Executive Summary

Modern telecommunications is a mind-boggling marvel of software, switches and electromagnetic spectrum. But telecommunications policy doesn’t have to be complex if guided by fundamental American principles.

Among the most basic of these principles is the protection of private property rights. But violation of this principle is the defining feature of current telecom policy, and the primary cause of its failure.

This report documents this policy misstep that has cost workers their jobs, investors their savings and consumers the benefits of a robust telecom market. We also recommend solutions grounded in sound economic principles that would help to restore rationality in telecom policy. Failure to institute reforms will inhibit technological innovation and economic growth, as well as undermine the reliability and security of our communications network.

The core of state and federal telecom policy for local calling is the requirement that wire line companies such as Verizon, BellSouth, SBC and Qwest allow rivals to utilize their networks at below-cost rates. We refer to this requirement as “forced access” throughout the report.

All too predictably, this regulatory approach, an obvious violation of property rights, has significantly skewed investment incentives and undermined technological innovation. And it hasn’t even produced the outcome Congress intended.

Forced access was conceived as necessary to jumpstart competition in local calling services. Lawmakers assumed that once new entrants gained market share, they would build new facilities to compete against incumbent wire line networks. But as documented in Section III of this report, most competitors in Michigan have shunned investment in independent facilities, preferring instead simply to resell the network services they obtain at discount, compliments of regulatory fiat.

This outcome is precisely the opposite of what Congress intended. And it is a significant factor impeding telecom investment and economic growth.

Based on data from the Michigan Public Service Commission (MPSC), we have found that 89 percent of the wire lines billed by competitors in 2002 actually were serviced in whole or in part by an incumbent network, up from 62 percent in 1999.

There has been a corresponding decline in the proportion of lines served by independent facilities. Competitors utilized their own facilities to service a mere 10 percent of their customers in 2002, down from 29 percent in 1999.

Northwestern University economist Debra J. Aron also has found that between March 2002 and March 2003, for every (net) new line competitors serviced via independent facilities, they added three lines dependent for service on an incumbent network.

This policy miscalculation carries serious consequences. Investors see little benefit in providing new telecom capital so long as the government continues to require that incumbent service providers subsidize their rivals. Indeed, the market valuation of publicly traded telecom companies has fallen by $2 trillion in the past three years, leading to the loss of 500,000 jobs.

Moreover, total capital spending on telecom facilities declined from $100 billion in 2000 to less than $40 billion last year. The cutbacks inhibit innovation and potentially jeopardize network reliability.

This reliance on incumbent networks also has largely failed to stimulate new products or services, or even lower rates — the hallmarks of competition. Local telephone rates, which held steady in Michigan in the years preceding the 1996 telecom act, actually increased thereafter.

The economic adversity has not been confined to telecom service providers. To the extent that capital expenditures have been restricted, the entire chain of technology supply has been rattled, including software firms, chipmakers, fiber optic manufacturers and even Internet Service Providers.

Congress was right in wanting to end the monopoly franchise system in local calling, a relic of the telephone history chronicled in Section II. But their faith in central planning evidently overrode any recognition of the technological changes sweeping the industry.

As documented in Section V, the tremendous growth of wireless service, Internet communications and cable telephony present a formidable competitive challenge to the wire line incumbents — all without benefit of subsidies. As Deutsche Bank analysts observed: “The [incumbents] are facing steep declines in total access lines, caused by a sharp contraction in both primary and secondary lines, as wireless, DSL and cable/satellite platforms continue to cannibalize fixed line connections.”[1]

Most state telecom law is dictated by federal statute, which complicates reform efforts. However, the Michigan Legislature and the Public Service Commission can take steps to improve the regulatory environment. Specific recommendations for reform are provided in Section VI.

If we strip away all the technical jargon and irksome acronyms that often cloud the policy debate, what we essentially are left with are disparate visions about the power of markets to maximize technological innovation. As the data in this report demonstrate, the regulatory model has failed to achieve state and federal policy objectives. It is yet another reminder that deviating from time-tested principles of property rights carries costly consequences.