Set the Telecom Industry Free

Since the late 1970s, there has been a relentless movement to dismantle the regulatory apparatus that once controlled much of the U.S. economy. From airlines to telecommunications, industries that once had to answer to federal regulators have been increasingly exposed to the free market.

But if there's one lesson we've learned in the past 25 years, it's that partial deregulation can cause more problems than no deregulation at all. The savings and loan crisis of the 1980s, for example, was greatly exacerbated by the banks' freedom from regulation: Institutions competed with one another by offering higher and higher interest rates on deposits, yet were protected by federally mandated deposit insurance. More recently, freewheeling electricity traders such as Enron Corp. could profit by manipulating the rules in the regulated parts of the electricity market.

Right now, the telecom industry is at the same awkward halfway point. Business telecom services are basically deregulated, but under the Telecommunications Act of 1996, local residential service operates under complicated rules. In particular, the 1996 law forces local phone companies to lease their residential lines at discount rates to potential rivals such as AT&T and WorldCom Inc., with the goal of providing more local competition.

It's time to admit that the odd mixture of regulation and deregulation written into the 1996 act has not worked. The industry is in a shambles after one of the biggest financial bubbles in history burst. Local competition is barely visible, present mainly where state regulators have stepped in and forced the Baby Bells to lower dramatically the wholesale rates they charge rivals. Even that move has a big downside: The requirement to offer their competitors lines at superlow rates clearly reduces any incentive for local carriers to upgrade their equipment, since their rivals would reap the benefits without footing any of the bills. It's an economic truism that markets with regulated low prices have low levels of investment.

That's why Federal Communications Commission Chairman Michael K. Powell's move toward more deregulation is a good idea. Powell appears ready to offer a proposal to phase out those big discounts to alternative providers over the next two years and to require competitors to invest in their own switches. In the short run, that might mean that rates for consumers won't fall as fast as they might have. But over the next few years, it could lead to higher levels of investment and more capacity available to households, especially if the capital markets open up. Moreover, unlike 1996, now there are important alternatives to land-line phones. In many parts of the country, cellular phones, with low-priced long-distance service, can potentially provide a substitute, especially as coverage improves. And cable providers are signing up more and more telecom customers.

Further deregulation isn't going to solve all of telecom's problems, just as it didn't lead the airline industry to economic nirvana. But it's a good deal better than the alternative.

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