[BETA] Fortnightly

Lately I'm reading up on the new Telecommunications Act. Last week I printed a copy from the Internet and stuffed it in my briefcase. Each night on the train I give it a go and skim a few sections.

The new law unabashedly favors competition over regulation, but appoints state commissions (PUCs) to certify when that competition may be deemed effective enough to open markets. Thus, the PUCs will take at least one last shot at managing markets before they relax regulation for competitive services.

But what if this "relaxation" actually makes some rates higher (em to the advantage of the incumbent, which still exerts monopoly power? That result sounds counterintuitive, but read on.

The Incentive

Back in 1989, the California Public Utilities Commission (CPUC) imposed a "new regulatory framework" for incentive pricing for Pacific Bell and GTE California, the state's largest local exchange telephone carriers (LECs). As the plan evolved it imposed price caps, allowing rates to float as long as they did not exceed a price ceiling. The CPUC would adjust the ceiling periodically for inflation and other factors. Also, the CPUC would offset inflation by productivity gains in telecommunications. In essence, the productivity offset served as the ratepayer's friend. As new technology shaved costs, rising productivity would protect ratepayers from inflation-driven price hikes. The CPUC tabbed this offset the X Factor.

Meanwhile, growing competition took a bite out of LEC earnings. Competitive access providers (CAPs) siphoned off some business traffic. Cellular boomed. Market barriers fell for intraLATA toll. Finally, in July 1995, the CPUC announced it would open up the PacBell and GTE local calling areas to other facilities-based carriers, starting in January 1996. Reseller competition would follow by March. Other small and mid-sized LECs would face local competition in 1997. Then President Clinton signed the Telecommunications Act of 1996.

But timing is everything. Now, and during the transition that will come, the incumbent LECs find themselves engaged simultaneously in competitive and captive markets. Keeping both ends honest remains a full-time job for the state PUCs.

That Worked So Well

Last Winter, on December 20 (the date of its final order in the "Blue Book" electric restructuring case), the CPUC killed off the X Factor. No longer would productivity gains offset inflation in setting the price ceiling for LECs. The reason? The X Factor was working too well.

The productivity rate had grown to exceed inflation. The X Factor was driving rates down for local telephone services (em so far down, in fact, that the CPUC felt it threatened PacBell: "We conclude that in an era in which the price cap formula is producing price reductions, the resulting declines in revenues can jeopardize a firm's ability to finance capital investments."

In fact, PacBell and GTE offered evidence of losses in market share in the intraLATA toll market during the first six months of 1995 (6 percent for PacBell; 7.5 percent for GTE). The CPUC proved receptive: "It is clear that the market share loss in California is both extraordinary and unprecedented. ... [I]t took at least three years for