Untangling Tin Cans on a String: The Difficulty of Regulating Access to Even the Simplest Telephone Exchange

Abstract

The Federal Communications Commission recently decided that the price a local exchange carrier charges other carriers for access to its network may recover only long-run incremental costs and a reasonable share of forward-looking common costs. The FCC thereby rejected the "parity pricing" rule recently advocated in this Journal by William J. Baumol and J. Gregory Sidak as the standard for pricing access to the network bottleneck facilities controlled by monopolists. This rule calls for access prices to recover not only the long-run incremental cost but also all other "opportunity costs." These include any monopoly rents and any contributions to imprudent investment that monopolists are collecting in sales of retail services but will lose as a result of providing access. This Article presents evidence that parity pricing is not of general applicability to regulatory policies in the United States. When retail prices are already at efficient levels, the rule recovers the same costs as a traditional pricing model like the FCC plan. Parity pricing therefore is interesting as a replacement for the FCC plan only when retail prices recover substantial monopoly rents or cost inefficiencies. The issue is whether regulators in that situation are more likely to achieve efficient retail prices by setting prices directly after determining incremental costs for numerous services or by setting prices for a few bottleneck facilities to promote competitive entry. Results from the FCC's first formal study of long-run incremental costs show the difficulty of unraveling incremental costs, even when services are provided by the simplest configuration of facilities. The author thus agrees with William B. Tye and Carlos Lapuerta that regulators mandate access to bottleneck facilities as a way of fostering competition, moving retail prices closer to the efficient levels they cannot identify. These goals cannot be achieved by parity pricing because it requires access prices to include the monopoly profits and cost inefficiencies that regulators are trying to eliminate.