Academic journal article Economic Inquiry

Competition and Productivity Growth: The Case of the U.S. Telephone Industry

Academic journal article Economic Inquiry

Competition and Productivity Growth: The Case of the U.S. Telephone Industry

Article excerpt


There are few empirical studies on the relative performance of firms in competitive and monopolistic markets. This contrasts with the large body of literature that compares the performance of privately owned and governmental firms. One reason for the scarcity of studies of the former type is that competitive and monopolistic firms rarely coexist in the same industry and country.(1) This makes it difficult to distinguish between industry and market structure effects. On the other hand, relying on intercountry comparisons as, for example, Caves, Christensen, and Swanson [1981] do for U.S. and Canadian railroads, renders the analysis potentially sensitive to country effects.

The telephone industry in the United States offers one of the best opportunities for empirical analysis of the consequences of competition and monopoly. Some new entry in the long-distance telephone market was allowed by the early 1960s, while entry and competition in the local telephone market had yet to materialize by the beginning of the 1990s. Hence, it is appropriate to focus on differences in performance between AT&T Long Lines and the regional monopolies.(2) Since there may be differences in initial conditions between the local-service and long-distance markets, comparisons of performance should control for such differences. Both markets, however, clearly employ very similar technology. This, holding other relevant conditions constant, should lead to similar changes in productivity. To sharpen the analysis, we focus on differences in the annual rate of productivity growth and not the level.

While local exchange carriers (LECs) still largely maintain their monopolistic position, rapid technological advance in telecommunications is changing the established market structure in the local telephone industry. The recent U.S. Telecommunications Act of 1996 was aimed at eliminating legal barriers that have suppressed technically feasible local competition. Certainly some competition in local telephone markets is under way. Is such competition socially justified and an appropriate objective of public policy? The effect of competition on productivity growth holds at least part of the answer. We need to know whether competitive markets are likely to raise efficiency in assessing how much effort should go into reducing entry barriers and increasing competition in the local telephone markets. Still another policy issue on which our study has a bearing is the relation of firm scale to costs. For example, in the context of recent mergers of regional telecommunication companies, are reductions in costs and increases in productivity a plausible expectation?

Competitive effects in the telephone industry have been examined mainly through aggregate time series data. Thus, Oum [1990], using Chessler's competition index for long-distance service, concludes there have been positive effects of competition on productivity, whereas Crandall [1991], using a time dummy, finds the results inconclusive.(3) At the firm level, Denny, Fuss, and Waverman [1981] and Kiss [1983] decompose total factor productivity (TFP) growth for Bell Canada through estimated cost functions. Nadiri and Prucha [1989] measure productivity growth for the U.S. Bell system with several alternative cost models. But none of these careful firm level studies focuses on competitive effects. Ying and Shin [1993], on the other hand, do examine the spillover effect of the AT&T divestiture on cost saving by the regional companies. Their interesting study, which shows positive spillover effects, does not, however, permit strong conclusions because of the shortness of the period examined (1976-87).


Before the divestiture of AT&T, the U.S. telephone industry consisted of several vertically integrated common carriers. AT&T accounted for about 80% of industry revenues through a group of 22 operating companies plus the AT&T Long Lines. …

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