Prospects for Deregulation in Telecommunications Joseph Farrell Chief Economist, FCC Speech, May 9, 1997, at FCC. As released. Please note: I am continuing to work on this document and plan to post a revised/improved version on the FCC's website under "Economics Information" later this month [5/97]. -- JF. It's been a hard day's night and I've been working like a dog. But I'm leaving on a jet-plane. I left my heart in San Francisco and now I've got a ticket to ride. Tonight I should be sleeping like a log. Actually, never mind liquor ads or tobacco, the FCC itself seems to be addictive. You see people wandering the halls at midnight, muttering "just one more redlining, just one more edit, then I'll go home." I had promised to leave in January, but here I am still... And I'm planning to stay involved in selected issues for another few weeks -- but I'll be doing it from California. Today I want to share a few tentative thoughts on a subject that hasn't had as much discussion as it deserves -- deregulation. I stress that this talk does not purport to represent anyone else's thoughts. Even within my own mind, these are ideas in ferment -- or, as I think Woody Allen once said, "concepts in search of funding to turn them into ideas." It's been a remarkable experience for me the past sixteen months. The FCC is a group of extraordinarily dedicated people who have worked tremendously hard to reform regulation to make it more compatible with competition. The Access Reform and Universal Service Reform orders adopted this week are crucial steps in this direction. They will greatly reduce incumbent LECs' exposure to inefficient cream-skimming by competitors, so they should make us all the more enthusiastic about the arrival of competition, and the prospects for deregulation that come with it. After all the work making regulation competition-compatible, I think we can all look forward to deregulation. If there were suddenly flourishing competition, then most or all regulation could be removed without much controversy. Unfortunately, this is not a plausible picture. Instead, the process of deregulation will be controversial, contentious, and complex. I don't have the answers, but I want to do what I can to bring the questions to the top of everyone's agenda. First, why is deregulation desirable? If regulation helps keep prices close to cost, and stops users being gouged by firms with market power, isn't that good? Does that mean that deregulation should just be a matter of "delete needless rules" -- eliminating regulations that are redundant because competition is a tighter constraint, or about as tight a constraint, on price gouging? I don't think so. I believe, on the contrary, that deregulation should be pushed, and should be undertaken even where we can expect some adverse short-run price impact. Of course, this is a matter of degree and judgment, but even where deregulation would immediately result in higher than regulated prices, it likely has other, desirable consequences. This merits some explication, because economists have long been pushing regulators to bring prices closer to costs. Am I saying this is unimportant? Not at all. If we assume that prices are to be regulated, that's the right principle to aim at (although certainly paying very close attention to cost incentives as well as price/cost comparisons). But economists' other message, which probably is broadly more important if the two conflict, is that we should encourage competition, even quite imperfect competition, and allow market forces to work even if the result in the short term is prices considerably different from costs. Unregulated competition is typically better than regulation in many ways that have little to do with simple price levels. It's worth mentioning some of these ways, because if deregulation at a particular point in time would let prices rise somewhat, we must balance the bad effects of such a price rise against the good effects of deregulation. I won't try to give you a complete list, but here are a few. Ü Unregulated competition does subtler things on prices than bring price levels to cost in the long run. It allows firms to cover common costs in creative and flexible ways. More generally, it lets firms experiment to find how customers prefer to pay the costs they incur. (Regulators can use economic principles to predict what pricing structures should be efficient, but in the end efficiency should be measured by what customers actually want, not what we predict they will want.) And it lets prices -- both as consumption signals and as investment signals -- move at least somewhat in tandem with the first-best ideal, which, to oversimplify somewhat, is short-run marginal cost when there is plenty of capacity, and capacity-filling price, perhaps well above cost, when there is not. (Peak-load pricing is an example of this kind of pricing.) This is much subtler pricing behavior than "keep prices near long-run cost", which is probably the best that regulators can realistically do (trying to implement the first-best ideal would likely be terribly demanding in terms of information, and extremely subject to manipulation). The two coincide in long-run equilibrium, but transitory differences are likely to be important in industries in which investment and capacity costs are important and demand is somewhat unpredictable. Pricing at long-run cost pays for investment, but doesn't give the sharp signals "invest all-out in capacity" or "don't invest in capacity", with their high- powered incentives, that the market can give. Ü Incentives to minimize costs are surely much better under price caps than under old-fashioned regulation, but even price caps without explicit sharing are not the same as having an unlimited upside and a downside limited only by bankruptcy. Ü Both by improving incentives and by removing administrative/legal hurdles, unregulated competition (or even unregulated monopoly) encourages more rapid innovation. The incentive effects on regulated firms come from (probably justified) skepticism about a regulated firm's ability to keep the possible large rewards of successful innovation; although this can be mitigated if regulated firms can treat development expenses as cost, the resulting incentives are at best diluted. As to the hurdles and "may I?" problems created by well-meaning regulation, the long delays in introducing cellular and other wireless services are a painful reminder. Ü The smart and highly-paid lobbyists, and the smart and under-paid regulators, could do something more productive, and legislators could turn their attention to our society's serious problems rather than argue endlessly about who will or won't pay a few bucks more or less a month. So, with that background to remind us why we should yearn for deregulation, let me turn to the question I asked in the title: what are the prospects? My incomplete and, I stress, highly tentative answer today comes in four parts: (1) description of a immediate-deregulation option that I give partly just to shift our mind-set; (2) discussion of retail deregulation based on wholesale regulation; (3) discussion of removing wholesale regulation based on bypass; and (4) discussion of how to limit the regulatory/entitlement presumption in telecom. 1. An immediate deregulatory option Most of what I'll say today suggests a relatively gradual path to deregulation. But some people argue that we should simply deregulate everything except call termination, accept that some prices would almost certainly rise dramatically as the regulated local near-monopolists become unregulated local near-monopolists, and watch facilities- based competitors build out as fast as they can, to try to get in on the big profits before they're competed away, and in the process of course compete them away. There is a certain appeal to this picture, perhaps especially for economists. I think this appeal to economists is only partly because economists are more alert to the benefits of deregulation; it's also partly because economists by and large are fairly prosperous. Less prosperous people, and those less committed to the merits of deregulation, might take a less philosophical attitude to a short-run doubling of their phone bills, even if it speeds innovation and reduces costs and prices in the longer run. I therefore suspect that full-scale deregulation now is not an option. Moreover, let's not forget that the right to share the incumbent's network facilitates even primarily bypass- oriented entry by non-incumbents: more on this below. However, I firmly believe that we should keep this "immediate ruleburning" approach in mind, because at some point it will not lead to dramatic rate-shock, and then it may be the time for this approach -- and as you will see at the end of this talk, I think it may already be time for a limited version. Perhaps even more importantly, if we keep the immediate option in mind then we are closer to a world in which the default is deregulation, in marked contrast to the world of telecommunications we know. Should deregulation precede or follow development of "enough" competition? To the extent that the benefit of immediate deregulation is the resulting strong incentive for entry, one might ask whether it can be achieved equally well but with less by way of interim gouging, if deregulation follows rather than precedes facilities-based competition. This issue will recur later in my talk, but let me spend a moment on it here. In general, economists have argued that incentives for entry depend on entrants' expectations of incumbents' post- entry prices, not (directly) on what happens before entry. This would suggest that pre-entry regulation of the incumbent would be irrelevant for entry incentives. This view is somewhat oversimplified. In particular, it ignores the possibility -- probably important in telecommunications -- that entrants may be customers (notably long-distance companies, who are LEC customers in access services), who may enter so as not to continue paying high "pre-entry" prices. It also may be optimistic about how promptly deregulation would in fact occur after competitive entry. Nevertheless, if regulators commit strongly and publicly to prompt (partial or full) deregulation in response to the arrival of competition, then incentives for such entry may be much enhanced. So would be incentives for incumbents to refrain from trying to block entry. Finally, the same would apply not only to deregulatory responses but also to interim responses that would slow the regulator-enforced downwards trend in telecom prices, such as a drastic cut in the price-cap X-factor. Thus I believe we should actively seek opportunities to make such commitments -- not unthinkingly, but recognizing that some benefits flow from having such commitments even if the result sometimes looks "too deregulatory" when it comes time to follow through. Two views of bypass-or-share Turning at least temporarily from the immediate deregulation option, my other points will relate to the main competition policy established by the 1996 Act: the right of entrants to compete by sharing the incumbent's network and its advantages of incumbency. After describing how retail deregulation can be undertaken in the shadow of this "share the network" wholesale regulation, I will ask how we can in turn deregulate the sharing of the network. I believe there are two appealing interpretations of the point of these regulatory "network-sharing" provisions, and which interpretation you favor will color your views of specific de-regulatory proposals. Perhaps the two are best described by starting from the observation that competition requires that the incumbent's bottleneck facilities be bypassed or shared. In the first interpretation, regulation should strive to facilitate competition that involves efficient sharing by competitors of any or all parts of the incumbent's network, because from society's point of view there is no point bypassing the bottleneck if it can more efficiently be shared. In this interpretation, it's quite possible and quite OK if (for some parts of the network, in some areas) there is never bypass: it will prove that sharing works just fine, and save society the very large costs of bypass. If there is bypass, in this first interpretation, it should be driven not by the need to bypass merely in order to compete, but by the need to bypass in order to do things that sharing cannot do. Thus bypass will be driven by the urge to innovate in ways that the incumbent's network cannot allow, and by the inefficiencies of regulated sharing. Those inefficiencies include provisioning problems that regulators can't cure, and (relatedly) non-incumbents' simple reluctance to rely on a competitor, notwithstanding regulatory protection. They would also include overpricing of the incumbent's network, and underpricing too, especially if it makes the incumbent's network fall behind the technological frontier. This interpretation in its strong form takes no position on whether bypass or sharing, or what mixture of the two, is the desirable end result; it aims to let "the market" decide (element by element, and area by area) between unregulated bypass and regulated sharing. Moreover, to the extent that bypass will be the solution in the long run, it lets the market decide when, without meanwhile closing off all competition. In particular, it may be inefficient for competitors to overbuild now if the costs of overbuilding are falling rapidly. (Some have suggested that this is the case in cable telephony or in fixed-wireless local loop service.) In this perspective, if competitors delay buildout because they hope to share the incumbent's facilities at least for a while, that is perfectly fine. In the second interpretation, sharing is not a solution but a stepping-stone, because only bypass will enable (more or less) full deregulation. In this view, the rationale of the sharing rules is that bypass might never happen, or might be slower to arrive, if it had to happen all at once, so sharing is encouraged as a transition or as a fill-in to facilities-based competition or bypass. This interpretation rests on a grand judgment that bypass and (more) deregulation, not sharing, is the desirable end result. In this view, if competitors delay buildout because they hope to share at least for a while, it is a bad thing, because only bypass can bring true deregulation. This second interpretation is a more radical departure from the old "natural monopoly" theory, which supposed that bypass was generally undesirable. And, of course, since bypass will indeed permit much more deregulation than will sharing, it may appeal more to those who think regulation is most inefficient -- although this reaction may be too simple, in that the more inefficient is regulation, the stronger the incentives to bypass even under the first interpretation. I think we should not irrevocably choose between these two interpretations a priori, but rather should watch how competition with regulated sharing evolves. Does it come to be an effective means of having vigorous competition without inefficient bypass? Does it constitute a crucial stepping-stone to efficient bypass? Does it seem to be (especially in low-density areas?) the alternative to no competition, rather than the alternative to bypass? Or, does it tame competition through an incumbent firm's discretionary gift of unenforceable cooperation? Does it produce inefficient rent-seeking by entrants more interested in getting underpriced leases than in efficient competition? Whatever the answers, the tension between the two interpretations will infuse our thinking about deregulation of the terms of such sharing. Before turning to that topic, however, let me discuss one payoff of effective sharing: the opportunity to deregulate retail. 2. Retail deregulation based on wholesale regulation Smoothly functioning wholesale regulation (sharing the incumbent's network, including the so-called platform) permits and indeed almost demands retail deregulation. If multiple providers can compete for a customer's business and promptly supply it at a reasonable overall cost, even if they do so by leasing the incumbent's facilities, then it would seem that prompt deregulation of all charges to the provider's end- user will be appropriate. If a carrier tries to charge too much overall to the end-user then another will undercut, and by hypothesis this can happen quickly. If a carrier tries to charge a reasonable amount overall but in an inefficient manner, then another carrier can offer a more profitable alternative pricing package that is also better for the end-user. There should be no need for regulators to resolve the difficult issue of "how" end-users want to pay the cost of service -- how much in flat charges, how much in usage charges, how much for special features, etc. Indeed, if regulators continue to regulate the incumbent's retail prices, and don't happen to replicate the solution that the incumbent and the customer jointly find most beneficial, it puts the incumbent at an artificial competitive disadvantage. Thus, while there are obvious risks in premature deregulation of incumbents, there are also risks in waiting too long. Getting the timing just right will be a great challenge for regulators -- the FCC and the states alike. Long and variable lags will cause problems. I worry that the information flow and the organizational structures are not optimized for this kind of challenge, and I'd like to suggest we should rapidly try to improve them, although I don't today have specific suggestions for how. What about access charges in this world of platform competition? It seems logical that in such a world, originating access charges can be deregulated to the extent that they flow through causally to the end-user: that is, to the extent that if a LEC charges more to originate traffic to an IXC, the LEC's own customer pays the extra. This effectively turns them at the margin into an end-user charge. However, there are at least two potential problems with this. First, today in the long-distance industry firms do notvary long-distance charges according to the originating access charges imposed by the calling party's LEC. If a LEC takes that as given, then it will have every incentive to increase its originating access charges, since the increased charge is in effect socialized and paid by all long-distance customers. If the averaging were only a contingent custom, then we could at least hope that any LEC who charged much too much would find the custom changed. But, depending on interpretation, section 254(g) of the Act may make this hard. Thus it is not self-evident that originating access charges could be deregulated if we want to preserve "equal-access" competition. Of course, the surplus from high originating access charges will be part of the competitive reward to winning the customer, so it need not weaken "full-line" or "one-stop shopping" competition. Moreover, any individual long- distance company can compete for the customer and offer low long-distance prices as part of the package, so increases in "originating access" in this sense need not lead to high long-distance charges. Thus it may be that the only net effect would be that "equal-access" competition was displaced, not supplemented, by one-stop-shopping competition. As one- stop competition develops, how important should equal- access competition remain? Terminating access charges, like other termination, may be a different matter, because carriers may compete to sign up customers and then be able, to some extent and perhaps to a great extent, to gouge originating carriers. If the originating carrier passes any "gouging" through to the originating caller, this may be no problem -- it's like making your phone number a 900 number (a tempting option for dealing with telemarketers, perhaps). Similarly, termination charges assessed (as today in CMRS in this country) on the call recipient are an end-user charge and could be deregulated in line with other such charges. But shifting to these arrangements in wireline would demand institutional and perhaps technological changes. Whatever the details of the treatment of access, etc., the broad picture remains that retail could be deregulated in reliance on wholesale regulation. How valuable is this form of (semi-) deregulation? That remains to be seen. The answer may in turn affect our views on whether regulated sharing is an acceptable solution for the long term or whether it is only a stepping-stone. I tend to believe that it is unlikely to be a fully acceptable solution for the long term, and this raises the question: When should we move beyond it? 3. Wholesale Deregulation Let's start with two observations. First, when a bottleneck is bypassed, it's not a bottleneck any more, but two competing providers constitutes distinctly imperfect competition. Second, while pricing an incumbent's network at long- run forward-looking cost, correctly implemented (including full economic depreciation), pays for the incumbent's investments, it does not provide high-powered incentives for incumbents to invest or innovate. If I may play lawyer for a moment, I note that Section 10 of the Communications Act, as amended, authorizes the Commission to forbear from applying statutory provisions in light of competitive conditions, but this does not apply to section 251 "until fully implemented." However, section 251(d)(2) tells the Commission, in choosing what network elements should be unbundled, to consider, at a minimum, whether unbundled access to "proprietary" network elements is "necessary," and whether failure to "provide access" would impair competitors' ability to provide service. I won't pretend to be lawyer enough to untangle all this, but just note that there seems to be scope, as there ought to be, to consider the competitive implications of requiring or not requiring unbundling. With those ideas in mind, let's think about two situations that might perhaps warrant deregulation of the sharing of an incumbent's facilities: bypass by a competitor, and bypass or upgrade/overbuild by the incumbent itself. In each case, I think the analysis must have two elements. First, given the competitive situation, does regulation of sharing continue to help rather than hinder the growth of competition? And, second, what kinds of rules will create desirable rather than undesirable ex ante incentives for entrants and incumbents -- incentives to invest, to compete, and where appropriate to cooperate? Bypass by competitor Suppose a competitor bypasses -- say -- the incumbent's loop to my house. Then that element is no longer a true bottleneck: there is an alternative way to get calls the last mile to and from my home. Should this trigger deregulation of sharing of the incumbent's loop? Starting with the competitive analysis "ex post": -- there is now a second firm that can compete to serve me without leasing the incumbent's loop. -- a third firm that needs a leased loop can plausibly get one without being wholly at the mercy of an incumbent monopolist. It has two possible sources from which to lease a loop. If I the customer can be served using only one loop, then one of the two loopy firms likely has an idle loop to my house, so the third firm might be able to get a really good deal. -- the bypass is some evidence that further bypass would be perfectly possible, so it's less likely that the third firm is somehow subtly blocked (for instance through control of rights of way) from doing its own bypass. All these considerations weigh in favor of deregulation at this point, based on competitive analysis once the bypass is achieved. Against them must presumably be set the likely rise in the loop price facing "third firms" -- the second firm presumably would not have invested in bypass if it thought third firms would be able to lease the loop at less than long- run economic cost, and it would be a remarkable coincidence if the duopoly produced prices exactly equal to long-run cost. What about ex ante incentive effects of a policy of deregulating after bypass? Such a policy would reward the incumbent for cooperating (for instance, in rights of way, in co-location, or in number portability) with bypass. This is clearly good under the "pro-bypass" interpretation of the Act. It has good aspects under the "efficient sharing" interpretation too, although this is a little less clear, since it might also give the incumbent incentives to "encourage bypass" by hampering sharing. Turning to non-incumbents' incentives, the entrant has stronger incentives to bypass when it knows that, should it do so, the incumbent will no longer have to lease its loop at a regulated rate: the "post-entry pricing" effect I mentioned earlier. In particular, this rule could resolve what is otherwise a very troubling problem: if regulators inadvertently set sharing prices below true long-run economic cost, then absent some rule such as this, there may be no bypass even if bypass would be efficient, and we might never learn (for sure) of the error. With multiple (potential) entrants the rule might even create something of a race to bypass, since building a third loop will presumably not be very attractive. Is this good? Clearly it is if we want to drive bypass; it is less clear how to evaluate it if we want to preserve efficient sharing but also efficient bypass. For these incentive effects to work at full strength, deregulation would have to come promptly upon bypass and would have to be confidently foreseen, raising the timing and regulatory commitment questions I mentioned earlier. Naturally, implementation of any such policy contains challenges. For instance, does CMRS bypass count? One might argue that Congress presumably thought not in February of 1996, I suppose because wireless prices (and quality) are still not competitive with wireline. But how much must wireless capacity and/or prices change before it should count? Does the existence of coaxial cable that potentially can be, but for the most part currently is not, used for telephone service, count? And how should our answer depend on the duopoly behavior we observe in such cases? What if the two loop-owners manage to sustain near- monopoly prices? (In the long-distance industry, capacity is leased to at least some resellers at or near competitive prices, but there are more than two facilities-based carriers.) Again, much seems to depend on our balance between the two views of the Act's share-the-network provisions. If we aim to make sharing work as well as possible even in the long term, we should be concerned that (third-firm) entrants be able to share an existing network at prices not too far above long-run costs, even in the long term. If, on the other hand, we view interim sharing as a stepping-stone for gradual development of facilities-based competition and deregulation, this may seem a wise place to consider deregulating, for two intertwined reasons: deregulation makes considerable sense once there is bypass, and also, as argued above, a commitment to such a policy encourages bypass. Bypass (overbuild) and divestiture by the incumbent Now what about bypass/upgrade by the incumbent? A year ago in a speech here [since published in Federal Communications Law Journal, Nov. 1996] I drew some analogies between advantages of incumbency that are traditionally viewed as sources of "natural monopoly" on the one hand, and intellectual property on the other. The interconnection provisions of the Act require incumbents to share those advantages, just as intellectual property policy requires patent-holders to share their intellectual property after the patent's term expires. And, just as in intellectual property policy, this sharing is only part of the right policy: reward to investment must also be given great weight. This perspective suggests that when an incumbent creates a "new" network element, perhaps the new one need not immediately be made available on regulated terms, provided the old one remains available to non-incumbents. I have in mind, for instance, the case where the incumbent builds new high-capacity loops to some of its subscribers, leaving the old copper in place (and in good shape); or where it installs a new switch and leaves the old one "co-located". How would we ensure that the old facility is indeed maintained and made available for competition? One possible answer, seemingly less regulatory than today's provisioning and maintenance requirements, is that the incumbent could divest the old facility -- either to a competitor or to an entrepreneur who could lease it to competitors. Such a policy would enhance an incumbent's incentive to make such investments, and to leave the old, potentially competing investment in place rather than rip it out. On the other hand, it may give us pause to note that if the improvement is important enough, it would re-create a kind of bottleneck market power, perhaps so great that the old element would hardly constrain the incumbent's pricing. And if (for whatever reason) the incumbent has a strong first- mover advantage in such overbuilds, the policy might tend to re-create the "natural monopoly." Thus it would be worth exploring whether the exemption from unbundling might be temporary, like the patent-holder's exemption from sharing. Of course, the same tradeoffs apply as in intellectual property policy generally: the longer the period, the better the incentive for this innovation but the greater the potential market distortions during the exemption. And if truly workable competition arrives before the exemption period expires, then sharing presumably need not be imposed after all. Such an exemption policy would also affect non- incumbents' incentives. Leasing unbundled elements might become viewed more as a stepping-stone to innovative facilities-based competition, because a carrier who tries to rely permanently on the incumbent's facilities would risk being overbuilt out of business not only by other competitors but also by the incumbent. In other words, it may fit better with the "stepping-stone" interpretation than with the "efficient sharing" interpretation; the latter would lead us to worry somewhat more about the effects on entrants' rights to share the overbuild -- though not to the exclusion of concern about the incumbent's incentives. 4. Limiting the scope of end-user subsidy Most of this talk has concerned the "bottleneck power" reason for regulation. In this last section, I turn to the subsidy reasons. In telecommunications, some end-users currently are charged below cost --- in some cases much below cost. This kind of entitlement creates competitive problems if those subsidies are funded by implicit cross- subsidies from other users who pay above cost, or if they are funded explicitly but not all competitors are equally able to receive the subsidy. As Professor Lawrence White has elegantly put it, "cross-subsidies are the enemy of competition, because competition is the enemy of cross- subsidies." Congress addressed this problem in section 254 of the Act, instructing regulators to produce a system of explicit subsidies. This week the Commission adopted a plan for such a system. It will go a long way towards addressing the problem, compared to today's system of implicit subsidies. Nevertheless, it is probably impossible for regulators to identify and make explicit all implicit subsidies. Even within a relatively small high-cost area such as a census block group, customers will differ greatly in how profitable they are to serve. Thus, as long as incumbents are subject to carrier- of-last-resort obligations, they will have colorable claims that competition is at least partly inefficient "cream-skimming." In an apparent attempt to resolve this problem, section 254(e) states that only a carrier declared "eligible" under section 214(e) may receive the subsidy, and section 214(e) says that eligibility requires a carrier to offer service throughout a state-defined "service area." These two subsections protect these remaining implicit cross-subsidies by restricting the forms of competition that can receive subsidies, thereby discouraging other forms, perhaps including those most threatening to the remaining implicit subsidies. Some kinds of geographic specialization are permitted: those who serve only customers within a single state, for instance, are apparently eligible. But other kinds of specialization, such as service offered only to internet users, are ineligible. I see this as a compromise between allowing unrestricted competition and avoiding cream-skimming. As such, it inevitably compromises unrestricted competition to some degree. I am not arguing here that the subsections (e) are unwise. Although competitively troubling, they do try to address what could be a real problem, given the problems of carrier-of-last-resort status. Rather, my point is that such problems are difficult and their solutions will inevitably often be competitively troubling. Therefore I think it will be important in moving to deregulation that these broad subsidy entitlement programs be limited. Politically, however, some entitlement may be so entrenched that a strategy that relies on eliminating them will fail. Accordingly, I want to explore the idea that we can say at some point, "The subsidy buck stops here." By this I mean that in defining subsidized services, we should be rather slow to include "new" services, and this will aid in deregulating not only those services but also, as more people move to the deregulated sector because the offerings are more appealing, it will help even in limiting problems in the old, regulated sector. Moving from this rather vague notion to specifics, I'd like to propose that there is no need to subsidize second lines. A regulatory version of this proposal would involve moving the (still regulated) prices for second lines "to cost." I think that would be a very valuable step in the right direction. However, in part because many households are wired as a matter of course with two (sometimes more) lines even if only one is initially used, it is somewhat unclear what is the right concept of "cost" of the second line. To establish conceptually a limit on the scope of subsidy, perhaps it hardly matters psychologically what measure of cost is used. But here is a possible test of our willingness to change the presumption of regulation: perhaps we should actually deregulate the provision of second residential lines, establishing a conceptual limit not merely on subsidy but on regulation. This is a little like the "immediate deregulation option" I began with, but much less threatening because it's limited to a part of the market where (a) there is more immediate competitive discipline, and (b) there is less reason to worry about harm to low-income or otherwise highly vulnerable consumers; moreover, I have in mind deregulating only end- user charges, so no issues of prices to competitors should arise. For several reasons, I doubt that the prices charged for such lines would go up very dramatically if deregulated (while first lines remain regulated). For starters, few households must have a second line. For some users, especially those who plan to use their second line for "overflow" conversation (that is, when more than one household member wants to make calls at once), wireless would be an acceptable, and in some ways better, substitute for a second wireline; at low usage levels, wireless is already not very expensive, and wireless companies already claim some success in marketing as alternatives to second lines. For other users, cable modems are or will be very attractive once the cable industry gets its telecom act together. Multi- line users will presumably be among the first to become attractive to competitors. And -- a slightly strange point, but let's be pragmatic -- "cheating" by putting a second line in a second name (thus getting the still-regulated first-line price) would often be easy. Given all this, do we really think that incumbent LECs would raise the price to a level where we should be much more concerned than we are about the price of perfume or of microprocessors -- so much more concerned that we think the government should step in and set prices? This "not much immediate impact" prediction (if widely shared) might make it easier to overcome the objections from those who want to keep their subsidized rates. It's also probably important to do it soon, while second lines are still generally viewed as something of a luxury, so that people feel at least a hint of shame in arguing that they must be subsidized. But I don't want to enshrine the principle that "deregulation should only happen where prices won't go up, or where the good is not essential." This would not be a good principle, because deregulation in the presence even of limited or incipient competition will bring real benefits that should be seriously weighed against any possible price increases. How to do that weighing should be a subject of much more active discussion than it has been. If I've helped even slightly to push that agenda to more prominence, I'll have done a lot of good on my last day physically here in Washington. Thank you.