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PleadingHeader for numbered pleading paperP@n   $] X X` hp x (#%'0*,.8135@8:Rd{  Line Draw (Scalable-Cr)CG2cf D6f Af Mf vX",tB^ f ^wdHddd! !! 777 z!77! !!!! ooH!ho!!!!!!!    oooo!7777!!!!!!!77!! !   !!   8777777ok7p   o > !87(  ! ! !! !!! ! ! !WxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxN!!!ddddhh0!MMdz"!!!!!ddddr4d!d!!!!!!!!!!!d! !!7!!!!!!!!!!!!!!!!\ 7!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!    7!o7 z! 7! ! !7! 77!!%!7!!!hh@@hxxhhhhhh@xxhPPPP``H(( @`hhhxxxp8((hhhh(hhhhhhhhhhhhhhhhhhhhhhhhhhhhhhhhhhhhhhhhhhhhhhhhhhhhhhhhhhhhhh@@hhhhhhhh8888hh````hhHHH88888hh",tB^ f ^OY{YYYYYYYYY  wYhYYYYwwwYJJJchJwww EYJwwwwwwwwwwYJYJYJYJwuuuuuuYJYK`PK``eee`KuuuYYYYW                                                xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxNYwmm^^YYEE    YA^"               L#YY      Y   Yw       {                              q          wwYYYYwhwwYJwwwwwYwYYYwY  0[hE{ 00;;%e  + 5%%U{        U{U{          PPe",tB^ f ^OY{YYYYYYYYY  h YYYYww^JYJwhYw EYJwwwwwhJhJhJhJuuuueJhKkhJ-uuehek[ uwuYYYYW                                                xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxNYqq^^YYEE    Y7^"               L#YY      Y   Yw                                     q          YYYYwhwwwhJwwwwwhwYYYwY  0[hE{ 00;;%e  + 5%%U{        U{U{          PPe",tB^ f ^;C`ddCCCdCCCCddddddddddCCdxxxsCYoxxdoxxooCCCddCddYdY8dd88Y8ddddLL8dYYYLYdYd4dddddCddddddddd8xdxdxdxdxdYxYxYxYxYC8C8C8C8dddddddddoYxddddoYdxdxdxdxdXXddxxXxdxdxXdddddddD8ddddCdddddp8pHodp8p8dxddddxLxLxddLdLdLddpHp8odddddddodpLpLpLdoddddododxCddCCCWxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxNdddCd]]ddddddFddddFCCddd88ddzzdddkddCddF"ddd9dCCzCdzdoddCdYds]zUvdYYCCCCzzzozoYzNoYdYC8YooYdYzzdzddoYoYzzozzzzzCdoozYzzzzCCddddzdddooozCsdYC\   pxtll\tll@\@\`L2f d5Zto",tB^ f ^;C]ddCCCdCCCCddddddddddCCY~~vCN~sk~CCCddCYdYdYCdd88d8ddddJN8ddddYYdYd4dddddCddddddddd8YYYYYY~Y~Y~Y~YC8C8C8C8ddddddddddYdddddsdXdXXXddx|X~d~d|XdddddddC8ddddCdoddd|8|H~d<|8dtddddHHdlLlLlLkd|H|8~ddddddddXXXd~ddkd~ddxCddCCCWxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxNdddCYQQddddddFddddFCChhd44ddzzdddvooChdF"dhd9dCCzCddoddCdYds]zUvdYYCCCCz~ozoY~NYdYC8YooYdYzsdzdd~YYzozzz~CdzYzzzzCCdddddddzCsdYC\   pxtll\tll@\@\`L  ӆ~a8 "hi \\  \\\\ #_ p^7#KFEDERAL COMMUNICATIONS COMMISSION  lbK#  P79 P#  y %\> dddy~ F  \\ y %\dddy  kK # _ p^7eZ #HERITAGE REPORTING CORPORATION  W-!#Xu&_ x$&7QXX#Official Reporters#Xw P7XP# 1220 L Street, NW, Suite 600  Washington, D.C. )r(202) 6284888  In the Matter of: ) )  ?X<ECONOMICS OF INTERCONNECTION@h )  ? <PANEL DISCUSSION FORUMhh@h )  ?<,L I V E T A P Eă x(The following transcript was prepared from an audio cassette recordings provided by the Federal Communications Commission on May 21, 1996.)  ?h<Volume:` ` 1  ?<Pages:` ` 1 through 170  ?<Date:` ` Provided May 21, 1996 "0*ZZ  P"   X` hp x (#%'0*,.8135@8:0*H&H&@@-" requiring interconnection and so on because you might lose the benefits of differentiation. But that's not the kind of industry we're starting from. ` `  SPEAKER: You have Microsoft and Intel in mind? ` `  MR. SCHWARTZ: Who knows? But we're not starting with that. We're starting off with a very asymmetric structure. And if you don't incumbents some kind of nudge to interconnection, they're going to drag their feet until the cows come home. ` `  SPEAKER: I had thought initially that the question might have to do with whether there ought to be some oversight by the Commission or by antitrust agencies of voluntary agreements viewing with interconnection from the consumer point of view or from the antitrust point of view. And I'm surprised that no one has actually picked that up. ` `  SPEAKER: Please do. ` `  SPEAKER: Actually, I'm very curious to hear the speakers. But I had some ill-formed thoughts on the subject that perhaps the very same precepts that otherwise ought to be informing the setting of carrier to carrier prices would also be good principles to use for antitrust oversight of such agreements. ` `  For example, if one were concerned that the parties would arrive at variable element pricing that were too high so as to drive prices up towards the cartel level,"%?0*H&H&@@-" then that would fly in the face of, sorry Bill, across faces to the price as long as prices are under stand alone costs. ` `  For example, I think it would be hard to imagine that there will be monopoly power expressed by those prices. But a cost based ceiling would be expressing antitrust oversight as well as other elements of efficiency. ` `  I think maybe also, and here I'm surprised Michael that you didn't get into this and Carl. You folks have taught us with some article that I always force my students to read, although I can't remember the name of it anymore, that a licensee--the name wasn't so good, but the theorem was wonderful. That a licensee or a licensor might have incentives if not constrained to arrive at a very high usage based fee with a negative first part to a two part tariff to transfer some of the cartel profits. And thereby induce one another to go into this agreement under the guise of a commercial agreement. And here I thought you'd be speaking to that Michael, but maybe-- ` `  DR. KATZ: No, you spent so much time on your previous question, I cut things short. Also, I wanted to ask you when you said ill formed whether the ill and the formed were separated with a comma or a hyphen? ` `  SPEAKER: It was ill informed. ` `  DR. KATZ: No, I agree with that. In fact, Greg Rosston and I have a paper where we mention that as one of"%@0*H&H&@@-" the points in terms of overseeing interconnection arrangements to the extent to which carriers can influence the mix of traffic being outbound and inbound. Because if proportions are fixed and equal, then it's going to wash. But to the extent that they influence that mix, it seems to me there is a policy concern. It comes back to my point about worrying about third parties in this negotiations, that it would be potentially a way to have a implicit cartel agreement and it seems to me that somebody should be worrying about that from the public policy perspective. The comments I was making had to do with the guideline should you get to the disagreement. But it seems to me there are issues that I raised for exactly the same points. The third party's welfare is implicated by it. ` `  MR. FARRELL: Jerry. ` `  MR. BROCK: Just to emphasize that last point, that is what we are primarily concerned with here is the third party's welfare, that is the consumer's welfare. And that's why it's not simply an issue of dividing up the rents or exactly who gets what. And that would be also the reason I think that Professor Houseman and I have a somewhat different view of how to most efficiently gain those benefits. ` `  That is he would emphasize gradual case by case approach to arbitration. And I would suggest a more global"%A0*H&H&@@-" rulemaking kind of approach to set boundaries. That's a fairly wide ranging set of things and I'm certainly aware of American jurisprudence long emphasis on case by case arrangement. ` `  But it's at least my view that that is a relatively slow convergence process and that we would prefer in this industry not to deal with having each case decided and then perhaps eventually decide some were out of bounds or unreasonable by random arbitrator and certainly eventually it will converge. ` `  But I think we can get it more efficiently if we set by federal policy some basic standards that helped narrow the range over which we might allow arbitrators to consider reaching their decisions. ` `  SPEAKER: I just want to make one comment. and that is as economists, we are naturally inclined to focus on prices and talk about our Ps and our Qs. But when it comes to interconnection, I think we need to remind ourselves there's always more than one way to skin a cat. And I think a lot of the anticompetitive activity in this industry is going to occur in discriminatory interconnection that doesn't involve necessarily the prices that are set. ` `  For instance, I will give an example that was in the Wall Street Journal last year about the collocation rules. Bell Atlantic had allowed one of the companies to"%B0*H&H&@@-" collocate some facilities in their building, but when the workmen showed up to fix it, they wouldn't allow them to use the bathroom. So that's discriminatory interconnection. And that's an essential facility. ` `  So I think we need to worry about--the Act, by the way, on this mandates equal interconnection. But I can't see any enforcement mechanism through which that will be created. ` `  MR. FARRELL: Greg, you have a comment? ` `  MR. ROSSTON: I had a question that I hope some of the panelists can address. One of the things that I think Michael brought up and I noticed in looking at the comments was that in the difference about nationwide rules versus state by state rules that probably--maybe is an over characterization, but probably not by too much, that the new entrants to local exchanges want national rules and the incumbents want state by state rules. And they're worried about the unique characteristics of the different states and how these things can be addressed. Michael addressed it from some respect that you could actually address these in contracts. What I was hoping was someone could elucidate from an economic perspective the benefits to competition of why we should be going towards state flexibility. I know that we are very concerned with making sure that the states have co-competitive environments and to see why this might"%C0*H&H&@@-" help us if we have state by state rules. ` `  SPEAKER: Since I was one who mentioned the desirability of having the states have some discretion, I was referring only to the historical responsibility of the state commissions for determining the revenue entitlement of the utility companies. And I was arguing against, at either the state or national level, permitting commissions to act opportunistically and just change the rules when it seems to serve their political purposes to do so. ` `  When it gets to rules respecting access, competitive rules, I would think that there national uniformity would make sense. This is an industry that is indeed national. It's when you get to the size of the contribution, the entitlement, how do we get from here to there. How do we get past this lump of legacy so called? Inadequate depreciation, whatever it is. There I don't see how you can ignore the responsibility of the state commission. ` `  MR. FARRELL: Jerry. ` `  MR. BROCK: I think that national standards are good and I would agree with David. I think in terms of sort of quality of all of it, some type of national standards if they could be drawn up would be very useful. But I think the largest unique feature of each state is its regulatory policy."%D0*H&H&@@-"Ԍ` `  I've only been involved with about two or three states and I'm sure Fred has seen many more. But the way that they have regulated these companies is very different. I think it would be a mistake to assume that every regulatory commission has anticompetitive motives. ` `  But nevertheless, if you just look at sort of the balance between local exchange prices and long distance prices across states, it's really quite stunning. Or even within states. A lot of people here are from California. GTE's prices are $5 more a month than Pacific's prices in California for local exchange. That is not price based. One might say that's why California's not going to have its phone company anymore. But nevertheless, that-- ` `  (Tape Change.) ` `  And I think this is really what introduces the element of uniqueness. If we were writing a blank--I'm not sure that we should even have state commissions any more. We're an integrated country now. But the fact of the matter is we start off with I don't know how many 49 plus, whatever they're doing in the District of Columbia, I hate to think, in terms of regulation. ` `  And we have very much, we have these initial conditions which gets back to this transition. I don't think those can be forgotten about and I think that's really where the uniqueness of the state features has to be taken"%E0*H&H&@@-" into account. ` `  MR. FARRELL: Okay. Well, I see nobody jumping up and down to speak. So I will take that as-- ` `  SPEAKER: I don't usually jump up and down. First, the question was posed as what do we as economists think about whether there should be national versus state standards. And I think it would be a little self aggrandizing for economists to think that this is primarily an economic issue. ` `  I think the legal issues here are going to weigh far more heavily in the ultimate decision of this. Yes, there may be some arguments from an economic efficiency point of view to create some certainty in the marketplace for a standard set of rules. That I think is a fairly compelling argument. ` `  At the same time, I mean, there was one national policy and that is going to be competition in all markets. At the same time, I think it would not be right to encourage the FCC to take on more than is absolutely necessary. There is an enormous, just an enormous set of responsibilities the FCC has to complete over the next few months. And where there is some discretion, I would urge the FCC to withhold its urge to take on new responsibilities. 00But again, I think this is primarily not an economic issue. ` `  MR. FARRELL: Okay. Well, very briefly and then"%F0*H&H&@@-" we should go on. ` `  SPEAKER: These will be very brief. Two comments. First of all, the states, I'm not advocating one policy or the other right now. But I must say the states in fact moved very much ahead of the FCC in the interlater market in terms of relaxing regulation over AT&T and other carriers. In fact, Virginia deregulated, or essentially deregulated AT&T, in 1984. And so I don't think the FCC should sort of presume that they're going to do the right thing better than the states. ` `  The other thing is one thing I think you should all realize already from listening to the discussion so far. There's a great deal of uncertainty with regard to what's going to happen in this industry, when it's going to happen and what should be done. And in the presence of that uncertainty, I think there is some value in having some diversity and some experimentation taking place in the states and see what works. ` `  MR. FARRELL: Okay. Well, thank you all for that. So our last topic before our brief break will be price averaging, geographic and other price averaging. We have, of course, as everybody knows, a considerable amount of price averaging in this industry, retail prices. ` `  And that raises it seems to me some important economic questions about whether similar price averaging"%G0*H&H&@@-" provisions should be incorporated in carrier to carrier pricing. Thus, reducing the incentive for certain kinds of arbitrage, but at the same time perhaps increasing the incentives for other kinds of arbitrage or cream skimming. And there are, that's just one of the issues that I think arises here. So I'll ask John Baker if he'd be willing to kick things off here. ` `  JOHN BAKER: Thank you. Joe Farrell gave an all purpose disclaimer for all of us at the very beginning, but I'd like to have on the record on the tape next to where I'm speaking, the fact that I'm not speaking necessarily on behalf of the Federal Trade Commission or any individual commissioner. To share a few brief ruminations about the geographic averaging problem in my short time. ` `  My first thought is it truly is unfortunate that some consumers are high cost to serve and others are low cost because it gives us a lot of problems. The consumption distortions from geographic averaging are well known and they've been with us for a long time. The low cost users are presumably using the service too little and vice versa. And as the potential distortions from the regulatory structure scheme. ` `  What I have in mind is that regulators and shareholders can't necessarily perfectly monitor what the regulated firm has been doing. We might expect to see some"%H0*H&H&@@-" waste or inefficiencies or excessive fixed costs and nice lifestyles and that sort of thing. ` `  My FTC colleague, Richard Chin, tells me that he's been working over data involving interlata toll service and has found that in unpublished results that we hope are soon to come out that even price cap regulation doesn't fully squeeze the inefficiencies out of the actions of the regulated utilities. So there's lots to do here in getting competition underway. ` `  The distortions that show up when we start thinking about allowing entry which is really the subject of why geographic averaging is interesting today. The distortions from inefficient entry and perhaps even worse the sort of death spiral you get when inefficient entry comes and a geographically average incumbent has to raise rates and encourage even more inefficient entry. ` `  But there's another inefficiency that goes the other way that we can be deterring efficient entry as well. For example, low cost rural entry might not occur to the extent we like as a result of the geographic averaging. And, of course, in my heart I'd like to see some sort of universal service fund to fund subsidies to auction off the right to subsidize the high cost users to the various carriers who might want to do that. And I don't know to what extent that was possible under the current legislation,"%I0*H&H&@@-" but I suppose we could hope. ` `  The concern about deterring efficient entry though is one I want to highlight in a different way. It raises I guess a sort of legal question which is the statute talks about reasonable comparability between urban and rural rates between serving the high cost and the low costs customers. ` `  To what extent does reasonable comparability prohibit incumbent price matching or should it is a question that's implicated by the geographic averaging. This is not like the Robinson Patman Act where the statute gives you a meeting competition or cost justification defense. And there's sort of a question here about what reasonable comparability ought to be interpreted to do to allow incumbents to do. ` `  Essentially, if we allow incumbents to immediately match lower prices by entrants, we could be deterring efficient entry along with the inefficient entry. And if we don't allow it, we could foster inefficient entry and encourage the death spiral. This sort of thing was handled in the long distance world with allowing matching to a price floor and it's an issue that I wanted to highlight because it really wasn't in Joe's list of questions and I thought it was worth us thinking about. ` `  MR. FARRELL: Thank you, John. HAROLD FURCHTGOTTROTH."%J0*H&H&@@-"Ԍ` `  MR. ROTH: Thank you, Joe, for having me here. I had anticipated that in the earlier discussions there'd be many complaints about the language that Congress wrote in the Act and I was all prepared to sit up here-- ` `  SPEAKER: We're just being polite. ` `  MR. ROTH: And to say with the disclaimers that Michael introduced to sort of say I was here just representing Chairman Bliley in the Commerce Committee on the House side. And if there's any bad language, I was going to blame it on the Senate. But people have been far too courteous. ` `  But Chairman Bliley likes to say it's not a perfect bill, but it's a movement in a direction that economists might call Prado efficient, at least to the extent that a lot of groups seem to have signed on in the end, at least in hope or anticipation that it might lead to a better market structure. The geographic averaging provisions is one that may not be quite as Prado efficient as we might like to say for other parts of the bill. ` `  But I am a big puzzled by one of the questions that Joe posed which is given price averaging to users at least on the part of the incumbent, and I emphasize on the part of the incumbent, should it also be required of entrants? ` `  As I read the primary geographic averaging"%K0*H&H&@@-" section, it says within six months after the date of enactment of the Telecommunications Act of 1996, the Commission shall adopt rules to require that rates charged by providers of interexchange telecommunications services to subscribers in rural and high cost areas shall be no higher than the rates charged by each such provider to its subscribers in urban areas. Then it goes on. ` `  The effect of this will primarily be borne on incumbent carriers. That's correct. But it is not exclusively assigned to incumbents. That is if you're a new entrant and you want to provide service in multiple areas, you are bound by this same provision. ` `  Is there a way that the FCC can make this less burdensome on one set of carriers and not on another? I'm not sure. And I think Jonathan has pointed out some of the potential problems that this creates. I think it certainly may, has the potential to lead to some corporate restructuring that if you have high cost areas, those look very attractive to dispense with. And certainly if someone else can take advantage of some of the other provisions of the bill that apply to rural areas. ` `  One of the last questions that Joe raised troubles me a bit. It says can price averaging be used to spread the benefits of competition to areas that do not have the characteristics to support competitive networks? I guess"%L0*H&H&@@-" I'm not sure how much I would read into the price averaging other than the specific context, 254H and whether I would bring this into some of the other unbundling provisions of the bill. ` `  It's an interesting idea, but I would hope that those sections would be looked at somewhat separately rather than trying to combine them and read something that certainly in all the discussions in developing the bill there was no discussion about how those two would fit together. So there's no secret message that was trying to be written about price averaging there. This was purely a concern for some rural state interest. ` `  And I think in some fairness if you have a company that's providing service for a metropolis to farm bill within a state that the rate ought to be the same. It's the same call from a farm back to metropolis. In that simple concept, there does seem to be some sense of fairness. In practice, it may be a lot more difficult if there are different cost structures providing the service in farm bill as opposed to metropolis. ` `  One question you didn't ask but I will raise and that is how does this go across state boundaries? If you're a company that's operating in many states as a lot of telephone companies are, does this provision require that you charge the exact same rate for interstate calls and if"%M0*H&H&@@-" you're U.S. West and all the many different states that they operate in. I do not think that that interpretation is necessary. I think that within this language it is possible. I think the states would be very upset if it was read otherwise. That this could simply be within a state that interexchange calls have the same rates. ` `  MR. FARRELL: Marius. ` `  MR. SCHWARTZ: Well, to continue with the list of disclaimers, I also am not speaking for the Council of Economic Advisors or its Chair Joe Stigletz. Any of you know who know Joe Stigletz know that nobody can speak for Joe Stigletz. ` `  On the issue of averaging, let me reiterate what Harold said which is that as regard interexchange services, it seems like the law leaves us with very little latitude. It requires it for both incumbents and entrants. So I assume that part of your question, Joe, referred also to other services that just send local services. ` `  MR. FARRELL: Well, and also non-geographic averaging and a variety of other things. ` `  MR. SCHWARTZ: Okay. So let me speak to those. The first point I want to reiterate because it colors all of my perceptions on this is that there is this tremendous tension between rate averaging and competition. Competition is based on letting prices adjust to cost. Rate averaging"%N0*H&H&@@-" gets away from that. And the Act consciously aims to increase competition, increase flexibility, rely more on market forces. ` `  For example, in the principles for universal service reform, it explicitly calls for getting away from internal cross subsidies, opaque, etcetera, and moving towards above board explicit targeted and competitively non-distorting, whatever that means. We'll get to that later. ` `  Rate averaging goes against that trend. It distorts signals to consumers. It also distorts signals to entrants, leading to insufficient entry. Sometimes excessive or cream skimming type entries other times. ` `  It also raises the prospect perhaps of inefficient fragmentation. Firms might decide in order to get away from the averaging requirement, I will specialize in serving a fairly narrow niche. This way there's no averaging. Now, that's inefficient. That kind of artificial deintegration or specialization may be inefficient when the trend seems to be towards broader networks. ` `  So these are some of the problems with the rate averaging. ` `  Now, having preached to the converted, let's ask what do we do about it? And in particular what do we do about it with respect to entrants?"%O0*H&H&@@-"Ԍ` `  It seems to me there are two approaches here. One is what you might call the symmetry approach which is you impose similar constraints on entrants as you do on incumbents. That would say, for example, that entrants must price on an average basis and that they must enter on a pretty broad geographic scope. Because if they don't, then it makes a mockery of the average system. They can just enter selectively. It also could mean that you compute the prices for unbundled elements on an average basis rather than region by region or any other way that reflects true cost differences. ` `  Well, what are the pros of this approach and what are the cons? The pros are, of course, that in the short run this gives you the level playing field. It's equitable and it doesn't distort competition. And at first blush you might say that these considerations are dispositive. ` `  The problem, of course, is that it freezes the existing structure in place. We're trying to get away from this business of average prices and prices that deviate from cost and move towards more flexibility. Extending these kinds of symmetry requirements to entrants or averaging requirements, would delay competition. Competition's not going to be very likely if we force entrants to be essentially clones of the incumbent. It's going to be both more likely and probably more valuable if we let entrants"%P0*H&H&@@-" self select, enter market segments and using technologies to suit their comparative advantage. ` `  What about entrant flexibility? That would say let entrants decide where they come in. Let them deaverage their prices if it's consistent with the act. And finally, let them purchase unbundled elements at the true costs as opposed to average costs. ` `  We've mentioned the drawbacks of that. It's asymmetric. It's unfair to the incumbent. The pros is that it gets us, the big pro is that it gets us in a direction we want to move in, which is deaveraging and more flexibility, more competition. ` `  Now, if this were a permanent solution, I would not advocate it. You don't want to tie the incumbent's hands and leave the entrant to come in to cherry pick. My hope, and this is a political economy argument, is that if you let the entrants enter, then eventually the incumbents will pressure state commissions and other relevant bodies to unshackle them too and that that will set in motion a process where we are moving in the direction where we ultimately would like to head. ` `  There's still an issue that during this transition process you are favoring the entrants over the incumbents. And that's true and in general we don't like to play favorites. Here I would agree with the points that several"%Q0*H&H&@@-" panelists have made including Mike Katz and I think Joe Farrell made this earlier, which is if you're starting with such an asymmetric structure and you have to err on either side, you might as well err on the side of the entrants. Because what you're trying to do is get competition going. You don't want this as a steady state solution, but at the outset, it's not a bad direction in which to err. ` `  So if I have to conclude, I have to give the FCC some advice, and I'm sure you're very short of people offering you advice these days, very tentatively I would say the following. If you have the discretion, I would give incumbents flexibility to respond on a non average basis to entry, subject, of course, to antitrust restraints and predation. ` `  Now, an interjection here to address one of Joe's questions which is if you allow selective responses, then you are not spreading the benefits of competition to areas where there is no entry. You're confining those benefits to where the entry occurs. ` `  If you're core averaging, yes. The incumbent would say, gee. I could lower the price in this area a little to address entry, but that would require me lowering elsewhere. What's likely to happen? Well, it's true the incumbent may cut his price a bit everywhere else in the country, and that's what we mean by spreading the benefits. "%R0*H&H&@@-" On the other hand, he's not going to cut it nearly as much in that entered area as he would have otherwise. So you're gaining elsewhere, but you're losing in the entered markets. ` `  On balance, I would favor incumbent flexibility. Now, if you cannot give incumbents flexibility, and you're really boxing me in, would I leave the entrants with flexibility? I think the answer is yes for the reasons I mentioned which is that it hopefully pushes us in the right direction. ` `  And if needed, if you were worried about the deaveraging because it threatens universal service, etcetera, we're back to the old exhortation that the economists put which is if you have that problem, deal with it with the right tools. Explicit targeted subsidies. ` `  There's a general danger here that we don't want to let universal service side track us from competition. In a way we're being a little schizophrenic. If we do that, if we say we have competition, but your prices have to be uniform. You can't do this. You can't do that. You can only enter certain area. Well, gee, you're not going to gain very much. It's like the cow that fills up the bucket with milk and then kicks it over at the end. Don't quote me on that. ` `  SPEAKER: Is that a metaphor they use frequently in the old country?"%S0*H&H&@@-"Ԍ` `  MR. SCHWARTZ: On us. ` `  MR. FARRELL: Michael wanted to issue a disclaimer or perhaps it was a claimer. I don't know. ` `  DR. KATZ: Just one thing. I didn't mean to say it should favor the entrants. There may be times where entrants would not like low prices for some of these things. I assume that if one's going to make errors on the pricing of some of these intermediate goods or services that it's probably better to err too low than too high on those prices and that some of the dangers have been overstated. But I didn't mean that to be explicitly saying favor entrants or not. ` `  SPEAKER: There are times when have to favor specific in terms of PCF in California I'm sure. ` `  DR. KATZ: You're saying PCF is becoming an essential facility? ` `  SPEAKER: No, no. I just meant that perhaps they should be providing free roaming to all the PCF people as a way to jump start PCF in California. ` `  DR. KATZ: You'll have to ask them about it. ` `  MR. FARRELL: Jerry. ` `  MR. BROCK: This geographic averaging is a difficult issue for this panel to discuss because I think that if we were to take a survey should this provision be in the law or not, we would certainly have a majority and I"%T0*H&H&@@-" think close to unanimity that it should not. ` `  It's been a long standing policy debate that economists have been saying let's not put any geographic averaging rules on and for various political reasons there's been encouragement to do so and I know that the Commission for many years went through quite a charade of saying, no. We were not anxious to write geographic averaging into the rules, but we really think people will probably go ahead and average on their own so that you won't have to worry about it. ` `  And then now we have it written right into the law and what do we do about it? I'm not really sure what we do about it. It is going to cause some distortions just as people have already commented here. I guess the only suggestion I have is insofar as there is any flexibility which lawyers are usually very clever at finding flexibility in any set of words, I would urge them to read this provision as narrowly as possible in order to give some freedom to make some competition work. Because there is a clear contradiction between the general inclination of the act letting prices adjust and moving towards competition and these geographic averaging provisions that if they were interpreted very strictly could place a very severe constraint on the benefits we would expect to see on a going forward basis."%U0*H&H&@@-"Ԍ` `  MR. FARRELL: Bob. ` `  MR. CRANDAL: I was asking Harold why this was such an issue and was it a big issue on the Hill? And he reminded me that there are rather strong rural lobbies. If the rural lobbies are that strong, perhaps this is a cheap thing for the Congress to have given them compared to what else they could have gotten. Given that I'm not sure that it matters that much with the cost of transmission falling so rapidly. ` `  I mean, if you look at AT&T's reported cost structure and it's reported to the FTC enough, if these accounting costs at all represent anything close to what real costs are. I mean, the cost of operating their network is only something like 12 or 13 percent of the price of the service. ` `  Leonard Waverman tells me as hard as he works at it, he can't get the costs of shipping a call across the north Atlantic through a fiber optics cable much above two cents a minute. Maybe it's three cents a minute on a less dense route. The differences may not be very large and we may be, while we are concerned as economists about geographic averaging lead to distorted prices, the distortions may be very small compared to the distortion between two cents in a dollar that currently exists on those international routes or two or three cents domestically and"%V0*H&H&@@-" 18 cents on the interexchange market. ` `  MR. FARRELL: Larry. ` `  LARRY WHITE: No, it doesn't feel right to me, Bob. And I think we really have to see this thing as a real horror and as Jerry said going against the words of the act about pro competition. I will repeat an aphorism, a phrase, that I used at a Northwestern conference a week and a half ago. Cross subsidy is the enemy of competition. And I think we have to see it and fight it at every opportunity. What I really fear is that the wrong interpretation is going to inhibit entry if entrants have to be full service providers, they may say sorry, we're not going to do it. If they have to provide service which is not only the transmission but the billing and everything else to a wide variety of geographic areas, I'm just really afraid that this is going to inhibit competition. ` `  MR. CRANDAL: Well, I don't disagree with you except that I think this is one area of relatively small concern relative to the other areas of cross subsidy that currently exist in telecommunications. And your interpretation is that this might, that entrants have to enter as national carriers providing service to all areas. I don't think that's anywhere in the act, is it? ` `  SPEAKER: Just a factual point that might be useful here. My impression of studying the rural telephone"%W0*H&H&@@-" companies the reason they wanted averaging was not because of the transmission costs. In order to cloak the enormous access charges that long distance companies were paying, that is which could be up to 25 cents a minute by themselves. And if you did away with the averaging, then each route would expose these access charges. So there may be some way to deal with this in your access charging. ` `  SPEAKER: That leads to a point to me. The first thing I just want to help Larry out because nowadays everything has to rhyme. So I have a new aphorism for you which is if it's not explicit, then you have to diss it. ` `  SPEAKER: Thank you, Mike. ` `  SPEAKER: If you ever get in trouble in court, that will always work. Juries go for that sort of thing these days. The other thing I wanted to redirect the discussion. I agree that it's a very unfortunate part of the act and in fact at that same Northwestern conference I picked that out as my least favorite element of the act. It is about interexchange. And it seems to me that a lot of the really big issues with averaging and the problems they caused had to do with things that are being pushed by the FCC or by the states and that are more at the local exchange network. ` `  I'm not sure, I thought that Marius might be saying, well, maybe it would make sense to have asymmetric"%X0*H&H&@@-" policy and try to limit or at least give the flexibility to the entrants and not the incumbents. It seems to me it's really vital to give flexibility to the incumbents and it's vital for the purposes of entry. ` `  Because one of the reasons that these issues are so hard and such a mess is because we're dealing with a system that makes so little economic sense. Nobody at this table has said that the current set of prices served some legitimate social aim. ` `  Everybody I think thinks they need to be rebalanced. We may disagree on how they need to be rebalanced. And I think having this averaging and having prices that don't reflect costs just makes it harder for everything including figuring out ways to promote entry and that we need to push for flexibility and for rebalancing wherever we can. And it seems to me that most of those issues are not issues governed by the statute. They have to do with commission policy. ` `  MR. FARRELL: John Baker. ` `  JOHN BAKER: One brief comment which is that the problem raised by geographic averaging might be broader than the most recent discussion here seems to address. The act does mandate it on long distance, but it also instructs the joint board thinking about universal service to ensure that rural, insular and low income consumers and consumers in"%Y0*H&H&@@-" high cost areas pay for services that are reasonably comparable to what they have to pay in urban areas. And that potentially broadens the scope of all the distortions well beyond long distance. ` `  SPEAKER: But that's not rate averaging necessarily. ` `  SPEAKER: But also, the act does not say that. It never says that they have to ensure it. It says-- ` `  SPEAKER: Principle and it talks about reasonable comparability in rates as one of the principles and there are other principles as well. ` `  SPEAKER: It says it shall base policies on the following principles and those principles include, they all have this verb should. And if Congress in its wisdom says the sun should rise in the west every morning, Congress could do that. But that doesn't mean that these are enforceable. ` `  SPEAKER: But who gets arrested if it doesn't? ` `  SPEAKER: It does not say shall. It says should. ` `  MR. FARRELL: We're verging on issues of universal service which we'll come back to in a few minutes. But just to finish up for now. ` `  SPEAKER: I was just suggesting that we get to it when we get to universal service because I have a slight feeling of disorientation because of the colloquy between"%Z0*H&H&@@-" Bob and Larry. I mean, my conception of the real distortions are in the basic charge for basic residential services. Presumably those differences, we can permit selective entry and take care of them by the distribution of the subsidies. How important the residuum is, is where I thought what Bob was saying was persuasive. That it isn't nearly as important as the real distortion which the universal service will presumably take care of. ` `  MR. FARRELL: We may or may not get to access charges. We're going to take a short break, approximately 10 to 15 minutes, and then we will resume. Thank you all and we'll see you soon. ` `  (Whereupon, a brief recess was taken.) ` `  MR. FARRELL: Ladies and gentlemen, take your seats please for round two. Welcome back to the second round of the Economics Open Forum. Our first topic for the second part is universal service. And I'd like to ask Bob Crandall if he'd like to kick off for us. ` `  MR. CRANDAL: Thank you, Joe. I thought it was illuminating to hear HAROLD FURCHTGOTTROTH tell us about Congressional draftsmanship and how changing the language from shall to should is important. I was always under the impression that Congress shouldn't do anything in the universal services area, but I knew that they shall or would."%[0*H&H&@@-"Ԍ` `  So here we go. There is hope for progress, however, for at least a couple of reasons. One, of course, is that apparently it is anticipated that universal service subsidies will be explicit. I would hope that they would be extremely explicit that on monthly telephone bills it would be pointed out in Colorado that this charge however it is levied on all service providers to subsidize universal service, it goes to subsidize connections to Beaver Creek or Vail ski areas or whatever, very fancy homes up in Cordalair and places like that. ` `  The other type of progress is that even in the goals that comes from--I can't read this. This is Section254(b)(3). Access in rural and high cost areas. It says that consumers in all regions of the nation including low income consumers and those in rural, insular and high cost areas should have access to all sorts of services rates that are reasonably comparable to rates charged for similar services in urban areas. ` `  Well, that would be a tremendous improvement because at the present time they typically get them at far lower rates. As of the end of 1994, I think I count eight states where the rates were flat across geographical areas for Bell territories as reported to NARAG. ` `  So I guess there are several questions that arise here. One is why do we need--Joe's questions say Congress"%\0*H&H&@@-" mandates it would continue universal service, small "u" small "s". Well, there's no threat to universal service no matter what happens since we know the price of elasticity for demand for connecting to the network is extremely low. And a few targeted subsidies to low income consumers would take care of the whole problem. ` `  The question is how broad are these subsidies going to be? Are we going to continue to try to subside everybody who lives in a rural area regardless of whether he is rich or poor? ` `  And then secondly, how broad are the services to be? Congress leaves that open to regulators and a joint board and I guess state regulatory commissions. Well, if the subsidies have to be explicit, I think they will be much less broad than they otherwise would be if they could be concealed from the public. ` `  How are the universal services to be paid for? Well, we all I think would agree that we'd like as non-distorting a way to subsidize whomever Congress deems or the joint board deems needs to be subsidized. Some sort of a very broad tax, broad rate, broad tax levied on all telecommunications services, preferably on even a broader tax base than that if possible. But probably not achievable from regulatory commissions. ` `  Finally, I think a very interesting question here"%]0*H&H&@@-" is what's going to happen as far as competing for the right to provide this universal service to high cost areas. At the present we have lots of areas that are high cost because we provide every incentive for them to be high cost. That is we pay 65, 75 percent of the difference of their costs from lower cost firms or medium cost firms in their particular states. ` `  If we allow new wireless operators, be they cellular or PCS, like or fixed wireless carriers to offer service in competition to get the universal service subsidy in competition with existing wire line carriers, those who are interested in protecting the embedded cost and raising the regulatory taking issue have an entirely new issue here. It seems to me that there could be a lot of small rural telephone companies that go out of business and maybe they should. ` `  But that is a possibility that I think this new approach to handling universal service subsidies allows. That is it will be explicit and hopefully it will be transferable and hopefully it will be available on a competitive basis. ` `  MR. FARRELL: Thank you. Professor Kaserman. ` `  DR. KASERMAN: Thank you. As Bob said, I think a lot of people at this table will be in agreement on a lot of the issues pertaining to universal service. As a result, my"%^0*H&H&@@-" comments will be somewhat redundant, but I'll make up for that by making them brief. ` `  First of all, what do we mean by the term universal service? A definitional issue. Some people mean low local rates. That's what universal service means to them. Now, economists won't agree with that. We mean subscribership levels. But in a lot of states in which I've testified, the actual definition of universal service is low local rates for everyone. And also we get at this specific list of what services are to be provided at these low rates. So the definitional issue is one to be worked out. ` `  An important issue I think most people here would agree is a subsidy economically warranted at all? Most people, I think everyone here would probably agree the subsidy of the magnitude we observe now is definitely not warranted under any economic theory of externalities in this industry. ` `  But I think some serious question needs to be raised about whether any subsidy at all is warranted for universal service. In other words, is the externality at this point in history rate a relevant and therefore should certain prices be changed or individuals subsidized? ` `  SPEAKER: You mean on an individual basis of--such warranted or on a societal basis? ` `  DR. KASERMAN: I meant society wide. The size of"%_0*H&H&@@-" the subsidy we have now is certainly not warranted. But on an individual, no. I was talking in the aggregate. ` `  Then the targeted versus the untargeted subsidies. I have a paper right now with a fellow named Ross Erickson and John Mayo that's an empirical paper. We actually have a nice experiment right now with federal policy in that they have been subsidizing universal service both with targeted subsidies through the lifeline and the linkup program and also untargeted subsidies through the universal service fund. And so we have set a date that we have examined and have a paper on this subject. ` `  And what we find is as you would expect the targeted subsidies do have statistically significant effects on targeted levels. Interestingly, the untargeted actually lowers subscribership because it raises long distance rates and because it has no statistically significant effect on subscribership. ` `  Finally, what a lot of regulators want I think from economists is more specificity in what is the best system to do this. I think that the principles are you target the subsidy narrowly. You collect the subsidy broadly. Subsidize people, not companies and not geographic areas. And then target the subsidy by some sort of means testing. ` `  MR. FARRELL: Thank you. We had been hoping to"%`0*H&H&@@-" have Carl McDermitt here from the Illinois Commerce Commission, but his flight was canceled. However, in an independent and negatively correlated surprise, Milton Miller from Rutgers managed to come and I'd like to ask him to comment on this. ` `  MR. MILLER: Thank you. I have a disclaimer to make also. I'm not an economist. So I just thought the words we economists have been used a little too often. You could call me a political economist and my take on the universal service legislation should be interpreted from that standpoint. ` `  We have to--I want to take a broader take. That is I don't want to talk about the technicalities of universal service support because I think that is not the major universal service issue that the Commission will face in the future. ` `  I think you have to understand the reason we have a telephone monopoly today is because of universal interconnection or the desire to eliminate the fragmentation of telephone service that occurred when we had competition in the early 1900s. ` `  In other words, regulators intervened and the Congress intervened to-- ` `  (Tape Change.) ` `  -- could benefit from the demand side economies of"%a0*H&H&@@-" scope associated with having a single integrated network. And the assumption everybody has I think going forward now is that any new regulation has to maintain this universal interconnection, that we cannot contemplate the notion of a fragmented network anymore. ` `  But as I look about me in the modern environment, what I see is increasing fragmentation and just proliferation let's say of different types of technologies, different types of networks. So that when the commission determines that it is going to interconnect all networks and in a non-discriminatory fashion, it is in many ways saying that it's going to eliminate any competitive advantage that networks can get from expanding their scope or from differentiating their services from other networks. And this is related to two problems. One is that it may in fact limit technological innovation. The point I think you all understand. ` `  But the other point is that such non-discriminatory interconnection clearly results in what traditional viewpoints see as the universal service problem. That is we encourage networks to unbundle their networks and facilities. We also make it perfectly easy for new entrants to not assume any obligations for serving larger territories. In fact, we encourage them to enter those markets in which they can serve most profitably and leave"%b0*H&H&@@-" the least profitable ones or the least attractive ones to the incumbent. ` `  This is in fact what one of our participants called the essential schizophrenia of the new telecommunications act. On the one hand, we're saying we want unbundled and non-discriminatory interconnection. On the other hand, we're saying we want to eliminate the results of that by having a universal service fund that will fund universal service for everybody. ` `  Now, let me say that real telecommunications competition in this environment is primarily about service differentiation. And I just want to express opposition to the very concept of universal service in the future environment. ` `  There is no such thing as a single uniform, homogeneous kind of service that will supply access to people. And therefore, I think it's important to understand that when the Commission designates something as universal service, it is violating, in this fundamental respect, it is violating the competitive neutrality provision of any kind of universal service subsidy because they are picking some services out and saying this is important. We're going to subsidize it. And they're ignoring all sorts of other things that the market is supplying which may supply substitutable or perfect or imperfect for various kinds of"%c0*H&H&@@-" services that are now provided by voice telephony. ` `  The central feature of the new technology is that access is becoming heterogeneous. It's becoming unbundled. There's all kinds of different ways of customizing service and of reconfiguring service so that it is more or less affordable to different groups of people. ` `  So the whole idea of universal services is an anachronism. If I had time to, I'm not being very constructive. I'm basically trying to criticize the assumptions of the act. But I think you have to keep the realities of the new marketplace in mind as you go forward with these policies. ` `  MR. FARRELL: Thank you. Marius. ` `  MR. SCHWARTZ: Just on this schizophrenia point. I didn't say there's any schizophrenia in terms of the goals of competition of universal service. The schizophrenia arises in ensured competition and providing universal service through the method of regulating prices. That's where there's tension. There's no problem with having universal service and having competition as long as you finance universal service through broad non-distortion ways that Bob mentioned. ` `  SPEAKER: But what you're saying is that you don't want the real prices of local telecommunications access to reflect the unbundling of costs that's going to occur as a"%d0*H&H&@@-" result of deregulated interconnection. You want a universal service subsidy, right? ` `  MR. SCHWARTZ: Yeah, I'm saying let prices reflect costs, step one. Step two, when things shake out, see which groups are not served. And then if you want to help them, help them. But help them through taxes or other ways. ` `  SPEAKER: It strikes me that what is not focused on enough about the universal service debate and all the unbundling and interconnection debate is what pressures might be brought upon the state commissions to rebalance rates. ` `  I mean, presumably what Marius is saying here is not only are we going to have a more explicit universal service approach, whatever universal service means, but unfortunately it looks like the state commissions will be reluctant to allow rates in those areas which are unattractive to serve after the unbundled elements have been leased off in the highly profitable areas to allow those rates in the unprofitable areas to rise towards costs. ` `  I think that's where the regulatory takings issue is going to raise and where a lot of the problems are going to arise. ` `  SPEAKER: Incidentally, Bob, can I just point out a factual thing? The USOs for small rural telephone companies are not portable. They were exempted from"%e0*H&H&@@-" portability of subsidies under the act if I'm not mistaken. ` `  SPEAKER: I wasn't aware of that if it's true. ` `  SPEAKER: I would like to question the basic assumption which I guess has been true in U.S. telecommunications since 1934 that universal service, we're only talking about local exchange access. I think David Kaserman was also watching this in terms of his statistical findings if it's a paper I'm thinking of. If you actually want to look at some empirical research which perhaps has never been as much in telecommunications as we might have hoped. ` `  I published a paper a couple of years ago and Professor Kaserman has a paper and I've also now looked at Canadian data and I'm very much of the opinion that when people decide whether or not to subscribe to telephone service or taking long distance prices into account as well as local prices. ` `  So this notion that we've had since 1934 that universal service should focus only on the local exchange price I think is wrong empirically. And also technologically I think it's been implicit in what some people have said and certainly what companies are aiming to do. I expect competition down the road in a very, very near future to be over bundled services. And I expect long distance as a separate service to largely disappear. It's"%f0*H&H&@@-" distance insensitive now. And we're going to see companies offering bundled packages. ` `  So again, the focus on the local exchange price monthly rate I think is just completely wrong as a matter of economics and as a matter of where technology's going. ` `  MR. FARRELL: Carl, you had a point? ` `  MR. SHAPIRO: Well, I want to first absolutely agree with what Jerry Hausman just said. I mean, the thing to look at here has got to be the total phone bill and see what happens when we unleash the forces of competition. Long distance rates will go down. We can assume significant pass through of access cost savings by long distance carriers. ` `  That will offset any increases that individuals or certain groups such as rural groups might see in their local rates and it seems to me the question is to identify people who are currently paying less for their whole bundle of services than the cost or providing that whole bundle. And then sort of see how much money it's going to cost to protect them if we choose to do so. ` `  I think the big danger is that universal service will be a sort if a slogan used as an excuse to prevent moving forward with competition. And I'd hope that collectively everybody around the table agrees, first, that there's no, that universal service can be achieved however"%g0*H&H&@@-" the policymakers or regulators choose to achieve it. It's perfectly consistent with competition and that we all kind of work as economists to stress that point and not let universal service be used to prevent the efficiencies we all see from competition. ` `  MR. FARRELL: Let me jump in here if I may because I heartedly agree with Carl there, but I know that for instance Larry White has expressed the view, which I have quoted in this room before now, that as he was saying a few minutes ago cross subsidies are the enemy of competition. And it seems to me that one of the most important tasks we have as benevolent economists is to make sure that Carl is right and Larry is wrong and how do we do that? Larry. ` `  LARRY WHITE: Well, we'll be working on that at the Justice Department I assure you to help prove that I as Chief Economist am not just saying these things, that it's really true. Part of it is cross subsidy versus subsidy. I mean, subsidies can be achieved consisting with competition so long as the taxes to use the verboten word as well as the subsidies are neutral across the different providers and that's doable. ` `  SPEAKER: Yeah, but in a rapidly changing technological environment, it becomes less doable because new guys are going to come along and it's a question are they providing the same thing? Or is it close enough"%h0*H&H&@@-" substitute? Should they be taxed? Shouldn't they be taxed? In a very stable world, you're right. It's doable. In a rapidly changing world, it's less easy. ` `  MR. FARRELL: Janusz. ` `  Mr. Ordover: Just one point. I think that Carl was quite right in saying that, whoever was right in saying the universal service issue or universal service is really a subterfuge for trying to protect the economic power of the--at least that's my interpretation of the ILECs. ` `  I think that the evidence already is that they are going to be using reasonably aggressive scare tactics in trying to argue that unbundling and selling network elements at some rates based on costs is going to elevate prices to end users and therefore that we should engage in some massive slow down or some massive recovery of embedded costs and such. ` `  I read an article in the Washington Post which projected very large price increases as a result of the 1996 Telecom Act. So I'm just basing it on what the Washington Post reports which I take it to be--I'm just raising that as a political economy issue as opposed to necessarily economic issue. ` `  I think that it's quite clear that there's going to be a problem of transition. You have to figure out how to make subsidies that are necessary because we are not"%i0*H&H&@@-" going to be seeing these bundled offerings coming on stream quite yet, that people who want to provide local exchange service and again I have seen in an article in a submission by SIDAC that a large number, for example, in California alone, 48 or 50 people trying to provide some version of the local telephone service type. ` `  The question's going to be what are we going to do to subsidies during the period where we are going to have elements priced in relationship to cost in some way while the end user rates have not yet been rebalanced. ` `  It strikes me that it would be nice to hear from the members of this panel what it is that they propose during the transition period where neither technology's catching up with us yet nor the bundled offerings are still available and where the Arbachs or the ILECs are making perhaps reasonable statements that they need to offer. They cannot rise their rates. ` `  In New York State they are not allowed to raise their rates. What is going to happen during that period? I think the political economy of the situation is quite delicate. We have to figure out how to make subsidies portable, how to make them reflecting the underlying cost of purchasing the elements from the ILECs as well as the availability of the alternative technologies of providing these services."%j0*H&H&@@-"Ԍ` `  MR. FARRELL: Thank you. Michael. ` `  DR. KATZ: I agree with a lot of what people have said, but let me just trace out the implications of two of the principles people have put forth. ` `  One is about looking at the total bill, the total phone bill, which seems to me makes a lot of sense. And if you're going to do that, then it seems to me one ought to think more broadly than people have about the right way to tax consumers. ` `  And in particular it seems to me more attention should be given to, at least from the economics if not the politics, to coming to something like a poll tax or a fixed fee and then be a question of whether this would be for every time you interconnected or exactly how it would work. ` `  But in the ideal, it would just be if you decided you're hooking up to the PCTN you would pay a monthly fee. And then-- ` `  SPEAKER: Probably SLC I think. ` `  DR. KATZ: Well, except it's true but it's trying to do more than that because that's how you would use the SLC also to collect the subsidy revenues. If everyone were identical, clearly the right way to cover all these things like common costs, legacy costs and all the other ones would be to put it into that because that way all the other marginal decisions would be made efficiently and there's no"%k0*H&H&@@-" escaping the fact that you're going to have to pay that amount and it's going to distort the overall consumption decision. ` `  Now, obviously if everyone's identical, we wouldn't be worrying about this. Well, even that's not so clear because Congress might be able to figure out a way to claim this is still a benefit. But that aside, if you say, well, people are different. But now the question is are they different in such a way that it makes sense to distort what people pay based on volume as opposed to targeting this flat monthly fee to characteristics of the individual? ` `  It seems to me that one can make a strong case for saying it makes a lot more sense to target the fixed fee level based on income levels of the subscribers than to say, oh, well, we believe people that make lots of long distance phone calls are richer than other people. Although in fact there's tremendous within group heterogeneity of income levels for a given calling level. ` `  So it seems to me that while I certainly agree with this notion we want to have a broad tax base, that is a general principle that comes out of public finance, we also need to think more seriously about the mix that people buy and how you tax within that mix, and in particular some of the benefits of using the SLC, not just to bring it up to cost levels, but to beyond at least for high income"%l0*H&H&@@-" subscribers. ` `  The other thing I wanted to mention is just the principle that these things should be explicit. It seems to me that same principle then should apply to the treatment of legacy costs or embedded costs that if what we're doing is saying, okay. They're not forward looking economic costs, but the ILECs are entitled to them. Then it seems to me those should show up on people's phone bills as you were paying for the break you got for the last 30 years and this amount is explicit. ` `  And it seems to me I don't see anything to distinguish between universal service costs and legacy costs or I don't see where there's an economic theorem that says it's good to try and hide certain things from subscribers and not others. ` `  MR. FARRELL: Harold. ` `  MR. ROTH: There's only one important difference between the two. That is these two components. One, the legacy, the inadequate depreciation and those things. Those are costs which have uniquely been born by the local exchange companies. To the extent that the Commission decides they are entitled, where there's some settlement in which they get X cents on the dollar back. That should go only to them obviously. ` `  SPEAKER: You're not talking about the way it's"%m0*H&H&@@-" raised. ` `  SPEAKER: From that point of view, you're absolutely right. It's on the distribution end that it will differ. ` `  The only other thing that I reacted intemperately to what Janusz was saying. The point is it seems to me regardless of whom we work for, we can all agree that we have gross over pricing of services and particularly total services and particularly access services to businesses in concentrated metropolitan areas, that they are grossly over priced. And I think that we all agree with that. As I say, regardless of where we are. ` `  And that in those circumstances there's a real danger that it's not just a question of fairness or whether there's scare tactics by the arbachs. We agree that there's a basis for it. And there's a real danger there for the competition is inefficient. It's no accident that competitors are flocking into the areas that are grossly overpriced. We should be terribly pleased. That proves most elementary of economic propositions. ` `  I suspect that the universal service fund device may be a way of getting us past politically past the point at which we all would want to say--the first thing to do clearly is rebalance and diminish the necessity for the subsidy except where it can be reduced by a factor of ten I"%n0*H&H&@@-" suspect. But in the interim, the universal service fund may prove to be something we'll worry about, we'll fight over. By the time it's finally done, it will no longer be necessary. ` `  But in the interim, we've got to get from here to there. And I don't think it's a scare tactic. We all begin by saying it's perfectly clear that those prices are much too high. And that's true of the access charges. It's going to be true of the charges for elements, network elements. And it's going to be true if we keep--if we don't rebalance at all, it's going to be true of these competitively neutral taxes which clearly we all want to get down by about 90 percent. ` `  MR. FARRELL: Harold. ` `  MR. ROTH: It seems customary now to say I agree with most of what's been said and I guess I do. But I think there is a lack of a connection between what people are describing as universal service or how it will operate and I think what is actually in the act. ` `  What is in the act is in the universal service area, not a revolutionary document. It is just a very mild continuation of the $700 million universal service fund, federal universal service fund and I emphasize federal, that is used to subsidize certain high cost providers of the local telephone service."%o0*H&H&@@-"Ԍ` `  It is not something as was pointed out earlier that is portable. It is not something that certain folks have suggested is going to be billions of dollars or tens of billions of dollars, some radical departure from current practice. It is not necessarily something that is targeted at low income individuals. It is simply that's not in there. Maybe it should be, but it isn't. ` `  SPEAKER: No, it is in there. Low income individuals are mentioned specifically in the act. ` `  MR. ROTH: But not under the universal service fund. ` `  SPEAKER: And the revolutionary character of this, it all depends on what the SEC does really. But they have an extremely broad mandate in there to update the definition of universal service according to the changes in technology. If the FCC wanted to run with it, they could define universal services some package consisting of cable television, on line services in addition to telephone service. It's all in there. ` `  MR. ROTH: I think that would be-- ` `  SPEAKER: It would be stupid, but they could do it. ` `  SPEAKER: Is that a prediction? ` `  SPEAKER: No, no. ` `  SPEAKER: I wanted to say I don't know exactly"%p0*H&H&@@-" what Michael has in mind, but even under a many person Ramsy role, if we put this into public finance parlance, you would still put it in the SLC. So you don't need the assumption that people are identical. You're going to have different people and many person Ramsy rule you'll come to the same conclusion in this particular-- ` `  MR. FARRELL: The question is whether the differences are observable or not. If you have differences that can't be observed at the stage when you're setting this up. ` `  SPEAKER: I'll tell you what my assumptions are. My assumptions are to first order that the price elasticity is near zero for access which everybody agrees it is. Then I think under the many person Ramsy rule, you end up in the same spot. That's just empirically valid. Everybody's agreed on that for ten years. ` `  SPEAKER: Are we all agreed that the revenue generation mechanism turns out to be or should be that the end result of this money should go to drive down the price of those basically exchanged customers who are in the agreed upon group that is meritorious for whatever reasons of the subsidies. Is that what we mean by portable? That's certainly what I mean by competitively neutral because obviously that keeps competition on the merits among those servers who would seek to be the provider of that basic"%q0*H&H&@@-" exchange service. I think it would be great if we could all agree on that. ` `  SPEAKER: The law specifically says that universal service fund shall be paid to eligible carriers and eligible carriers only. It can't go to individuals and it can only be used for capital maintenance and other sorts of things. ` `  SPEAKER: What constitutes eligible? ` `  SPEAKER: There's a whole section on defining this stuff. ` `  SPEAKER: By the way, that gets into the question that Mel raises. I hadn't realized all these differences between shall and should and may and would. The law states that the state regulators must admit new carriers except in rural areas where they may admit new carriers. So the portability issue, even across carriers is in doubt in those states that do not wish to allow someone to come in and compete with the existing high cost rural telephone companies. ` `  SPEAKER: So it was something the FCC could speak out on and urge true portability for the sake of competition. If so I so move. ` `  SPEAKER: Will someone read him the tenth amendment? ` `  SPEAKER: Part of this comes into question this whole notion the high cost area versus individuals. So they"%r0*H&H&@@-" think in fact there isn't agreement on that. There seems to be agreement on low income subscribers that you should target to the subscriber and let them bid. I think on the high cost area. ` `  SPEAKER: That's illegal. ` `  SPEAKER: The way it has evolved in the universal service proceeding is that the FCC is going to designate an affordable rate. And if your costs are above that rate, you'll get subsidized. It has nothing to do with whether you need it or not. ` `  SPEAKER: Not the individual, but the carrier. ` `  SPEAKER: The carrier. ` `  MR. FARRELL: Marius. ` `  MR. SCHWARTZ: Just a quick point. Harold, you obviously write about what the law says, but they also talk about principles for reform looking down the road. And some of those principles that they mentioned seem promising. They say let's move towards transparency, competitively neutral and so on. So I guess the question is, is that just fluff or do they really mean it? ` `  SPEAKER: Transparency, I don't think is a should word, but I think some of the other things are. You have to read it very carefully. ` `  SPEAKER: It seems to me as economists one thing we know not to get hung up on whether the money has to first"%s0*H&H&@@-" go to the carrier and then they can pass it onto the consumer or pay the consumer directly. So long as there's not some barrier on who the reasonably eligible carriers will be and they'll compete and pass it along. ` `  SPEAKER: In rural areas there may be variables. ` `  SPEAKER: That goes to Bobby's point, Bobby's motion. It hasn't been seconded yet. ` `  SPEAKER: That's the question is what it has to be an eligible carrier. Because if you're told, well, you need to come in, in the entire state on the same basis as--anyone concerned about sunk costs, raising the cost and risk of entry it seems to me would be worried about that and ask whether that's really appropriate. ` `  So it seems to me the statute says it, but there are an awful lot of problems with trying to subsidize areas instead of individuals. And it makes it extremely hard to--especially if you have very broad areas when you do it and that's something else that's been debated i this proceeding is whether you should--the level census block or the state. And it seems to me there are some serious problems with doing it at the state level that would make entry so difficult. ` `  SPEAKER: How about if it were done by carrier in terms of how many individuals in the select target population that carrier serves as basically exchange"%t0*H&H&@@-" carrier? That might meet the act's need to target eligible carriers and yet still as Carl points out direct the subsidy where economically it belongs, namely on the basic exchange service of the target population. ` `  SPEAKER: But then the issue is what you can do within high cost areas so called cream skimming. And presumably I like to say you could and you'd expect the entrants to go after the low cost customers and the high cost areas. ` `  SPEAKER: I would just suggest looking at where the current federal universal service fund goes. This is not something that targets low income folks and it's not something that targets even necessarily the highest cost carriers. It's based on a very complicated set of regulations that lead to lots of subsidies in certain states. There are no universal services funds that flow into a whole lot of states. There's no universal service funds that flow to mini carriers that have lots of very high cost customers. And what this provision does is sort of where does that fund go onto? It's not intended, I don't believe, to address all of the social and economic ills of the telephone industry in one fell swoop. ` `  MR. FARRELL: Well, running a mere 15 minutes late at this point. Let's move on finally to lessons from other industries. What I'd like to do here is to solicit brief"%u0*H&H&@@-" statements if they're willing to give them from ProfessorKahn and Dr. Winston and then have a specific discussion of railroad interconnection from Professor White and Professor Willig if they're willing to do that. Fred. ` `  DR. KAHN: With Cliff Winston here, and he's done far, far more work than I on airlines, I'm going to be very brief, unaccustomedly so. It's just that I feel a little bit like George of Mice and Men when Lenny keeps saying, George. Tell me about the rabbits. Whenever Fred Kahn appears, it's always tell me about the airlines. ` `  I'm not at all convinced that the similarities and differences are worth pursuing. There are obvious advantages as have appeared in the last 15 or 20 years on configuring airline operations in a network form. It's the hub and spoke system which was scarcely predict beforehand. ` `  And hubs do have characteristics of natural monopolies. We have virtually no two carrier hubs any more. Certainly no three carrier hubs. The two carrier hubs are quickly turning down to one carrier hubs and there are reasons for that. And the reasons are that there are enormous economies of scope and scale in operating a hub. ` `  But it hasn't created severe problems in the airline industry because what we have is the possibility of competing hubs. And so we have very intense competition over different hubs for long distance carriage, travel as"%v0*H&H&@@-" well. ` `  And the other thing is as it's turned out that the hub dominating carriers have not been able to prevent the emergence of point to point, low cost point to point competition. So that it has not created the kind of problem in the airline industry that seems to exist in the telephone industry. ` `  Now, it may well be that we will find that you can have the same sort of phenomenon in telephone, that is of essentially self-contained networks competing with one another. But we're never going to find out so long as basic service is so grossly under priced. ` `  And I think that's the significant difference between the telephone situation and the airline situation. It may not be inherently any different. The local exchange network may not be any more of a natural monopoly than the airline hub, whether it's a hub on Chicago or a hub on Minneapolis St. Paul or St.Louis. But we're never going to find as long as we so grossly under price. ` `  So that's why I was so emphatic on coming back to that. That's the reality with which all considerations have to begin in deciding how do we open this industry to efficient competition? ` `  And the reality is in addition that as long as some services are grossly overpriced, we have no way of"%w0*H&H&@@-" ensuring that competition is efficient. It is no accident that competitors are flocking to the areas where the rates are far above the costs of the incumbent companies themselves. And that's why I think we have to recognize the ultimate necessity if we're going to have real competition of rebalancing of rates. ` `  And in those circumstances, and this is really my last observation, the various statements that I find running through the NPRN that the height of the charges for network elements if they're too high, they will be a barrier to entry, is I think "bass-ackwards". ` `  A barrier to entry as Stigler was at great pains to point out is a situation in which there are costs that are born by entrants that are not born by incumbents. What we have here is precisely the opposite situation. ` `  We have the incumbents who are or feel they are entitled or have been told that they're entitled to recover costs that the entrants do not have to bear. They are the ones so far that have the burden of universality of subscription at rates that are grossly below economically efficient levels. That certainly is the main thing that comes out from Bob's book. ` `  So that in these circumstances it is the incumbents who are at a cost disadvantage as compared with the entrants. And that is the essential efficiency argument"%x0*H&H&@@-" for incorporating a markup in their charges for access to basic network elements. It is to equalize competition in a situation in which the barriers, they're not barriers to entry. Entry is indeed encouraged by the excessive pricing of the services which have for that reason attracted entry. ` `  And, of course, for that reason as well, the incorporation of a markup in a charge for network elements becomes, obviously subject to regulatory control, becomes a means of equalizing competition rather than preventing competition. ` `  And finally, I don't see any recognition anywhere in NPRM that it isn't the height of the access charge that determines the viability of competition. It is the margin between that charge and the retail charge by the incumbent company. And I was really terribly tempted to say it's the margin, stupid. Height is not irrelevant because it does determine the size of the market. And, of course, it's not economically irrelevant because the height of the charges is a scandal in terms of economic efficiency, but it is not a scandal because it is a barrier to entry providing imputation rules are followed. I'm through. ` `  MR. FARRELL: Thank you. Cliff. ` `  DR. WINSTON: I actually stockpiled all my comments. So I think I'm not going to be too short. My assignment was to look at lessons from other industries and"%y0*H&H&@@-" try to apply it to this industry. My obvious disclaimer is I know nothing about this industry. So what I've had to do is first develop a framework from the industries that I knew about and then try to apply it based on the things that you said to educate me about this industry. @@So what I'll do is I'll go through my framework and then I'll apply it to the details that have been discussed in this industry and see how that works. ` `  Deregulation for the transportation industries was a protracted process. It's not going to be as protracted as this process. This looks frightening to put it mildly. I think the kind of advice that I sense you're looking for is you've got a lot of problems here big time and you don't want to make things worse. ` `  And I think the best thing at least from my perspective on the industries that I know that I can say is try to explain how the market seems to have solved these problems and give you confidence in saying, yes, let's let the market do this because I think it's going to be really hard for us to do it. And if we try to, we might make things worse. But obviously, you need evidence to take that position. ` `  As I said, deregulation was a protracted process. The political economy part you mentioned briefly, but they certainly run through all this kind of thing. Obviously the"%z0*H&H&@@-" political economy with transportation was the concern of certain kinds of shippers and consumers and railroads, the people in low density markets concerned about having to deal with a single railroad. And so they put in maximum rate regulation. Concern for communities, small community air travelers an they had essential air service provision. We'll get back and see whether this was really essential to do or whether maximum rate regulation was ever binding. ` `  Obviously, we did not have the states to the extent that you do. And labor, of course, looms over all of this, probably the most political economy issue involved in the skill in dealing with labor will be extremely important in your industry to put it mildly. ` `  Now, the substantive problem that we've learned I think from coming out of deregulation is you had many decades of regulation where industries built up a tremendous amount of efficiency. As Jerry pointed out, this is a first order problem of this inefficiency. It's a giant shift of the rectangle, not the triangle that most academics were concerned with and certainly that problem was there. ` `  But I think in retrospect as we've really looked over how deregulation has evolved it really is the efficiencies that were so big, so much bigger than we ever imagined, that we've now seen as we've had from deregulation gross inefficiencies in operation, utilization of capital"%{0*H&H&@@-" and labor was often frightening and missed opportunities for technical change even in industries as low tech as trucking which you might think you're going to deregulate. This industry's going to be perfectly competitive. The process is going to be over. But in fact, there's actually been major technological change in trucking. ` `  So this really has been the problem that has emerged or been solved I think through deregulation. But the problem is the adjustment of this has taken a long time. When you have industries that have been locked into the regulatory environment for 30 to 80 years or whatever, it takes a long time for them to get out of this. And there's an awful lot of resistance to doing this. ` `  And so the question is, and this is the framework that I want to talk about is what's really been the important factors in this adjustment process. There are three things that I see. ` `  One obviously is competition which we've talked about, but particularly new entrants and the importance of having these new entrants be able to come in and the presence of entry barriers effecting these new entrants. ` `  The second is the adoption of technical change. This is obviously very important here. And third, maybe less important here but certainly important in the transportation industries is the adjustment to the business"%|0*H&H&@@-" cycles. ` `  All the transportation industries have had significant gains in efficiency. Like almost every year actually we see this thing. The adjustment process is far from over. But these have come slowly and obviously have been influenced as I said by competition, technical change and sometimes slowed down by the chaos created by the business cycle and the problems that the carriers have had in adjusting to this. ` `  So let me go through these things with these industries. First, the importance of competition going through air, truck and rail. In the early '80s, late '70s, when airline deregulation took off, a key part in getting this going was the entrance of the new low cost carriers, People Express, new kinds of carriers. Obviously to challenge the established carriers in getting them going and that was really important in getting them to change their operations and become more efficient. ` `  And this works to a point, but as you recall the established carriers tended to beat those carriers back. People's Express disappeared and we didn't really have these new low cost entrants for a while. And this is really in a way where deregulations sort of slow down in terms of his adjustments during the mid to late '80s the carriers really focused on trying to exercise and acquire market power with"%}0*H&H&@@-" hubs, frequent flyer programs, restrictions, computer reservation systems, all these kind of devices where now they wanted to turn things back and get the rents for themselves. So the empire strikes back is how I tend to think about what happened. ` `  Now, this was serious because in a sense they really lost their focus on the long run which is really what we need to think about here because when the late '80s, early '90s came along, they weren't nearly as efficient as they should have been at this point. They really hadn't aligned their capacity with demand and they had very terrible problems in dealing with the business cycle and lost all this money except for Southwest who had been getting its act underway. ` `  So now I think they've come through this but now we see there's a new source of entry in these low cost carriers. Delta is now undergoing what they call a 7.5 plan. I think you've heard of this. And what it is trying to get their operating costs down to 7.5 cents a mile. ` `  And I asked the CEO, I said, look, you know. It's been 20 years since you had deregulation. Why are you doing this now? And he said, well, you know, when we were first deregulated, we had to focus on expanding in the markets. I said, 20 years? And he said, well, you know, these things take time."%~0*H&H&@@-"Ԍ` `  I said, well, wouldn't Valuejet have something to do with this? Valuejet's in Delta's backyard. I am convinced if it weren't for Valuejet we would not have heard about the 7.5 plan. Now, obviously Valuejet has its problems now, but what is very important about the press frenzy about this is they really are sort of obscuring the fact that Valuejet's had a big impact on Delta becoming more efficient and this has been a key part to this industry. But these carriers have a long, long way to go. They all want to be like Southwest and it's just not going to happen for a long time. ` `  Let me quickly move on. Trucking, what has driven this industry is the new entrants to what they call less than truckload trucking. These are small shipments, less than 10,000 pounds is what those things are called. Now, this is an industry where they had roughly 70-75 percent of the shipments used to go by what they called the general common carriers in less than truckload trucking. They're down now to about 40-45 percent now since deregulation. ` `  The new entrants, UPS and Federal Express air service. So you've had new entry there which has come and taken a lot of their business. These carriers now had to become much more efficient in changing their terminals and their networks. There's now a big three there, Roadway, Yellow and Consolidated, but they're under a lot of pressure"%0*H&H&@@-" now to shed their union labor and it's very clever what they're doing. ` `  What they're doing is they're buying up regional non-union trucking companies. They're forming sort of subsidiaries of their big national company that are separate based on these and then they're saying, well, to hell with the union company. We're now just going to go with our non-union company. ` `  So this is a way now even at this point where they're trying to shed labor costs and become much more efficient. And if you look at what their operating costs are pre and post deregulation, even in an industry like this, they're far more efficient. ` `  Truckload they've had a new emergence what they call the advance truckload carrier, J.B. Hunt, Schneider National, so on. These carriers have operating revenues of more than a billion dollars per year and they provide competition for railroads. So this is a new part of what's happened in this industry with a lot of technical change too and how they do their operations. ` `  Two key parts and then we'll get into specifics. A lot more intermodal competition now. Truck now uses rail operations. And overriding all of this is what they call third party business logistics firms. ` `  What these firms do is they work with shippers and"%0*H&H&@@-" carriers trying to negotiate rates and get their whole inventory operation under control. Another way they're trying to minimize cost, even in areas where they have low density service and not a lot of competition and this has developed really in the market. ` `  So we've had a lot of efficiency improvements. In rail we haven't had new entry of new railroads obviously. That's difficult. But we've had short line carriers come in and we have these low cost non union carriers that really give the promise of what railroad operations could be and they're trying to get that way. ` `  As you know, there's been a reduction in true operations railroads. We don't have the caboose anymore. You're down from five to two person crew training. So you have two people up in the engine. Before you used to have three and now you have two and you don't have the caboose. ` `  A lot of abandonments in track, but there's still a long, long way to go. But the carriers are doing better and they're now actually verging on profitability. But if you look at this, it's not because of the raising the rates. The rates have been quite stable with contract rates, just lower costs. It's really competition that has driven this. So it's contract with rail, yield management with air, all these things with pressure to drive the cost down. ` `  Okay. Thinking of this framework, what"%0*H&H&@@-" implications for telecom? Well, obviously you have greater possibility for technical advance. Although we had some certainly in these industries a rich source of different kinds of competition from different types of modes, cable versus telecom, long distance versus short distance, all this kind of stuff. Probably less sensitivity to the business cycle. ` `  But as I see it, you have a long, long process of adjustment, a huge potential for shedding inefficiencies. It's almost frightening I think in this industry how far you can really go. And the real thing also that's different is the prices just didn't seem to make any sense. At least in transportation there was some rationale, distance, shipping weight. They had the sort of Ramsy pricing in rail that was crazy. But it's not nearly as bad as what you have here. So the key thing is really the competition just cannot be blocked. ` `  Now, how do you apply this to the specific issues that have been raised here in terms of trying to get the details right, cost, interconnection, pricing and universal service? Carl started off the discussion with a comment about that you want to replicate what will be charged in terms of costing in a competitive market and using your framework of your T.S. long range incremental costs or just long range incremental costs."%0*H&H&@@-"Ԍ` `  I would slightly rephrase that actually and the issue is what will be charged in a competitive deregulated market, not competitive market but a competitive deregulated market. And what I mean by that is you have no idea what this market is going to be looking like. And that's really why I said what I said before. ` `  The adjustment is going to be tremendous and you're going to have all this cost adjustment, new technologies, all these kinds of changes going on. It seems to me trying to really somehow micromanage this with a sense of how to handle the cost is going to be very difficult. And whatever you do in terms of what costing concept you want to have I will put as a parentheses in there as a function of T where T is little that means time. ` `  Because your costs are going to go down in many different ways and obviously you want to peg this. Obviously, you want to have this stuff adjust. As they become more efficient, you want your costs and prices to do that. I'm not quite sure that this is the FCC's comparative advantage to being on top of this kind of thing, but in a sense you would need to do this if you want to try to micromanage this. ` `  The second thing on the interconnection obviously this issue is a tricky one, providing access and how to handle the negotiation and then weaving in this business"%0*H&H&@@-" with the state and federal government and the threat points and this just also sounds frightening. ` `  Obviously, you want to encourage efficient entry. Well, the market in transportation is done in a crude way, but it's working in some sense. Railroads use other railroad's track. So they have access in that way. And they do it through revenue divisions and rules of thumb and in mergers they have some notion of incremental cost. I don't know how serious that's taken. Bobby will comment on that. ` `  But also a big change in terms of access has been intermodal. In 1984, there were 4.6 million truck trailers shipped on railroads for intermodal operations. Ten years later there are 8.2 million trailers, 79 percent. So there's been now access through different modes, truck and rail now have access there. ` `  So the market has been able to work it out in a crude way some sort of access. It might be useful to sort of look at more of the details about how they've done it. ` `  The two final points you discuss are pricing. This mandate of average pricing is obviously awful. Awful, awful, awful. This is just counter what you want to have in deregulation. ` `  You know, when I see this, you know, there are ways the market have solved this for your concerns about the"%0*H&H&@@-" low density consumers and the people that you think are going to face inadequate competition. Contract rates have been negotiated in railroad. More than half the things now move under contract. You have as I said these third party logistics firms that get a bunch of firms together. ` `  They work with carriers. They provide ways of efficiency, matching loads, volume commitments, all these kinds of things. They lower their costs. The rates go lower. ` `  (Continued on next page.) // // // // // // // // // // // // //"`"0*H&H&@@@)" ` `  DR. WINSTON: (Continuing) The market has found a way to do-- you have specialized entry, you have what they call Class 3 railroads, they are trying to get the branch lines again, lowering costs. Airlines, you have certain niche carriers. ` `  So, in a way, the market has tried to solve this problem, having average pricing, just seems like a bad idea unless the prices are all set by South West. ` `  Universal service, again, you know, if you look at the transportation network, you know, the market seems to have solved this better, this notion of essential air service that turned out not to be essential. You had better service for nonhubs to nonhubs when we had airline deregulation. I think they are phasing out the program. Maximum rate regulations I think it's rarely been binding, if at all. ` `  So, I guess, my bottom line is, obviously, there are more sophisticated problems here in terms of potential market failure with scale economies and the like. But the market, thus far, in terms of other deregulated industries who has found creative and, I think, efficient ways of dealing with some of these problems and, certainly, raises questions about your interest in trying to micromanage these things. ` `  MR. FARRELL: Thank you."%0*H&H&@@-"Ԍ` `  I'd like to invite Larry White to talk about his views on the railroad issues. ` `  MR. WHITE: Okay. I'm going to be building a little bit on things that Cliff said and reacting a little bit to some things that Fred said. ` `  On the surface, if you just sort of drew a stick diagram, which I have sometimes done, a railroad system and a wireline telephone system look sort of similar. There is a lot of fixed equipment there, connections are necessary, switching is important, much of longdistance railroad traffic involves more than one carrier, joint rates are important. This should all sound pretty familiar to the people in this room. ` `  You've got besides this very capital intensive fixed major switching facility, you have got an alternative, it's called trucking. It's imperfect, it's a good alternative for some types of shipments, not such a good alternative for other kinds of shipments. But it's there as an alternative. And, in fact, and you might think of that as sort of analogous of spectrumbased, say, cellular type service. ` `  And then as a yet, another alternative, with trucking you still have some kind of collecting and sending out again, switching type of function. But for a manufacturer, there is always the possibility of doing the"%0*H&H&@@-" trucking yourself. And substituting your own switch for somebody else's switch. And that's sort of like CB radio, where, essentially, you've got your own switch and you are not then limited to specific gathering and sending out types of facilities. ` `  So, there is some analogies. Also, prior to 1980, a history of regulation, trying to enforce crosssubsidy. Crosssubsidy within rail traffic and trying to limit competition among rail. Trying to limit competition between trucks and rail. ` `  And, oh, buy the way, a lot of railroad companies went bankrupt in the '30s and then again in the '60s and '70s. There may be some connection there. ` `  Now, there is a big difference, however, and it comes back to a point I made earlier this afternoon. We model and think of railroads as a freight transmission system, with both the shipper and recipient being sensitive to the rates and choice of carrier. So, customers in the system are sensitive to inbound as well as outbound prices. ` `  And I would guess, I don't know this for sure, but I would guess that General Motors is sensitive not only to its outbound freight costs, but to its inbound freight costs as well. And would, you know, understands that there may be some passing on of inbound freight costs to us and, probably, George Eads, at some point, told them about"%0*H&H&@@-" elasticities of demandsupply influencing, incidents of things like freight rates. ` `  However, though I would guess most of the people in this room would be sensitive to our outbound calling costs and prices. I don't know how many of us would be sensitive to inbound prices. Because that's going to be incurred by somebody else who is going to be calling us. And, you know, not clear how the incidents is going to shake out there if were to think of it at all. ` `  And so, this pricing of termination, I think, is crucial. In fact, that's what all this negotiation stuff we've been talking about earlier today, is all about. And, as long as we are in a wireline type system, we don't have the advantage of competing hubs. That is what allowed a lot of the competition in airline to emerge. We don't have the alternative of the point to point. ` `  If you went to a CB radio type of spectrum based telephone system, where essentially, everybody's got their own switch, then, hey, we're no longer tied into somebody else's switch and then access is not a problem. And all of this negotiation stuff goes away. But until we are there, this question of termination termination pricing is very important and it is something that makes the telephone system very different from rail. ` `  Now, briefly, since 1980, as Cliff was saying, we"%0*H&H&@@-" have had, really, a total revolution in rail regulation. Where, basically, the Interstate Commerce Commission was able to walk away from pricing for the most part. Even where shippers were basically linked into one rail system, for the most part, the ICC walked away form pricing. ` `  Now, why? Why did they do that? I think, partly, they could tell themselves, well, there is always trucks there. It's an imperfect substitute, but there is always trucks there and that puts a limit somewhere on the pricing. ` `  Also, and this is something Cliff didn't mention, the ICC at that point, was dealing only with freight shipments. Which meant that we were talking about businesses as customers, not people as customers. That, basically, since the early 1970s, passenger transportation had been shunted off to government enterprises, of various kinds. Amtrack at the national level, and various government run commuter railroads at the local level. Where there is various levels of subsidy. Also, by the way, concerns about competition. You see it at the most compact commuter level, I know, in New York City, the Metropolitan Transit Agency, gets very upset about Jitney competition to the uniform rate of $1.50 on buses and on subways. hhSo, it shows up there. ` `  But it's only freight and I think the fact that it was businesses, not people, made it easier for the ICC to"%0*H&H&@@-" walk away from rate regulation. ` `  As Cliff mentioned, entry has largely been absent. There have been some various sales, shortline railroads, etcetera. When mergers occur, however, the same questions of access that show up in telephone show up in rail. The ICC has adjudicated this, sometimes mandated trackage rights, which is, basically, the one railroad running its trains over the tracks of another railroad.   But again, the ICC mostly waiving its hands at pricing issues. ` `  This was, I guess, looking back on it, I think this was the right thing. Would I have walked away from these local monopoly pricing questions as readily as the ICC? I don't know. But then it's easy to see how you would be on a slippery slope. That you have got to start worrying about these local monopoly questions, then it's easy to see how that starts to get out of hand. ` `  So, I think there are analogies, but I think we have to be with between telephone and railroad, but I think we've got to be very careful in those analogies and have to understand how, first, the different histories were important. And also, this question of termination pricing, is a terrifically important one. And railroads and airlines didn't have that kind of problem, and so, you can't use their experience to be dealing with the termination pricing question."%0*H&H&@@-"Ԍ` `  MR. FARRELL: Thank you. ` `  Bobby? ` `  MR. WILLIG: Thank you. This termination pricing discussion is scaring the life out of me. Do you mean that when some discount broker calls me during dinner and says, can I trade your three shares a year, I not only have to hang up on the person, I have to pay for the phone call? Give me a break. ` `  (Laughter.) ` `  MR. WILLIG: But I'm not (inaudible) the floor to you Larry. ` `  MR. WHITE: You should have your own 900 number, Bobby. ` `  MR. WILLIG: Allow them all to call me for free? ` `  MR. WHITE: No, charge them to call you. ` `  MR. WILLIG: Oh. ` `  MR. WHITE: Charge them to call you. ` `  MR. WILLIG: Good idea, why didn't I think of that. ` `  MR. WHITE: Charge them to call you. ` `  UNIDENTIFIED MALE SPEAKER: It's all a marketing (inaudible) ` `  MR. WILLIG: Great. ` `  UNIDENTIFIED MALE SPEAKER: You need class service."%0*H&H&@@-"Ԍ` `  MR. WILLIG: Well, I want to use railroading because I've been assigned that task, but I welcome it. ` `  (Laughter.) ` `  MR. WILLIG: To talk about two issues which have, I think, come up and down all day long, and they strike me as more or less the core of the toughest issues which we have been discussing. And in some parts, I thinking ducking as a group, occasionally. In any event or at least being circum locutions in our language. ` `  Railroading has all of the same problems, surely, that have arisen in telecom over the years, as Larry said, and Cliff point out. With some huge differences. Which, I think, need to be pointed out. ` `  The first question that I would like to draw the comparison to is one that I think it was Fred who articulated his view and that is, you said, Fred, I think, that economics has nothing, or little, to do, in any event, with embedded cost recovery. And a lot of people sort of said, oh good, I'm so glad that's off the plate. That's only $100 billion issue. Let's not think about that, let's talk about termination pricing instead. ` `  (Laughter.) ` `  MR. WILLIG: Which may be all we can say. But I think economics has a lot to say about embedded cost recovery, or at least it can. And that economics is the"%0*H&H&@@-" first place to look, in any event, for guidance on the subject. And I actually think the contrast between telecom and railroading is very instructive as an entryway to that issue. ` `  In railroad, if one were to price network elements or enduser services at, not only based on, but at TS lurics, there would be a humongous gap between the recovery of revenues from those prices and total embedded costs. That's just a fact and I think it's intuitive we all understand it. ` `  I think we also understand the reason in railroading. For the huge disfunction between embedded costs and the sum total of TS lurics. In railroading, the reason is the enormity of the common costs of the technology. And that's not just the enormity of the common costs that had been expended in the past, a la, embedded, costs. But it's also the enormity of the common costs looking forward. If one were to estimate total systemwide costs on a forward looking efficient basis, in railroading, one would still, I believe, I'm told, come up with an enormous pool of common costs that would not be recovered from prices that were literally equal to TS lurics for enduser services or network elements or what have you. ` `  So that's one reason why we might see a disfunction between embedded costs and the sum total of TS"%0*H&H&@@-" lurics. And if that's the reason, then I know, and I think we could all agree, that if that were the reason, there would be a case for big markups in prices above TS lurics, so as to make it possible for the railroad, or the entity, to recover their total costs on a forward looking basis. ` `  But now, what I'd like to do is contrast that reason for disfunction between embedded costs in total, and the sum total of TS lurics with a bunch of other reasons that come to my mind which, I think, also have implications for whether we should be building prices on TS lurics or, as Fred would say, keep our eyes on the margins instead of on the cost foundations. ` `  So, reason two. Reason two suppose that in embedded costs, there are very significant costs of continuing inefficiencies in operations. Not to throw any stones, but I'm trying to make a fairly complete list. If that were the reason for disfunction between efficient TS lurics and embedded costs, I think here too, we would all agree it would be a grave error to build component prices on a base of those embedded costs. Because that would put into concrete those extra charges for those inefficiencies and very much remove the impetus that competition provides for weeding out those inefficiencies. ` `  So that might be a reason. And if that's the reason, don't price components on the basis of embedded"%0*H&H&@@-" costs. Absolutely not. ` `  Third possible reason. Suppose the embedded cost base includes costs, investment costs, of future services. Costs that were really not necessary for the regulated services that underlie the network elements and underlie the advent of local exchange competition, maybe costs rationally expended, maybe not. But costs that are really for different services than those basic regulated ones. ` `  If that were the case, then basing component prices, or even enduser prices, on those costs would constitute crosssubsidy with all of the inimical relationships to competition that we have heard mentioned so aphoristically today. ` `  And, thereto, it would be a bad idea in a competitive regime to build those costs into the prices of basic regulated enduser services and also into the network elements, the components that underlie them. That would not be competition, that would be maybe appropriate for franchise monopoly industry, but not for a competitive one. That's very discriminatory, Chairman Farrell. I will not abide by your watch being swung in front of my face. ` `  (Laughter.) ` `  MR. WILLIG: In view of what has gone before. ` `  (Laughter.) ` `  MR. WILLIG: Thank you very much. Perpetrator"%0*H&H&@@-" number one. ` `  Well, I'll give you a category you might be more amused by. ` `  (Laughter.) ` `  MR. WILLIG: How about costs of investments which, when they were once made, were prudent in their time, but have turned out now to be obsolete. Obsolete for the regulated basic services and, moreover, suppose that those investments are viewed as being covered by a regulatory compact. Which is a construct we have heard mentioned, somewhat obliquely, today. ` `  Then I think if that were the rationale for the disfunction between embedded costs and the sum total of TS lurics there would be a reasonable case to be made, for seeking recovery of that gap. Perhaps, through a competitively neutral mechanism of the kind that we have heard talked about today. Quite different in it's conclusion, I believe, from the previous categories of reason for the gap. ` `  Finally, a fifth category, I'm not sure it fits accounting wise, but costs of regulatory burdens. Fred mentioned that and I think it may be proper to include universal service in the past as having fit into that category. And, I think, we've all agreed if someone would second my motion, that those costs ought to be recovered on"%0*H&H&@@-" a forward looking basis, in a fully competitively neutral way. Both in terms of how the finances are generated for the subsidies and also how they are doled out, so as to be coherent with the competition. ` `  So, in any event, sorting among those five different causes of the gap is very much a matter of economics. And I think it's a task that Chairman Farrell of the econ subgroup of the Commission ought to, if he hasn't already, put himself to. And one that I think ongoing testimony may be very helpful in resolving. Because there is an enormous implication as for pricing of enduser services and of network elements. ` `  That was the first lesson from railroading. ` `  (Laughter.) ` `  MR. WILLIG: The second one I will do in two minutes. Larry says that the ICC got out of the business of regulating railroad rates, and to some extent, certainly, the way of regulation changed dramatically. And the amount of litigation changed. But my favorite lesson from that history is that after the Staggers Act was passed, the Commission established a new form of rate regulation, based on standalone costs, which is a version of economic costing. It's a form of costing which is very allied to TS luric for the network elements that are before us in these questions. At least according to the engineers that I have"%0*H&H&@@-" been listening to. ` `  And the experience was, that once the Commission laid out principles of what constitutes appropriate standalone costing, and once there were a few examples that had been blessed by the ICC, and by the Railroad Accounting Principles Board a group not unlike this group, in terms of the diversity of views. But the homogeneity of intelligence and education ` `  (Laughter.) ` `  MR. WILLIG: Once there was harmony expressed by such a group, the amount of litigation went down from, literally, hundreds of rate cases to really less than a handful. Because settlements and individual contracts resolved all of those disputes, except for a few that raised new issues of principal, because things tend to get settled when there is common knowledge about the way litigation will come out, when litigation and delay are costly. As was, certainly, the case before the ICC. ` `  So the lesson there is, yes, FCC mandates sensible principles, gets this group to agree on a host of them, and then the future for negotiations is really a very propitious one, with good economic principles being applied through commercial agreement, rather than through litigation. ` `  Thank you. ` `  MR. FARRELL: Thank you."%0*H&H&@@-"Ԍ` `  Cliff, you have a comment? ` `  MR. WATKINS: First comment. You remind me of Bill Clinton. ` `  (Laughter.) ` `  MR. WILLIG: At the convention, right. ` `  UNIDENTIFIED MALE SPEAKER: (inaudible) back to Hilary Clinton. ` `  MR. WATKINS: This is on the air. ` `  (Laughter.) ` `  MR. WATKINS: I just want to clarify. My general point was not to say whether these other industries were like telecommunications. I think that's not the point to make because air is different from rail, is different from truck. And I think that we could have had this discussion in 1976 and, you know, we could have talked about air. And then someone said, well, I think we ought to deregulate rail. And people would say, oh, rail is very different from air. We can get all hung up on that. ` `  My point is, and I think this is one to keep in mind, technologies may be different, demand and preferences may be different, but the adjustment, thus far, that we have seen in the deregulated industries, have been the same. And that's really the issue. ` `  What creative ways will industries adjust to deregulation to become more efficient? And what creative"%0*H&H&@@-" ways will competition arise in ways that you may not be able to anticipate in a partially regulated environment? And you will never be able to anticipate this. And this is really the thing that I think that we have learned from deregulation. It's very hard to sort of sit around and say what we think will happen, because a lot of these things, you know, you see from the experience. And I think it's difficult to sort of say, well, telecom isn't like this, this won't happen. Because, obviously, there are going to be things 10 years from now, we'll look back upon and say, God, that was a creative surprise. ` `  MR. FARRELL: Okay. Well, we look forward very much to some of these creative surprises. ` `  I would like to spend some time taking questions from the floor, so I think let's move onto that now, if there are people who have questions. ` `  AUDIENCE MEMBER: Yes, particularly in the rural areas, it seems to me without using exemptions provided by the Acts, that we will be engaged in a kind of musical chair scenario, where we have one chair and several competitors, and when the music stops, somebody is in that chair serving the customers. To what extent do we make sure are you concerned I guess this is for everyone in body, are you concerned about rural service, generally I mean, Dr. Crandall, you had spoke about, I think it was you, saying it"%0*H&H&@@-" might be good that the rural carriers, or some of them, lead the area, using PCS or some other technology? ` `  However, it seems that you will definitely need to have some consideration given to rural customers, as provided by the Act. And I just wanted to get some comments, possibly, on yours Dr. Crandall, on alternative technologies and how that's going to force the carrier's last resort out of the rural market? ` `  MR. FARRELL: Before you do that Paul, I should try and repeat the essence of the question, just for the record, because I don't think the microphones will have picked it up. ` `  So the question is, starting by drawing an analogy between providing service in rural areas and some kind of musical chairs, what are the concerns about the provision of rural service, about who will do it, and about the effect on rural customers? ` `  Mr. Crandall: Well, I guess I would take Cliff Winston's admonition seriously, which is to say that we don't know what the efficient way to serve these rural areas is, but if we look at what's going on in developing countries, where they are wiring rural areas, are often not wiring them, but using wireless. If the services were thinking of delivering a narrowband services, I wouldn't be at all surprised if wireless could begin to serve as a"%0*H&H&@@-" competitive threat to these existing wireline services. ` `  Of course, what it could do is to reduce the value of those wirelines companies substantially, maybe force them into reorganization. But they might, given that there are already some costs there, they might continue to operate. ` `  I think the notion that rural areas will be under served is one that I would not lose sleep over, simply for the reasons that JERRY HAUSMAN advanced. Which is that there is very little evidence that the demand for connections is very price sensitive and if rates have to go up 50 percent, 100 percent, 200 percent, I would doubt that very many people would fall off the network, even in rural areas. ` `  The picture which was painted before the joint board in this room a month ago, which is that all people who live in rural areas are, obviously, destitute, is simply wrong picture of rural life in the United States today. ` `  MR. FARRELL: Other questions? Yes? ` `  AUDIENCE MEMBER: I have (inaudible) in connection with (inaudible) issues from the perspective of not only of access prices, but also from taking the juris prudence, and I wonder how today's panelists might reconcile their economic prescriptions with the requirements that any price that is mandated by government for access to one's property, has to be just compensation? And the basic formula for that"%0*H&H&@@-" is that, that the person who is being compelled to turn over use of his property, receive the same amount that he would receive if he were a willing seller, selling to a willing buyer. So, in other words, the price result in voluntary exchange. ` `  MR. FARRELL: Okay, Mr. Sidack's questions, as I understand it is, one that I should really rule out of order because it's not an economics question, but I'll allow him to mention it. ` `  Anyway, which is ` `  AUDIENCE MEMBER: can inform the takings analysis. ` `  MR. FARRELL: Okay, to think about what economics tells us about the takings analysis with particular reference to the idea that the price of compulsory purchased thing, should be what the seller would have expected to get from a willing buyer. ` `  UNIDENTIFIED MALE SPEAKER: And that means if the seller was a monopolist, Greg, you've got to pay him the monopoly price? Whoa! ` `  AUDIENCE MEMBER: (inaudible) being regulated now, are being required by regulators not to charge monopoly prices. That's the idea of utility regulation. Pardon me? ` `  AUDIENCE MEMBER: Then your theory of regulation is, by definition, a taking is anything that stops them from"%0*H&H&@@-" being monopolists ` `  UNIDENTIFIED MALE SPEAKER: No, no. ` `  UNIDENTIFIED MALE SPEAKER: Let me just say this. It seems to me the one part of economics would say, if you just started by saying are you compensating the party for whatever they are being compelled to do, the first thing would come to mind, again, would be some notion of incremental costs, and then we could say, well, maybe it should be total service incremental costs. ` `  But, again, it would tend to look at that to say, if you asked the question as, are you making them worse off then they would have been had they not offered the service at all? So that would be one standard. ` `  Now the second standard is, are you making them worse off then they would be if they could have gone out and sold the service for abovecost? And it seems to me that's when it gets much trickier because it gets into the whole question of are you allowing them to exercise market power? And how you would do that? And it seems to me then you are going to get into semantics of what does it mean to be a willing buyer? And does that mean that you, supposedly, had a lot of alternatives and this is supposed to be a competitive situation or not? ` `  So, I don't know that the legal standard is going to be a whole lot of help in those words, guiding it, once"%0*H&H&@@-" you get beyond saying that some notion incremental costs. And then people will fight on how much above that you would want to go. ` `  MR. FARRELL: Sid, do you have a comment, Sid? ` `  SID: I think Mr. Sidack is raising the same question that follows from Bob's taxonomy of all the possible contents of possible justifications for recovery or disallowance, over and above incremental costs. You cited five possible circumstances. When I said that embedded costs were not essentially an economic question, I was talking about the first one only. Sunk costs. But even there, it's not totally noneconomic, obviously. Can a system simply ignore some costs because they were sunk? ` `  But the point is that you've got these five categories, possible inefficiencies, investments that were made prudent when they were made but now prove no longer to be economic. The cost of providing other mixed costs, of providing video services, where you have to distinguish the two. You have got then there are the sunk costs, which are a consequence of inadequate depreciation, and there was common costs, which are true economic, forwarding looking costs. ` `  I suggest that they, in conjunction with Mr. Sidack's question, suggest that this is not the kind of thing that the FCC is going to be in the position to do"%0*H&H&@@-" nationwide because, is the FCC going to go and say, well, now look, there is a telephone company in Utah that is inefficient, so we are going to decide that it should be disallowed? It seems to me that the locust of those decisions has got to be at the level at which the revenue entitlement has to be evaluated. ` `  And, of course, it is not a question of unrestricted monopoly pricing. It is an interpretation under regulation, and it seems to me it's got to be done at the state level. At that point, simply, what is the degree of entitlement? I don't see any way in the world that it could be done by rulemaking at the federal level. ` `  Are you going to decide which investments are prudent at the time but are not prudent now? ` `  MR. FARRELL: Carl? ` `  MR. SHAPIRO: I'm sure mostly it will be done at the state level, although, it seems to me the FCC could give some guidance in, generally, as they are doing throughout this rulemaking. And I think this is, basically, a point of equity or fairness. In addition to the economic analysis we can get into. ` `  UNIDENTIFIED MALE SPEAKER: That was the point I was making. ` `  MR. SHAPIRO: I agree with that. I think it's well to be reminded that this Act, and there is a quid pro"%0*H&H&@@-" quo, which is the entry into the longdistance markets that should not be forgotten. ` `  MR. FARRELL: Milton? ` `  MR. MILLER: Yes, I think you've been discussing it primarily as a legal issue. I think that there is an important economic element. In the same sense in which people are compensated for a copyright or a patent, there is no precise economic methodology that I know of for determining what the value of a patent is, even though it is some kind of a monopoly. ` `  And I think this is a relevant issue because if a network creates capabilities, functions, and so on, which give it a competitive advantage and the effect of the interconnection regulations is to open up those functions and capabilities to every other competitor you are, in effect, devaluing some of the innovation that this company has invested in. ` `  Now, I don't agree with the efficient component pricing method as a way of addressing this because of the problem of defining opportunity costs for monopolies, but I think the issue is an extremely important one as we move forward into an environment in which innovation is the key method of competitive differentiation. ` `  AUDIENCE MEMBER: May I make one comment further on that? There is a great value that the economists can"%0*H&H&@@-" provide on this issue because, as a general legal matter, courts and they would, for sure, at the regulatory agencies, should attempt to interpret their statutes in a way to avoid constitutional controversies. ` `  You have the opportunity to interpret the pricing provisions of this new statute in such a way as to reduce the likelihood that the constitution of litigation will arise. ` `  MR. FARRELL: Okay. The suggestion is that we should interpret pricing provisions in such a way that this set of constitutionally difficult questions doesn't arise. ` `  UNIDENTIFIED MALE SPEAKER: You know, I think one thing along these lines, which is economics, is that this area these businesses have been very closely regulated by the FCC and, in fact, I think I don't usually get involved in this, but I think there has been some type of price cap appearing every year in the last five years that I know about. I usually get a call a year from somebody saying, we are looking at it again. ` `  And to the extent that regulation means anything here and this question means anything, unless the FCC wants to say it is allowed over earnings, by the lacks, or going into the rate base, nonprudent investment, or some other  ?#<regulatory term. I used to be on the Bell Journal and it was used and useful. Maybe they have sneaked into the rate"%0*H&H&@@-" base as well, nonused useful. ` `  But it seems a fairly amazing fact, that for an industry which has been regulated so closely by the FCC, that all at once the FCC's going to turn around and say, ah, that was Willig's category number two. That investment was nonused and useful. It was used and useful for the last six or seven years, but all at once, we want to set these rate elements and we've now decided it's nonused and useful. ` `  And Bobby's coauthor in the context of nuclear power, you know, came out a number of years ago and said, this is going to have horrible productive efficiency problems because you don't have time consistency from the government when they come in and do this. So I am not saying that Bobby's wrong. There could be a lot of imprudent investment, and a lot of nonused and useful investments. ` `  But I find it striking that it's come up now, and despite this very close regulation of this august agency, over the last five years, it was totally missed. ` `  (Laughter.) ` `  MR. WILLIG: What can I say, it was before I arrived. ` `  MR. FARRELL: Yes? ` `  UNIDENTIFIED MALE SPEAKER: As one who have been"%0*H&H&@@-" closely involved in this, it's not just immediately that this issue has come up. That particular question of whether or not this agency, in particular, or regulatory agencies in general, could evaluate whether an investment was prudent or costs were properly incurred, was a primary reason during the '80s for going to price cap regulation. It was the decision at that time, after much extensive public discussion, that the agency simply could not make any reasonable evaluation of what was prudent investment or what was appropriate costs and, therefore, we would give much greater freedom to the companies by going to price caps. ` `  So it's not a completely new issue at this point. ` `  UNIDENTIFIED MALE SPEAKER: How is the same agency going to determine TS luric from an efficient network then? I mean, if in the past you couldn't have determined what was an efficient investment, ` `  MR. BROCK: We assume the current people are smarter then the ones that were here earlier. ` `  (Laughter.) ` `  MR. FARRELL: Thank you Jerry. ` `  Question? ` `  AUDIENCE MEMBER: I think it's absolutely, positively the case that this agency has never regulated at least 75 percent of the costs that are at issue and, probably, 90 percent. So, the notion that this agency can"%0*H&H&@@-" make that decision, I think, is wrong and it ought to be avoided. ` `  On the other hand, what this agency ought not to do is try and tell the state regulators how to handle those costs, equally. Because even though I agree with Dr. Willig's list of categories of things that you shouldn't include, it's too short. Because I would certainly include excess profits. And I would certainly include, not only strategic investments, but managerial investments, done for profit opportunities in the nearterm, not just the longterm. ` `  You would certainly only want to include prudent investments, you would not want to include misreported costs. And I have been in cases where you can find companies reporting different costs to the FCC and the state, and misallocated costs. So, there are at least six categories of costs that have to be looked at. ` `  But in addition, after you are done with those costs, the legal standard and here is why I will disagree with the previous statement. The legal standard is not whether you have imposed a loss on the company. The legal standard is disallowing a once prudent cost that is no longer prudent, has to threaten the financial viability of the company in order to get a constitutional claim. ` `  And I submit that, certainly, the (inaudible)"%0*H&H&@@-" serving 90 percent of these companies would not have a chance of showing that they are about to go bankrupt if you don't let them recover their embedded costs. ` `  So this is not a decision that should be made at the FCC, and it is certainly, I think, a decision subject to sound legal analysis that will, in fact, make the vast majority of the difference between embedded costs and TS luric. It will go away in those six categories of inefficiency and excess costs, and in the legal standard of actual threat to bankruptcy. ` `  I don't think there is any reason the FCC should suggest that there is any reason to recover those costs. And let's have a go at it at the state level. ` `  MR. FARRELL: Okay, well, I think we are getting into questions of jurisdiction and congressional juris prudence, which I feel illqualified to chair a session on. ` `  Yes. ` `  AUDIENCE MEMBER: I was just wondering if there was any consensus as to whether the loop is essentially joint or common with respect to state and interstate services? Bill Taylor stated earlier, I believe, that in your view ` `  MR. TAYLOR: That there is no joint cost. ` `  AUDIENCE MEMBER: that there is no joint cost. ` `  MR. TAYLOR: Correct."%0*H&H&@@-"Ԍ` `  AUDIENCE MEMBER: Wouldn't the loop be joint with respect to peak and offpeak pricing, for example, since those services are produced in fixed proportion ` `  MR. FARRELL: The question is ` `  MR. TAYLOR: But they are not. ` `  AUDIENCE MEMBER: Pardon? ` `  MR. TAYLOR: But they are not. The usage services, peak and offpeak, can vary any way you like. They don't come like beef and hides, one to a cow. ` `  MR. FARRELL: The question was, is the loop joint costs to peak and offpeak? And the answer given was, because they are not provided in fixed proportion, it's not joint. I think you were going to say it's common. ` `  UNIDENTIFIED MALE SPEAKER: Yes, in any case, it doesn't matter. I mean, near as I can tell, the sole purpose of joint and (inaudible), is to sell more ink for printers. Because what people do, is they are always sort of insecure. So they say, well, I don't dare put just common costs, I'll write joint and common. I don't think anybody can point to anything any more where, somehow we say, joint costs are going to be treated this way and common costs are going to be treated differently. So ` `  MR. TAYLOR: Well, there is a specific answer to his question. The specific you could argue, as an economist who shall be nameless, has argued, that the"%0*H&H&@@-" provision of the capacity is joint in the sense that there is a fixed amount of capacity available on peak and available offpeak. ` `  So, in that sense, you may argue that those proportions of the capacity aren't fixed. That does not say, however, that the efficient pricing is on any other basis then marginal cost. The marginal cost of that fixed amount of capacity that's available, if that capacity produces sawdust, it's marginal cost is zero. If it produces lumber, all the costs get borne by the lumber. If it's a gas pipeline, which can carry a certain amount of gas in July and in January, you can say, in a sense, the proportions are fixed, so far as the capacity is concerned. But that's not the efficient price. ` `  The marginal cost of the carriage of gas the capacity cost of the carriage of gas in July is zero. The marginal cost in January is the whole thing. So fixed doesn't take you anywhere. ` `  AUDIENCE MEMBER: But does the loop, essentially, joint with respect to state, interstate? I realize that they are not produced in fixed proportion, but one could argue that jointness is like publicness that you rarely ever see it in a perfect form. ` `  MR. TAYLOR: It's not joint with use. If it doesn't vary with use, and that's what yo are talking about"%0*H&H&@@-" of interstate, then the marginal cost of that loop is zero. I don't care whether ` `  UNIDENTIFIED MALE SPEAKER: I think that state and interstate, from my point of view, is a figment of a regulatory accountant's imagination. I mean, the 25/75 never made sense to start with. So, we are not talking about any type of economic reality. It's just that some accountant sat down and said, that's how we should do it. It's not based on underlying economics. ` `  AUDIENCE MEMBER: So you are saying, since they are not real separate services, that it doesn't make much sense to talk about whether they are jointly produced or not? ` `  UNIDENTIFIED MALE SPEAKER: No, the service an interstate call is a different service from an intrastate call. The critical thing is, are there marginal costs of the loop that are imposed when you place an interstate call? Or are there marginal costs of the loop that would be saved if you didn't place the call? ` `  And the answer to those so far as I know, is no. Therefore, you can use the word joint from her until Christmas time, it still have no part of the marginal cost of interstate usage. ` `  MR. FARRELL: Okay. ` `  UNIDENTIFIED MALE SPEAKER: Or with intrastate"%0*H&H&@@-" usage. ` `  MR. FARRELL: Okay. Let me, one more question then. ` `  AUDIENCE MEMBER: I'm sorry, just one more question on joint and common. Would we agree that business and residential service are two different services? If that's the case, then there are joint costs because you have a business representative in staff, you have a staff of business reps, and you have a staff of customer reps, that do completely different functions and they are completely different in size and scope in their ` `  UNIDENTIFIED MALE SPEAKER: There is a piece of a complete allocator. The question is, if you have more business ` `  (Laughter.) ` `  UNIDENTIFIED MALE SPEAKER: if you have more business customers, will you hire more business reps? If you have fewer business customers, will you hire fewer? If the answer is yes, then those are part of the marginal costs of those separate services. ` `  MR. FARRELL: Okay. Greg had a question. ` `  Mr. Rosston: I'm actually trying to see if maybe we could try and form some sort of consensus to educate us here a little bit on something that I have been hearing a lot of. If we start out with costs that are based on TS"%0*H&H&@@-" luric, I realize that's to be based on, and then there is some other ` `  (Laughter.) ` `  Mr. Rosston: Well, no, I'm going to go on. There are some other costs, magnitude between zero and a lot, that could be added to those and whether those are common embedded or USF funding or whatever, that somehow need to be recovered, in what I've heard today and in submissions and everything is, sort of, every which way that we should try and recover these costs. ` `  And what I was trying to see if people had some sort of whether these should be recovered as additions to the incremental costs from (inaudible) elements, whether they should be included in termination charges, whether they should be enduser charges? Are there some way that we should think in principal about which of these charges should be added to which sorts of prices in order to recover them? And how we should try and form sort of an agreement among the panel here, maybe, on the principal of how to do that? ` `  UNIDENTIFIED MALE SPEAKER: It exhibits the one no one thinks you will do and I think almost everybody says, raise the slick. ` `  MR. FARRELL: Yes, let's have a vote. How many people think that it would be a good idea for this"%0*H&H&@@-" Commission to raise its slick? ` `  (Laughter.) ` `  UNIDENTIFIED MALE SPEAKER: What do the nonslick people want to do? ` `  UNIDENTIFIED MALE SPEAKER: What is this slick, anyway? ` `  (Laughter.) ` `  MR. FARRELL: Local rates by another name? ` `  UNIDENTIFIED MALE SPEAKER: Oh. ` `  UNIDENTIFIED MALE SPEAKER: So they are all slicks? ` `  UNIDENTIFIED MALE SPEAKER: (inaudible) low cost thank you. ` `  MR. FARRELL: I want you to have an item on the bottom of every retail telecommunications service. A universal service fund charge, that the consumer ` `  UNIDENTIFIED MALE SPEAKER: You could call it the JERRY HAUSMAN charge. ` `  (Laughter.) ` `  MR. HAUSMAN: The JERRY HAUSMAN charge, okay. I would be glad, if the Commission would do this, I will be glad to my name could be taken in vein by the Consumer Federation of America for the rest of my days. It would be the best thing I could ever do for this country. ` `  (Laughter.)"%0*H&H&@@-"Ԍ` `  MR. FARRELL: I would note that it can only be on interstate services though. ` `  MR. HAUSMAN: In fact, I've done a calculation. On interstate services, so far as I can see, to I think this would be in everybody's favor the consumer's favor, the IXC's favor and the LEX favor. If we wanted to reduce access fees, which I know Bobby is dying to talk about, incremental costs, according to my calculations, we need at $2.50 increase, of which all except $.83 would be an inflation increase from 1984. ` `  So, you know, if my calculations are nearly correct, we are talking about, about a $2.50 increase, all of which, except $.83 is inflation. And, you know, it's too bad when we passed Slick that we didn't have a real adjustment to it like Social Security, and everything. But it would not I don't think it's impossible for this Commission to do. It's been talked about, but ` `  UNIDENTIFIED MALE SPEAKER: I actually have a much better idea. ` `  MR. HAUSMAN: we haven't done it. ` `  UNIDENTIFIED MALE SPEAKER: If you define the affordable rate of universal service as $40.00 a month, then the telephone companies will have the option of raising their local rates to that level if they so chose. And then the onus is on them. But otherwise, you wont' have any"%0*H&H&@@-" universal service fund to fund because most local lines don't cost $40.00 a month even under the present system. ` `  UNIDENTIFIED MALE SPEAKER: Well, that went over like a lead balloon. ` `  AUDIENCE MEMBER: In fact, that is precisely what I want to (inaudible). I feel some econometric estimate. You are basically taking total cost and (inaudible) it on output, come out with some estimates of local access. And, generally, they come about $300.00 to $400.00 per year, on average. ` `  And if you actually do some kind of assume the marginal cost pricing is done on these services and these are aggregate level. I mean, we are not talking about flying detail. But, I mean, we will get some base idea on what's going on. ` `  I found that 97 to 99 percent cost recovery result under marginal cost pricing. So, do you have any comments on that, or you know? ` `  UNIDENTIFIED MALE SPEAKER: Well, I think that's a common finding that we've seen elsewhere when one compares econometric incremental costs, particularly for local loops, with engineering models. And my explanation of it almost always was that, the engineers never catch overhead costs. By which I mean, lawyers ` `  (Laughter.)"%0*H&H&@@-"Ԍ` `  UNIDENTIFIED MALE SPEAKER: vary with the number of loops. And the econometric methods do catch that. And just so I can catch so your numbers, they were between $200.00 and $300.00 per year, per loop? ` `  AUDIENCE MEMBER: My estimate was $300.00 to $400.00. ` `  UNIDENTIFIED MALE SPEAKER: Per year. So that's in months is ` `  AUDIENCE MEMBER: About $3,200.00 ` `  UNIDENTIFIED MALE SPEAKER: Right, considerably higher then current average local rates. ` `  UNIDENTIFIED MALE SPEAKER: But those estimates are based on an econometric analysis of regulated firms. And they have all of Bobby's five sources of inefficiencies in there, right? ` `  UNIDENTIFIED MALE SPEAKER: Thank you, Bobby. ` `  AUDIENCE MEMBER: I agree that's a good point. You know, because the data is not available for efficient firms. ` `  UNIDENTIFIED MALE SPEAKER: Right. ` `  (Laughter.) ` `  AUDIENCE MEMBER: That's the only thing they can do. ` `  UNIDENTIFIED MALE SPEAKER: But they are available to engineers who know it perfectly, don't worry. We'll get"%0*H&H&@@-" it just right. ` `  (Laughter.) ` `  AUDIENCE MEMBER: Well, for example, if in the data the firms were overinvesting for well, not overinvesting, but investing for futuristic services. Fattening up loops, then that would be part of what your study catches on the margin, is that right? ` `  UNIDENTIFIED MALE SPEAKER: Well, for fattening up loops, yes. For fattening up minutes, no. I mean, it's just measuring it at the margin, so it's those wasted costs that vary with the number of loops that you could object to, not the wasted fixed costs. ` `  UNIDENTIFIED MALE SPEAKER: Or correlated with the growth of the loop plan, yes. ` `  MR. FARRELL: Okay, well, we are a little late. But, better late then never. I would like to thank all of our distinguished panelists for kindly volunteering their time in coming here to help us out. ` `  (Applause.) ` `  UNIDENTIFIED MALE SPEAKER: John, what about (inaudible) ? ` `  (Laughter.) ` `  MR. FARRELL: The hell with them. ` `  (Whereupon, the open forum was adjourned.) //"%0*H&H&@@-"  ?<(!   X` X W>OHeritage Reporting Corporation 0(202) 6284888W REPORTER'S CERTIFICATE ă  ?<  ?X< FCC DOCKET NO. :N/A  ?< CASE TITLE :ECONOMICS OF INTERCONNECTION  ?x< HEARING DATE :Provided May 21, 1996  ?< LOCATION :   I hereby certify that the proceedings and evidence are contained fully and accurately on the tapes and notes reported by me at the hearing in the above case before the Federal Communications Commission. Date: __________ _____________________________ Official Reporter Heritage Reporting Corporation 1220 "L" Street, N.W. Washington, D.C. 20005 Live Tape  ?<< TRANSCRIBER'S CERTIFICATE ă  I hereby certify that the proceedings and evidence were fully and accurately transcribed from the tapes and notes provided by the above named reporter in the above case before the Federal Communications Commission. Date: _5/22/96__ ______________________________ Official Transcriber Heritage Reporting Corporation Christine Perkins  ?< <PROOFREADER'S CERTIFICATE ă  I hereby certify that the transcript of the proceedings and evidence in the above referenced case that was held before the Federal Communications Commission was proofread on the date specified below. Date: _5/22/96__ ______________________________ Official Proofreader Heritage Reporting Corporation Jim Maxfield