Wednesday, March 23, 2005 - The Progress & Freedom Foundation Blog

After the Level 3 Petition

Level 3 has withdrawn its forbearance petition with the FCC in advance of a certain denial. The petition asked the FCC to forbear from requiring access charges on VoIP calls originating or terminating on the public switched telephone network. On balance, I favored the petition, with perhaps some time limit to keep the incentives right for more holistic intercarrier compensation reform.

A large part of my favorable inclination toward the petition is based on the belief that this "piecemeal" approach to allowing escape from the access charge regime begins to push the incentives toward broader, more complete intercarrier compensation reform. That is arguable, and it surely is arbitrage -- but arbitrage is a morally neutral activity. It can be good to rationalize markets; it can be bad if it stops beneficial price differentiation.

So, where are we now? The incentives for "holistic" intercarrier compensation reform look spotty, and the political rewards for doing so are probably negative. Nevertheless, the current system is inexorably leaking, as consumers migrate to platforms not subject to the access charge tax.

The goal should be toward a private, bilateral contract model. These models exist and work in other network industries: railroads, automated teller machines, Internet backbone markets. Therefore, the question is why or whether regulatory intervention is necessary at all, except to devise a transition strategy.

A bilateral contract model does leave the terminating access monopoly question unsolved. Professor Speta sent me back to my Laffont & Tirole, who describe that a terminating access monopoly problem will exist when there is an interconnection mandate. Further, a small carrier is best disposed to exploit the terminating access monopoly.

Without an interconnection mandate, then, the terminating access monopoly should not arise. Because you don't grant a property right to interconnect, then a carrier cannot exploit the hold-out position that such a right bestows. (You also count on the desire of a network owner to maximize the value of his own network by interconnecting voluntarily as giving sufficient incentive for interconnection to happen. Also, there is obvious value to some segments of the market if the network is not interconnected. Think Bloomberg financial data, where the value is derived from it being a private information network.)

Bilateral interconnection arrangements probably require more regulatory intervention if an interconnection mandate is involved. In various FCC Office of Plans and Policy Working Papers, Patrick De Graba and Atkinson & Barnekov, respectively, have argued on slightly different lines for a default bill and keep regime.

A later paper by Atkinson & Barnekov takes a less-prescriptive approach. Describing a Coasian solution that would set default rules to facilitate negotiation, they describe their purpose:

Our goal is to find a default rule that, ideally, need never actually be applied by a regulator. The point of a Coasian approach is that if rights (i.e., default rules) are well defined, the parties can and will work out efficient resolutions (more efficiently than a regulator could achieve). We develop a simple default rule that assigns interconnection costs in an efficient, non-arbitrary and competitively neutral manner, even when one carrier has market power. The rule is first to identify those facilities that are solely incremental to interconnection, then to split the cost of providing these facilities equally between the two carriers. Each carrier would recover these and all its other costs from end user customers, not from interconnecting networks. For several basic types of networks, we demonstrate below that this simple default rule results in efficient, competitively neutral interconnection. We argue that this result can also be generalized to more complex networks. We believe this rule provides a conceptual solution to the problem of interconnection between dissimilar networks in the presence of market power, and that it provides a default that can enable interconnectors to reach competitively neutral and, with respect to interconnection, efficient outcomes.

The Atkinson/Barnekov approach would aspire toward bilateral, negotiated solutions once property rights are defined. It would also appear to be consistent with the Kahn & Shew arguments from their 1987 Yale Journal on Regulation article that a network's fixed-costs should be recovered from end-users.

The issue of whether a bilaterally negotiated intercarrier compensation system will work is rich theoretically and attractive practically.

The withdrawal of the Level 3 petition takes intercarrier compensation off the front-burner, but it will not go away. A considered exploration of the notional difficulties of intercarrier compensation combined with a political shove from some combination of the FCC, the VoIP players and progressive incumbents could rationalize the current system and ensure that business models going forward are focused on consumers, instead of the wasteful, expensive games to avoid the current system.

posted by Ray Gifford @ 12:19 PM | Communications , The FCC , VoIP , Wireline