What's Yours is Mine: Open Access and the Rise of Infrastructure Socialism - Softcover

Theirer, Adam; Crews Jr., Clyde Wayne

Softcover

ISBN 10: 1930865422 ISBN 13: 9781930865426

Publisher: Cato Institute, 2003

Synopsis

This book explores how regimes that respect property rights including the right to exclude rivals better serve consumers and innovation.

About this title

About the Author

Adam Thierer is the director of telecommunications studies at the Cato Institute.

Excerpt. © Reprinted by permission. All rights reserved.

WHAT'S YOURS IS MINE

Open Access and the Rise of Infrastructure SocialismBy ADAM THIERER CLYDE WAYNE CREWS JR.

CATO INSTITUTE

Copyright © 2003 Cato Institute
All right reserved.
ISBN: 978-1-930865-42-6

Contents

Introduction.........................................................................................................1Part I: Open Access: Theory and Reality1. The Case against Forced Access....................................................................................92. Debunking "Natural Monopoly" and "Essential Facility" Rationales for Forced-Access Regulation.....................233. Why Network Proliferation Spells the End of the Essential Facilities Doctrine.....................................37Part II: Case Studies: How Forced Access Harms Specific Industries4. Case Study 1: Open Access to the Electricity Grid.................................................................475. Case Study 2: Open Access to Local Telephone Networks.............................................................556. Case Study 3: Open Access to Broadband Services...................................................................657. Case Study 4: Must-Carry Mandates on Cable and Satellite Networks.................................................918. Case Study 5: Open Access to Software.............................................................................99Part III: Conclusion9. What Really Protects Consumers and Network Reliability-Markets or Mandates?.......................................105Notes................................................................................................................109Index................................................................................................................125

Chapter One

The Case against Forced Access

Despite its advocacy by regulators, misguided consumer advocates, and opportunistic businesspeople, forced-access regulation has many problems.

Problem 1: Forced Access Is a Taking of Private Property

Forced-access regulation is essentially at war with private property rights. In one sense, forced-access regulation is really nothing more than a variant of socialism since it demands that private companies surrender control of their systems or technologies to a governmental vision of efficient and proper distribution of resources.

Forced-access crusades are always undertaken in the name of advancing consumer choice, competition, and "openness." But even if forced access helped advance these ends, the ends do not justify the means. Free market competition means that private property owners-even owners of network properties-are at liberty to use their property as they see fit, and citizens are free to shop around for better arrangements when they feel they are not getting the best deal possible. The alternative is that of government bureaucrats demanding that control over private property be surrendered. Commenting on open-access conditions imposed on the AOL Time Warner merger, American Enterprise Institute scholar James K. Glassman noted that regulators "have served notice to high-tech firms that if they make big investments in new products like cable modems and instant messaging services, their property rights to those innovations may be stripped from them at will for political reasons."

Moreover, because forced-access regulation forces private property owners to surrender the ownership or control of their property to regulators, there remains a legitimate question of whether it represents an unconstitutional taking under the Fifth Amendment to the Constitution. Some scholars, such as J. Gregory Sidak of the American Enterprise Institute and Daniel F. Spulber of the Northwestern University Graduate School of Management, argue that this is the case even for industries that were formerly treated as regulated monopolies, such as electricity and local telecommunications. They argue that these entities deserve compensation for the past investments or "stranded costs" they have incurred in the past.

The facilities of the regulated network industries did not fall like manna from heaven, but rather were established by incumbent utilities through the expenditures of their investors. Utilities made past expenditures to perform obligations to serve in expectation of the reasonable opportunity to recover the costs of investment plus a competitive rate of return. Investors must be compensated for those past costs; it follows a fortiori that investors must be offered additional compensation if existing responsibilities are perpetuated or new burdens imposed.

Stranded cost recovery remains a controversial proposition given that these entities enjoyed geographic service monopolies and guaranteed rates of return. But while these sectors do not necessarily deserve any special consideration or compensation for the investments they made decades ago, what should not be the least bit controversial is the proposition that these entities deserve to be compensated for future takings of their property in a deregulated marketplace in which they have lost their monopolistic service territories and guaranteed rates of return.

Consequently, if forced-access mandates are being applied to such network industries in an attempt to transition them into a more competitive marketplace, they will need to be compensated for the costs they and their investors are now incurring as they deploy new systems and technologies. Regulators cannot continue to confiscate network assets without just compensation merely because certain portions of those networks may have been deployed years ago. Of course, as discussed below, the better solution is to end all exclusive service territories and regulatory advantages for these entities and comprehensively deregulate these markets immediately to avoid such takings controversies in the future. If forced-access mandates are not applied, of course, there would be no takings concern to begin with.

It has also been alleged that a regulatory taking might occur when "must-carry" rules are imposed on cable and satellite companies. Such regulations require those companies to carry the signals of broadcast television stations without compensation. Must-carry mandates were imposed on the cable industry through the Cable Television Consumer Protection and Competition Act of 1992 and on the satellite industry through the Satellite Home Viewer Improvement Act of 1999. The rules compel firms to carry broadcast television signals on their networks without receiving compensation for doing so.

"Must-carry rules constitute a taking of property," argues Harvard Law School constitutional scholar Laurence H. Tribe. "Must-carry rules do not simply regulate the manner in which cable operators use their systems. Rather, they effectively condemn a portion of cable operators' property and turn it over to third parties who are entitled to exclusive use of the channels in question on a continuing basis. This system is effectively the exercise of eminent domain power over a portion of the cable system." Roger Pilon, vice president of legal affairs at the Cato Institute, has noted that, "Under must carry ... we have in essence a publicly sanctioned private condemnation, with local broadcasters 'taking' the channels that belong to cable operators. And as is the case with so many modern regulatory takings, the cable operators are made to serve the public-and made to serve their broadcast competitors, in particular-while bearing the whole cost themselves."

The courts have on occasion supported the notion that mandatory access to network properties can constitute a taking. In the 1994 case of Bell Atlantic Corp. v. FCC, the D.C. Circuit court struck down the FCC's physical collocation rules, which gave competitors access to the central offices owned by local telephone companies. The court found the FCC collocation rules to be a violation of the Fifth Amendment since a "permanent physical occupation authorized by government is a taking without regard to the public interest that it may serve." Likewise, in the 1982 case Loretto v. Teleprompter Manhattan CATV Corp., the Supreme Court dealt with state regulations requiring building owners to grant access to cable firms for purposes of wiring and attachments. The Court held that even a "minor but permanent physical occupation of an owner's property authorized by government constitutes a taking of property for which just compensation is due." So certainly a strong claim can be made by property owners that mandatory network access imposes costs and burdens on them that must be taken into account by policymakers. At a minimum, just compensation is due for such takings, but the better policy would be for policymakers to reject confiscatory infrastructure-sharing mandates altogether since they are at odds not merely with private property rights but even with the stated aim of open-access supporters-that of better service to consumers.

Problem 2: Forced Access Hinders Innovation and Network Integrity

Forced-access regulation rejects the long-standing and time-tested proprietary model of business ownership and management. Companies create goods, services, technologies, and networks in the hope of maximizing shareholder wealth. Often, if companies hope to generate profits on those investments, they must tightly control access to their product to ensure they can recoup their initial investment. "In an efficient economic system, risk and reward go together," notes David Kopel of the Heartland Institute. "Whoever takes the risk of failure should reap the reward of success. If a company must bear all the risks, but must share much of the rewards with its competitors, the company will stop taking risks." And Daniel F. Spulber and Christopher S. Yoo, associate professor of law at Vanderbilt University Law School, argue that "regulation that compels access to networks at regulated prices that fall below market rates in effect requires network owners to subsidize competitors."

For example, automakers would not produce new lines of cars if they were forced to share the vehicle design plans, or specific component innovations, with their competitors. Forced-access regulation, however, presumes that new products, systems, or technologies will be produced by companies regardless of the regulatory environment or legal incentives in place. But firms will not develop and deploy expensive new goods and services if the regulatory regime requires that they share the fruits of their investment and innovation. This is especially true for network industries where elaborate and expensive systems of wires, switching services, support systems, and other technologies must already be in place before one can hope to attract customers and generate a return on investment. A prerequisite that network providers share these facilities can, therefore, chill overall investment incentives. As AT&T chairman and CEO Michael Armstrong put it in 1998, "No company will invest billions of dollars to become a facilities-based broadband service provider if competitors who have not invested a penny of capital nor taken an ounce of risk can come along and get a free ride on the investments and risks of others."

The impact of access regulation on infrastructure integrity must also be considered. At a time when many express concern over network security and critical infrastructure protection, this concern is particularly pertinent. One of the core fundamentals of security is redundancy. For example, in contrast to the dedicated-line telephone system, the Internet was designed to withstand physical damage by routing traffic (via packet-switching) around any disruption. John C. Wohlstetter of the Discovery Institute has pointed out that the telecommunications vulnerabilities exposed on September 11 could be attributable to "current telecommunications regulatory policies that prefer shared local exchange facilities to separate ones, thus discouraging multiple local facilities."

Problem 3: Forced Access Discourages Entrepreneurial Competition from Rivals

Not only does forced-access regulation discourage investment and innovation by the incumbent network owner, but it also destroys the incentive for rivals to invest in new facilities of their own. In other words, contrived competition via forced access destroys actual competition.

The competition of which forced-access supporters speak is a fiction based on the sharing of existing facilities. Sharing is not competing. When regulators allow one set of companies to engage in regulatory arbitrage by picking and choosing the networks or network components to which they seek access, "it cannot but have a fatally discouraging effect on their own imitative and innovative efforts," says noted regulatory economist Alfred E. Kahn, former head of the now defunct U.S. Civil Aeronautics Board and author of The Economics of Regulation and Letting Go: Deregulating the Process of Deregulation. Kahn, discussing telecommunications regulation, continues: "When every applicant can be a free rider, at such minimum prices, who is going to build the vehicle? The [Federal Communications] Commission appears completely to have ignored the discouraging effect of their rules on facilities-based competition."

What is true for telecommunications regulation would be equally true in any other industry where interconnection, unbundling, and infrastructure sharing rules are applied haphazardly. Imagine this hypothetical scenario: Lawmakers encourage a large number of firms to enter the market for cola beverages by mandating that Coke and Pepsi share their soda formulas and manufacturing facilities with rival firms at a regulated wholesale rate. New firms are given the right to purchase soda for 17 to 25 percent less than what it actually costs Coke and Pepsi to produce each can or bottle. Having received the products from Coke and Pepsi at such a steeply discounted rate, these new "rivals" then turn around and sell the beverages under their own brand name for a profit.

As a result, several dozen new "competitors" enter a market in which there are currently only two primary providers. Wouldn't this represent a "pro-competitive" result? No, it would not, because it would not promote genuine competitive rivalry to Coke and Pepsi but would instead encourage a handful of opportunists to make money off an existing product without offering the public anything legitimately innovative or unique. Even worse, it might discourage Coke and Pepsi from creating new products, since they would likely fear additional government mandates forcing them to share their innovations with other companies. Finally, while the overall number of firms in the market would increase temporarily, the charade would end once investors realized there was no legitimate business model behind this parasitic regulatory scheme. Even with the generous assistance of bureaucrats, such a regulatory house of cards is bound to collapse if the firms benefiting from it are doing little or nothing to deploy innovative services of their own.

But that scenario illustrates what has happened in the American telecom marketplace in the wake of the implementation of the Telecommunications Act of 1996. Firms are engaging in a blatant form of regulatory arbitrage by reselling access to existing lines to which the government gave them access at generously discounted wholesale rates, which are significantly lower than the likely cost of providing those expensive networks. Under the Telecom Act, such infrastructure socialism was to be limited to the old voice-based copper lines that the Bells already had in the ground for many years while they were still protected monopolies. But the open-ended language and ill-defined terminology of the Telecom Act encouraged creative and quite expansive interpretations of "access" from the start. This led to proposals to apply forced-access mandates elsewhere, such as cable broadband markets, AOL's instant messaging service, and even wireless networks.

Policymakers would be wise to heed the words of Supreme Court Justice Stephen Breyer, who, in the 1999 case of AT&T Corporation et al. v. Iowa Utilities Board, warned of the hazards of carrying forced access to extremes: "A totally unbundled world-a world in which competitors share every part of an incumbent's existing system, including, say, billing, advertising, sales staff, and work force (and in which regulators set all unbundling charges)-is a world in which competitors would have little, if anything, to compete about."

Problem 4: Forced-Access Proponents Often Assume Technological Stasis and Unchanging Marketplace Conditions

The zero-sum mentality that motivates proponents of open access often assumes that once a network has been built and used by a large enough group of consumers, it is the only facility the public can expect to provide service in the future. Somehow, when a company and its shareholders make the expensive investments necessary to provide an innovative new network service, it is a one-time event, never to be repeated. Many forced-access proponents are quick to label some industries "natural monopolies," or certain networks "essential facilities," and then demand companies surrender control over their property to policymakers who will ascertain what is in the public interest.

But is such technological pessimism truly warranted? History suggests the opposite is the case. Ours is an innovative culture and new technologies and industry sectors have developed in the past, and will be developed in the future, but only if creators (1) believe they can reap the fruits of their labor and (2) are not directly or indirectly prohibited by government from entering new markets or providing new services.

Still, skeptics will claim that the fixed costs associated with network development and deployment are substantial, so much so that it is foolish to assume rivals will rise up to offer truly competitive alternatives. The best we can hope for once a network has been built is for its owners to share those facilities with other rivals. Genuine facilities-based competition is assumed to be an impossibility given the prohibitively expensive upfront costs of offering service.

(Continues...)

Excerpted from WHAT'S YOURS IS MINEby ADAM THIERER CLYDE WAYNE CREWS JR. Copyright © 2003 by Cato Institute. Excerpted by permission.
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Edition details

• Publisher: Cato Institute
• Publication date: 2003
• Language: English
• ISBN 10: 1930865422
• ISBN 13: 9781930865426
• Binding: Paperback
• Number of pages: 100