TABLE OF CONTENTS

1. The Value of Researching Telecoms Regulation in the UK… *

2. A Basic Question: How Well Has Local Competition Served Consumer Interests in the UK? *

3. Another Comparison: The UK Telecoms Industry Is Much Less Productive than the US Telecoms Industry *

4. Why are UK Consumers Worse Off Than California Consumers? *

5. Lessons for the US *

In the second half of this decade, the foremost goal of US policy-makers and regulators in the field of telecommunications has been to bring about robust competition for local telephone service. The US has not been alone in this endeavor. Since the beginning of the decade, and arguably since 1984, the UK has also been striving to inject competition into local telephone markets.

For residential and small business customers (collectively referred to as the mass market), who are the focus of this report, the UK has considerably more local competition than the US. While only a negligible percentage of American households have a meaningful choice for local telephone service, 50% of UK households have such a choice, and 16% of households take local service from a company other than the former monopoly, British Telecommunications (BT).

Where local competition exists in the UK, it is duopoly competition. In this duopoly, the alternative to BT is the cable television operator that holds the franchise for a given territory. Whereas cable operators in the US have not yet been able to deploy voice telephone service on a large scale, UK cable operators have been able to do so because they only began building their networks in the late 1980s and early 1990s. With this relatively late start (compared to US cable operators), UK cable firms were able to incorporate into their networks copper wires to use for telephony. The competition that exists in the UK is mainly attributable to the advantage gained from its late start in deploying cable television networks. Unfortunately therefore, the lessons that the US can learn from the UK do not include how to accelerate the growth of local competition.

Instead, the important lessons to be learned from the UK’s experience fall into two categories: (1) lessons about the limitations of local telecoms competition in delivering the best possible deal for consumers, and (2) lessons about the nature and extent of infrastructure competition that can reasonably be expected to develop under the most favourable of conditions.

This report finds that, despite the relatively advanced state of local competition in the UK, consumers in that country are worse off than California consumers. Unlike Californians and most other Americans, UK residents do not even have the option of subscribing to unmetered (flat-rated) local service, depriving them of numerous benefits, not the least of which is the ability to use the Internet without regard to usage-based charges. In addition, UK residents pay substantially more for telephone service, particularly local service, than California consumers.

Another significant finding, made by a leading UK consulting firm, is that the UK telecoms sector is 40% less productive than the US telecoms sector.

In sum, the UK’s relatively competitive environment has not kept pace with the monopoly environment in California in terms of delivering benefits to consumers or even productive efficiency. This report identifies two main reasons for this result.

First, regulation of BT has been weak. When BT was privatised in 1984, the initial regulatory scheme was designed to achieve the objective of ensuring BT’s financial success, not delivering the best possible deal for consumers. Since then, BT has been able to wield excessive regulatory influence by virtue of its privileged status in the regulatory structure. Moreover, consumer representatives and other interested parties are denied access to the information that BT relies upon in its presentations to the regulator, further favoring BT in the regulatory process. Finally, as local competition has begun to emerge in recent years, the UK regulator has considered projections of increasing competition a reason for leniency in price regulation of BT. This approach was based on the perception that lenient price regulation would accelerate competition.

Second, despite highly favorable conditions for infrastructure competition, the extent of competition has been disappointing and insufficient to discipline BT’s prices. The UK offers conditions that would fulfil a US infrastructure competitor’s dreams. They include: prevailing local rates much higher than those in California, an incumbent with a history of poor service quality, and freedom from requirements that competitors offer their customers access to other long distance operators.

Nevertheless, only cable operators have been able to mount a challenge to BT. And that challenge has been far weaker than expected because their business models relied on higher revenues from television services than they have been able to earn. The UK’s weak duopoly contrasts sharply with the vigorously competitive environment that the UK’s regulator became convinced would develop. This miscalculation, in turn, resulted in a premature relaxation of price regulation that has worked to the detriment of UK consumers. The UK is now flirting with a vicious cycle of needing to persist with overly lenient regulation of BT just to keep the cable operators in business.

The UK’s experience offers six important lessons for US policy-makers and regulators.

• Beware of unrealistic expectations for local competition. Having devoted substantial resources to promoting competition, regulators are prone to allowing their hopes, rather than actual results, to influence their assessments of the extent and potency of competition.
• Beware of market projections and promising new technologies. Many business plans fail, and many supposed technological breakthroughs are never deployed.
• Effective local competition for voice telephone service may never develop. If only cable operators can survive (barely) in a market as favorable to competitors as the UK, then there is little hope that existing technologies will deliver significant and widespread infrastructure competition in the US.
• Efforts designed to increase local competition, such as increasing the incumbents’ local rates, may invite inefficient competition and will only harm consumers. Increasing local rates in the US will not permit any additional efficient competitors to provide service. It may invite inefficient competitors to enter, who will then seek overly lenient regulation of the incumbent in order to protect their precarious positions in the market.
• Merger analysis and high bandwidth strategy should not be dominated by the goal of promoting local competition for voice services. For the foreseeable future, competition for voice telephone service is likely to be limited and not offer any new features and functions to consumers. Promises of competition that either is unlikely to materialize or offers little benefits for consumers is not a sufficient quid pro quo to offset the drawbacks of industry consolidation and closed access to high bandwidth cable modems.
• Sound regulation effectively promotes the public interest. A history of relatively strong regulation in California and other states has enabled US consumers to benefit from more choice and lower prices for essential telecoms services than their UK counterparts. Strong regulation will continue to be necessary in the absence of robust local competition.

This is the final report of my nine-month Atlantic Fellowship in Public Policy. In my research, I have studied telecommunications (hereinafter telecoms) regulation in the UK from the perspective of residential and small business consumers. Although I have attempted to gain a broad understanding of UK telecoms policy and regulation, my particular focus has been the UK’s effort to promote competition, which has followed a path distinctly different from that of the US. My principal goal has been to ascertain whether the UK’s experience might offer lessons for policy and regulation in the US.

My main research tools have been extensive reading and numerous interviews. I have read thousands of pages of material, including documents issued by Oftel (the UK regulatory agency), books and articles designed for practitioners, books and articles of a more academic nature, reports and studies prepared by consultants, publications by consumer organisations, and media articles. I have interviewed dozens of key players in the UK regulatory community, including regulatory staff at Oftel, consumer representatives, academics, consultants, and representatives of all types of firms offering telecoms services in the UK. I am extremely grateful to all of the people who generously offered their time to assist in my research. Although my thinking has certainly been influenced by the opinions I was exposed to in my research, my conclusions are mine alone and should not be attributed to any of the individuals with whom I spoke.

I am enormously grateful to the UK government and its people for making possible this extremely gratifying fellowship experience. The opportunity to examine the key public policy issues in my field from a different perspective will prove invaluable to me throughout my career. The non-professional education will prove equally valuable. Though the opportunity to live and travel widely in the UK, my family and I have a much deeper appreciation of the culture and people of a magnificent nation.

Finally, I wish to thank the University of Glasgow Law School for graciously hosting my research and offering a congenial environment in which to work. In particular, I am grateful to Professor Tony Prosser of the Law School for his invaluable assistance in guiding my research.

1. The Value of Researching Telecoms Regulation in the UK

Since the enactment of the Telecommunications Act of 1996 (TA 96) in February of that year, the US has been embarked on a crusade. The nation has thrown the better part of its considerable telecoms regulatory resources into achieving one objective – robust competition for local telephone service. (In many states, the effort began well before February 1996).

Promoting local competition is a difficult endeavor for a variety of reasons. One critical factor is the enormous amount of investment that would be necessary if a competitor were to attempt to replicate the telephone networks of the incumbents. For fixed link telephony, each household and business must be connected to a switching office by wires called "the local loop". To construct a new set of wires linking customer premises with switching offices would involve massive capital investment and a huge construction program that would cause considerable public disturbance.

Despite the concerted effort of federal and state regulators, when I came to the UK in September 1998, almost no US residential and small business customers (which I will collectively refer to as the "mass market") had a meaningful alternative to their traditional local telephone company for local service. (I will refer to the traditional local operators as "incumbents" and to the new entrants into the local market as "competitors.") Ten months later, little has changed. Based on the (unfortunately less than detailed) available data, I estimate that less than 2% of US households have a meaningful choice for local telephone service and that less than 1% of US households actually take service from a competitor. The US is clearly struggling in its effort to bring local competition to the mass market.

In contrast, the UK enjoys probably more fixed link local competition than any country in the world. More than 50% of UK households have a meaningful choice of local operator, a number that continues to grow each year as cable operators extend their reach. Approximately 16% of UK households actually take service from one of the competitors to the UK’s incumbent operator, British Telecom (BT). BT’s market share has fallen from 100% to 85%, a noteworthy erosion of its monopoly.

Much of the UK’s lead over the US with respect to local competition is attributable to the UK’s relatively late start in deploying cable television networks. UK cable operators began building their networks in the late 1980s and early 1990s and were able to design their systems with telephony in mind. UK cable networks use both copper wire, for telephony, and coaxial cable, to connect with customers’ premises. In contrast, US cable operators deployed their networks long before they contemplated offering telephone service. As a result, US cable systems were designed only for television service and use only the single coaxial cable to connect with homes.

This difference has proven significant. When TA 96 was passed, it was believed that US cable networks could be readily upgraded to provide telephony. It has not worked out that way. Because of technical problems in achieving the necessary transmission quality for conversations over coaxial cable, US cable networks have proven more costly and difficult to upgrade for telephony than expected. Even though AT&T has acquired the largest US cable operator, TCI, and claims to be eager to use the cable infrastructure to offer local telephone service on a broad scale, many question whether cable telephony will ever be competitive in terms of price and quality with copper-wire telephony offered by the incumbents.

Thus, the UK does not offer a blueprint for local competition that the US can (or should) easily follow. Most US cable networks have already been built, and for existing cable systems, it would take a daunting, perhaps prohibitive, investment to rebuild them to include copper wire.

But, in light of the relatively advanced state of local competition in the UK, its experience has much to inform the US about what it is reasonable to expect from local competition. In particular, the UK offers lessons about the nature and extent of infrastructure competition that we can expect in the US and about the effect of local competition on the goal of satisfying consumers’ desires for lower rates and better quality service.

The UK has presented conditions for the development of infrastructure competition that US competitors would envy. First, the UK has had a longstanding national policy commitment to infrastructure competition, beginning with the privatisation of BT in 1984. Second, in sharp contrast to the US, the UK has a single national regulator, and competitors have not been burdened by conflicting priorities and decisions of numerous state regulators. Third, throughout this decade, competitors have been free of any requirement to allow their customers to access other operators through their networks. Fourth, the UK has favoured infrastructure competitors by not permitting other forms of competition that piggyback on the facilities owned by the incumbent. Fifth, competitors in the UK have been able to compete against relatively high prices for local service compared to rates in many US states. Since BT’s privatisation in 1984, the government and Oftel have permitted BT to raise its quarterly line rental charges (a fixed charge that includes no usage) significantly. In addition, as will be discussed in more detail below, BT’s local usage charges are much higher than comparable charges in California and many other states.

Notwithstanding the existence of conditions that many competitors would consider ideal, infrastructure competition in the UK has been slower to develop and far less diverse than most UK observers expected. This outcome offers many valuable lessons for the US and will be discussed extensively in this paper.

The ultimate test of policies to promote local competition will be whether they have benefited consumers. Although local competition in the UK may not be as robust as expected, there is still far more local competition than in the US. The UK thus offers an excellent opportunity to make some early assessments about the virtues and limitations of competition for local telecoms service in terms of addressing consumer needs.

2. A Basic Question: How Well Has Local Competition Served Consumer Interests in the UK?

I pursued a fundamental question in my research: how well has the UK’s relatively advanced state of local competition served the interests of consumers?

Definition of Consumer Interest

Oftel defines the consumer interest as obtaining the best possible deal for telecoms service in terms of quality, choice, and value for money. This is consistent with the goals of state and federal regulators in the US. I accept this definition and used it in my research.

A Comparative Approach

One way to assess how well the UK is serving consumer interests is to compare it with other countries in its peer group. Given my expertise regarding telecoms in the US, particularly California, it was natural for me to compare telecoms service in the UK and in California, the largest state in the US. Because California, like the other US states, has almost no mass market local competition, the comparison offers an opportunity to assess whether competition is delivering a better deal for UK consumers than their US counterparts who do not have a choice of local operators.

I believe such a comparison between the UK and the US is fair. Our two countries have comparably modern telecoms networks, comparable standards of living and levels of economic development. Telecoms firms in both countries aspire to be the best in the world and intend to compete in each others markets. The two companies that are the focus of my comparison, SBC (which owns Pacific Bell) and BT, are two of the largest and most successful local operators in the world. Our two countries have been pioneers in telecoms policy and regulation. In both our countries, policymakers and regulators seek to provide their citizens the best deal in the world. To this end, Oftel has occasionally (but not recently) published comparisons of UK telecoms prices with prices in Europe and the US.

This cross-national comparison is certainly not the only way to assess the extent to which local competition has served to benefit consumers. Another approach would be to compare the deals available from BT over time, as competition has increased. However, this approach involves difficulties of interpretation, particularly for an outsider.

The primary difficulty is disentangling the effects of regulation and competition. An example from the US will illustrate this point. From the data, one could easily conclude that reductions in US long distance rates of 50% or more over the last 15 years are the result of efficiencies driven by competition. This would be the wrong conclusion. In the aggregate, the rate reductions have been the result of changes in regulation that have reduced the charges that US long distance operators pay to local operators. If long distance had remained a regulated monopoly service and these same regulatory changes had been made, the aggregate level of long distance rates would be about the same.

From my interviews and other research, it became clear that it would be equally difficult to disentangle the effects of competition and regulation in the UK. For example, over time, BT has reduced its rates for national (i.e., long distance) calls. In part, this has been driven by regulation, as the price caps have required BT to reduce its overall rate levels by a prescribed amount. Another factor is that, as in the US, the UK regulator has reduced interconnection charges significantly, which enables competitors to offer steeper discounts off of BT’s rates. As a competitive response, BT has chosen to reduce its national rates, as opposed to other rates for less competitive services. It appears, therefore, that both regulation and competition bear some responsibility for the reductions in national call rates, with regulation being primarily responsible for the aggregate level of rate reductions and competition explaining the distribution of those rate decreases. In any event, much ink could be spilled attempting to apportion this responsibility. My research unearthed similar opportunities for controversy in attempting to explain the reasons for the significant improvements in BT’s service quality in the last decade.

For these reasons, I have used a cross-national comparison as a starting point for my effort to ascertain the impacts of local competition on the consumer.

Service Quality

The first element in the Oftel definition of the consumer interest is service quality. Statistics in the UK Comparable Performance Indicator reports and in reports by Pacific Bell to the California Public Utilities Commission show generally equivalent performance levels. Of course, in both countries, there are questions about how carefully the data are audited, and hence their reliability.

My experience is that, both technically and in customer service by company representatives, BT and Pacific Bell now offer a comparable quality of service. This obviously subjective opinion seems to be shared by other people I have talked to who have spent significant periods of time in both countries.

While this area could certainly be more rigorously researched, I conclude that the quality of service is comparable in the UK and California.

Choice

With respect to Oftel’s second criterion, choice, there is one dramatic difference between the UK and the US in the provision of basic telephone service. Most residential customers in the US have the option of obtaining unmetered local service, whereas almost no customers in the UK have this option. Instead, in the UK, customers pay a recurring "line rental" charge, and then must pay on a timed basis for every local call. In addition, BT charges a 4.2 pence (excluding value added tax) (about 7 cents) minimum for each local call, regardless of duration.

When establishing telephone service in the US, most residential customers have a choice between flat and measured local service. Flat service means that, for a fixed monthly charge, the customer may make an unlimited number of local calls of unlimited duration at any time of day or night, all without any additional charge. This is fully unmetered local calling. Measured service carries a substantially lower monthly charge than flat service (the differential is often $5 or more), but requires the customer to pay for most local calls on a usage basis. Even measured service is not always fully metered; some measured service offerings, as in California, include an allowance of uncharged local calls. Nevertheless, measured service is the closest the US has to BT’s scheme of charging for all local calls on a usage basis.

Flat service is enormously popular in the US. Despite its relatively high price compared to measured service, the vast majority of California residents (about 85%) take flat service.

There are several reasons for the popularity of flat service in the US.

First, it promotes civic affairs. Citizens can call their neighbours regarding community, school, and church meetings and activities without extra charge. Likewise, charitable or political organisations can raise money or engage in get-out-the-vote efforts without extra charge.

Second, it promotes local commerce. Unmetered calling enables US consumers to do a considerable amount of shopping by telephone, especially to determine in advance whether a particular merchant has a product meeting the customer’s specifications (e.g., shoes in the right style and size). This makes shopping more convenient and benefits the environment by curtailing unnecessary uses of the car (upon which Americans are far too reliant). A 1998 McKinsey report found that, on a per capita basis, for every 100 call minutes in the US, there are only 37 in the UK. The report found "considerable evidence" that "many of the calls foregone in the UK are . . . consumer-to-business calls . . ., calls that might have created economic value."

Third, it promotes universal service. Consumers have the security of knowing exactly how much they will be billed for local service at the end of the month, which greatly assists in keeping people connected to the telephone network.

Fourth, of increasing importance, flat service promotes Internet use and e-commerce. Internet searches do not lend themselves to time constraints, as one piece of information typically leads to another path of research that may have been previously unforeseen. If consumers cannot afford to stay on-line to complete their desired research or browsing, they are not able to exploit the Internet’s full potential. Moreover, many software applications assume that the consumer has an open link to the Internet. However, with metered calling, keeping the link open is cost prohibitive, again preventing many consumers from taking full advantage of their computer.

The detrimental impact on e-commerce is evident. If consumers cannot afford to browse, they are less likely to use the Internet for shopping. Many businesses that have a strong marketing base in the UK do not have sufficient UK demand for Internet shopping to sustain e-commerce operations. Internet shopping is now dominated by Americans and, hence, American corporations. UK businesses may be missing a time-limited opportunity to establish a presence in the world of e-commerce.

A common misconception about unmetered local calling in the US is that US local calling areas are much smaller than they are in the UK. In urban areas in California, the local calling area is defined by a 12-mile radius from the "calling center" for a given telephone exchange. (The calling center is usually a key building in one's neighborhood, such as the post office.) This means that the local calling area where I live in California has a 24-mile diameter, which is comparable in size to the local calling areas in the UK, if not larger than most. Of course, each state in the US has different rules and hence different local calling areas, but California's rules are fairly typical. There are states with much larger local calling areas.

The existence of an unmetered local calling option in the city of Hull, offered by the municipally-owned Kingston Communications, is evidence that UK telecoms networks should be capable of providing unmetered local calling. Yet, except for this one enclave outside of the BT service territory, UK consumers have no such choice for voice telephone service.

Thus, with respect to choice, I conclude that US consumers are much better off than UK consumers. There is strong demand for unmetered calling in the UK, as evidenced by the existence of well-organized pressure groups, such as the Campaign for Unmetered Telecommunications (CUT) www.unmetered.org.uk. In addition, various media reports have highlighted the demand for unmetered local calling. Not only are UK consumers being deprived of a valuable choice, the absence of unmetered calling probably has adverse spillover effects for the UK economy.

 

Value for Money – Rate Comparison

The third Oftel criterion, value for money, is the most difficult area of comparison. My approach was to compare first the local rates of the incumbent local operators in the UK (BT) and California (Pacific Bell). Then, I compared these same operators’ non-local calling charges.

With respect to local charges, ideally, I would have made two comparisons. First, I would have compared the price of flat service in California to the call charges that would be incurred in the UK for the local call basket (i.e., minutes of local calls arrayed by time of day) of a typical California household. Unfortunately, I do not have the California data necessary for such an analysis. The second comparison, which I was able to make, was to compare the price of Pacific Bell’s measured service with its UK analogue, BT’s line rental, and then compare the per-minute call charges of the two operators.

The results of this comparison are shown in the following table.

 

Comparison of Residential Local Rates in the US (California) and UK

	US	UK	% Difference
Line Rental ($/month)	$8.70	$12.14	+40%
Local usage (5 min. call in cents)
Day	6.6	27.0	+309%
Evening	4.6	10.0	+117%
Weekend	2.9	6.8	+134%

Source: US – Pacific Bell rates, UK - BT rates; taxes and surcharges excluded; assumes £1 = $1.60

Local service is considerably more expensive in the UK. Monthly line rental charges are at least 40% higher in the UK than in California. UK local usage charges are more than double those in California and, in the daytime period, UK charges are over four times higher

I next compared the most comparable non-local rates offered by Pacific Bell and BT. This comparison is important, because Pacific Bell’s lower local rates could be offset by higher non-local rates, which many in the UK assume to be true. For the UK, I used BT’s national call rates, and for California, I used Pacific Bell’s rates for intrastate regional long distance calls (called intraLATA calls in US jargon). The results of the comparison are shown in the next table.

Comparison of Residential Long Distance Rates of Local Operators in the

US (California) and the UK

(charges for a 5-minute call in cents)

	US (21-40 miles)	UK	% Difference
Day	42.0	54.0	+29%
Evening	33.6	28.5	-15%
Weekend	25.2	20.0	-21%

Source: US – Pacific Bell rates, UK – BT rates; taxes and surcharges excluded; assumes £1 = $1.60

This comparison shows that, in the daytime period, the UK rates are higher, whereas in the evening and weekend periods, the UK rates are lower. Overall, the rates are roughly equivalent, though a consumer who made most calls in the evening and weekend period would pay somewhat less for non-local calls in the UK.

In sum, the rate comparison shows that local service costs California consumers considerably less than UK residents, and that this disparity is not offset by significantly higher non-local rates in California.

A note about methodology: As noted earlier, rate comparisons are difficult, particularly those between non-local rates. There are geographic and market structure differences between our two countries that make it challenging to be sure one is making a fair comparison. For example, in the US, the largest local operators do not yet carry national long distance calls, only certain regional long distance calls. However, since national long distance covers such a larger area in the US than in the UK, national long distance charges in our two countries are not necessarily an appropriate comparison. Even if they were, the complexity of the rate offerings, the variance between intrastate and interstate rates, and the multiplicity of long distance operators in the US make it an enormous task to attempt to find rates comparable to BT’s national call rates. For example, at any time, AT&T, the largest long distance operator, typically has in place several calling plans for intrastate and interstate calling, all with very different rates and rate structures at any one time. Finally, exchange rate fluctuations affect cross-national rate comparisons.

Using Pacific Bell’s regional rates offers a fair and feasible comparison. California is a large state and Pacific Bell’s regional calling covers distances reasonably comparable to BT’s national calls. In addition, it is often argued on both sides of the Atlantic that the incumbents in the US are able to keep local rates low through excessively high non-local rates. My comparison addresses this claim and shows that, even if true, California’s non-local rates are still not significantly higher than BT’s.

Finally, it may be argued that some of the revenue that Pacific Bell could use to support low local rates is derived from "access charges" levied on long distance operators. However, for better or worse, beginning in 1996, the FCC has been restructuring access charges so that they include a sharply reduced level of usage sensitive charges to support the local network. Instead, long distance operators are now charged a flat fee per-line (called the primary interexchange carrier charge or PICC), which they typically pass along in their charges to consumers. In addition, as part of this transition, the FCC has increased per-line charges (known as the Subscriber Line Charge or SLC) for non-primary telephone lines. I have included these additional charges, at their new July 1, 1999 levels, in the cost of measured service (the "line rental") set forth in the first table above. I believe that my comparison captures most of the access charges that some observers suspect are responsible for California’s low local rates.

Summary of Results of the Comparison

My comparison yields what many would consider a counterintuitive result. Even though the UK has considerably more local competition than California and the rest of the US, UK consumers are deprived of a highly valuable choice for local telephone service. Moreover, most UK consumers, especially those whose calling basket is more heavily weighted to local than non-local calling, pay considerably more than California residents for voice telephone service.

3. Another Comparison: The UK Telecoms Industry Is Much Less Productive than the US Telecoms Industry

A 1998 study by the UK’s highly regarded McKinsey consulting group found that telecoms industry productivity in the UK lags considerably behind that of the US. The study concluded that total factor productivity in fixed link telecoms in the UK is about 60 percent of the US level. Put another way, the UK telecoms sector is 40% less productive than the American telecoms industry. The report identified differences in income levels, pricing structures and product innovation as causes for the productivity gap. With respect to pricing structures, the study highlighted the UK’s lack of unmetered local calling and stated that "the high price of calls [in the UK] has constrained demand and given the phone, at least until recently, the image of a luxury item for many people."

The McKinsey study corroborates my finding that UK consumers are getting a worse deal than California consumers. The absence of unmetered local calling causes the UK telecoms network and labor force to be used far less efficiently than the American network and its workers. As a result, UK customers are paying the price in higher rates.

4. Why are UK Consumers Worse Off Than California Consumers?

Before drawing any lessons, it is necessary to examine the likely explanations for these findings.

Based on my research, I conclude that the explanations for the UK’s lagging performance lie in two areas -- the quality of regulation and the quality of competition.

Quality of Regulation

For a variety of reasons, BT, which is still the UK’s dominant local operator, has not been regulated sufficiently to achieve Oftel’s objective of gaining for consumers the best possible deal in terms of choice, quality, and value for money. These reasons are addressed below.

Weak Regulation at Privatisation. When BT was privatised in 1984, the government’s primary objective was to ensure BT’s financial success as a private company, not to get consumers the best possible deal. Out of public view, the government and BT negotiated a deal that allowed BT to begin with lenient price regulation. The government required BT to offset inflation-based rate increases by only 3 percent per year for five years, even though the industry was enjoying higher technology-driven productivity gains. The leniency of this scheme of regulation was enhanced by the fact that the price cap applied not to each of BT’s monopoly services separately, but in the aggregate. This meant that BT could offset decreases in the prices of relatively competitive services, such as long-distance, by increases in the prices of monopoly services, such as line rentals and local call charges. Accordingly, BT was permitted to charge higher overall rates than its easily achieved cost savings justified and to pay for competitive price reductions through increases in monopoly rates. Since the conclusion of this first price cap period in 1989, Oftel has been put in the difficult position of playing "catch-up" to try to force rate reductions that better matched the industry’s cost reductions. This effort has been rendered more difficult by other factors discussed below.

BT’s Excessive Regulatory Influence. The legal structure of UK telecoms regulation places BT in a privileged position relative to consumers and other market participants. The rules for regulating BT are set forth in its license, which BT negotiated with the government at the time of privatisation. Oftel is charged with enforcing those rules. With its resource advantages over Oftel, BT has disproportionate influence in how those rules are interpreted. More importantly, should Oftel seek to modify any terms of the license, as it must do to establish new price controls at the end of each price control period, Oftel must attempt to reach agreement with BT before a license change may be implemented. Should Oftel and BT fail to agree, the matter will be referred to an entirely separate body, the former Monopolies and Merger Commission (now the Competition Commission, hereinafter "CC").

The effect of this legal structure is to give BT formal equality with Oftel in the regulatory structure, rather than placing BT as a supplicant before Oftel. If Oftel refuses to compromise with BT, Oftel must endure a relatively lengthy and resource-intensive decision-making process before the CC and risks an uncertain determination which, from Oftel’s viewpoint, may be worse than compromise with BT. In contrast, consumer representatives are mere supplicants and therefore at the periphery of the regulatory process. The legal structure permits "BT to negotiate or bargain with Oftel, where third parties are simply consulted."

Information Imbalance Favoring BT. Rate regulation, even under the UK’s price cap regime, depends on factual information regarding BT, such as costs of providing various services and profits. This information can be easily manipulated by the regulated entity to support a particular regulatory goal. For example, a company such as BT which operates in markets facing different levels of competition has an incentive to show that its costs of providing monopoly services are high relative to the costs of more competitive services, in order to support higher prices for the monopoly services.

Particularly in the early years of regulation of BT, Oftel lacked the expertise to challenge BT’s presentation of financial information. Even when Oftel improved its competency and gained an ability to probe BT’s information, interested parties, such as consumer representatives, have not been able to see the critical financial information underpinning BT’s positions. As a result, Oftel has been deprived of informed perspectives challenging the methodology and assumptions behind BT’s data. Instead, in price cap reviews, consumer representatives have been forced to address BT and Oftel proposals based on speculation rather than detailed analysis of the data presented to Oftel. Combined with the problem of extremely limited resources, the effect is to render consumer representatives ineffective.

Oftel’s Focus on Promoting Competition. The premise behind Oftel’s policy of promoting competition is that competition will displace regulation as a means of promoting the best deal for consumers. In the review leading to the new retail price controls that went into effect in August 1997, Oftel was strongly urged by both BT and BT’s competitors (particularly the cable operators) to exercise restraint in setting BT’s price cuts. The industry made a twofold argument. First, they claimed that local competition was developing sufficiently to discipline the market. Second, they argued that ordering aggressive price cuts would hinder the ability of the cable operators and others to offer a competitive alternative to BT and that network investment would suffer. Oftel claims not to have been influenced by such arguments, but at least some UK observers are sceptical. They posit that it is unrealistic to expect that Oftel did not moderate the level and scope of price cuts to some extent in response to pressure from a unified telecoms industry.

Oftel’s own words lend support for this view. Even when it disclaimed being influenced by arguments about the effect of price controls on competition, Oftel used language that suggested the contrary was true. Oftel said:

OFTEL is not seeking to further its objective of promoting network competition through this review; it is addressing that through other measures. Equally, however, OFTEL does not want the outcome of the review to slow the development of competition. It has, therefore, had regard to the impact of its conclusions on the capital markets’ and companies’ ability to fund existing investment commitments and their willingness to continue to see the UK as an attractive, growing advanced market in which their companies must be active. (Pricing of Telecommunications Services from 1997, OFTEL’s Proposals for Price Control and Fair Trading, June 1996, par. 2.4, emphasis added).

The second and third sentences in the quoted passage strongly suggest that the cable operators received a sympathetic response when they argued that steep price cuts for BT would cause the cable investors to take their money to other markets in the US and Europe.

Moreover, the industry also successfully convinced Oftel that local competition was developing briskly. In its final proposal for the 1997 price controls, Oftel proclaimed, "Oftel is confident that at the retail level effective competition is not far away and that the retail price control arrangements proposed here will be the last." (June 1996, par. 2.12). Such confidence likely was another reason for Oftel to moderate the scope and extent of price controls.

As discussed below, Oftel misjudged the extent and potency of the potential competition, which has not served to constrain prices nearly as much as Oftel expected.

Weak Competition

In the mid-1990s, when Oftel’s multi-year effort to construct a framework for local competition was concluding, there were encouraging signs that competition might prove to be potent and relatively diverse. However, as the end of the decade approaches, the early trends toward vigorous competition have abated. Instead, local competition has been limited to the cable operators alone and they have not displayed an ability to discipline BT’s local prices.

Oftel’s Expectations. In a December 1997 speech, Oftel’s then-Director General Don Cruickshank was positively euphoric about the pace at which competition was developing. He was particularly encouraged by the development of two types of fixed link infrastructure competition to challenge BT in the mass market. In addition to the cable operators, a variety of fixed radio access operators, led by a firm called Ionica, appeared ready to deploy service on a broad geographic basis. Cruickshank predicted that, by the year 2000, 70-80% of the population would have a choice of three different access networks. In addition, he renewed an assertion he had previously made, that there would no longer need to be any retail price controls after 2001. He rejected the views of "cynics" who thought that competition would only reduce slightly BT’s dominance and posited that by "around 2000/1", BT would no longer be at the "centre of the web." "In the not too distant future," he expected effective competition and for telecoms to operate as a "normal market."

The Reality. As of mid-1999, the fixed radio operators have almost disappeared as a competitive force. Ionica failed in 1998, and another operator using the same technology, Scotland-based Atlantic Telecom, is struggling to retain a small niche in a small market. For the foreseeable future, fixed radio access no longer appears to be a significant threat to BT. The UK is left with a duopoly and no longer appears on the path to effective competition for voice service.

The cable operators are the only current competitive threat to BT, and a weak threat at that. (I discuss mobile competition below.) As noted above, they have built out their networks to pass about 50% of UK households and have about a 15% market share. They have not been as financially successful as their primarily American investors had hoped. For example, Telewest, one of the big-three cable operators, has consistently posted losses, the level of which increased in the first quarter of 1999, even though analysts expected the losses to begin shrinking.

Many observers attributed the weak performance of the cable operators to the weak demand for their television services. Although their initial business model was for telephone to be an adjunct to their core television services, the reverse has proven true: telephone service is making money, but they have to give away the basic cable television service. Because of strong competition from Rupert Murdoch’s satellite-based BskyB, the high quality programming on the UK’s terrestrial channels, and the low relatively low quality programming offered in the basic cable packages, cable television has not been popular in the UK. One knowledgeable observer of the UK market even opined that, if the cable investors had it to do over again, they would not enter the UK market for cable. Evidence for this view is the fact that the cable operators have scaled back the pace and coverage of their build-out plans. In February 1997, Oftel reported that cable telephony would be available to 70% of UK households by the end of the century. In February 1999, Oftel stated that the cable operators were only due to pass 60% of homes by the end of 2001. Further scale-backs are possible.

The weak financial performance of the cable operators has thus far rendered them incapable of offering aggressive price competition for BT. With weak revenues from television, they are not able to undercut BT’s prices significantly. Their biggest selling point is the offer of basic cable service or an additional phone line for "free". Otherwise, the cable operators offer only modest discounts (in aggregate roughly 10-15%) off of BT’s line rentals, local and national call charges. For the most part, the cable operators (unlike BT, which is obliged to do so) do not permit indirect access to other national and international operators, which offer rates significantly lower than BT and the cable operators. Thus, depending on one’s calling patterns, a customer could pay less overall for telephone service by keeping BT for local service and using an indirect access operator for national and international calls.

The cable operators have been unable to exert any pressure to force BT to reduce its local call charges, nor have they attempted to offer unmetered local service, except for calls to other customers on their network during off-peak periods. As explained earlier, when BT serves the overwhelming majority of customers, this offer is not particularly valuable, particularly when customers are generally not permitted to access an Internet service provider on an unmetered basis.

Mobile Competition. Mobile telephones are not a substitute for fixed link ("wireline" in US parlance) telephone service and will not be a substitute for the next few years, if ever. In February 1999, Oftel reaffirmed its view that the two markets are not substitutes, citing the continuing price and quality differentials between the two modes of service. Oftel noted that, for some calls for particularly high usage customers, mobile service may be competitive with BT’s rates. However, Oftel concluded that, in general, mobile is a premium service that provides extra functionality for which consumers must pay higher prices. In addition, for the next few years at least, mobile networks will continue to be unable to offer Internet access at speeds that compete with basic fixed link telephony. Few, if any, customers are likely to give up their wireline phones that offer cheaper and more reliable service in favour of a mobile phone. In sum, for the foreseeable future, mobile competition cannot be expected to have a disciplining effect on the market for fixed link local telephone service.

Oftel Stance. Oftel has not publicly addressed the fact that competition is not developing as robustly as it had hoped less than two years ago. After having proclaimed success in charting a path toward robust competition, Oftel appears to be having difficulty accepting that its (or at least its Director General’s) expectations were overly optimistic. As I discuss below, I believe this is the result of the investment of several years of effort and public resources and the understandable desire to see that effort succeed. Until July 1999, the only public indication of a revision of thinking in Oftel was that, under the new Director General, who took charge in mid-1998, there were no longer any assertions that retail price controls will terminate at the end of 2001. (In July 1999, just as I was completing this paper, Oftel announced an intention to require BT to unbundle its local loop for high bandwidth services. As I discuss below, this is an implicit admission that local competition was not forcing BT to satisfy consumer interests.)

Oftel has developed a strong concern for protecting the large investments of the cable operators. As previously noted, in the review leading to the price controls for 1997 – 2001, one factor that Oftel weighed was the potentially adverse effect of BT price reductions on cable investment. In statements in 1997 and since, Oftel has continued to treat this as an important concern.

For example, with respect to local loop unbundling, Oftel explained in a February 1997 statement that it believed that such unbundling could jeopardise the development of existing network competition. In a December 1998 consultation that revisited the issue of mandated local loop unbundling for BT, Oftel invited comment on the effect of such a requirement on investment in alternative local networks (i.e., investment by cable operators).

Another revealing example is Oftel’s March 1999 response to a parliamentary inquiry about unmetered local calling and e-commerce. One of Oftel’s main areas of concern when considering the possibility of unmetered local calling by BT was the impact on competitors. Oftel reiterated its view that the consumer is best protected by competition and that the "UK is now seeing growing competition from a variety of carriers."

Oftel does not publicly ask whether protection of the cable operators’ investment is in the interests of consumers or whether the cable operators are efficient challengers to BT. It is entirely possible that the US investors in UK cable badly misjudged the television market and are forced to recover a much larger share of the joint and common costs of their hybrid telephony/television infrastructure from telephony than anticipated. Under these circumstances, the cable operators may be in no position to be cost and price competitive with BT. If this were a competitive market, it is entirely possible that the cable operators would fail. One has to ask why the financial fortunes of the cable operators should enter into Oftel’s calculations at all. If Oftel is truly focused on delivering the best possible deal for the consumer, then it should make the best decision regarding matters such as the level of BT’s prices, or local loop unbundling, or whether to mandate unmetered local calling, regardless of the impact of that decision on the cable operators. Otherwise, Oftel risks protecting inefficient competition, rather than promoting efficient competition.

The obvious difficulty for Oftel is that it claims to have charted a course where competition will soon replace regulation as the chief safeguard of the consumer interest. Yet only one clear competitor to BT has emerged. If the cable operators fail, then the UK’s post-1990 efforts to develop infrastructure competition will have failed. This would be hugely embarrassing to the government and to Oftel.

On the bright side, the emerging market for high-speed Internet access may rescue the cable operators and hence the UK’s telecoms policy in the 1990s. Cable modems may be a good, and cost competitive, alternative to the DSL technology used by BT. If this market grows as expected, the cable operators could be able to offer attractive bundled packages of telephone service and fast Internet access that could compete effectively against similar offerings by BT. This scenario is far from a certainty, however, and is no reason to adopt a protective stance toward the cable operators.

The July 1999 Unbundling Consultation. In July 1999, Oftel surprised most observers by announcing an intention to require BT to unbundle its local loop by July 2001. Oftel’s purpose is to wrest control of the deployment of DSL services – which allow high speed Internet access over copper telephone wires -- from BT and permit other operators to use BT’s local loops for the deployment of alternative services. The consultation finds that BT, with an 85% share of the local market, has the ability to delay the delivery of high-speed services that consumers crave in order to promote BT’s objectives of dominating this new market. Local loop unbundling is designed to correct this problem.

If Oftel proceeds with this intention, it will show a new-found recognition that the interests of consumers are not congruent with the interests of the lone infrastructure competitors, the cable operators. Oftel’s decision is not good news for the cable operators, since their cable modems will now face stiffer competition. (However, with their extensive networks, cable operators are well positioned to take advantage of local loop unbundling.) Oftel needs to adopt a similarly fresh perspective to the question of whether regulatory intervention is necessary with respect to unmetered local calling.

5. Lessons for the US

As a nation that is ahead of the US on the local competition learning curve, the UK offers a preview of the future. The UK’s experience offers a number of important lessons for the US.

The effort to promote local competition requires a large investment of public resources. In the UK, Oftel has devoted the better part of its resources over several years to bringing about local competition. On a per capita basis, the US has probably devoted even more resources to this enterprise than the UK, for two reasons. First, the federal system has led to many of the same issues being addressed at both the state and federal levels. Second, the regulatory framework for UNE-based competition, which the UK has not yet attempted, is even more complex than that for infrastructure competition.

Because they have devoted so much of the public’s resources to this enterprise and have needed to justify their efforts, policy-makers and regulators are prone to succumbing to inflated expectations for local competition. In 1996 and 1997, just as local competition appeared to be taking hold, Oftel was certainly guilty of this. In fact, Oftel’s Director General proclaimed the end of the natural monopoly in the local loop and derided "the cynics" who believed that BT would remain at the center of the UK telecoms market. This kind of rhetoric is commonplace in the US as well, even when there is virtually no local competition for the mass market.

The danger of such inflated expectations, of course, is that it leads to a premature relaxation of regulation of the incumbent. It is certainly in the interests of the industry, particular the incumbents, to feed the regulator’s desire to be optimistic about the growth of competition. When the debate is framed about expectations for the future, regulators find it difficult to resist concluding that competition is just around the corner. In such a crystal ball-gazing exercise, it is particularly difficult for consumer representatives to challenge the "expertise" of the industry and regulators.

The increasingly difficult nature of regulation in a market that is supposedly making a transition to competition also makes regulators inclined to accept optimistic assessments of the potential for competition. In a transitional market, regulators must balance a new set of interests, those of the competitors, who in turn may have conflicting interests depending on their business strategies. For example, rate reductions that may be appropriate because of excess earnings by an incumbent may stir objections among some groups of competitors who will vigorously press their case with regulators. Because regulation becomes more difficult and complex as competitive implications are weighed, regulators have an incentive to find reasons to discard regulation.

Regulation based on optimistic expectations for the future, rather than being firmly rooted in the present, risks doing considerable harm to consumers, as the UK’s experience unfortunately shows. The UK continues to disadvantage its consumers and its general economic health as long as it continues to believe that it should not mandate unmetered local calling because of the potential adverse effect on the cable operators. Consumers are deprived of the many benefits of unmetered calling, and UK industry faces an unnecessary obstacle in taking part in the huge new market for e-commerce.

In fact, the UK is struggling to avoid a vicious circle that could result from excess optimism about local competition. Having created an expectation of vibrant competition, Oftel now feels pressure to preserve the appearance of competition by protecting the cable operators, even when their interests diverge from the interests of consumers. If Oftel continues to prop up the cable operators, UK consumers will be further disadvantaged. Fortunately for UK consumers, the tentative decision to require BT to unbundle its local loop is a promising sign that Oftel is becoming attuned to this danger.

The fodder for regulators’ unrealistic expectations is the barrage of announcements of new entrants, new business plans, and new technologies that proliferate in the telecoms industry today. This media blitz conveys the impression of accelerating competition. But many new technologies and business plans underperform or simply fail, as the UK’s experience with radio fixed access shows. There is a big difference between announcing success in a laboratory or trial and broad-scale deployment. Prior to the US Telecoms Act, the US cable industry announced imminent plans to provide low-cost telephone service to all of their customers over their existing coaxial cable networks. Over three years later, this has not happened and there is a serious question whether it ever will ever happen, even with a massive investment from AT&T. Similarly, about three years ago, AT&T announced it was developing a fixed wireless local loop technology that would allow it to serve the mass market and challenge the incumbents’ dominance of the local loop. However, in 1998 and 1999, AT&T has felt the need to acquire two of the largest cable corporations in the US in order to be able to take advantage of the cable access to the home. Apparently, AT&T’s wireless local loop was not the silver bullet it was once proclaimed to be.

The lesson is clear: policy-makers and regulators need to be conscious of the risk of putting excessive stock in announcements that only represent potential, not reality.

The UK’s experience highlights the difficulty of developing infrastructure competition for voice telephone service. As previously noted, UK cable operators had ideal conditions for success in telephony -- the opportunity to deploy a brand new, state of the art infrastructure, relatively high prices to compete against, a regulatory structure that overtly favored infrastructure competitors, and an adversary (BT) that was saddled with a history of indifferent customer service. However, as discussed above, the cable operators have struggled and have not shown an ability to discipline BT’s prices. In light of the weakness of their television businesses, it is fair to ask whether they will ever exert such an effect on the market.

In short, after almost a decade of attempting to develop full-scale infrastructure competition for local service, the UK has only been able to achieve a weak duopoly for the majority of mass-market customers, with a sizeable minority still served exclusively by BT. If ideal conditions yield only a weak monopoly, then the less than ideal conditions in the US cannot be expected to yield more facilities-based competition. Unless and until there is a major leap in technology that can provide a cost-effective substitute for the incumbent’s local loops, it is wrong to expect robust facilities-based competition for voice telephone service, either in the UK or the US.

Impact of high bandwidth services. It may be argued that high-bandwidth services will transform the telecoms market and foster more potent competition for voice service. In particular, cable operators in both countries are likely to gain a sizeable share of the high bandwidth market through cable modems. In the US, AT&T argues that the revenues it collects from cable modem services will enable it to finance broad scale voice telephone service.

The experience of both the UK and the US counsels scepticism. As previously noted, the UK cable operators over-estimated their television revenues and have been weak competitors for telephone service. Likewise, US cable operators may find that demand for either their voice telephone services or their cable modem services falls short of expectations. In particular, US cable operators have been notorious for poor customer service, and it is questionable whether even AT&T can fix these customer service problems and entice consumers to take their telephone service from a cable company. In addition, in the US, voice service over coaxial cable remains an unproven product. If past trends continue into the future, wide-scale cable network improvements to permit voice service could prove far more costly than now anticipated. Moreover, if the cable operators need high bandwidth revenues to challenge the incumbents with respect to voice telephony, then they are likely to market their voice services primarily, or even exclusively, to high bandwidth customers. Customers who do not want high bandwidth services may not even have the option of voice telephone service from cable operators.

Thus, it is still far from certain that cable operators in either country will offer stiff competition for the incumbents’ voice services. Even if such competition emerged, it would be unlikely to reach rural areas, and would at best be a duopoly. This is hardly the robust competition that many US policy-makers and regulators still claim will develop.

Effect of local loop unbundling. It may also be argued that, because the UK has not yet adopted local loop unbundling, the UK’s experience is not instructive about the potential for unbundled network element (UNE)-based competition in the US. There is some truth to this point, as the UK’s experience thus far directly applies only to full infrastructure competition. Still, UNE-based competition requires significant investment in facilities (particularly switches and trunk lines), albeit much less than the resources needed to replicate the local loop, so that the UK’s experience has some relevance to the question of how much UNE-based competition to expect.

The main lesson from the UK, as noted previously, is to base expectations for investment on facts, not hopes and industry projections. UNE-based competition is off to an extremely slow start in the US, with almost no voice telephone service being provided by competitors over unbundled local loops leased by competitors. The basic framework of prices for UNEs and operational interfaces between competitors and incumbents is taking far longer to develop than expected. Once this framework is completed, the success of this form of competition will be heavily dependent on the recurring and one-off prices for UNEs that will be set by state regulators.

Even if regulators set rates that favor competition, it should not be presumed that all residential customers would be reached by multiple UNE-based competitors, let alone any such operators. A competitor that is leasing an incumbent’s local loop still must provide its own switching and other network facilities, which requires considerable investment. Outside densely populated areas, it is likely that only a small number of competitors will undertake the investment necessary to reach mass-market customers. In addition, quickly and seamlessly switching a customer’s line from the incumbent’s network to the competitor’s network raises difficult technical challenges. It may not prove possible for competitors to switch enough customers in a day to generate sufficient revenues to earn a sufficient return on their investment. Thus, it is still far too soon to conclude that UNE-based competition will foster much more local competition than the UK has developed.

In both the US and UK, it is often assumed that any measure that promotes local competition is good for consumers. However, the UK’s experience has shown, at least with respect to infrastructure competition, that the minimal benefits of weak competition do not warrant the imposition of significant costs on consumers.

This lesson is particularly relevant to the ongoing debate in most US states, including California, regarding whether the incumbents’ local rates should be increased to facilitate more competition. The UK experience clearly shows that increasing local rates would harm consumers. As previously noted, BT’s local rates are significantly higher than local rates in California. Yet these higher rates have not fostered a diversity of infrastructure providers, but rather offered a high price umbrella to allow the cable operators to offer only a mild challenge to BT. Indeed, a strong argument can be made that the cable operators had a flawed business plan and should not have entered the voice telephone market at all. In the 1990s, UK consumers probably would have been better off if there were no cable alternative to BT, and Oftel had simply focused on regulating BT’s rates to ensure the best possible deal for consumers. Contrary to Oftel’s expectations, competition has exerted little, if any, disciplining effect on BT’s local rates.

If local rates were increased in the US, the UK’s unfortunate experience would likely be replicated. There is no reason to believe that an increase in the incumbents’ local service rates would bring any additional competitors out of the woodwork. Competitors, who are free of the price regulations imposed on incumbents, are already able to design their service packages to limit the risk that their customers will be unprofitable. For example, competitors can offer bundled service packages of local and non-local calling and a variety of additional features for a flat charge designed to cover their fixed local loop costs as well as their variable costs. If competitors cannot profitably take advantage of their relative pricing freedom compared to the incumbent and need a boost in the incumbent’s up-front charges in order to survive, then such competitors probably do not belong in the market.

US policy-makers and regulators have focused on bringing about local competition, perhaps to the point of obsession. There is a danger that this obsession will lead to poor decisions that will lead to a mal-formed structure for the new telecoms market. This danger is particularly relevant to two current issues of vital importance: (1) how much consolidation to allow in the telecoms industry and (2) whether to require cable operators to allow non-affiliated Internet service providers to have access to their cable modems.

With respect to mergers, US regulators and antitrust officials have permitted tremendous consolidation in the telecoms industry. One of the key factors that they have relied on in permitting such consolidation is the likelihood that the combined company will somehow enhance local competition. For example, the merger of Bell Atlantic and NYNEX was approved in part because of a pledge by the combined company to cooperate more fully with operational requirements to permit local loop unbundling by competitors. One of the main selling points of the proposed merger of SBC and Ameritech, a combination that would control over one-third of the telephone lines in the US, is a claim that the consolidated company would be better able to compete for local service outside the service territories of the two companies.

The experience of the UK shows that regulators and antitrust officials need to be more thoughtful about the likelihood that the promised competition will materialize, as well as the potency and reach of the promised competition. A competitor that only mirrors the prices of the incumbent does little to help consumers. Likewise, a competitor that offers deals benefiting only the highest-spending residential customers may not be worth the considerable drawbacks of industry consolidation. Larger companies can stifle innovation, be insensitive to regional and local needs, and use their increased economic and political might to thwart effective regulation. Instead of just placing a heavy thumb on the pro-merger side of the scale whenever a deal offers the potential for increased local competition, analysts should carefully consider the nature of the proposed competition and attempt to quantify the benefits for mass market customers.

With respect to the high bandwidth market, local, state and federal policy-makers are now considering whether to require the cable operators to afford open access to their cable networks. The cable operators, led by AT&T, argue that such a requirement would stifle their investment incentives, particularly their incentives to upgrade their networks to provide voice telephone service.

Policy-makers should not allow themselves to be dazzled by the cable operators’ uncertain promise of local competition. Voice telephony over cable networks may never happen or it may be limited and provide only weak competition. Questionable assertions about the impact of open access on cable telephony should play little, if any, part in decisions on whether to require open access.

On both sides of the Atlantic, regulation is disparaged. A major reason for the strong push for local competition is a prevailing view that regulation serves the consumer interest poorly. Some policy-makers think so little of regulation that they would discard most economic regulation even when there is only limited competition and incumbents retain significant market power.

That some policy-makers hold such views is not surprising. Regulated firms have expended considerable resources in attempting to make the case that regulation often interferes with the consumer interest. Moreover, as noted above, regulation becomes more difficult when the interests of competitors must be considered, leading some to conclude that regulation is no longer worth the increased effort.

Yet this study offers an opportunity to compare one regime (the UK) that has relied on competition and relatively weak economic regulation with another (the US – California) that has been characterised by monopoly and has relied on relatively strong economic regulation. These two regimes can be compared for their ability to serve the consumer interest where it counts, in results.

UK regulation, which only began in 1984, is weak because it places the incumbent in a favored position and deprives interested parties of essential information. Moreover, there is a strong aversion in the UK to interfering with the business judgment and desired business practices of the industry participants. Oftel has also shied away from strong economic regulation as it has anticipated increased competition.

In contrast, US regulation has a much longer history of comprehensive scrutiny of the regulated firms. The need for such scrutiny is ultimately rooted in the view that telephone service is essential to the economic and social life of Americans and that careful regulation is necessary to ensure that telephone service comports with the public interest. Traditionally, regulators have had considerable discretion and have not hesitated to constrain a desired business practice when deemed necessary to serve the public interest. This strong regulation approach is certainly under challenge today, and many regulators around the country have come to favor a weaker regulatory approach. Nevertheless, even US proponents of weak regulation will sometimes accept strong regulation on some issues.

This study has shown that California consumers are enjoying a much better deal for telephone service than their UK counterparts. In large part, this owes to a legacy of strong regulation. As one pivotal example, in the 1970s and 1980s, California regulators, like most of their counterparts around the country, rejected concerted Bell System efforts to eliminate unmetered local calling. In contrast, the UK tends to view the type of calling plans offered by the incumbent as a matter of business judgment that should not be questioned by the regulator. The strong regulatory approach to unmetered calling in the US has yielded enormous benefits for US consumers and the US economy generally. Unmetered calling has always fueled commerce, and today it has accelerated the US’s unmatched growth in Internet use and e-commerce.

The relatively low rates (compared to the UK) that California consumers enjoy is again a legacy of strong regulation in the 1970s and 1980s. In the 1990s, the California regulatory commission became increasingly dominated by proponents of weak regulation. However, efforts by incumbents to gain big rate increases during this period have been thwarted in large part because of effective consumer advocacy made possible by complete access to essential information.

Thus, even though California mass-market customers are still served by a near total monopoly, strong regulation has secured for them a much better deal than UK customers can obtain. Strong regulation has not weakened California’s incumbent local operators. SBC, owner of Pacific Bell, is one of the best financed companies in the industry and one of the most likely firms to survive the ongoing industry consolidation.

Strong regulation is not perfect and certainly involves difficult judgments. But for the foreseeable future it is unlikely that robust competition will develop for local telephone service. In the absence of robust competition, strong regulation can ensure that essential telecoms service are provided in a way that serves the public interest.