needs of these markets through a common in- frastructure maximizes the commonality of inter- ests o f all c o n s u m e r s and yields e n o r m o u s economies of scale and scope to ttie benefit of the United States economy.

The cost of a modern telecommunications in- frastructure will vary across regions depending largely on current states of technology, size of serv- ing areas, and market density. We are confident that both private and social benefits will justify these expenditures. We are also confident that regulatory reform will produce the optimal deployment sce- nario. These changes are vital if we are to keep pace with the deve lopments occurr ing outs ide the United States and to meet the needs of the 1990s customer. []

READINGS SUGGESTED BY THE AUTHOR: Arnheim, Louise. Telecommunications Infrastructure

and Economic Development in the Northeast- Midwest Region. Washington, D.C.: Shooshan and Jackson, Inc., 1988.

REGULATING COMMUNICATION / 21

Coopers and Lybrand. State Policy and the Telecommunications Economy in New York. New York: Coopers and Lybrand, 1987.

Davidson, William H. Trends in Telecommunications Networks: Regulatory Issues and the Outlook for the U.S. Information Economy. Los Angeles: University of Southern California, 1988.

Intelligent Network Task Force. The Pacific Bell Intelligent Network Task Force Report. San Francisco: Pacific Telephone, 1987.

Johnson, Leland L. Price Caps in Telecommunications Regulatory Reform. Washington, D.C.: Rand Corporation, 1989.

Bailey M. Geeslin is vice president of marketing and technology for the NYNEX Service Company, a subsidiary of New York Telephone Company and New England Tele- phone and Telegraph Company. His responsibilities in- clude product development, regulatory planning, and network implementation planning. Previously, he was di- rector of regulatory matters at the NYNEX Service Com- pany and held several positions at New England Telephone and AT& T.

Looking Not Far into the Future

Henry Geller

i n focusing on United States domestic telecom- munications policy, I am not going to try to look

far into the future. It is too difficult to do that. We are lucky to be able to look ahead five to seven years because the technology is so dynamic. Telecom- munications has to be consistent with the tech- nology and the market. Both of these factors count far more than policy measures. The policy that was in place from 1900 through World War I I - - the end- to-end AT&T monopoly--was consistent with the use of the paired or twisted copper wire. It was con- sistent with the marketing environment, and it served the United States well.

It came to an end not because the Federal Com- munications Commission (FCC) decided deliber- ately to abandon it. The c o m m i s s i o n - - a n d I include myself--was not farsighted when the oppor-

tunity came to introduce competition. We thought that we could introduce just a little bit of competi- tion in private lines, which represented less than 2 percent of the revenues of the AT&T. We could therefore keep the system essentially intact, includ- ing the subsidies. We were wrong; market segmenta- tion simply does not work.

What really took the old system apart was the changing technology and the changing demands of the market. There has been a technological revolu- tion; we now have the microwave, coaxial cable, the satellite, and, above all, the revolution in photonics. The computer, the integrated circuit, drastically changed system switching and enabled packet trans- mission for data. There has been a convergence of the communication and computer fieldsm the one regulated and the other unregulated--that forced

22 / SOCIETY ,, JULY / AUGUST 1989

policymakers to lean in the direction of deregula- tion as much as possible.

There also has been a change in the marketplace. New vendors and value added networks wanted to enter. Most importantly, the large users wanted tele- communications that were tailored to their needs. They wanted to be able to deal with customers or offices in a manner customized to the unique needs or requirements of their business. That again shook this entire structure.

Today there is a global competition. Our indus- tries--whether financial or manufacturing--are en- gaged in global competition and therefore have to be as compet i t ive as possible. While telecom- munications is not a panacea, it can make a signifi- cant contr ibut ion to improved productivity. In some industries, such as in the financial sector, it is critical, as in the case of Citicorp. Here again the global market demands call for a different policy environment.

There is also a need to have telecommunications make a contribution to the quality of life, for exam- ple through the intelligent network. People have to develop the specialized information services that go over this intelligent network. We want that network to be in place, not only for business, but also for the residence, as a way of making a contribution to edu- cation, environmental and energy control, to the provision of information, to any number of objec- tives that people want met. When all these factors are considered together, their combined force clearly calls for a telecommunications policy that permits the industry to respond quickly to a dy- namic technology and marketplace. That in turn calls for the greatest possible use of competition, rather than the old, slow administrative minuet wherein the industry has to get permission to intro- duce some new product or service.

Full, all-out competition was introduced in the equipment area, and it has worked very well. There have been enormous gains to the nation in that area, since this competition has spurred innovation and lower prices. The same thing is true when we turn to the toll area, other than intra-LATA toll. (A LATA is a local access and transport area, often but not always equivalent to a standard metropolitan statistical area.) The inier-LATA toll area is now wide open to competition. There are three full facil- ities competitors, a host of regional ones, and rail- roads and pipeline companies using their rights of way for fiber optic transmission facilities. There are thousands of miles of fiber optic as a result.

This has greatly benefited the nat ion. It is true that the large user has benefited the most, but that phenomenon should not be denigrated. Our large user cannot compete well if it does not have effi- cient telecommunications and will lose out in the current global competition. Thai means the nation

loses jobs and suffers. Thus, we are not simply dis- cussing "trickle down," but something that is an essential factor in how this nation meets its compe- tit ion in the global and emerging informat ion society.

I shall briefly suggest the principles that govern this policy area and give some examples of their application. The first principle is to use competition wherever it is feasible, wherever it can flourish. This needs no defense. If there is a choice in the United States between monopoly--wi th government reg- ulation to substitute for the market - -and competi- tion as a regulatory policy, competi t ion will be selected. It is, after all, the norm in this country. It does the best job of spurring efficiencies and inno- vation, of driving prices to marginal costs.

The second principle is equally undisputed: when we opt for competition and get effective competi- tion, deregulation should follow. Regulated compe- t i t ion makes no sense in such circumstances; however, government often has a tendency to do just that, to handicap some and protect others in- stead of allowing effective competition to take its course. This is because competitors like to come to government to ask for help. Senator Magnuson put it well when he said that "all each industry seeks is a fair advantage over its rivals."

An example of this tendency is our failure to de- regulate AT&T. There are two full facilities rivals, several regional ones, and thousands of miles of fi- ber optic cable. It is true that AT&T still has about 70 percent of the inter-LATA toll maket. It is also true that in a few areas, such as Vermont where no competitor wants to enter because of the sparse traf- fic, AT&T still has a monopoly. Those situations can be handled by simply relating tariff prices there to the competitive areas. There is no need to hold on to this rate-of-return regulatory system as to this one competitor. That is particularly true of the bid- ding war now going on for the large user. If AT&T wins that war with its tariff number 12, or whatever, it then has to file with the FCC- -and it is the only one that can be challenged. If MCI, U.S. Sprint, or some other competitor oppose the filing at the FCC, since it delays AT&T's service, it may discourage the large user from taking the AT&T option.

Were it not for short-term political considera- tions, the FCC probably would have deregulated AT&T. To spur competition in this field, we broke up AT&T and required equal access for its com- petitors to the divested Bell Operating Companies, the BOCs. We now have roughly 75 percent of the end offices cut over to equal access; that is, the com- petitors of AT&T have the same high-grade access to the BOC's local facilities as AT&T receives. It is time to stop handicapping the competitive race, to de- regulate and see how the market really functions.

My third principle deals with the fact that we do

REGULATING COMMUNICATION ] 23

end up with monopoly on the local level. That is what we have now. The third principle is that this monopoly should be earned in the marketplace. At the local level, there should be open entry, resale of local services, and fair interconnection with the lo- cal exchange carrier. That last is very important in view of the burgeoning number of networks. There is thus a need for the regulatory process to ensure that there is fair interconnection for these new networks.

We have not followed or implemented this third principle. Take the example of intra-LATA toll. In many states, we have very large LATAs. Within those LATAs, the BOCs have a monopoly on tolls. That monopoly represents about 24 percent of the toll revenues in the country--bi l l ions of dollars. The monopoly may be a de jure one since in many areas the state legislature or public utility commis- sion (PUC) will not allow competition. Even where there is no legal bar, competition is ruled out, for example, in New York because there is no equal access. In Texas, Southwestern Bell charged AT&T more for access to its local lines than a customer would pay for an end-to-end intra-LATA toll call over Southwestern Bell.

This situation has to change; it is the wrong pol- icy, and it is bound over time to embarrass the BOCs. The BOCs say that they do not want to be fenced in, to be prevented from competing in infor- mation and inter-LATA services. If they are at the same time fencing out competition, that is a poor hand to play in this game. It may be that even with open entry and fair interconnection, the BOCs will win the competitive struggle and we will still end up with monopoly. But the principle here should be open entry and fair competitive conditions, with the monopoly earned fairly in the marketplace.

I have been discussing intra-LATA toll, but the same principle holds for all intra-LATA services, in- cluding the "last mile" into the business or home. There should be open entry and resale of local serv- ices. It will be difficult to get full, effective competi- tion in this area, and I am not sure if there will be such competition in the next decade. For the de- ve lopment s - In teg ra ted Service Digital Network (ISDN), greater use of fiber and digital equipment, Open Network Architecture--wil l all enrich the network and thus strengthen its local monopoly.

There are competitive niches. The large user cer- tainly can bypass the local monopoly and get access to the toll networks. For such large users, the local exchange company has become its own bypasser, giving special access at lower rates so as to retain some of the revenue. There can also be niches for data transmission. But they are relatively small. When we look at the overall picture, the local ex- change carrier remains the powerful ubiquitous lo- cal network. I see nothing in the next seven years or

so that will undermine that monopoly. We will see effective competi t ion--perhaps in digital radio or cellular--in the next century, but it is not likely to occur now.

It is unlikely to occur for another reason: the sub- sidy in the present scheme keeps local rates ar- tificially low. We put what is, in effect, a tax or surcharge on the access charges for toll users of the local facilities, and use the substantial sums so ob- tained to reduce the local residence charges. It is hard for any competitor to enter in such circum- stances. Maybe no one could compete anyway, but we are certainly not going to find out when the local system receives substantial subsidies.

That brings me to the fourth principle: to phase out the substantial and untargeted subsidies. The present system makes no sense: we subsidize every- body, whether they need it or not. It should be grad- ually phased out; ending the subsidies abruptly would be politically disastrous. We must slice the salami every year and shift the present "tax" on the toll user to the end subscriber. If we fail to act over time, the system will continue to give this false eco- nomic signal. We will be skewing local competition, and we will not get the full contribution to im- proved competitiveness that we want in this era of global competition. We will be overcharging our large business users and therefore handicapping them.

In the present system, we subsidize everybody whether they need it or not.

The present scheme encourages uneconomic by- passing of the local carrier's access charges for com- pleting the toll call. There is nothing wrong with bypassing when it occurs because it is more efficient for a Citicorp to go that way. Economic bypassing is just another name for competition. But bypassing that occurs in order to avoid this governmental pol- icy of a subsidy tax on tolls represents poor policy. When we impose a toll tax on a large user like Proc- ter & Gamble or General Electric or General Some- body, they do not absorb it; it is just another expense to pass on to the consumer. The consumer, including the poor, end up paying anyway. Indeed, it may be regressive taxation, as compared to monies coming from the general treasury.

I am not against targeting subsidies to those who really need them. That is my fifth principle: to tar- get and avoid skewing the competitive system by

24 / SOCIETY �9 JULY / AUGUST 1989

using the general treasury, as, for example, Mary- land does. That is what we do in areas such as elec- tricity, gas, or food. Why should we not do the same here? If we wanted to subsidize the poor with food, we would not knock on the door of every house in town and say, "Here, have some food." Nor would we fly over a community and drop food in the hope that it got to the people in need. We would target those in need.

We may change the nature of the subsidy over time. Today it would be directed to POTS (Plain Old Telephone Service) while tomorrow it may well in- clude elements of PANS (Pretty Amazing New Stuff), such as described in the recent Pacific Telesis study. Whatever the nature of the subsidy, it ought to be on-budget. Politicians love the present scheme precisely because it is off-budget. They are indif- ferent to the fact that it is poor policy to proceed in that fashion. Ambrose Bierce once said that one should never underestimate the ability of a Con- gressman to hold two antithetical thoughts at the same time. Here one thought is to have competition with all its benefits and the other thought is to con- tinue the large subsidies as if the old closed monop- oly scheme still existed.

With monopoly, there must be regulation to pro- tect the monopoly rate payer and those who depend on that essential transport. As a fifth principle, I emphasize the desirability of such regulation rather than the suppression of competition, unless there are the most compelling reasons to do otherwise. I am taking aim at the modified final judgment in the antitrust case against AT&T, since that does sup- press competition by the BOCs in several important respects. The modified final judgment looks like an elegant economic solution: it separates the worka- bly competitive (interexchange toll and manufac- turing) from the naturally monopolistic, and these monopolies were therefore forbidden from engaging in interexchange toll service, information services, or manufacturing communications equipment.

I have no quarrel with the barring of interex- change service. If AT&T has been broken up in order to insure that the local monopolies no longer have any conflict of interest in serving the toll com- petitors, it would make no sense to allow the BOCs immediately to enter that toll field. But the other two proscriptions are wrong, and wrong from their inception. They were flawed policy in 1982.

Consider the ban on information services. It sim- ply repeats the mistake of a prior 1956 consent de- cree that kept AT&T out of the competitive data processing field. This restriction is against the driv- ing technology. The computer and integrated circuit are now integral parts of the local telecommunica- tions system. The system is driven to make full use of its resources and expertise. What we did in 1982 says to one-half of the Uni ted States telecom-

munications industry that it cannot make its contri- bution in this important area, even though that contribution is much needed. The Bell Operating Companies can provide protocol and code con- version for everyone so that they become a univer- sal gateway for data. The BOCs can provide voice storage and forwarding for everyone, so that this service is available to small businesses and resi- dences, not just to the large user who can afford a PBX. They can provide the infrastructure for a suc- cessful videotex system, for electronic mail.

It is not possible to delineate all the information services that might be provided, because we simply do not know all of them. Unless we let the BOCs go forward, we will not know what services might be developed by one or another of them. These infor- mation services are not easy to develop or establish. They take deep pockets and resources and great ex- pertise. It makes no sense to suppress the competi- t ion of the c o m p a n i e s that have the n e e d e d qualities. It is true that it will be messy to let them enter this field, because the BOCs have a monopoly of the essential local transport facilities. An appro- priate analogy here would be to the incident in the Vietnam War in which the commander said, "We had to destroy Bien Loc in order to save it." We are so worried that the BOCs may do bad things, that we have prevented them from doing good things; and the good far outweighs the bad.

In two recent decisions, Judge Greene modified the modified final judgment as to the information services restriction, so the erosion of the restrictions has begun. The judge had previously employed a so- called section 8(c) test, which came down to one consideration: If the BOC still is a monopoly, the answer is "no" on entering these forbidden services; because with monopoly, there remains a substantial possibility that the BOC could inhibit competition in these areas. The judge, after looking at what the French have done to develop a national videotext infrastructure, decided to abandon the 8(c) test and used instead the test he should have employed from the start in 1982--a cost/benefit test: on balance, does the nation and the consumer gain more from the competition of the BOCs than would be the cost from allowing their entry? Clearly, we gain much more from allowing the competition, not just as a gateway for v ideo tex t but in all i n fo rma t ion services.

The judge has also allowed protocol and code conversion, voice storage and forwarding, elec- tronic mail and electronic white pages. He con- t inues to bar conten t generat ion and conten t manipulation. I do not know what is meant by con- tent manipulation, and I doubt if anyone really knows. If in a voice storage service, the subscriber asks for Tuesday's messages , is tha t c o n t e n t manipulation?

The restriction on electronic yellow pages stands out like a sore thumb. The judge calls it content generation, but the content of a yellow page ad does not come from the BOC. The advertising subscriber supplies the information that it wants to come up on the screen. If that subscriber wants to supply price and availability information, and change it, why should that not be allowed? What the judge is saying is that the BOC can do electronic directory service, but only inefficiently. That is poor policy, particularly as the electronic yellow page may be a core service, much needed to make videotext suc- ceed. The policy has no legitimate foundation. It is simply protectionism--to protect the newspaper in- dustry, which wants to preserve its classified ad revenues.

The manufacturing restriction is similarly flawed. I do not know if the BOCs want to get into man- ufacturing. They would be starting from a zero base in a difficult and competitive field. But it is poor policy to have the government prevent one-half of United States te lecommunicat ions from making whatever contribution it wants to in this area, in which we now face a large trade deficit. Without manufacturing, the contribution of the BOCs to re- search and development is discouraged. There are large definitional problems as to what constitutes manufacturing: often when a BOC tries to obtain equipment with great specification, parties claim that this is an illegal intrusion into manufacturing.

These restrictions will erode over t ime--al l con- ditions erode. The restrictions on MCI eroded, as did the many restrictions placed by the FCC on cable television. So I believe these modified final judgment restrictions will be gone by the mid- nineties.

That is a healthy development. When we look back at the end of the century on what we gained from divestiture, the big plus will not be in the area of toll competition. The largest gain will stem from the fact that we cloned AT&T seven times. We now have seven large companies, worth 16 to 24 billion dollars, all doing their own strategic planning. Our policies therefore ought to be directed at fully effec- tuating that gain as soon as possible, not as late as possible.

With entry of the BOCs, the government clearly has to protect the monopoly rate payer and compet- ing information provider. It has to insure fair inter- connect ion and insure against improper cross- subsidization. In a 1980 decision, Computer In- quiry II, the FCC used a separate subsidiary scheme (FSS) to do that, which was a good idea. I notice that Japan is using the separate subsidiary concept in dealing with NTT, its AT&T equivalent.

In its 1986 decision, Computer Inquiry III, the FCC abandoned the FSS on the ground of ineffi- ciencies. This claim was exaggerated. In some areas,

REGULATING COMMUNICATION / 25

such as protocol and code conversion, it is neces- sary to integrate the enhanced service into the net- work; bu t in mos t ins tances , this t echn ica l integration is not called for. In abandoning the FSS, we have gone in the wrong direction. There is agree- ment that the future lies with Open Network Archi- tecture (ONA), but ONA is unbundling the network into its basic elements. If that is the future, is there a need to integrate today?

We are in transition, and transitions are messy.

The FCC is now using accounting to prevent im- proper cross-subsidization. Many people, myself in- cluded, are dubious: we have never seen accounting work well in these circumstances. As for intercon- nection, the FCC is now using comparable effective interconnection, a specific interface for each spe- cific information service the BOC wants to under- take. For the future, the FCC is promoting the development of ONA, a generic interface.

ONA will certainly be a welcome development. It will allow the BOCs to bring information services on-line much more quickly, and it allows informa- tion providers to do likewise, and not to have to disclose their plans prematurely to the BOC as they have to do today if they want to introduce some information service. But I believe that ONA will come as a consequence of evolving technology and market demand, not because of government fiat.

There is a final regulatory principle that is ap- plicable to this monopoly area. Government must regulate the rates charged the monopoly rate payers for basic services. The principle I recommend is to regulate in a way that emulates competi t ion as much as possible in the important sense of spurring efficiencies, innovation, and the full effective em- ployment of the intelligent network. That principle has brought rate-of-return regulation under some pressure; for it is a "cost plus" way of regulating, and that often can spur "goldplating" rather than effi- ciencies. If the carrier is earning near the top of its rate of return, it is not motivated to be efficient; and we want to spur efficiencies and innovation in this environment of global competition.

Regulators have therefore turned to different ap- proaches. One state, Nebraska, has deregulated, while others have turned to, or are considering, so- cial contracts or price caps, which have a formula that uses the consumer price index minus some pro-

26 / SOCIETY �9 JULY / AUGUST 1989

ductivity figure. That formula is applicable to a bas- ket of basic services, with no regulation of services where there is effective competition. The FCC is now authorizing the use of price caps for AT&T. I strongly favor that; I would choose to deregulate AT&T and therefore regard price caps as a step on the road to deregulation.

As to the BOCs or local exchange carriers (LECs), the price cap approach is not a step to deregulation. It is an alternative way of regulating the monop- o l y - o n e that hopefully will spur efficiencies and yet protect the monopoly rate payer. At the end of, say, a four-year period, there has to be a review of how much the LEC has earned. If it is too high, the prices are then adjusted downward. If it works cor- rectly, it is a win-win situation. The LEC is induced to be as efficient as possible because if it can beat the productivi ty figure, it keeps the profits so earned; the public gains by the lower prices result- ing from the efficiencies. What has really happened is not deregulation; rather, it is institutionalized reg- ulatory lag.

Some states have gone different routes. New York has incentive regulation, in which if the LEC earns above a prescribed rate, it keeps half and the other half goes to the rate payer. California is considering a variation of this approach, and there are still oth- ers under examination. Some states are simply keeping rate-of-return regulation. This process of development is healthy. It establishes the states as laboratories. In that way, we will gain valuable in- sights and be in a much better position to make judgments five years from now.

We are in transition, and transitions are messy, but we are moving in the right direction. Other countries are imitating what we have been doing-- including the United Kingdom and Japan--which suggests that we are on the right track.

The process of making policy is also an important area, and one in which there are serious flaws. Con- gress is operating under a 1934 act that is based upon a 1910 act and has no relation to the realities of the seventies and eighties. Congress is, however, unable to legislate. There are too many warring in- dustries, so each industry can block legislation. Congress is important to the process because it sends messages to the FCC, which is supposed to follow and salute. When the FCC failed to do so in the fairness doctrine controversy in the broadcast field, a war broke ou t - -one the commission cannot win in the long run. I regret some of the messages sent, because often they reflect short-term political considerations.

In the federal/state area, I have reconsidered my prior position favoring federal preemption. The states generally have done a good job and have be- come the laboratories I discussed. In some areas such as intrastate toll, the states have been more

innovative and experimental than the FCC. There is the one big problem of states blocking competition to the LEC in order to preserve its subsidy schemes. I do not see any solution on the horizon: the Con- gress will not act, and the FCC has dubious power to act and, in any event, would not act if Congress will not.

The final relationship is that between the FCC and the antitrust court. It makes no sense at all. The FCC has the comprehensive charter to consider all aspects of the public interest. The court is con- cerned solely with antitrust. It is poor policy to have them both operate in the same field. Both are con- cerned with the information or enhanced service (data processing) area. Each can deal with the terms and conditions for BOC entry--colocat ion, FSS, and so on. The FCC, with its broader charter, should be the sole focal point.

The judge has criticized the FCC members as marketplace ideologues, who do not really protect the consumer. There may be some validity to this charge, but the answer is not to bifurcate policy but to get a good FCC. It is important that the president make appointments to the FCC that reflect what has now happened-- the complexities of telecom- munications regulation. When television was the focal point, it did not matter too much who was appointed to the commission. I remember one chairman saying when the common carrier agenda was called, "Here comes mystery land." A change is called for: people appointed to the FCC should be well qualified in economics, engineering, and so on, in the common carrier field. Look at the appoint- ments to the Federal Reserve Board or the Se- curities and Exchange Commission: no one is appointed without the requisite background and ex- pertise. If they were, the Senate would not confirm their appointments. The same principle is now ap- plicable to the FCC in light of how complex the telecommunications field has become.

The principles I have set out here may all prove wrong in the coming years. The FCC commissioner has to be flexible and able to adjust to this dynamic area, for the field is changing rapidly. That causes g rea t p r o b l e m s , b u t it a lso p r e s e n t s g rea t opportunities. []

Henry Geller is director of the Washington Center for Public Policy Research in Washington, D.C. The center, which focuses on telecommunications policy issues and research, is part of Duke University's Institute of Policy Sciences and Public Affairs. He has been assistant secre- tary for communications and information, and admin- istrator of the National Telecommunications and Information Administration in the Department of Com- merce. Most of his career was spent at the Federal Com- munications Commission, where he was general counsel and, subsequently, special assistant to the chairman.