperform- ing RHC utility operations (Selwyn and Montgomery 1993, 2) ‘These findings raise significant questions of cross-subsidization and of cost and risk shifting as between regulated basic ex- change and unregulated services. For exam~ ple, there is little question that the more speculative undertakings of the holding companies will increase the credit risk, and therefore the capital costs, of the parent company. The capital costs of the regulated entity accordingly will be increased above the levels, and those of the unregulated entity decreased below the levels, that would have prevailed if the borrowing activities of the unregulated entity had not taken place, or if the total cost of these endeavors had been assigned to the speculative enterprise. Miller: Public Utility Concept m It should be noted that such misgivings are not of recent origin, and. do not “apply uniquely to a contemporary era. Concerns about precisely this type of risk shifting have been expressed through the years by institu- tional public utility economists (e.g, Bon- bright and Means (1932] 1969, 198). Diversification carries the potential for additional types of risk and burden shifting. ‘The potential for diversion of capital, man- agement, and labor from the monopoly to the competitive side of the business exists. To prevent cross-subsidization it is neces- sary to avoid sharing of personnel. Even more difficult to avoid is the transfer of attention and enthusiasm from workaday utility activities to the more glamorous and technologically more sophisticated activities of the nontraditional endeavors. Telephone industry investment in nontra- ditional activities has been substantial. At the same time, RHCs are dramatically cut- ting local exchange costs. As part of the cost-cutting, and perhaps its major vehicle, industry-wide labor force reductions have taken place (e.g, Keller 1992, Al; 1994, A3; Cauley 1993, B6; 1994c, A3). To use the inelegant jargon of the day, wid “downsizing” and “rightsizing” (layofis), ac- companied by “outsourcing” (contracting out) is occurring. ‘The elimination of unnecessary jobs is an unexceptionable policy. However, if overen- thusiastic work force paring results in an inability to perform necessary tasks, the re- sult is the degradation of service; a decrease in efficiency in real, if not monetary, terms.' Moreover, if this occurs, cost burdens are not eliminated, but simply shifted. The bur- den is shifted, first of all, to the monopoly subscribers whose service quality suffers, and ee " Some quality of service problems currently may be emerging. For example, complaints of service degrada: tion in US West territory, including reports of substan- tial increases in “held orders” (telephone installation delays) and of substantial repair delays, have been 30 ‘numerous and insistent that the Colorado Public Utii- ties Commission has instituted an investigation (Zeiger 1994, 2C). It is difficult to determine if this is an isolated and localized matter, or a more widespread phenomenon. 28 Land Economies then to workers, both those who have lost employment, and those who remain and now are required to do much with little.* Modernization Recent advances in communications technology have both transformed. tradi- tional service and enlarged its menu of of- ferings. The use of digital and optical fiber technologies increase capacity, clarity, and speed of communication, and hold the promise of a near future provision of an array of interactive and multimedia (simul- taneous distribution of voice, data, and video ‘over the same transmission pathway) ser- vices. It is indisputable that these develop- ments have the potential to enhance the quality of life substantially. This should not be allowed to obscure the fact that there also exist some potential abuses. Not least of these is a strategic response made possi- ble by modenization. pe There is wide support within the tele- phone industry for the development of an integrated broadband fiber optic network. It is acknowledged that the capital require- ments of such a network are substantial. ‘Abandonment of the traditional copper plant is required. Informed estimates of the nationwide cost of construction range up- ward from $250 billion to $1 trillion. Supporters of such a system posit it as the optimal technology of the future, a means to secure dazzling new capabilities such as tele-medicine, tele-learning, tele- banking, tele-shopping, video-on-demand, and so forth, that promise to transform home life, and improve efficiency and productivity at the workplace. It also is asserted that the ‘economic efficiency thus achieved will en- hance the ability of this nation to compete in the “new global economy.” Lurking be- hind the technological wonders, however, are a number of controversial matters, in- cluding questions about whether particular technologies are required for specific ser- vices, the appropriate means of funding, and the identification of suitable providers. For example, it is clear that the existing copper plant remains satisfactory for the distribution of traditional services. However, aa August 1995 it is not entirely clear that it is not also serviceable for the distribution of new, ad- vanced services; that is, that construction of a prosdband, optical fiber network is neces- sary. Advances in compression have increased the capacity {and thereto the functionality for these purposes) of the existing copper plant. For example, asym- metric digital subscriber loop technology de- veloped by Bell Communications Research Corporation permits the transmission of video over copper wire, with sufficient spare capacity to carry voice communications (Carnevale 1993, Al). Further, an ‘integrated services digital network (ISDN) permits the transmission of voice, data, and video over the existing cop- per network. Required supporting invest- ‘ment requirements are on a much smaller scale than those for broadband and, more- ‘over, much of the necessary upgrade already has occurred. The telephone industry in re- cent years has been upgrading plant to digi- tal switching, transmission, and signalling. In the last five years, AT&T has invested almost $20 billion in digital switches, fiber optic lines, and high-capacity transmission ‘equipment (Keller 1993, Al). The RHCs, since about the mid-1980s, have invested more than $100 billion in network digitaliza- tion. They have not, however, widely de- ployed or offered ISDN; where offered, it seems targeted to a small number of busi- ness customers, at high rates (Selwyn 1992, 3-2). ‘An upgraded plant used for the provision of multiple services is characterized as joint investment, whatever the technical require- ments for specific services. The nature of the cost allocation process permits a large 2-The willingness of the RHCs to sell their rural ‘operations in the interest of cost contral provides @ possible ational example of cost shifting. The sale of Faral exchanges may be a harbinger of an overall ‘eetine in quality of service for nonurban segments of the population, 1t also may be viewed as a possible concomitant ov precursor fan erosion is pir enee to principles of universal serv tational, adheressteees te cont burden that Bas been shifted is no less real because itis qualitative and therefore immeasurable. 713) proportion of joint costs to be allocated to local exchange. Thus, modernization stands to be monopoly ratepayer-funded to a large ‘extent. Moreover, in the years since divesti- ture telephone companies have sought sub- stantial increases in rates and speed of recovery of depreciation, on grounds of technological obsolescence, despite the fact that the plant retains its serviceability for many purposes. Since divestiture, close to 90 percent of gross new rate base plant addi- tions has been funded by depreciation charges recovered from monopoly ratepay- cers (Selwyn and Hatfield 1994, 225-27), In addition, in the current environment there is no assurance that a new service will not be moved to an unregulated category if it becomes profitable, ensuring that monopoly ratepayers will be unable to capture future benefits. ‘The telecommunications industry has lit- tle to lose and much to gain by moderniza- tion. Not only will the replacement technol- ogy be substantially funded by monopoly ratepayers but the sophisticated new tech- nology also is essentially centralizing (Miller 1993, 35). The significant capital require- ments, assured excess capacity, high fixed and sunk costs, will constitute’ substantial barriers to entry for potential rivals. Consolidation and Concentration Telecommunications divestiture occurred in the name—perhaps even the spirit—of decentralization. It did not take long for patterns of recentralization to be estab- lished. First of all, the divestment of the operating companies in seven RHCs itself encouraged the endurance of preexisting market power. The Bell operating compa- nies (BOCs) were separated, not as the atomistic entities celebrated in economic myth and text, to which many of the as- sumptions posited by the mainstream might apply, but as power collectivities. Within their economic spheres, each RHC retained much of the market and strategic power of the former parent, including most notably, control over essential bottleneck facilites. Moreover, it is important to recognize that the political strength of the RHCs is at Miller: Public Utility Concept ra) least the equal of their economic strength. Their ability to wield political power and thus influence their economic environment should not be underestimated. For example, immediately upon the specification of the LOB restraints, the RHCs launched an intensive lobbying effort in almost every conceivable forum—national and state: leg- islative, judicial, and regulatory—for their elimination. Their use of the full arsenal of political weapons—financial contributions, extensive and expensive lobbying, employ- ment arrangements—to achieve this goal, is ‘well recognized and has been documented (Wartzman and Harwood 1994, Al). ‘The RHCs advocate for the elimination of the LOB restraints in the name of com- petition and efficiency. They maintain that ending the restrictions will increase compe- tition by increasing the number of providers. There is little doubt, however, that the as- sumption that an increase in the number of providers will increase competition does not hold when one of the providers has the built-in advantage of the use of monopoly snues to cross-subsidize competitive ac- ities. It is evident that the RHCs do not be- lieve that the LOB restraints are perma- nent, and are doing all within their power to make of this a self-fulfilling prophecy. The expectation has led to employment of a number of tactical maneuvers. The pace of development and deployment of ISDN is within the control of the RHCs. It is reason- >For example, there have been introduced in Congress a succession of bills promulgated by different interests, prominently incuding the various interests that now comprise the telecommunications industry, that would end the LOB restraints under varying com” ditions. These have encountered support or oppesition from the many involved interest groups, depending ‘pon the conditions imposed. The RHCs, for example, tive opposed bils that would put tecth in a requre- ment thatthe elimination of the restraints be acomps- nied by the opening of local service to competition, Several ofthe RHIC also have fled a motion in federal district court (undoubtedly with one eye on the appel- fate proces) requesting that Judge Harold Greene, the presiding judge in the divestiture proceeding, dissolve {he eonsent decree and relinguish oversight ofthe local companies If successful, this action could end the LOB restrictions (Cauley 1994, BO). “This content downlode from 103 10154. Sa, 8 Jun 2013 01:45:14 AM Ate sbjeto JSTOR Terms and Condtons 280 Land Economics able to view the limitations upon ity, failure to deploy and high rates. pro- for the new ISDN technology ax strategic tactics, It is to the advantage of the RHC to keep conditions as unfavorable as possible for their future competitors when, as expected, the RHCs are allowed into these markets. Among the available weapons is the strategic withholding of technology (Selwyn and Hatfield 1994, 197-98), ‘The RHCs also claim that they require new lines of business because of increased competition in present markets. It should be noted, however, that despite the advent of such new and competitively designated en- deavors as cellular telephone and Competi- tive Access Providers (CAPs), 99 percent of all local calls still must go through RHC networks; that is, that RHCs retain 99 per- cent of local markets.‘ Moreover, rivals are both dependent upon and vulnerable to LEC actions. The Consent Decree approach to the es- sential facilities issue was to exclude RHCs from markets in which the use of their es- sential facilities is necessary, and thus hin- der their ability to leverage this control into adjacent markets (Selwyn and Hatfield 1994, 46). The interexchange carriers (IECs) con- tend that the LOB restrictions should be kept in place until certain changes are ef- fected. That is, they maintain that the RHCs should not be allowed into these markets unless and until customers of the RHCs have a choice of providers in local markets, the service is offered through a separate subsidiary, RHCs are required to pay the same price as their competitors for call completion, and they are prohibited from using sensitive customer information (Car- nevale 1994, B4). The RHCs, in turn, pro- claim the present viability of local market competition. Some also have announced a willingness to open local markets to compe- tition in return for an end to the restric- tions, although details and time frame for this are not well specified (Cauley 1994, By). ‘The elimination of the cross-ownership restriction of the Cable Act of 1982, under which LECs may not transport program- ming in their service territory is an addi- August 1995 tional important priority for the RHCs. They also have achieved some success in the at- tainment of this goal. The FCC has recor mended to Congress that of Cate Act that prohibit LEC® from offering video service through their telephone lines be dropped, and that LECs be permitted to carry video service in their own areas. The FCC terms this video-dial-tone; that is, the provision of transmission capacity to multi ple video programmers on a nondiscrimina- tory basis, in effect, common carriage. The FCC also has entered a video-dial-tone or- der that authorizes LECs to install broad- band facilities in their service territories that integrate transmission of voice, data, and video, and to transport programming pro- vided by others over these facilities. In addi- tion, a Virginia federal district court has found the video programming prohibitions in the Cable Act unconstitutional on first amendment grounds in application to Bell Atlantic, The court authorized Bell Atlantic to provide video programming in its own service territory. The easing of these restric- tions gives the RHCs the ability to move extensively into ancillary fields. In addition, we currently are witnessing in communications and related fields an extensive interindustry consolidation and centralization. Not too long ago, the RHCs and cable interests were widely viewed as contesting vigorously to be the first to install the interactive, multimedia infrastruc ture of the future. Companies across the industrial spectrum now are taking turns— here competing as rivals, there cooperat- ing as partners, and then again as rivals—in their approach to future partici- pation in this infrastructure. On a wide scale and across communications, informa- “Thus, calls made to and from cellular phooes ‘preponderantiy are made from and to lané-line phones. ‘At the same time, it should be noted that ATT still fetains 60-65 percent of the long-distance market, and that the long-distance market is by com scious parallelism in pricing, with ATT supplying ‘Obvious price leadership. Such conditions do not in- Spire much more confidence in the competitiveness of the long-distance market than is warranted for local or short-haul toll markets. scot dows fom 0.101540 a $50 2013 0454 AM ™ “All use subject to JSTOR Terms and Conditions a 710) tion and entertainment industry lines— long-distance cellular, telephone cable, telephone /entertainment, cable /ente ment—a rash of successful and failed joint ventures, acquisitions, and mergers beto- ens what seems a future blurring of indus- try distinctions.* All of this activity raises important ques- tions, including that of the purpose and result of this activity. For example, are there ‘genuine public interest considerations in- volved? That is, do the changes point to enhanced economic efficiency by, say, cap- turing economies of scale or scope? Or is this simply a series of purely strategic moves with the goal of securing strictly tactical advantages? Depending upon final resolu- tion, the net result of the changes underway in the communications, information, and entertainment industries could be a vertical integration that would redefine the concept of end-to-end service. In the pre-divestiture period, the term end-to-end service had a specific meaning; it referred to the integrated R & D, manufac- turing, and transmission and distribution operations of AT&T. In the post-divestiture era there is the strong possibility that the term will take on new meaning; that is, that it would signify the concentration hands of the generation and ownei content, programming, transmission, and distribution. The potential for constriction of access and for conflicts of interest as a result of these changes are evident. It is difficult even to speculate about the future configuration of this environment, or about the identity of eventual winners and losers. There is little doubt, however, that whatever the outcome, substantial centers of power will remain. IV, CONTEMPORARY REGULATION: AN EXERCISE IN MINIMALISM It is reasonable to interpret current de- velopments as an indication that the tele~ phone industry today has on its agenda one overriding priority and a number of subpri- orities, The dominant priority underlying the plan of action is the abrogation or mini- Miller: Public Utility Concept Bi mization of regulatory authority. To this end, Programs are proposed that take shape a 1) to the extent politically feasible, deregu- lation; (2) for services that remain regu- lated, the adoption of alternatives to tra- ditional ROR regulation; (3) an end to restraints on entry into all ancillary markets; (A) the upgrade and modernization of in- frastructure, using make-whole cost alloca- tion processes; and (5) the use of principles of costing and pricing based upon varying demand elasticities. The strategy to date may be judged to have achieved a high degree of success. The telecommunications industry now is permit- ted to engage in a host of deregulated or only loosely regulated related and unrelated activities. Moreover, an extension of deregu- lation clearly seems on the horizon. “The goal of substituting, for services that remain regulated, alternatives to traditional ROR regulation also appears close_to achievement. At the federal level the FCC thas adopted a price-capping system for AT&T and, to the extent of its jurisdiction, for the local operating companies. Most of the states have replaced traditional ROR regulation with one or another of the cur- rently popular options, variously identified by terms such as price-capping, incentive, or ficxible pricing. The details of these pro- grams vary substantially among states and as between state and federal programs. 5 Some prominent examples of recent cross-industry moves to consolidate, both achieved and discontinued, include: in the long-distance /cellular market, the AT&T purchase of McCaw Cellular, a Sprint-Centel ‘merger, and an on-again, off-again purchase by MCI of fa share of Nextel. Various RHC alliances to combine their cellular operations also are in the works. Concern is expressed that the AT&T purchase of McCaw may portend a reentry of AT&T into local markets. Tn the telephone /eable industries, the trend is evi enced, for example, by the Southwest Bell purchase of two cable systems ouside ofits service ternitory from Hauser Communications, the US West purchase of a 25 percent share in Time Warner's cable and entertain- ‘ment operations, the aborted Bell Atlantic-TCI merger, fand the US West purchase of two Atlanta cable sys- tems. Companies in the entertainment and cable indus- tries, and in entertainment and network TV also have expressed interest, in some cases not much beyond the Talking stage, in some form of alliance. “This content downloaded fom 103 101581 on Say tn 2013 01:45:16 AM white subject wo STOR Terms and Conditions —————————— 232 Conceptually, however, the plans center upon the elimination of earnings and profit control in favor of control over prices. The elimination or relaxation of camings and profit control in turn permits an increase in the gap between prices and cost of service, an inattention to quality of service and, at the same time, a decrease in regulatory dis- cretion and authority. Regulatory authority also is diminished by the holding company form of organiza- tion itself. As Bonbright and Means pointed ‘out in their classic study of the holding ‘company more than sixty years ago, a major attribute of the holding company structure is its ability to distance itself from social control (Bonbright and Means [1932] 1969, 6). In this seminal work, Bonbright and Means recognize that the holding company is not simply a purely economic entity sub- ject only to economic laws, but a political force as well. That is, they recognize the strategic use of the holding company as a means both to move business beyond regu- latory control and to attenuate extant regu- latory authority. This is confirmed by current experience. ‘The divestment of the operating companies from AT&T as parts of regional holding companies has decreased the ability to exer- cise public oversight. For example, spread- ing operation of specific service categories across many jurisdictions attenuates control even over regulated services. The provision of both regulated and deregulated opera- tions by a single organization makes possi- ble various forms of risk and burden shift- ing, one reason for the high priority the RFCs place upon termination of restric- tions on their market entry. Allocation pro- cedures adopted for joint assets make pos- sible the use of costing techniques that burden the core customer, as is illustrated in the case of telecommunications modern- ization programs. The holding company structure increases the long recognized (c. Bonbright and Means [1932] 1969, 180-87) potential for abusive inter-affliate transac~ tions. The holding company structure has significantly reinforced the “deregulation in regulatory clothing” that is the current ex- perience in telecommunications.® ‘This content downloaded from 103. ‘inst Land Economict August 1995 ‘The rejection of traditional ROR reguta- tion, and the divorce between prices. and costs, also would be facilitated by the adop- tion ‘of costing and pricing proposals ad- vocated currently by many mainstream economists. In effect, under such proposals ‘consumers of new, advanced, and custom- type services would be charged only the incremental cost of upgrade required for provision of that service, while ratepayers would be allocated all residual costs. This proposal is made in the name of economic, or Pareto, efficiency, equated with a maximization of consumers’ and produc- ers’ surplus, and identified with the public interest (Baumol and Sidak 1994, 26). ‘The position of the dominant economics is that so long as the rates of demand-in- clastic consumers do not exceed stand-alone cost and the rates of the demand-clastic consumer cover its incremental cost, no cross-subsidization occurs. Accordingly, Baumol and Sidak (1994) suggest the adop- tion of a system they call “market guided regulation” in which a range of prices is specified when competition sufficient to control prices does not exist. Prices, it is asserted, should range from the higher of the marginal or average incremental cost of the service as the floor (for services to de- ‘mand-elastic customers) to the stand-alone "That the contribution of the holding company strueture to the curent erosion of social control is not Confined to telecommunications is demonstrated by recent developments in the electric industry. The Ex- cengy Policy Act created a new classification of suppli- ers exempt wholesale generators (EWG2), entities = gaged solely in the generation and sale of electric omer at wholesale. EWGs are exempted from PUHCA regulation. In addition, regulated utilities may have ‘ownership interests in EWGs. They thus are permitted both to provide a larger proportion of their supply ‘needs from purchased power, and to provide for them by purchases from their EWG subsidiaries. The shift {fom reliance upon sel-generation to the use of pur~ ‘chased power results in differences in regulatory teat- ‘ment (generation iavestment is rate based, purchased power costs passed on to consumers) and a shift in Jurisdictional’ authority (state commissions have juris- diction over retail distribution, FERC over wholesale purchases). The Energy Bill thus permits both sef- Sealing and self-selection as between levels of regula- tion 54.1 on Sa § Ju 2013 0:45:18 AM Tena and Condens renee oT eee 710) cost as ceiling (for services to demand-in- clastic customers), Such a system, itis main- tained, will prevent either predation or cross-subsidization (Baumol and Sidak 1994, 55-59, 63-64). The average incremental cost of a service is identified as covering only the direct cost of the service, including service specific fixed costs, but not any contribution toward fixed costs incurred in common or jointly for the specific service or for other services sup- plied by the firm (Baumol and Sidak 1994, 69). All other costs are to be absorbed by the native load consumer base. The stand- alone cost is further identified as the highest Price it is possible to charge in contestable markets (Baumol and Sidak 1994, 77-78). Needless to say, ifthe precepts and assump- tions of contestability theory are incorrect, that price turns out to have few economic limits and the process becomes a matter of sauve qui peut—that is to say, pricing limits are exclusively political ‘The proposal is advanced under the ban- ner of economic efficiency. It is proposed also in the name of accuracy and precision. However, as institutional economists long have pointed out, cost allocation is not, and nor can it be, a precise process. A consistent throughout the institutional ist literature is that of the essential ambigu- ity of costs (eg, Commons [1924] 1959, 208-13; Clark [1923] 1981, 35-69). When it comes to the production of multiple scr~ vices, cost allocation is unavoidably arbi- trary. The assignment of costs thus becomes a political rather than an economic exercise, designed more as a tactical maneuver to achieve strategic objectives than as a means to achieve so-called economic goals such as Pareto optimality. It should be noted, moreover, that as the importance of fixed to total costs increases with increased network development in telecommunications, incremental costs will be a declining component of the total, and as the importance of joint to total costs increases, the opportunity for the arbitrary exercise of political power will increase. That is, adherence to mainstream costing and pricing principles will result in the assign- ment of responsibility for an increasingly Miller: Public Utlty Concept smaller share of costs 10 the competitive sector, and the assignment of an increas- ingly smaller share of the benefits of joim development to the monopoly sector. The telephone industry emphasizes its need for pricing “flexibility” in the face of current technological and economic turmoil. The coveted and much vaunted “flexibility” is

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