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The FCC and the Telecommunications Act of 1996: Putting Competition on Hold?

by G.A. (Jay) Keyworth, II and Jeffrey A. Eisenach

Progress On Point
Periodic Commentaries on the Policy Debate
Release 2.1 n October 1996

After years of hard work, Congress passed the Telecommunications Act of 1996, a law designed to "provide a pro-competitive, de-regulatory national policy framework … by opening all telecommunications markets to competition."1 The bill has been heralded by leaders of both major political parties as a significant step toward moving America's telecommunications system into the digital age.However, as many of us pointed out at the time, the Act did not guarantee a deregulatory outcome. Instead, it gave the Federal Communications Commission (FCC) and state regulatory commissions permission to pursue deregulation. Unfortunately, the early signs suggest the FCC has gone in the opposite direction, attempting to use the Act to expand its regulatory authority.

The best evidence that the Commission has gone astray is its massive "interconnect" order, issued this August. Intended to implement the provisions of the Act requiring competition in local telephone service, the order established a complex and pervasive system of Federal price regulation, effectively pre-empting the process of private negotiations and state oversight Congress intended as the means to achieve competitive markets.

This month, acting at the behest of state regulators, local telephone companies and others, the U.S. Court of Appeals for the Eighth Circuit issued a stay of the FCC's rules, pending a hearing scheduled for early next year. Thus, by overreaching and failing to abide by the Act's intent, the FCC has allowed the entire process of telecommunications deregulation to be placed, at least in part, "on hold." The new rules -- and the litigation they have inspired -- will in all likelihood delay the advent of competition for local telecommunications services. And, as the FCC moves to implement other provisions of the Act -- including its universal service provisions -- the new rules send a worrisome signal that the Commission still views itself as the regulatory czar of the telecommunications marketplace.

The 1996 Act and Congressional Intent

The intent of Congress in the Telecommunications Act was clear: to open up local telephone networks to competition, principally through the interconnection of telephone networks so that all carriers can compete and complete the calls of their customers. However, the Act, like many such massive bills, speaks only in broad terms, leaving tremendous discretion to the FCC and to state Public Utility Commissions charged with implementing its provisions.

According to the Act, the interconnection process is to be driven principally through negotiations among the carriers competing in the market. Congress considered private negotiations, not regulatory fiat, to be the best means of moving rapidly toward a competitive telecommunications industry. Congress gave the FCC authority to implement the interconnection policy contained in the Act through the adoption of overall guidelines, but did not intend for the FCC to write detailed requirements governing every aspect of interconnection agreements. That was supposed to be left to the market and to the states, which are authorized to act as arbitrators in cases where interconnection negotiations break down.

Implementation: Undermining the Law

In some areas of implementation, such as the entry of the Baby Bell telephone companies into video, the FCC seems to accept the broad deregulatory intent of the Act. But in the interconnection proceeding, the FCC adopted a very heavy-handed, regulatory approach. In its August 1996 "interconnect" order, consisting of more than 1,400 single-spaced pages and 3,200 footnotes, the FCC issued minutely detailed regulations governing local-loop competition.2 The rulemaking addresses nearly 10,000 issues and sub-issues, and adopts meticulous directives for many of them. Among the egregious examples of over-regulation is a requirement on how to allocate square footage in a telephone company central office, including how floor plans must be devised. There is even a requirement that phone companies check with their competitors before remodeling.

The FCC's approach to implementing the Act demonstrates its lack of faith in the ability of the market and states to promote competition in telecommunications. For instance, the FCC regulations determine in detail the manner in which interconnection should occur, leaving little room for private negotiations among competitors. The FCC expressly rejected the prospect that individual states might implement the Act in ways tailored to local market conditions, suggesting that such an approach would create too great an administrative burden for Federal regulators. Instead, the rules provide for a national baseline for companies to follow in negotiating the price and manner of interconnection agreements. These provisions usurp from the states their historic authority to regulate local telephony and reduce their role to merely checking that the FCC's rules are followed.

Back in Court

After years of difficult negotiation in Congress, where competing sectors of the telecommunications industry were heard and their interests and the public interest were carefully balanced, the 1996 Act emerged as a bill that no one saw as perfect, but most saw as a step forward. Importantly, the Act offered the prospect of removing oversight of telecommunications markets from the courts (which have acted as de facto regulators under the infamous "Modified Final Judgment" breaking up AT&T) and placing it back in the hands of the marketplace, the states and -- to a limited extent -- Federal regulators.

The FCC's interconnection order has had the opposite effect. By attempting to use the Act as the basis for a Federal power grab, the Commission ensured a court challenge. That challenge came not just from aggrieved parties (i.e., local telephone companies) who found the Commission's pricing rules unfair, but also from states who saw the order as an infringement on their authority.

In granting a stay of the FCC's order, the Eighth Circuit Court of Appeals made clear its view that the Commission's order was more likely to harm competition than encourage it. "Before the FCC published its regulations," the court found, the parties were "working together to implement the local competition provisions of the Act. The Act's system of private negotiation backed by state-run arbitration was operating without input from the FCC."3 The Commission's order, said the court, would "establish a price ceiling," which "inevitably confines and restricts the give and take of free negotiations and arbitrations." As a result of the order, the court continued, "the negotiations preferred by Congress are already breaking down due to the competitors' desire to hold out for the FCC's proxy rates" (i.e., the price ceilings set in the FCC's order).

The court was also clear in suggesting that the Commission overstepped its bounds. "[W]e are skeptical," it stated, "that the FCC's roundabout construction of the statute could override what, at first blush, appears to be a rather clear and direct indication . . . that the state commissions should establish prices." As a result, the court concluded, "the petitioners have demonstrated that they will likely succeed on the merits of their appeals."

Still, no one can be sure how the court -- which will not issue a final decision until at least next Spring -- will ultimately rule. Thus, the process of creating competition in local telephone markets is effectively on hold. Such legal wrangling, which may drag on for years, will delay the implementation of the law, denying to consumers the benefits of competition in the local telephone market -- including access to low-cost ISDN and other advanced services needed for growth of the Internet.

What Next? Implementing Universal Service

The FCC's interconnection order has implications well beyond the question of local competition. In particular, it creates a dangerous precedent as the FCC prepares to implement the universal service provisions of the 1996 Act.

By November 8, the Federal-State Joint Board created by the Telecommunications Act will make a recommendation to the FCC on implementing the universal service provisions. The Joint Board is almost exclusively composed of regulators, and it thus will not be surprising if they recommend regulation as the best method of implementation. If the interconnect rule really does signal the FCC's continued love affair with detailed, excessive regulation, the result could well be yet another attempt to expand Federal authority. The intent of the Telecommunications Act could, in other words, once again be turned on its head.

The Joint Board and the FCC should keep in mind a number of principles regarding universal service, including:

While people may have a "right" to dial-tone service to call the police or paramedics, no-one has a "right for that dial tone to be delivered over wires." In some cases cellular phone service may be less expensive than wire. If anything is to be mandated, it should be the service offered, not the technology by which it is accomplished.

Federal mandates, if any, should be minimal and limited to lifeline telephone service. Provision of other telecommunications services (for example, voicemail or Internet access) should not be mandated from Washington but left to state officials to order and purchase.

Federally mandated universal service should be paid for by the Federal government; such subsidies should be raised in a competitively neutral manner and be obvious to those from whom they are collected. States should be responsible for paying for any supplemental state mandates. The FCC should set guidelines to ensure that any state subsidies are raised in a competitively neutral manner and are explicit to those from whom they are collected.

The essentially local nature of universal service – as ordered by Congress and demanded in practice – reinforces many of the arguments advanced by Congress and the Courts on interconnection. The costs of specific universal service programs are impacted, in large part, by the progress of competition in specific local markets and the pricing of interconnection agreements. The devolution of Federal authority over interconnection agreements therefore implies the devolution of universal service mandates. On the other hand, Federal usurpation of state authority on interconnection issues makes state leadership on universal service questions nearly impossible.

Wherever possible, the FCC should rely on the market, not regulation, to most effectively implement universal service policies. For instance, competitive bidding (similar to FCC-auctioned licenses for personal communications systems) could be used to control the cost of subsidies in high-cost areas. Auctions to provide service among potential competitors would reveal the minimum subsidy required for them to provide service. This would remove the arbitrariness and controversy associated with cost estimation by government mandate.

Moving Ahead: Accountability to Congress

The telecommuncations marketplace is not yet fully competitive. Congress recognized the need for continuing, limited oversight by the FCC to manage the transition. But massive, detailed regulation is not the way to achieve competition. Instead, in implementing the Telecommunications Act, the FCC should concentrate its efforts on a few overarching issues and articulate a limited number of boundary-setting guidelines. The practical, prudent approach is for the FCC to defer largely to the states, while preserving the FCC's ability to address significant problems on review.

If the FCC fails to reaffirm both the deregulatory intent and the devolutionary spirit embraced by the Telecommunications Act, the prospects for rapid progress toward a competitive telecommunications marketplace will be dramatically reduced, and Congress' central intent in passing the Act will be frustrated. The question for Congress will then be clear: Will it allow a regulatory agency to flaunt Congressional will, or will it act to ensure that the goal of a competitive marketplace is achieved?

The views expressed here are the authors and do not necessarily reflect those of The Progress & Freedom Foundation, its Board, Officers or Staff.



The Progress & Freedom Foundation