It is often said that competition and regulation are substitutes. Where there is competition, price regulation is not needed. Where there is monopoly, price regulation may improve things, though a large body of empirical evidence suggests the cure is often worse than the disease.
Yet, competition and regulation are ideas that encompass a huge range of possibilities. What is competition? It is a noun indicating the number of sellers, or is it a verb describing the intensity with which sellers pursue patronage through price and quality choices? Do regulators control price but not quality, or quality but not price? Or, as economists tend to believe, is regulation merely a tool used by firms to handicap prospective competitors, attenuate price competition, or achieve advantage over related firms including input suppliers?
In telecommunications, the tendency is to talk of competition as a “head-count” of sellers, a view often attributed (somewhat falsely) to the DOJ/FTC Horizontal Merger Guidelines. Since telecommunications markets tend to have relatively few providers given the enormous costs of building networks, competition in the industry is often viewed as imperfect. Prospective regulation, on the other hand, is a sort of Nirvana, where appointed officials act with great precision to solve problems without side effects. Oddly, this Nirvana view is promoted most by advocates ready to admit that historically regulation has been clumsy, ineffective, and counter to consumer interests. Every new regulator, it seems, is infinitely wiser than the last, though no one can point to any evidence of such progress.
As competition began emerging in communications market in the 1970s, it became clear that regulation did more harm than good. The competitive process is far more dynamic, creative, and efficiency driven than a regulatory body can fathom or imitate. And competition cares not for politics. Recent additions to communications law are uniform in the stance that competition trumps regulation. For instance, under Section 623 of the 1992 Cable Act the mere presence of half a competitor—giving a Hirschman-Herfindahl Index (HHI) of above 8,800—is sufficient to constitute “effective competition” and warrant the elimination of price regulation. A little competition far outperforms a lot of regulation. For this reason, the Preamble of the 1996 Telecommunications Act directs the Federal Communications Commission to “promote competition” and “reduce regulation.”
Regulators often speak of promoting competition, yet it seems few, if any, know what that entails. How are the number of sellers determined? This outcome is not fixed, despite much talk to the contrary, by the preferences of regulators, politicians, or industry gadflies. Instead, the number of sellers is an equilibrium outcome driven by economic forces, not policymaker preferences. Policymakers dabble, but the real drivers of competition are underlying economic forces.
Economic theory, empirical evidence, and casual observation tell us that the equilibrium number of firms depends mostly on the size of the market, the intensity of price competition and the capital costs of getting into the business. In telecommunications, the ratio of market size to entry costs does not permit a large number of sellers. Oddly, aggressive price competition makes matters worse, making it even more difficult to justify becoming a seller. “Few” firms is the rule, and this fewness may be the result of aggressive price competition, not a lack of it. If an equilibrium of few firms is the best we can hope for and these firms engage in non-cooperative price competition, then what more can we ask for?
Despite the 1996 Act’s directives, the Federal Communications Commission has proven reluctant to accept market realities and curb its regulatory proclivities, but there is now some evidence of a turnaround. In its 2017 Business Data Services Order, the Commission authorized price deregulation of special access services in the presence of just two firms. This decision was recently and unanimously upheld by the Eighth Circuit in Citizens Telecommunications Company of Minnesota v. FCC, 901 F.3d 991 (8th Circuit 2018).
At issue before the court was whether the FCC was bound to use the traditional market power analysis contained in the Horizonal Merger Guidelines used to scrutinize mergers as the sole basis for its decision to regulate prices. Consistent with established case law, the Eighth Circuit ruled that the Commission was not so bound.
First, the court recognized the issue at hand was not the evaluation of a merger, but the decision to impose price regulation. For this reason, the court held that the Commission was correct to reject the generic market power framework of the Guidelines because the “benefits of regulatory relief outweighed any costs of granting relief while an incumbent still had market power.” 901 F.3d at 1007. Moreover, the court held that the FCC was entitled to set aside generic measures of industry concentration because, viewed in isolation, such indices are “largely poor indicators of whether market conditions exist that will constrain business data services, and overstate the competitive effects of concentration.” (Id.) Indeed, the Commission recognized (citing the Phoenix Center’s work) that if markets are highly localized as claimed, thereby leaving only one buyer and (at worst) one seller, then price regulation “reduces welfare and probably reduces investment in communications infrastructure.” (See 2017 BDS Order at n. 130.)
Second, the Eighth Circuit rejected the notion that the Commission was required to show that potential competitors could drive prices to reasonably competitive levels in the near term. According to the court, this argument “wrongly presumes” that the Commission needed to find direct competition in the short term. In the court’s view, while a naïve market power analysis is short-term oriented, under the public interest balancing that the FCC applied, the Commission (again citing the Phoenix Center’s work) was entitled to weigh competition in the medium term, a view not entirely at odds with the Merger Guidelines.
Finally, yet perhaps most significantly, the court refused to rule that duopolies are per se anticompetitive. As the court correctly observed, there are no “bright line rule[s] about when duopolies are competitive.” The Eighth Circuit’s understanding of the economics stands in stark contrast to findings of the 10th Circuit in Qwest Corp. v. FCC, 689 F.3d 1214 (10th Cir. 2012) when upholding the FCC’s improper conclusion in the Phoenix Forbearance Order that duopolies always pose “significant risks of collusion and supracompetitive pricing.” See 689 F.3d at 1221. Duopoly, the Eighth Circuit determined, is not a dirty word. (Indeed, efforts to regulate cable rates in the mid-1990s used the duopoly price as the target.)
In sum, the FCC’s 2017 BDS Order—and Eighth Circuit’s affirmation—marks a welcome shift in the economic analysis of telecom markets. Given high entry costs and aggressive price competition, two wireline firms may not only be the best we can hope for but entirely adequate to protect consumers without regulation.
Rather than duopoly, the greater threat we now face is regulatory policies that discourage and limit competitive outcomes. Regulators do not promote competition, or preserve what competition we have, by imposing regulations that shrink markets and raise costs. Misguided policies on net neutrality, privacy and municipal broadband risk reducing competition, not expanding it, in turn feeding subsequent calls for more regulation—an unvirtuous cycle. Perhaps Chairman Pai and his new Office of Economics and Analytics is a watershed on analytical rigor at the agency, but the jury remains in deliberation.
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Lawrence J. Spiwak is the President of the Phoenix Center for Advanced Legal & Economic Public Policy Studies (www.phoenix-center.org), a non-profit 501(c)(3) research organization that studies broad public-policy issues related to governance, social and economic conditions, with a particular emphasis on the law and economics of the digital age.