Universal Service: Competition, Interconnection and Monopoly in the Making of the American Telephone System

Published by EH.NET (February 1999)

Milton L. Mueller, Universal Service: Competition, Interconnection and

Monopoly in the Making of the American Telephone System. Washington, D.C:

AEI Press, 1997, 13 + 213 pp. $40.00 (cloth), IS BN: 0-8447-4063-2.

Reviewed by Jeff Kraft for H-business, LECG, Emeryville, California.

jeff_kraft@lecg.com

Milton L. Mueller’s thoughtful, extensively-researched and at times

controversial book should be required reading for public policy makers

(regulators, legislators and judges) and consultants (this author is one)

who are grappling with the implementation of the Telecommunications Act of 1996

because it provides an unconventional analysis of the question at the heart the

debate surrounding the Act’s local competition provisions: What are the

appropriate interconnection and unbundling rules for promoting efficient

competition and maintaining universal telephone service?

Mueller makes a strong argument that the current meaning of “universal service”

is different from the original meaning of the term. Today, it means that

regulators should implement public policies which provide all households with

access to an affordable set of basic telecommunications services. As proposed

by AT&T’s Bell System

in the early 1900s, universal service originally meant that competing local

telephone providers should be consolidated into local monopolies. Between the

end of the nineteenth and the first third of the twentieth centuries, a

substantial proportion of the nation’s population lived in areas where two

competing local exchange companies (the Bell system and independents) offered

local exchange service, a condition known as “dual service.” In almost all

instances the competitors did not interconnect their

networks. Universal service would allow all local subscribers in a given

geographic area to call all other subscribers with a single subscription and

was thus an antidote to the inefficiencies of dual service.

The book’s chapters progress chronologically and weave together economic

theory and the competitive, regulatory, and legal history of local telephone

service in the United States. Mueller’s narrative moves from the early days of

the Bell monopoly through the years of dual service competition between the

Bell system and independents, the Kingsbury Commitment and the advent of state

monopoly franchise regulation, and the consolidation of the Bell System, to the

Telecommunications Act of 1996.

Mueller does a good job of clearly and concisely explaining economic concepts

like demand side economies of scope and scale, network externalities and

natural monopoly, in the process making a strong case that local telephone

service has never been a natural monopoly. Mueller traces the historical and

legal

roots of key regulatory debates such as the argument that mandatory

interconnection requirements are unconstitutional because they amount to an

appropriation of private property. This dispute remains at the heart of modern

regulatory policy-making from the overturning of the FCC’s initial expanded

interconnection and physical collocation ruling (See Bell Atlantic Telephone

Companies v. FCC., 306 U.S. App. D.C. 333; 24 F.3d 1441; 1994) to the current

legal challenges by incumbent

local exchange carriers to the FCC’s attempt to implement the local

competition provisions of the Telecommunications Act of 1996.

The

book builds on the work of Gerald Brock and others (see for example Gerald

Brock, The Telecommunications Industry: The Dynamics of Market

Structure, Harvard University Press, 1981), providing one of the most

detailed

early histories of telecommunications competition and regulation.

The explanation and analysis of the Kingsbury Commitment, the 1913 compact

between the Bell System and the federal

government which called on Bell to slow down the acquisition of independent

telecos and offer limited interconnection to competitors, is the most

fully-documented interpretation of this seminal event I have seen.

Throughout the book Mueller provides fascinating bits of economic history

about local telephone service. For example, with early hand-operated and

mechanical switches, average per unit costs actually increased with the number

of subscribers served, meaning there were dis-economies of scale in large

urban exchanges. Each additional subscriber led to a geometric increase in the

physical complexity of the switching function. When these dis-economies of

scale were combined with the fact that local political forces tended to favor

the incumbent Bell companies, competitive local entry by independents became

difficult in the largest urban areas.

Mid-sized mid-western cites and more rural areas frequently had more

competitive entry than the large cities on the East Coast. This is, of course,

precisely the opposite of the situation today where economies of density and

scale have made large urban business corridors the most lucrative places for

competitive local exchange carriers to build competing fiber facilities. The

economics of today’s digital switching technologies make per unit costs

unambiguously lower for larger urban exchanges.

One of Mueller’s

central ideas is that the period of dual service competition

played a key role in the geographic expansion of local telephone infrastructure

to near-ubiquitous coverage because competitors raced to acquire additional

customers to increase the size of their subscriber bases and the scope of their

service offerings. This massive geographic expansion would not have occurred

if there was a single monopoly provider or if competitors were required to

interconnect their networks in what would be called today “non-discriminatory

and cost-based terms.”

Thus, the current conventional wisdom that a failure to interconnect is

inherently anticompetitive is misguided. Mueller correctly points out that

there are inherent contradictions within the Telecommunications Act of 1996,

which on the one hand requires cost-based interconnection and extensive

unbundling of incumbent’s local networks that will ultimately lead to “radical

deaveraging of rates,” while on the other hand calls for the continuation of

universal service subsidies and geographic rate averaging.

Like any truly original scholarship, Mueller’s work raises many important

questions. Although having

separate non-interconnected competitors clearly contributed to the development

of the telecommunications industry during its start up years, it leads to

serious inefficiencies in a mature industry because customers would be required

to subscribe to multiple networks in order reach all other local telephone

users. Today, ubiquitous reachability is an implicit, yet paramount, goal for

all communications networks. The whole concept of the Internet is based on

the value of world wide reachability. When competition authorities at the

European Union and the U.S. Department of Justice required either MCI or

WorldCom to sell off their Internet assets in order to gain approval for their

merger,

it was because they were concerned that the combined company’s backbone would

carry such a large share of traffic that it might have incentives to bifurcate

the Internet by reducing the quality of interconnection with other backbones.

Thus, key but unanswered questions arising from Mueller’s scholarship involve

quest ions surrounding interconnection policy:

When are mandatory interconnection rules an optimal public policy solution?

At what stage in the development of a network industry do the benefits of

ubiquitous reachability dominate the incentives for network expansion which

come from having competing, non-interconnected networks? Should regulators

require non-discriminatory and/or cost-based interconnection terms? These

questions are relevant for public policy makers examining a wide range of

digital-age products and services from basic local telephone service, to broad

band services such as cable-modems and ADSL, to PC operating systems and

applications software.

(Jeffrey Kraft is a Senior Consultant at LECG, an economics, finance and public

policy consulting

company in Emeryville, California. He has consulted with private companies,

law firms, regulatory bodies and other government agencies on a wide range of

public policy, litigation and antitrust issues affecting the telecommunications

and other communications-related industries. He co-authored an article in the

Fall 1997 Journal of Economic Perspectives on the history of local

telephone regulation titled: “Meddling Through: Regulating Local Telephone

Competition in the United States.” Mr. Kraft has

recently spoken at conferences in Osaka, London, and Brussels on the impact the

MCI-WorldCom merger would have had on the Internet, absent intervention by

competition authorities in Europe and the United States. Kraft has a Master

of Public Policy degree from the Richard and Rhoda Goldman Graduate School of

Public Policy at the University of California at Berkeley.)