Deregulation Disasters: Sometimes the Market Doesn't Work

A very common refrain I'll hear when it comes to UTOPIA and other municipal fiber efforts is "let the market decide!" On the surface, it sounds like a good idea: let private competitors enter the area and give the incumbent providers a whatfor. Where they consistently fail, however, is in delivering a plan that works to achieve these ends.

One of the more prominent deregulation efforts in the utility markets took place in California with the power utilities. On the surface, the plan sounded good: turn the transmission grid into an independent entity and have retailers and wholesalers of electricity pay a fee to use the capacity. In practice, it ended up failing miserably. Retailers were hamstrung by not being allowed to raise rates without approval, though the wholesalers took advantage of the immense shortfall in generation capacity to increase their own rates. The retailers ended up selling power at a loss because they were required to and almost went under entirely. This partial-deregulation scenario caused price-gouging of the worst kind of an essential commodity.

The retailers decided to get in on the action as well. After posting big losses, they got state regulators to tack on transmission surcharges to bills that ended up increasing the cost of power. Because of their size and incumbency, they held significant clout with legislators to try forcing the smaller and better-managed competition out of business. Much like the telephone and cable companies, they have also crafted out their own monopoly territories, selling the notion that competition would actually end up hurting the market and raising prices. Indeed, this attempt at splitting the retail and wholesale operations was doomed from the start.

The other prominent example of failed deregulation occurred as part of the 1996 Telecommunications Act. One of the key features of the bill is that incumbent phone companies (ILECs) had to lease lines near-cost to competitors (CLECs). It sounded like a good idea at the time. Almost immediately, however, this plan began to unravel as the ILECs would delay repairs on lines for CLEC customers, stall new installations for CLECs and abuse their control of the plant to stifle competition. Because the plant and retail operations of the incumbent were not separated, the ILEC always gave itself preferential treatment. The CLECs had no way to seek appropriate recourse either; it's hard to prove the sabotage that the ILECs engaged in and no CLEC had the financial resources to have their day in court.

A big problem for competition is that the plant is so expensive to build, requiring that they capture a significant amount of the market to pay down the debt and be able to invest in capital improvements. It also doesn't help that incumbents have no problem with impeding their progress every step of the way through anti-competitive legislation, stalling approval from regulators, trapping customers in service contracts (a relatively new invention from the cable and phone companies) and plain old FUD (fear, uncertainty, doubt). The competition also has to go through the same franchising requirements as the incumbent which will usually include universal service, making the roll-out even more expensive.

The vogue solution to introducing competition has been statewide franchise agreements. The idea is to streamline the process with regulators so that competitors can operate with fewer restrictions and seek faster approval. The reality of this solution, however, is that it leads to a few deep-pockets competitors duking it out over only the most lucrative neighborhoods. Low-income neighborhoods do not see the benefits of reduced pricing through competition and universal access is dealt a serious blow. Smaller start-ups also seek the wealthier neighborhoods to reach profitability quickly but the crowded market space leaves them gasping for air against the marking machines of multi-billion dollar corporations.

Where does this leave us? It seems that we need to have several keys things in place for true competition to exist in the telecommunications space. First, there needs to be a neutral party in charge of the plant in order to ensure that all retailers have equal access. Second, wholesalers must not be able to manipulate the supply in order to inflate prices. Third, we need to maintain universal access so that all parties benefit. Because of the infeasibility of breaking up the existing vertical monopolies, it seems that systems like UTOPIA and iProvo are our best bet in ensuring a truly competitive market. If any of you free market types can come up with something better, I'm all ears.