Telecommunications Pricing and Innovation
For many years local telephone service has lagged behind long distance service with respect to the incorporation of technological advances. The costs of providing long distance telephone calls have fallen dramatically over time relative to the costs of providing local calls due to the uneven applications of advancing technology. Until the AT&T divestiture in 1984, federal and state regulators had been imposing a growing share of the total industry costs on revenues from the interstate market, thus heavily subsidizing local subscriber costs. The subsidization of local exchange operations as well as the economies of scale in conventional telephone service and regulatory restrictions on entry eliminated the possibility of unsubsidized competition in local markets, such competition often being the vehicle by which cost-reducing innovations are introduced. On the other hand, many observers were concerned about the possibility of encouraging uneconomic entry as an indirect effect of providing incentives for competition.
The focus of this chapter is on pricing and the rate of innovation in local exchange companies, since it is the local telecommunications markets that, through economies of scale in conventional technology, cross-subsidization and depreciation policies, were the most protected from competition and thus from pressures to introduce new technology.
The system of cross-subsidization of local exchange operations through separations and settlements could be made to work, however imperfectly, when telecommunications were a national monopoly, but such a system creates unacceptable distortions in an asymmetrically