Telephone Man

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After the Breakup: U.S. Telecommunications in a More Competitive Era, by Robert Crandall, Washington: Brookings Institution, 174 pages, $25.95

Ever wonder why your phone bill has 10 pages of itemized charges? Since the Bell System breakup in 1984, the economics, politics, and technology of telecommunications have all been incredibly messy. Nevertheless, Robert Crandall, senior fellow in economic studies at the Brookings Institution, has written a book that covers all three topics well.

After the Breakup explains what's regulated, what's not, and why it all matters. And those who are intimidated by—or just impatient with—the complex jargon and economics of telecommunications will be happy to know that this is a relatively user-friendly volume. Crandall displays none of the academic pomposity that sometimes arises when scholars write tomes on applied economics.

On this note, Crandall's first chapter deserves special mention. All too often, books like this begin with a "road-map" chapter—a terse string of passive-voice summaries that has all the rhetorical charm of a bad high school lab report. In contrast, Crandall's first chapter does what a first chapter should do: It sets out the context, explains why the subject is important, and develops the reader's interest.

"The telephone equipment and services sector," Crandall states, "has changed from a tranquil, regulated monopoly into a set of increasingly competitive markets in which domestic and foreign suppliers compete for the patronage of household and business users." He then gets right on with telling the story of how this change occurred and what it means. I kept reading, not just because his magazine paid me to write a book review, but because I wanted to find out how the story would end.

Of course, the regulation story is far from over. "Many people believe that telephone services have been deregulated, but in fact precious little deregulation has taken place," notes Crandall. "Local rates remain regulated. State commissions still regulate intrastate toll rates. The FCC regulates dominant carriers, such as AT&T." And "the divested Bell operating companies are the most constrained of all the players," prohibited from manufacturing telecommunications equipment, offering long-distance service, or providing information services.

Deregulation has largely occurred in the long-distance and equipment markets. In 1971, the Federal Communications Commission permitted competitors to challenge AT&T in the long-distance telephone market. Then in 1984, the AT&T breakup threw open a competitive market in telecommunications equipment, with anyone free to manufacture except the local Bell telephone companies.

These policy changes have been controversial. Opponents predicted that fragmenting the Bell System would raise costs, degrade quality, and jeopardize universal phone service. Supporters favored the consumer benefits of competition over the efficiencies of integration.

Six years after the AT&T breakup and 19 years after competition came to long-distance service, there is an ample historical record to put these theories to the test. Crandall's statistical research reveals that telecommunications productivity has accelerated, prices more accurately reflect costs, and there is no evidence that quality has deteriorated. He also finds a negligible effect on universal service, estimating that the number of low-income families with phone service is at most 2 percent or 3 percent lower than it otherwise would have been.

Unfortunately, many in the policy arena will probably interpret these results as an endorsement of the status quo, which features 50 state regulatory fiefdoms, a maze of FCC regulation, and a national telecommunications czar named Harold Greene, whose court administers the Bell breakup agreement.

If Crandall's findings get used to justify this mess, it won't be his fault. His concluding chapter points out that even though we're better off than before, there's plenty of room for improvement: "As the telephone network fragments further, regulators will be forced to abandon the distorted rates that seem partially responsible for this fragmentation. Then it will become possible to get a market test of the magnitude of scale-scope economies versus the benefits of competition." It's refreshing to find someone in Washington humble enough to admit that he doesn't know the most efficient structure for the industry.

This volume will no doubt be heavily discussed in the ongoing congressional debate over allowing the Baby Bells to manufacture equipment, produce information services, and offer long-distance service. Opponents argue that the Bells can cross-subsidize these services with revenues from regulated local phone service. For example, a Bell company might install new high-tech equipment to provide information services but convince regulators that they need the equipment to provide ordinary local phone service. Households would then get charged for equipment they aren't using when they pay for basic phone service. Meanwhile, in the market for information services, the Bells would have a cost advantage over competitors who lack a base of captive customers to squeeze.

Proponents of freeing the Bells argue that the FCC can control cross-subsidization; therefore, it makes little sense to keep certain markets off-limits to companies controlling 60 percent of the nation's telecommunications assets.

If this book has a (slight) weakness, it's that the discussion of cross-subsidization assumes that the reader is already familiar with the issue. This poses a problem, because it isn't clear that many policy makers really understand what cross-subsidization is, or why the Bell companies might have a reason to engage in it. Such ignorance can have dire policy consequences, because if one doesn't understand why the Bells might cross-subsidize, it's also hard to discern circumstances under which they would not cross-subsidize. Without such knowledge, one can never figure out how and when it might be appropriate to free the Bells.

Judge Greene's references to cross-subsidization in his court opinions, for example, often seem to say no more than "big companies can do whatever they want." Opponents of allowing the Bells to compete have picked up on this theme, seemingly unaware that the fundamental reason for cross-subsidization lies in the structure of regulation itself.

Local telephone companies are, by and large, subject to rate-of-return regulation by state regulatory commissions. Under some conditions, they may have an incentive to increase profits by increasing capital expenses; the more capital they use, the more profits regulators let them earn. And what better way to increase capital expenses than to enter new, competitive markets using facilities and equipment that they claim are being used in old, regulated markets?

Crandall points out that regulatory reform or further deregulation can take away the Bells' incentive to cross-subsidize. Eliminating rate-of-return regulation, he says, is the policy option "most attractive to traditional economists familiar with the literature on the distortions caused by rate-of-return regulation." I agree, but his observation would be more convincing if he devoted more space to explaining the economics of cross-subsidization.

Nevertheless, After the Breakup is one of the most lucid books I've read in a field awash in abstruse economese, legal lingo, bureau-babble, and techno-speak. Readers familiar with telecommunications will appreciate Crandall's new findings, and readers unfamiliar with telecommunications will better understand their phone bills.

Jerome Ellig is an assistant professor of economics and associate director of the Center for the Study of Market Processes at George Mason University.