The Board of Regents of the University of Wisconsin System

Is the Public Utility Concept Obsolete? Author(s): Edythe S. Miller Source: Land Economics, Vol. 71, No. 3, Social Control of Private Power: The Past and Future of Public Utility Regulation (Aug., 1995), pp. 273-285 Published by: University of Wisconsin Press Stable URL: http://www.jstor.org/stable/3146346 . Accessed: 08/06/2013 01:45
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Is the Public Utility Concept

Obsolete?

EdytheS. Miller
ABSTRACT.Publicutility is a uniquely regulation Americanstructural innovation,and has evoked ambivalence on the part of the public, and more theeconomics overtheyears. particularly profession, Almostfrom the timeof its inception, diverse voices have soundedits death knell. Whilemany of the earlycriticsof regulation, irrespective of philosophic that inherent structural conditions bent,recognized precludethe emergence of competition, contempobe eliminated and rarycriticsurge that regulation or a competitive surroreplacedwith competition gate. Thepaper examinesthe opposingviewpoints andcurrent within proposals for "regulatory reform" the contextof contemporary structural conditions.

(JELL9)

I. INTRODUCTION It often is noted that economicsis highly Of the manymetaphorschermetaphorical. ished there maybe none more powerfuland enduringthan that of "the invisible hand." Attachment to this ideal, however, should not be permitted to obscure market realities. Under certainconditionsmarketforces are inadequateto protectagainstabuse;that is, structuralpatterns deprivethe "invisible hand" of its ability to ensure optimal outcomes. The public utility concept and administrative organizationoriginatedprimarilyin the United States to providethe social control necessary to prevent abuse of private market power by firms providingessential services. Recognition of this potential for abuse today seems blunted. Indeed, adherence to the metaphorof the invisiblehand may be strongerat present than at any time duringthe last sixtyyears. The economics profession consistently has manifested an ideological bias toward free markets. In the past, however, some diversity of thought was tolerated. Many economistsquestionedunconditionaladherence to noninterventionist positions,including members of the institutionalistschool who playedcentralroles in the development of a theory of public interest regulation

(Trebing 1994, 200-10). The discipline today, in contrast,exacts ideologicalconformacademicliteratureis ity. The contemporary almost single-mindedin its endorsementof laissez-faire. The message of the academicians is echoed in virtuallyeverypublicpolicyforum -judicial, congressional, even regulatory. Deregulation and decentralization are equated with competition, irrespective of market conditions. For example, the 1982 resolution of the antitrust suit against AT&T, divestingthe local operatingcompanies, was widely heralded as "pro-competitive" because it was deintegratingin effect. Recent energy legislation is hailed because it is deregulatory and thereforeperceivedas competitive.The price cap decisions of the Federal Communications Commission (FCC) and many state commissions are viewed as advancing competition because they eliminate or erode traditionalrate-ofreturn (ROR) regulation and provide for price "flexibility." A recent California "wheeling"decision increasingdirect access in electricitymarketsis proclaimed"a crucial step . . . to wider deregulationof the industry"and therefore to the achievement of "directcompetition" (Pasztorand Kansas 1994, A13). In each of these cases the of the changedstatus is extolledirrespective relative marketstrengthof affected parties. Yet marketflaws remain;they have not, as if by some stroke of these magical pens, been dissipated. The publicutilityconceptis not obsolete. It is not obsolete because, despite the prevailing ideology, not all markets are effec-

The authoris unaffiliated. Her most recent affiliation was with the ColoradoPublic Utilities Commission, where she served as commissionerand chairwoman.She is a past presidentof the Associationfor EvolutionaryEconomics,and was a recipient of the DistinguishedMember Award of the Transportation and PublicUtilities Groupof the AmericanEconomic Association.
Land Economics * August 1995 * 71 (3): 273-85

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tively or contestably competitive. Specific structural conditions preclude the emergence of competition,make an emptythreat of potentialcompetition,and thwartthe operation of automatic market mechanisms. Marketbarrierspreventthe entrythat gives meaningto the premiseof competition.Despite the continued viability of the public utility concept, however,its applicationcurrentlyis at risk. II. BARRIERSTO ENTRYIN PUBLICUTILITYMARKETS Among the barriersthat impede the development of competition in public utility markets are the following: The industries are characterized by high thresholdlevels of investment,mandatedat a minimumby the necessityto connect and/or interconnectall customers.They thus also will have as distinguishing features the existence of substantial sunk costs and a high fixed to variable cost ratio.The assets of publicutilities, moreover, typically are substantiallynonfungible. Incumbentprovidershave control over essential bottleneck facilities, and uniquelyare grantedthe power of eminent domain. Public utilities typicallyserve a number of distinct markets,with differing demand elasticities.Thus, for some part of the commodity or service in question, demandwill be highly price inelastic;that is, there will exist a high element of necessityin demand. In addition,the requirementthat networks be constructed in advance of demand almost ensures the existence of economies of scale, when demandis properlyforecasted. Public utilities also are distinguishedby the substantial utilization of joint assets. The use of joint assets for the production of multipleservicesensures and distribution that joint costs comprise a significantproportion of total costs, and is a source of significanteconomies of scope. That is, investmentin joint assets permitsthe developof multipleservicesat ment and distribution lower cost than if each service were required to expend its stand-alone cost to construct for itself a self-containedmeans of operation. Moreover,the fact that net-

works essentially entail a large number of segmentscontributesto networkeconomies of flow; the larger the numberof segments included as part of a network,the greater the flow of traffic to all segments (Selwyn 1994, 22-24). Additionalimpedimentsto the establishment of competition in the current industrial environmentinclude the presence of significantexcess capacity,a common characteristic of public utilities if only because facilities typically are constructed in advance of demand.However,excess capacity in these industriesmay be more of a factor currentlythan in the past. For example,in telecommunicationsstructural change has resulted in the installation of redundant carnetworksby the variousfacilities-based riers.In the electric industry, a majorthrust of the Energy Policy Act of 1992 is the creation of multiple sources of supply and the opening of the transmission networkto the varioussupplysources. Public utility industries also are distinguished by essential interdependencies,into coordinateacross cludingthe requirement markets.As with other impedimentsto entry, the need for coordinationin these markets is not a new phenomenon;it has existed historically. Conspicuous examples include interconnectionin telecommunications, interlining in transportation, and Howpowerpoolingin the electric industry. also appear ever, coordination requirements to have increased in the current environin the ment. For example,the authorization Energy Policy Act for the Federal Energy RegulatoryCommission(FERC) to require mandatorywheeling is all but certain to increasethe need for coordinationas transmission increases. Public utility industries also historically have been characterized by the presence of The individualsdiexternalities. significant rectly involveddo not bear all the costs or realize all the benefits of transactions.Under such circumstances, strictlyprivatemarket considerationswill not bring about optimal results. Often recognized examples the benefit include:in telecommunications, of the service to all consumersis enhanced of the network;in by the interconnectivity

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electricity, the service is degraded by the simultaneousproduction of pollution as a by-productof the primarycommodity.An additional factor inhibiting the establishment of competition in public utility markets is customer inertia and loyalty to incumbent providersand establishedbrands. Conditionssuch as these, in varyingcombinations, generate or constitute significant barriers. It is important to recognize that these are structural, rather than merely legally imposed,barriersto entry and exit. It is demonstrablyevident that public utility networkstypicallyexhibit such characteristics.It is irrefutablethat public utilities require high minimumthresholdlevels of investmentbecause of the need to interconnect consumersand the common practice of constructingin advance of demand. Public utilities also are distinguishedby a substantialrelianceupon joint and common assets that yield important economies of joint service and product development. These structuralconditions also, however, give these entities significantstrategic maneuverability that permits market dominance. For example, the fact that consumption in public utility markets is highly concentrated gives firms the ability to segment markets and differentially price, favoring consumerswith higher price elasticities of demand over relatively demand-inelastic consumers.Moreover,suppliervulnerability to the exerciseof monopsonypower(including the threat of bypass) enables high-use customersto extractprice reductionsand to achieve network improvementsthat advantage these influentialgroups. Indeed, monopsonypower appearsto be a drivingforce behind many developments in publicutilitymarketstoday.For example, in gas markets,it appearsto be the motive force behind current steps to "unbundle" transportand marketingfunctionsand thus enhance the ability of industrialcustomers to secure low-costsourcesof supply.In electric markets,it seems to be a drivingforce behind steps to substituteprice negotiation for price regulation,thus effectivelyachieving a system of selective discounting,and behind decisions to permit high-use con-

sumersto pick and choose amongstsources of supply. This, in itself, gives to favored classes of consumersthe abilityto abandon -or to threaten to abandon-the system, and to leave fixedand sunk systemcosts the of low-volume who consumers, responsibility do not have this option. In telecommunications markets,monopfactorbehind sony powerappearsa primary modernization many programs. Moreover, low-usagecustomersmaybe allocateda disproportionatelyhigh share of the costs of network development.This occurs because irrespective of technical specificationsfor deliveryof particularservices, these assets nevertheless are jointly used to distribute the variousservices. The stage thus is set for the implementation of practices of market segmentation, and price discrimination cross-subsidization, that are self-sustainingand ensure market dominance and high profits. It should be noted that the existence of incentives such as these and the potentialfor their abuse in public utility marketsconsistentlyhas been recognizedin the institutionalpublic utility literature. The existence of economies of scale implies that it is necessary for companies to achieve a high minimum efficient market share (MEMS) to reach the minimumefficient scale (MES)of operation.If the MEMS is more than 50 percentof the market,only one firmwill have the abilityto survive.If it is more than one-third,the marketwill not supportmore than two firms.This requirement gives to incumbentprovidersan important-what, in fact, may be an insurmountable-advantage over challengers. Recent research indicates that many telecommunicationsmarkets presently are characterizedby high MEMS (e.g., Selwyn and Hatfield 1994).If competitionis to survive, however,the MEMSmust be low. Under conditionsinvolving a high MEMS,markets will, at best, be oligopolistic. It is important to emphasizethe essential interrelationship and interdependence of these characteristics. It is evident that the existence of structural impediments prevents the developmentof competitioneven in the absence of legal barriers.Structural

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imperfections make possible specific patterns of behavior that, in turn, exacerbate structuralflaws and conditions of market concentration.The patterns of dominance that emerge constitute the interplayof the combinedand interactiveeffects of interrelated and interdependentstrands of structure, behavior,and performance. The issue of the continuedviabilityof the public utility concept will be explored furin referenceto telecommunither primarily which cations, providesvivid illustrationof of these conditions. many

prises. In a related action, the Cable Act of 1984prohibitedthe offeringof video service by telephone companiesthroughtelephone lines in their service areas. In short order, many of these restrictions were relaxed. Limitationsplaced upon investmentsin unrelated endeavors and prohibitionsin regard to information services were eliminated. The restrictionsincorporatedin the Cable Act also were substantially eased. Implicitin what was included and, more specifically,in what was omitted from the category of LOB restrictions,was that the RHCs were now permittedto offer through subsidiariesrelated and unrelated services III. THE CURRENT that previouslythey had been required to TELECOMMUNICATIONS offer only as part of their regulatedoperaENVIRONMENT tions, or had not been permittedto offer at The contemporary telecommunications all. It also is important to note that the subsidiariesformed to offer such services era may be viewedas havingbegunwith the generally were organized as unregulated reorganizationof the industryset forth in the 1982ConsentDecree and relatedorders subsidiariesof the parent holdingcompany, rather than of the local exchangecompany that concluded the U.S. Department of Justice antitrust suit against AT&T. It (LEC). Initial diversification activities of the is useful to delineate three trends-what may indeed be definingtrends-of the cur- RHCs includedactivitiesthat had been the era: diversification, province of the regulatedLECs; for examrent telecommunications of the profitable modernization,and consolidationand con- ple, ownership yellowpages and cellular operations were transferred centration. from operatingcompaniesto parentholding Diversification companies.Domestically,the RHCs moved aggressivelyinto a wide assortmentof unTo begin with, the 1982 Consent decree regulatedactivities,rangingfrom real estate freed AT&T from a prior agreement that to computerservicesto cable TV. They also had limited its activities to regulatedcom- moved forcefullyinto foreign markets,indimunications. Among the more important viduallyand jointly acquiringand installing additionalprovisionsof the settlement was cellularandcablenetworks, large purchasing the divestitureby AT&T of its 22 operating equity blocks in public telephone companies, and engagingin myriadenterprisesin companies.It is importantto note that the as indenot to be divested were geographic areas that spanned the globe. companies AT&T also moved assertively,diversifying as of seven but entities, parts pendent into both domestic and foreign markets. regional holding companies (RHCs). In That the process has not been solely a onean attempt to prevent the abuse of the monopoly bottleneck power acquiredfrom way internationalflow is demonstratedby AT&T, the RHCswere subjectedto certain British Telecom'spurchaseof a 20 percent line-of-business (LOB) restraints. Specifi- share of MCI. The magnitudeand costs of these activically, the RHCs were prohibitedfrom proties raise a host of concerns about their in the distance service, engaging vidinglong in regardto manufacture of equipment,or in the gener- consequences,most particularly ation or transmissionof information ser- the future of basic telephone service. The era ushered in an unprecevices. In addition, limitationswere placed post-divestiture upon RHC investmentin unrelated enter- dented mixed mode of monopolistic-com-

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petitive, regulated-unregulatedenterprise coexisting under one roof. The RHC subsidiariesformed after divestitureto provide nonutilityservice initiallywere requiredto be organized as operations that were fully separatedfrom the LECs. While the ability of the initial separation requirements to protect against cross-subsidizationis not undisputed,at the least the separationrecognized this as a possibilityand attempted to prevent indemnification of the risky nonutilityoperationsof the RHCs by basic telephone service. The separation requirements for the monopolyand competitiveactivitiesof these companies subsequentlywere relaxed. Significant questions of risk and burden shifting, present even when separation is required, are magnified with the easing of requirements. Deepening these concerns, recent research reveals that a preponderance of the capitalization of RHC nonutility ventures derive from Bell LEC operations, which account for by far the majorpart of the assets, revenues, and earnings of the RHCs. The researchfinds a generalpattern of diversionof funds away from the regulated to the nonregulatedactivities of the RHCs and, moreover, that most of the nonutility operations of the RHCs are either showing a loss, or generating very small returns. Indeed, it is found that in almost every instance these unrelated activities are substantially underperforming RHC utility operations (Selwyn and Montgomery1993, 2). These findingsraise significantquestions of cross-subsidization and of cost and risk shifting as between regulated basic exchange and unregulatedservices.For example, there is little question that the more speculative undertakings of the holding companieswill increase the credit risk, and therefore the capital costs, of the parent company.The capital costs of the regulated entity accordinglywill be increased above the levels, and those of the unregulated entitydecreasedbelow the levels, that would have prevailedif the borrowingactivitiesof the unregulatedentity had not taken place, or if the total cost of these endeavors had been assignedto the speculativeenterprise.

It should be noted that such misgivings are not of recent origin, and do not apply era. Concerns uniquely to a contemporary aboutpreciselythis type of riskshiftinghave been expressedthroughthe yearsby institutional public utility economists (e.g., Bonbright and Means [1932]1969, 198). Diversificationcarries the potential for additionaltypes of risk and burdenshifting. The potential for diversionof capital,management, and labor from the monopoly to the competitiveside of the business exists. To prevent cross-subsidization it is necesto avoid of sary sharing personnel. Even more difficult to avoid is the transfer of attention and enthusiasm from workaday utility activitiesto the more glamorousand more sophisticatedactivities technologically of the nontraditional endeavors. Telephone industryinvestmentin nontraditional activities has been substantial.At the same time, RHCs are dramatically cutlocal costs. As of the ting exchange part and its vehicle, cost-cutting, perhaps major industry-widelabor force reductions have taken place (e.g., Keller 1992,Al; 1994,A3; Cauley 1993, B6; 1994c, A3). To use the inelegant jargon of the day, widespread and "rightsizing" "downsizing" (layoffs),accompanied by "outsourcing"(contracting out) is occurring. The eliminationof unnecessary jobs is an if overenHowever, unexceptionable policy. thusiastic work force paring results in an inabilityto performnecessarytasks, the result is the degradation of service;a decrease in efficiencyin real, if not m6netary,terms.1 Moreover, if this occurs, cost burdens are not eliminated,but simplyshifted. The burden is shifted, first of all, to the monopoly subscribers whose servicequalitysuffers,and

Somequalityof serviceproblems currently maybe of servicedegradaemerging.For example,complaints tion in US West territory, including reportsof substantial increasesin "held orders"(telephone installation delays)and of substantialrepairdelays,have been so numerousand insistentthat the ColoradoPublicUtilities Commission has institutedan investigation (Zeiger 1994, 2C). It is difficult to determine if this is an isolated and localized matter, or a more widespread phenomenon.

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it is not entirely clear that it is not also serviceablefor the distributionof new, advanced services;that is, that construction of a broadband, fiber network is necesoptical Modernization sary. Advances in compressiontechnology have increased the capacity(and therefore Recent advances in communications the functionalityfor these purposes)of the technology have both transformed tradi- existing copper plant. For example, asymtional service and enlarged its menu of ofmetricdigitalsubscriber loop technologydeResearch ferings.The use of digital and optical fiber veloped by Bell Communications technologies increase capacity, clarity, and Corporation permits the transmission of video over copperwire, with sufficientspare speed of communication, and hold the of a near of an future promise provision capacity to carry voice communications arrayof interactiveand multimedia(simul- (Carnevale1993,Al). taneousdistribution of voice, data,andvideo Further, an integrated services digital over the same transmissionpathway) ser- network(ISDN) permitsthe transmission of vices. It is indisputablethat these develop- voice, data, and video over the existingcopments have the potential to enhance the per network. Required supporting investThis should not ment requirementsare on a much smaller qualityof life substantially. be allowed to obscure the fact that there scale than those for broadbandand, morealso exist some potential abuses. Not least over, muchof the necessaryupgradealready of these is a strategicresponse made possi- has occurred.The telephone industryin recent years has been upgrading ble by modernization. plant to digital switching, transmission,and signalling. There is wide support within the teleIn the last five years, AT&T has invested phone industryfor the developmentof an almost $20 billion in digital switches, fiber It broadband fiber network. optic integrated is acknowledgedthat the capital require- optic lines, and high-capacitytransmission ments of such a network are substantial. equipment (Keller 1993, Al). The RHCs, Abandonment of the traditional copper since about the mid-1980s, have invested more than $100 billion in networkdigitalizaplant is required.Informedestimatesof the nationwide cost of constructionrange up- tion. They have not, however, widely dewardfrom $250 billion to $1 trillion. ployed or offered ISDN; where offered, it seems targeted to a small number of busiSupportersof such a system posit it as ness customers,at high rates (Selwyn 1992, the bptimal technology of the future, a means to secure dazzling new capabilities 3-7). An upgradedplant used for the provision such as tele-medicine, tele-learning, teleas joint banking, tele-shopping, video-on-demand, of multipleservicesis characterized home investment,whateverthe technical requireandso forth,that promiseto transform life, and improveefficiencyand productivity ments for specific services. The nature of the cost allocation process permits a large at the workplace.It also is assertedthat the economic efficiency thus achieved will enhance the abilityof this nation to compete in the "new global economy."Lurkingbe2 The willingnessof the RHCs to sell their rural hind the technological wonders, however, in the interest of cost control providesa operations are a number of controversialmatters, inadditional exampleof cost shifting.The sale of possible whether particular rural exchanges may be a harbingerof an overall cluding questions about technologies are required for specific ser- decline in qualityof servicefor nonurbansegmentsof means of funding,and the population.It also may be viewed as a possible vices, the appropriate concomitantor precursorof an erosion in a prior of suitableproviders. the identification national adherenceto principlesof universalservice. For example,it is clear that the existing Under such circumstances the cost burden that has and been shiftedis no less real becauseit is qualitative copper plant remains satisfactoryfor the of traditionalservices.However, thereforeimmeasurable. distribution

then to workers,both those who have lost and those who remainand now employment, are requiredto do much with little.2

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proportionof joint costs to be allocated to local exchange.Thus, modernizationstands to a large to be monopolyratepayer-funded extent. Moreover,in the years since divestiture telephone companieshave sought substantial increases in rates and speed of recovery of depreciation, on grounds of technologicalobsolescence, despite the fact that the plant retains its serviceabilityfor close to 90 manypurposes.Since divestiture, percent of gross new rate base plant additions has been funded by depreciation charges recovered from monopoly ratepayers (Selwyn and Hatfield 1994, 225-27). In addition, in the current environmentthere is no assurancethat a new service will not be moved to an unregulatedcategory if it becomes profitable,ensuringthat monopoly ratepayerswill be unable to capture future benefits. The telecommunications industryhas little to lose and much to gain by modernization. Not only will the replacementtechnology be substantiallyfunded by monopoly ratepayersbut the sophisticatednew tech(Miller nology also is essentiallycentralizing 1993, 35). The significant capital requirements, assured excess capacity, high fixed and sunk costs, will constitute substantial barriersto entry for potential rivals.
and Concentration Consolidation

Telecommunications divestitureoccurred in the name-perhaps even the spirit-of decentralization.It did not take long for patterns of recentralizationto be established. First of all, the divestment of the operating companies in seven RHCs itself encouraged the endurance of preexisting market power. The Bell operating companies (BOCs) were separated, not as the atomistic entities celebrated in economic myth and text, to which many of the assumptionsposited by the mainstream might apply, but as power collectivities. Within their economic spheres,each RHC retained much of the market and strategicpower of the former parent, includingmost notably, control over essential bottleneckfacilities. Moreover, it is important to recognize that the politicalstrengthof the RHCs is at

least the equal of their economic strength. Their ability to wield political power and thus influence their economic environment should not be underestimated. For example, the immediatelyupon specificationof the LOB restraints, the RHCs launched an intensive lobbying effort in almost every conceivableforum-national and state: legislative, judicial, and regulatory-for their elimination.3 Their use of the full arsenalof political weapons-financial contributions, extensive and expensive lobbying,employment arrangements-to achieve this goal, is well recognizedand has been documented and Harwood1994,Al). (Wartzman The RHCs advocate for the elimination of the LOB restraintsin the name of competition and efficiency.They maintainthat ending the restrictionswill increasecompetition by increasingthe numberof providers. There is little doubt, however,that the assumptionthat an increase in the numberof providerswill increasecompetitiondoes not hold when one of the providers has the built-in advantageof the use of monopoly revenues to cross-subsidize competitiveactivities. It is evident that the RHCs do not believe that the LOB restraints are permanent, and are doing all withintheir powerto make of this a self-fulfillingprophecy.The expectation has led to employment of a number of tactical maneuvers.The pace of development and deployment of ISDN is withinthe controlof the RHCs. It is reason3 For example, there have been introduced in Congressa successionof bills promulgated by different interests, prominentlyincludingthe various interests that now comprise the telecommunications industry, that wouldend the LOB restraints undervaryingconditions.These have encounteredsupportor opposition from the many involved interest groups, depending upon the conditionsimposed.The RHCs,for example, have opposed bills that would put teeth in a requirement that the elimination of the restraints be accompanied by the opening of local service to competition. Severalof the RHCsalso havefiled a motionin federal districtcourt (undoubtedly with one eye on the appellate process)requesting that JudgeHaroldGreene,the presidingjudge in the divestitureproceeding,dissolve the consentdecreeand relinquish of the local oversight If successful, this actioncouldend the LOB companies. restrictions (Cauley1994b,B6).

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able to view the limitationsupon availability, failure to deploy and high rates proposed for the new ISDN technology as of the strategictactics.It is to the advantage RHCs to keep conditionsas unfavorableas possible for their future competitorswhen, as expected, the RHCs are allowed into these markets. Amongthe available weapons is the strategic withholdingof technology (Selwynand Hatfield1994, 197-98). The RHCs also claim that they require new lines of business because of increased competitionin presentmarkets.It shouldbe noted, however,that despite the advent of such new and competitivelydesignatedendeavorsas cellulartelephone and Competitive Access Providers(CAPs),99 percent of all local calls still must go through RHC networks;that is, that RHCs retain 99 percent of local markets.4Moreover,rivalsare both dependentupon andvulnerableto LEC actions. The ConsentDecree approachto the essential facilities issue was to exclude RHCs from marketsin which the use of their essential facilities is necessary,and thus hinder their abilityto leveragethis controlinto adjacentmarkets(Selwynand Hatfield1994, carriers(IECs) con46). The interexchange tend that the LOB restrictionsshould be kept in place until certain changes are effected. Thatis, they maintainthat the RHCs should not be allowed into these markets unless and until customers of the RHCs have a choice of providersin local markets, the service is offered through a separate subsidiary,RHCs are required to pay the same price as their competitors for call completion, and they are prohibited from using sensitive customer information(Carnevale 1994, B4). The RHCs, in turn, proclaim the present viabilityof local market competition.Some also have announced a willingnessto open local marketsto competition in return for an end to the restrictions, although details and time frame for this are not well specified (Cauley 1994a, B7). The elimination of the cross-ownership restrictionof the Cable Act of 1982, under which LECs may not transport programming in their service territoryis an addi-

tional important for the RHCs.They priority also have achieved some success in the attainmentof this goal. The FCC has recommended to Congressthat provisionsof the Cable Act that prohibitLECs from offering video service throughtheir telephone lines be dropped,and that LECs be permittedto carryvideo service in their own areas. The FCC terms this video-dial-tone; that is, the provisionof transmissioncapacityto multion a nondiscriminaple video programmers in common tory basis, effect, carriage.The FCC also has entered a video-dial-toneorder that authorizesLECs to install broadband facilitiesin theirserviceterritories that integrate transmissionof voice, data, and video, and to transportprogramming provided by others over these facilities.In addition, a Virginia federal district court has found the video programming prohibitions in the Cable Act unconstitutionalon first amendmentgrounds in applicationto Bell Atlantic.The court authorizedBell Atlantic to provide video programming in its own serviceterritory. The easingof these restrictions gives the RHCs the ability to move extensivelyinto ancillaryfields. In addition,we currentlyare witnessing in communicationsand related fields an extensive interindustry consolidation and Not too long ago, the RHCs centralization. and cable interests were widely viewed as contesting vigorously to be the first to installthe interactive, multimedia infrastructure of the future. Companies across the industrialspectrumnow are takingturnshere competing as rivals, there cooperating as partners, and then again as rivals-in their approachto future participation in this infrastructure.On a wide informascale and across communications,

4 Thus, calls made to and from cellular phones are madefromandto land-linephones. preponderantly At the same time, it shouldbe noted that AT&T still retains60-65 percentof the long-distance market,and that the long-distance marketis distinguished by conscious parallelismin pricing, with AT&T supplying obvious price leadership.Such conditionsdo not inof spire much more confidencein the competitiveness for local or marketthan is warranted the long-distance toll markets. short-haul

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tion and entertainment industry lineslong-distance/ cellular, telephone / cable, telephone/entertainment, cable/ entertainment-a rash of successful and failed joint ventures, acquisitions, and mergers betokens what seems a future blurringof industry distinctions.5 All of this activityraises importantquestions, including that of the purpose and resultof this activity.For example,are there genuine public interest considerations involved? That is, do the changes point to enhanced economic efficiencyby, say, capturing economies of scale or scope? Or is this simplya series of purelystrategicmoves with the goal of securing strictly tactical advantages?Depending upon final resolution, the net result of the changesunderway in the communications,information, and entertainmentindustriescould be a vertical integrationthat would redefine the concept of end-to-endservice. In the pre-divestitureperiod, the term end-to-endservicehad a specificmeaning;it referredto the integratedR & D, manufacturing, and transmission and distribution operationsof AT&T. In the post-divestiture era there is the strong possibilitythat the term will take on new meaning;that is, that it would signify the concentration in few hands of the generation and ownershipof content, programming,transmission, and distribution.The potential for constriction of access and for conflicts of interest as a result of these changesare evident. It is difficulteven to speculate about the future configuration of this environment, or about the identity of eventual winners and losers. There is little doubt, however, that whatever the outcome, substantial centers of powerwill remain. IV. CONTEMPORARY REGULATION: AN EXERCISE IN MINIMALISM It is reasonable to interpret current developments as an indication that the telephone industrytoday has on its agenda one overridingpriorityand a numberof subpriorities.The dominantpriority the underlying plan of action is the abrogation or mini-

mizationof regulatory To this end, authority. programsare proposed that take shape as (1) to the extent politicallyfeasible, deregulation; (2) for services that remain regulated, the adoption of alternativesto traditional ROR regulation; (3) an end to restraintson entryinto all ancillary markets; (4) the upgrade and modernizationof infrastructure,using make-wholecost allocation processes;and (5) the use of principles of costing and pricing based upon varying demandelasticities. The strategy to date may be judged to have achieveda high degree of success.The telecommunications industrynow is permitted to engage in a host of deregulatedor only loosely regulatedrelated and unrelated activities.Moreover,an extensionof deregulation clearlyseems on the horizon. The goal of substituting, for servicesthat remain regulated,alternativesto traditional ROR regulation also appears close to achievement.At the federal level the FCC has adopted a price-capping system for AT&T and, to the extent of its jurisdiction, for the local operatingcompanies.Most of the states have replaced traditional ROR regulationwith one or another of the currently popular options, variouslyidentified incentive,or by terms such as price-capping, flexible pricing. The details of these programs vary substantiallyamong states and as between state and federal programs.

examplesof recentcross-industry 5 Some prominent moves to consolidate,both achievedand discontinued, include: in the long-distance /cellular market, the AT&T purchaseof McCawCellular,a Sprint-Centel merger,and an on-again,off-againpurchase by MCIof a share of Nextel. VariousRHC alliancesto combine their cellularoperationsalso are in the works.Concern is expressedthat the AT&T purchaseof McCawmay portenda reentryof AT&Tinto local markets. In the telephone/cable industries,the trendis eviBell purchase of denced,for example,by the Southwest two cable systemsoutside of its service territoryfrom Hauser Communications, the US West purchaseof a 25 percentsharein TimeWarner's cable andentertainmentoperations, the abortedBell Atlantic-TCI merger, and the US West purchaseof two Atlanta cable systems. Companies in the entertainment and cable indusand networkTV also have tries, and in entertainment expressedinterest,in some cases not muchbeyondthe talkingstage, in some formof alliance.

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Conceptually, however, the plans center upon the eliminationof earningsand profit control in favor of control over prices. The elimination or relaxation of earnings and profitcontrol in turn permitsan increasein the gap between prices and cost of service, an inattentionto quality of service and, at the same time, a decrease in regulatorydiscretion and authority. Regulatoryauthority also is diminished by the holding companyform of organization itself. As Bonbrightand Means pointed out in their classic study of the holding companymore than sixtyyears ago, a major attributeof the holding companystructure is its ability to distance itself from social control (Bonbrightand Means [1932] 1969, 6). In this seminal work, Bonbright and Means recognizethat the holding company is not simplya purely economic entity subject only to economic laws, but a political force as well. That is, they recognize the strategic use of the holding company as a means both to move business beyond regulatorycontrol and to attenuateextant regulatoryauthority. This is confirmedby currentexperience. The divestmentof the operatingcompanies from AT&T as parts of regional holding companieshas decreasedthe abilityto exercise public oversight.For example, spreading operation of specific service categories acrossmanyjurisdictions attenuatescontrol even over regulatedservices.The provision of both regulated and deregulated operations by a single organizationmakes possible various forms of risk and burden shifting, one reason for the high priority the RHCs place upon termination of restrictions on their marketentry.Allocationprocedures adopted for joint assets make possible the use of costing techniques that burden the core customer, as is illustrated modernin the case of telecommunications ization programs. The holding company structureincreasesthe long recognized(e.g., Bonbrightand Means [1932] 1969, 180-87) potential for abusive inter-affiliatetransactions. The holding company structure has in reinforcedthe "deregulation significantly regulatoryclothing"that is the current experience in telecommunications.6

The rejectionof traditionalROR regulation, and the divorce between prices and costs, also would be facilitatedby the adoption of costing and pricing proposals advocated currently by many mainstream economists.In effect, under such proposals consumers of new, advanced,and customtype services would be charged only the incremental cost of upgrade required for provision of that service, while monopoly ratepayerswould be allocated all residual costs. This proposalis made in the name of economic,or Pareto,efficiency, equatedwith a maximization of consumers'and producers' surplus,and identifiedwith the public interest (Baumoland Sidak 1994, 26). The position of the dominanteconomics is that so long as the rates of demand-inelastic consumersdo not exceed stand-alone cost and the rates of the demand-elastic consumer cover its incremental cost, no cross-subsidization occurs. Accordingly, Baumol and Sidak(1994) suggest the adoption of a system they call "marketguided regulation"in which a range of prices is specified when competition sufficient to control prices does not exist. Prices, it is asserted, should range from the higher of the marginalor averageincrementalcost of the service as the floor (for services to demand-elasticcustomers)to the stand-alone

6 That the contributionof the holding company structureto the currenterosionof social controlis not confined to telecommunications is demonstratedby recent developments in the electric industry. The Enof suppliergy PolicyAct created a new classification ers, exemptwholesalegenerators(EWGs),entities engaged solely in the generation and sale of electric powerat wholesale.EWGsare exemptedfromPUHCA regulation.In addition, regulated utilities may have interestsin EWGs.They thus are permitted ownership both to provide a larger proportionof their supply needs from purchased power,and to providefor them The shift by purchasesfrom their EWG subsidiaries. from reliance upon self-generation to the use of purchasedpowerresultsin differencesin regulatory treatment (generationinvestmentis rate based, purchased power costs passed on to consumers),and a shift in jurisdictional authority(state commissionshave jurisdiction over retail distribution, FERC over wholesale purchases).The Energy Bill thus permits both selfdealingand self-selectionas between levels of regulation.

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cost as ceiling (for services to demand-inelastic customers).Such a system,it is maintained, will prevent either predation or cross-subsidization (Baumoland Sidak 1994, 55-59, 63-64). The averageincrementalcost of a service is identifiedas coveringonly the direct cost of the service,includingservicespecificfixed costs, but not any contributiontowardfixed costs incurredin common or jointly for the specific service or for other services supplied by the firm (Baumol and Sidak 1994, 69). All other costs are to be absorbedby the native load consumerbase. The standalone cost is furtheridentifiedas the highest price it is possible to charge in contestable markets (Baumol and Sidak 1994, 77-78). Needless to say, if the preceptsand assumptions of contestabilitytheory are incorrect, that price turns out to have few economic limits and the process becomes a matter of sauve quipeut-that is to say, pricinglimits are exclusivelypolitical. The proposalis advancedunder the banner of economic efficiency. It is proposed also in the name of accuracyand precision. However, as institutional economists long have pointed out, cost allocationis not, and nor can it be, a preciseprocess.A consistent theme runningthroughoutthe institutionalist literatureis that of the essential ambiguity of costs (e.g., Commons [1924] 1959, 208-13; Clark[1923] 1981, 35-69). When it comes to the production of multiple services, cost allocation is unavoidablyarbitrary.The assignmentof costs thus becomes a politicalratherthan an economicexercise, designed more as a tactical maneuver to achieve strategicobjectivesthan as a means to achieve so-called economic goals such as Pareto optimality. It should be noted, moreover,that as the importanceof fixed to total costs increases with increased network development in telecommunications,incremental costs will be a decliningcomponent of the total, and as the importance of joint to total costs increases, the opportunityfor the arbitrary exerciseof politicalpowerwill increase.That is, adherence to mainstream costing and pricing principleswill result in the assignment of responsibilityfor an increasingly

smaller share of costs to the competitive sector, and the assignment of an increasingly smaller share of the benefits of joint development to the monopoly sector. The telephone industryemphasizesits need for pricing "flexibility"in the face of current technological and economic turmoil. The coveted and much vaunted "flexibility"is difficultto distinguish,however,from plain old-fashionedmonopolypricing;that is, the indisputably unscientific and inelegant what the trafficwill bear." "charging At the same time, continuing requirements such as that for high initial capital sunk investment,the existenceof substantial costs, and the presence of excess capacityin most public utilitymarketssignificantly limits potential entry into monopolyand ancillary markets,thus strictlylimitingconsumer options.The politicalagendaof the industry would seem to be fulfilled. V. CONCLUSION The publicutilityconcept is not obsolete. It is not obsolete because the conditions that gave it life-the abilityto extractexcessive prices from captive consumers, the presence of economies of scale and scope, high MEMS, high entry barriers ensuring concentrated markets-persist. Moreover, the public utility concept is not obsolete because, as institutional economists long have recognized,a publicutilityis not solely a business,with only "bottomline" business intereststo advance.Publicutilitiesproduce an essential public service and operate under a unique public franchise.Such enterprises sustain,in additionto privateprerogatives, public interest franchise obligations to returnsomethingto the community. As a of practicalmatter,however,the application the public utility concept today is in jeopardy. In the United States where it was conceived, the public utility concept and social control characteristically receivedonly halfhearted support. Competition was sanctioned as the only appropriateregulator. Yet simultaneously it was widelyrecognized that industries classified as public utilities are uniquely endowed with characteristics

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that make faith in market control untenable. Economists in the United States displayed a similar ambivalence.Although, as has been noted, institutional economists generally endorsed regulation as necessary for the control of market power in public utility markets,there were manywithin the profession who viewed any public policy, save one that favoredfree markets,an abdiThere cation of professionalresponsibility. also were economistsof varyingphilosophic who denied the effectivenessof persuasions either competitionor regulationand sought other options. For example,althoughthe early Chicago School economist Henry Simons was a staunchadvocateof competitionand called for its preservationthroughvigorousapplication of antitrust laws, he believed that marketforces had limitationswhen it came to the controlof publicutilities. In his view, however,regulationwas a flawedpublicpolicy. He advocated public ownership and managementof public utilities. In the case of utilities, he acknowledged, "competition simply cannot function effectively as an agencyof control"(Simons[1934]1948,51). A similarconclusionwas reached by the institutional economist Horace Gray who, in 1940, pronounced regulation a failure and invokedthe celebrated"passingof the public utility concept."He describedpublic utilityregulationas a policythat while originating as a means of social restraint and consumerprotection,had become a method to protect monopoly property(Gray 1940, from prosecu15-16), including"immunity tion under the anti-trustlaws, . . ." and, perhaps, most important, "public acceptance and legal recognitionof the economic fiction of 'natural'monopoly"(Gray 1940, 11). Gray called for less reliance upon private enterprise and more upon direct government action. Although examination of all options was invited (Gray 1940, 20), the impressionthat he found public ownership the most viable is difficult to avoid. It is interestingto note that each of these early analyses, animated by opposing economic perspectives, considered the regulatory but nonetheless did not model inapplicable,

view competition as a reasonable alternative. It should be reemphasized,however, that efforts of membersof the institutional school almost without exception were directed towardstrengtheningand improving economic regulation (e.g., Bonbright and Means [1932]1969, 176-87 passim;Glaeser 1957, 3-13 passim;Trebing1987,passim). This diversityof opinion should be contrasted with present day uniformity of thought,dominatedas it is by a mainstream that demandsideologicalpurityand invokes only variations upon competitive solutions and cobbled together marketmodels to address these complex issues. Advocacy of market control is transformedinto belief that public interventionis the only impediment to its emergence,or that acting"as if" it exists will assure optimal solutions.Thus we have a plethora of market and quasimarket proposalstaking shape as contestability, contract, bidding, and auction theories proposedas cures for all economic ills. Actual marketconditionsare deemed irrelevant. It is importantto understand,however, that actual market conditionsinclude technical barriersto entry that prevent the emergenceof competition. The central public utility issues have not changed materiallysince institutionaleconomists initiallybegan their analyses shortly after the turnof the twentiethcentury.They involveissues of consumerexploitationtaking shape as market segmentation, crossand discriminatory subsidization, pricing;of concentration and the abuse of market power; of the ability to limit market entry. They involve also questions of how to preof monopolyoperations vent the "milking" to cushion competitiveones and to support extravagant construction and acquisition programs.That the problemsmay take different forms in different eras is an indication that regulationcontinuallymust be reformulatedto fit the problem at hand, and not that it shouldbe eliminated.At bottom, while the form the public utility problem takes may vary over time, its substanceremainsthe same:that of the social controlin a public interest of the abuse of private marketpower.

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