State Experience in InterLATA Toll Deregulation
Loube, Robert, Pilalis, Labros E., Journal of Economic Issues
While the Federal Communications Commission has declared on numerous occasions that the interstate toll market is competitive, this declaration is not universally accepted. It can be argued that significant market power exists and is being exploited. The purpose of this paper is to examine the experience of three states in regulating the state interLATA tell markets.(1) These markets are served by the interexchange carriers (IXCs). Prior to 1984, AT&T had almost a complete monopoly of these markets. Since then, other IXCs have actively pursued customers in these markets. In response to the entry of the other IXCs and to AT&T requests, state commissions have adopted regulatory changes that provided AT&T with significant price flexibility and freedom from earnings reviews. Regulators adopted these changes in belief that these markets had become effectively competitive. This paper provides evidence that disputes the claim that effective competition exists in the state toll markets and presents alternative regulatory policies that would protect consumers from the existing economic power.
The State Experience
The experiences of three states, Florida, Indiana, and Wisconsin, will be reviewed. At divestiture, each state was nominally regulating AT&T. All rate changes required commission review. In the late 1980s, each state introduced a regulatory experiment.
Acting upon a request from AT&T for regulatory relief, the Florida Commission granted AT&T limited pricing flexibility in 1986. The Commission found that AT&T retained significant market power derived from its historical monopoly position. However, the existence of alternative providers mandated the need for limited pricing flexibility. This flexibility was bound by a cap and a floor, where the cap was the existing price and the floor was the local exchange company (LEC) access price plus billing and collection costs. AT&T was required to maintain statewide average rates and pass through reductions in access rates [Fla. PSC 1986].
The Commission has revisited the issue twice, in 1988 and 1993. In its 1988 order, the Commission extended its plan by retaining its price cap and floor rate regulation and refused to consider any adjustment related to an earnings review [Fla. PSC, 1988]. In its 1993 order, the Commission found that market power was a function of market share. It noted that AT&T's market power was higher in the residential market than in the business market because AT&T's share of the market for evening calls was higher than its share of the daytime calls. Thus, it found that effective competition existed for the larger business customers but did not exist for residential and small business customers. It also found that prices were reasonable because there had been price decreases, even though it acknowledged that AT&T's price decreases followed LEC access rate reductions and that all other carriers copied AT&T's changes. The Commission removed price caps and floors from many of the non-message toll service (MTS) markets.(2) For the MTS market, it removed the requirement to pass through access rate reductions [Fla. PSC 1993].
In 1985, Indiana enacted the Competition in the Provision of Telephone Services statute. This statute provided the IURC with the discretion to limit its jurisdiction over various types of telecommunications carriers and services. In accordance with the legislation, AT&T, MCI, and Sprint filed a joint settlement agreement in March 1988. The agreement specified that AT&T would come under a "price cap" form of regulation, which contained substantial pricing flexibility, and that the operations and services of MCI and Sprint were to be substantially deregulated [Joint Submission 1988]. The IURC technical staff's analysis of the joint proposal established that: (1) The "price cap" formula for AT&T's services prices was flawed since it did not contain a "productivity adjustment" factor (an omission that would have led to higher AT&T rates, while, in fact, AT&T services rates were declining at that time under the more traditional "rate of return/cost of service" regulation); (2) AT&T still had a dominant market share in the market for IXC services; and (3) AT&T enjoyed very high levels of profitability that were not consistent with an anticipated "competitive environment" for IXC services [Pilalis 1988]. …